Inflation Problem Could Improve the Case for Precious Metals

An inflation problem could be returning, according to current signals. April numbers are in, and they reveal that the cost of goods and services is rising at a pace unseen for well over a decade. The good news is that, whenever inflation looks as though it’s about to rear its ugly head, precious metals chatter picks up. It’s no different this time around.

One indicator is the Consumer Price Index (CPI). It measures average consumer price changes in a specific example “basket” of goods and services. According to Labor Department data released Wednesday, this important indicator increased 0.8% after rising 0.6% in March.¹ But the more revealing news is that the CPI jumped 4.2% on a year-over-year basis. That marks the fastest increase in the inflation rate since September 2008. Economists previously surveyed by Dow Jones had expected the increase to come in at a more modest 3.6%, so even professional observers were jarred by the actual figure.

Fears have been building for some time that we would begin to see meaningful signs of inflation. The global economic recovery continues to gather momentum and both the Federal Reserve and federal government effectively are doubling down on expansionary monetary and fiscal policies—all contributing factors to a potentially inflationary environment. It is partly due to this influence of a weak global economy on monetary and fiscal policy that I believe gold and silver have enjoyed solid performances over the past couple of years.

It has been some time since retirement savers have had to address an apparently real and significant threat of an inflation problem. But a similar situation once again seems to be upon us. Analysts suggest the addition of inflation to an environment already characterized by ultra-low interest rates and significant levels of government spending could provide a great deal of energy to precious metals going forward.

Fed’s “Hands-Off” Approach to Inflation Problem Could Be Good News for Gold  

Precious metals are seen broadly as effective hedges against inflation, but some inflationary climates are better for gold and silver than others. If history is any indication, the inflationary climate that seems to be brewing right now could prove particularly beneficial for metals.

The core of the pro-metals argument this time around has to do with a significant change made last year by the Federal Reserve in its policy approach to addressing a potential inflation problem. In August 2020, Fed Chairman Jerome Powell ushered in what he called a “robust updating” of that policy when the central bank agreed to adopt “average inflation targeting” as the way to deal with CPI increases.²

Traditionally, the Fed has acted quickly to control inflation at the first signs it was brewing. However, after many years of seeing minimal actual inflation, the Fed wants to encourage the onset of an average annual inflation rate around 2%. The central bank considers that figure to be indicative of an economy that’s healthy but not at risk of overheating.

The way the Fed plans to achieve this goal using the targeting approach is by refraining from acting too quickly to tamp down inflation and instead give it some room to run (increase) before raising rates. This means the Federal Reserve likely will not act immediately to contain inflation when the rate appreciably exceeds 2% at any given time. Accordingly, it’s not expected that we’ll see the Fed raise rates in response to the 4.2% April inflation figure. The Fed would prefer to avoid taking action too quickly and risk dampening a healthy growth trend as long as it remains confident the average rate of inflation will remain at or about the 2% target and not move significantly higher in a sustained fashion.

For his part, Powell recently reiterated his commitment to keeping rates near zero for the foreseeable future in the face of singular inflation signs because, in his words, “an episode of one-time price increases as the economy reopens is not the same thing as, and is not likely to lead to, persistently higher year-over-year inflation.”³ Whether his assumption proves correct and the average inflation rate remains modest in spite of instances of sharp increases – like the one we just saw – remains to be seen.

If the Fed does let any inflation “problem” go unchecked for a time, it potentially could be especially good news for gold—if we judge by some other past inflationary climates. History shows that inflationary conditions can be even better for gold when inflation is not being chased down actively by rising rates. This is because metals – which don’t pay interest – do not have to compete as hard with certificates of deposit, bonds and other interest-bearing vehicles for savers’ money when interest rates are so near to zero as they are right now. And the higher inflation goes, the lower real rates (interest rate minus inflation rate) drop. As a matter of fact, real rates generally are seen as negative currently, when considered in the context of inflation.

So is the Fed playing with fire in adopting this approach – letting inflation rise unchecked for a time? Many think so. They’re worried that if inflation gets away from the central bank, any drastic action it might take later on could be especially disruptive to the economy and markets.

One of those Fed doubters is Tim Hayes, chief global investment strategist at Ned Davis Research. In a recent conversation with Kitco News, Hayes referred to inflation as “the genie in the bottle, and once it is let loose, it is difficult to get back in.”⁴

Hayes told Kitco the Fed’s declared posture on keeping rates near zero have made him plenty bullish on gold for at least the next several years. “Gold can go a lot higher from here; we’re not just looking at record highs,” he said. “Once we get a breakout, it will bring in a whole new group of investors who will start to buy into the idea that they need gold as an inflation hedge.”

Currency Strategist: “Can’t Help but Be Bullish on Gold” as Record Deficit Looms

A weak dollar and our exploding national deficit are other factors that could create influence toward an inflation problem and a positive environment for gold. Hayes said he expects inflationary pressures to be exacerbated by a weaker dollar, which he sees as one prominent consequence of a free-spending Biden administration. Dollar weakness has a tendency to make imports and commodities more expensive, contributing to an overall rise in inflation.

As I noted last week, we’re just a little more than 100 days into the new regime and not only has the $1.9 trillion American Rescue Plan become law but the President already is pushing two more massive spending packages: the $2.3 trillion American Jobs Plan and the $1.8 trillion American Families Plan. The Balance, a respected financial website, reports that, on the basis of the American Rescue Plan’s passage alone, the federal budget deficit is estimated to hit $3.4 trillion this year, which would make it the highest deficit in history.⁵

Adam Button, chief currency strategist at ForexLive.com, is particularly optimistic about gold’s prospects based on the enthusiasm with which President Biden and the Democrats are pursuing their expensive stimulus and policy agendas.⁶ He points, as well, to the central bank commitment to historically low rates as additional justification for his optimism.

“You can’t have a better environment for gold,” Button says. “The government wants to spend more money and the central bank is going to keep interest rates low,” adding that “with everything that is going on, you just can’t help but be bullish on gold.”

¹ Jeff Cox, CNBC, “Inflation speeds up in April as consumer prices leap 4.2%, fastest since 2008” (May 12, 2021, accessed 5/13/21).

² Jeff Cox, CNBC, “Powell announces new Fed approach to inflation that could keep rates lower for longer” (August 27, 2020, accessed 5/13/21).

³ Craig Torres, Steve Matthews and Catarina Saraiva, Bloomberg, “Powell Waves Inflation Worries Away as Fed Holds Rates Near Zero” (April 28, 2021, accessed 5/13/21).

⁴ Neils Christensen, Kitco News, “Unleashed inflation ‘genie’ to send gold prices higher – Ned Davis Research” (May 4, 2021, accessed 5/13/21).

⁵ Kimberly Amadeo, The Balance, “What Is the Current U.S. Federal Budget Deficit?” (May 9, 2021, accessed 5/13/21).

⁶ Neils Christensen, Kitco News, “Gold looks good as Biden pushes trillions in new infrastructure, education spending in Address to Congress – Analyst” (April 28, 2021, accessed 5/13/21).