Thursday, February 18, 2010

Gold Down on IMF Sales, Then Up on Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Two pieces of news are affecting gold's price currently.  First, the IMF just announced that it will soon begin phased sales of 191.3 metric tons of gold and this pressured the market causing a sudden sharp sell off. Shortly thereafter, the U.S. released the PPI, the Producer Price Index, for January and there was a very inflationary 1.4% rise from December. This caused gold to rally sharply. While the longer-term direction for gold is unquestionably up, the shorter-term picture is murkier.

The 191.3 metric tons (also known as tonnes or long tons) of gold that the IMF is planning on putting on the market is part of their sale of 403.3 tonnes that they announced last year. Central banks bought 212 tonnes, with India buying over 90% of that amount. Central banks still have the option of participating in the gold sale and this would keep the gold off the open market. The IMF has stated that any sale outside of those to central banks "will be conducted in a phased manner over time". While this is a positive, the IMF has missed the heavy market demand months for gold - November, January and February, and looks like it will be selling during low demand periods. The 191.3 tonnes is part of the Central Bank Gold Agreement, which limits total sales to 400 tonnes a year.

While IMF sales are a negative for the gold market, inflation is always a positive. The 1.4% rise in U.S. wholesale prices in January follows a rise of 1.5% last November. Core PPI, which excludes food and energy, was up 0.3%. Core inflation was a concept implemented by Fed Chair Arthur Burns in the 1970s as a public relations gambit to take attention away from the two major causes of inflation - food and energy. Core inflation is only relevant if food and energy prices remain relatively flat in the long term, but are volatile in the short term. This is not the case; food and energy both go up over time. A Bloomberg study done in 2008 found that not once in a forty-year period did U.S. food prices decline on a year over year basis. Oil prices are choppier, but the $147 high in 2008 was almost four times the high of $39.50 in 1980.

Over the last year PPI is up 4.6%. Almost all of the increase is being blamed on oil. The figures bear this out. However, oil prices affect the price of food and any good or service in the economy that requires transportation, so increases in energy prices percolate through the economy. The Fed's response to this inflation threat is that wage pressures remain tame in the U.S., so there can't be inflation. The wage pressure argument was also common in the 1970s and was used as an excuse by industry to justify not raising salaries. It is a politically based argument that has little to do with the realities of inflation. Inflation is caused by excessive government money creation. There is no case in history though where a government blamed itself for causing inflation even though in each and every case government actions were the root cause.

IMF gold sales will be with us for a while. After the current sale, there are likely to be others, so this could be a multi-year process. The heyday of central bank gold sales is over however. European banks sold large amounts of their gold reserves in the 1990s and early 2000s. There could still be more sales, but Asian banks are now buying. Gold is moving from Europe to Asia and this is a reflection of a greater movement of wealth moving from one continent to another. Gold sales will become less important to the market over time, while inflation is going to become more important.

Disclosure: None

NEXT: Fed Sends a Message with Discount Rate Hike

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

No comments: