Finally, the gold price is higher .. but so is everyone’s pulse

Two big stories hit the market this week that made investors sit up and pay attention. Firstly, though later denied, the Chinese property giant Evergrande apparently defaulted. The story was quickly rebutted but that didn’t stop equities from taking a small hit, recovering quickly afterwards. However, this is definitely an ongoing story that could pose significant risks to the global financial system and needs to be monitored. 

Secondly, and more importantly, the shocking CPI inflation number from the United States was released – over 6% is the highest number in decades. Inflation is well and truly with us now due to so much stimulus and supply-chain issues.

Surging gasoline, food prices fan U.S. inflation 

It is now firmly in the political realm and the US President Joe Biden was quick to assure the American public it would be dealt with. The fear, both in markets and more generally, is that this inflation is structural and that raising rates can do little to stop it without causing a huge recession. With so much debt on company balance sheets, and so many public companies not anywhere near profitability, such an interest-rate rise would cause a significant revaluation of asset prices. 

As seen above in Ben Carlson’s tweet, the purchasing power of savers has dramatically declined. In contrast, holders of stocks have seen their nominal wealth rise massively. The total value of the US stock market has risen from USD8 Trillion in 2008 to over USD50 Trillion now: 

Looking at this chart from @Marcomadness2  on Twitter, the expansion of Central Banks’ balance sheets suggests their actions have something to do with such an asset-price rise: 

But recent inflation cannot only be blamed on monetary or even fiscal stimulus. There are structural problems in the supply chain and demand is high: 

Much of the world appears to be experiencing a real economic boom and it is pushing prices for almost everything: 

Even furniture prices are skyrocketing:  

The above statistics are from the United States but it is very rare that, when the US leads, the rest of the world does not follow. Indeed, for energy prices, it is Europe that is leading in terms of inflation. But that is already happening in the US too (Charlie Bilello): 

It is in this context that gold, finally, made the much-anticipated move higher. There had been many questions over the last few months as to why gold had not moved higher, despite so many signs pointing to higher inflation, especially in commodity and labour prices. Some argue that this had already happened over the past decade or more and that gold had already priced in such inflation. Perhaps that was partly true, and indeed it took a shocking inflation number for gold to move higher. True, gold is still more or less flat versus the USD this year but the direction of travel is perhaps a little clearer: 

The next target for gold bulls is to break the USD1900 per Troy ounce level and hold it for an extended period. If inflation numbers globally continue to surprise to the upside, then this remains a distinct possibility. Furthermore, if labour-market tightness and supply-chain concerns (such as continued problems at global ports) continue, then both will also add to the worries that inflation is not as transitory as central banks would have us all believe.  

M&S hails turnaround as it returns to profit but sees supply chain and labour cost strains ahead 

Beef prices soar from labour crunch, freight costs  – in Canada, prices for a prime rib roast have risen 20 per cent in the past year and are the highest since at least 1995 

Australian businesses warn of supply-chain crunch, stoking inflation fears 

Of course, inflation has self-fulfilling tendencies. The longer it rises, the more it is talked about on the street, discussed in the media and felt in the pocket, the more likely employees will start demanding higher wages to compensate. Additionally, any potential interest rises designed to cool inflation will actually make life more difficult for consumers, especially homeowners. For businesses, higher interest-rate costs as well as inflation of input costs also mean that, where possible, costs will be passed on to customers, further fuelling the inflationary cycle. 

For so long, at a consumer level at least, the West has lived in an era of relative price stability. Decades have passed since high inflation was a phenomenon. Indeed, prices of technology and clothes have dramatically fallen. But if we have real, sustained, and long-lasting inflation in basic goods such as energy, housing and food which bring accelerated interest-rate rises, the consequences could be rather dramatic to financial markets and to businesses dependent on low rates. It could quickly affect the entire global economy. Therefore, it is no wonder, for the first time in quite a while, there is an increasing nervousness in markets.

That said, equities remain at all-time highs and the markets are reluctant to believe that rates will go up quickly. While the music keeps playing, people keep dancing. Just make sure you are near an exit when the music stops.

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Important disclaimer: this document is not an official research report and the views expressed in it are those of the authors. The authors are not registered research analysts and there is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Gold as a commodity is not a specified investment for the purpose of giving advice under the Financial Services and Markets Act 2000, therefore, this does not give rise to rights to claim compensation under the Financial Services Compensation Scheme.