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
http://investing.meetup.com/21

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.

Why Inflation Is and Will Be a Problem

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.

In December 2008, I predicted at the New York Investing meetup that inflation would reappear in the U.S. by the end of this year. The just released PPI report for November had wholesale prices up 1.8% (a 21.6% rate annualized). Year over year PPI was up 2.4%, the first positive reading in a number of months. The CPI report for November had prices up 0.4%. Year over year was up 1.8%. I made last year's prediction that inflation would be turning just about now based on another prediction that oil prices would be much higher today than they were in late 2008. Both government reports cited higher energy prices as the main driver of the uptick in inflation.

As would be expected, many mainstream economists (who as group significantly underestimated the PPI number) and Fed Chair Bernanke quickly told the public not to worry. They argue that this has to be just a temporary blip because inflation can't have a sustained rise unless the economy is expanding strongly. They point out that the most recent U.S. capacity utilization rate is 71.3% and claim that inflation can only become a problem if this number is over 80%. The capacity utilization argument might have some validity if the U.S. was a self-sustained economy that didn't engage in trade (something I refer to as a non real-world condition). The U.S. not only engages in trade though, but imports much more than it exports. The country has run a trade deficit with the rest of the world continually since the 1970s. One thing that we import a lot of is oil. Like almost all commodities (natural gas is the exception), the price of oil is set globally. The U.S. capacity utilization rate has only an indirect and minor impact on oil and other commodity prices. The error that many mainstream economists have made in their thinking is that the U.S. inflation rate is controlled by conditions that exist solely within the U.S. In actuality, markets outside the U.S. are the key determinant of the how much inflation American consumers experience.

The capacity utilization argument can also be debunked through historical analysis. Not only have there been cases of major inflation in countries with low capacity utilization, but this condition invariably accompanies hyperinflation. The most extreme example of this took place in the last few years in Zimbabwe. The unemployment rate there rose to 94%. With almost the entire nation not working, presumably capacity utilization was as low as it possibly could get under any circumstance. According to many mainstream economists and the U.S. Fed, Zimbabwe couldn't possibly have had inflation. Instead, it had sextillion percent inflation, the second highest rate ever recorded.

While capacity utilization is a red herring when analyzing inflation, currency policy is not.Commodity prices are affected by the strength of the U.S. dollar since all commodities are priced in dollars. A weaker dollar means higher commodity prices and higher inflation in the U.S. This is merely a specific example of a declining currency being the actual correct definition of inflation. Central bank easy money policy with excessive government borrowing backed up by money-printing is what causes a currency to decline.

Many economists refuse to accept that the declining value of a currency is the root cause of inflation though. When not using the capacity utilization argument, inflation-denying economists and other Fed apologists resort to defining inflation as a rise in credit and deflation as a drop in credit. Like capacity utilization, this viewpoint doesn't stand up to real world analysis either. For this to be true, there would have to be ever increasing amounts of credit in real terms in hyperinflationary environments. Not only does this not happen, but credit availability tends to implode during hyperinflation - the exact opposite of what would be predicted. The one thing that all hyperinflations do have in common though is excess money-printing.

Inflation is not a new phenomenon. There have been hundreds of inflationary episodes over time. The one thing they all have in common is that there is too much money (currency actually) for the size of the economy. Central banks in most major economies are currently engaging in excess money creation with abandon. At the same time, they are telling the public not to worry because things will be different this time. They also said that last time and the time before by the way.

Disclosure: Long gold.

NEXT: U.S. Plays Shell Game with Bailout Money

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.

Inflation Versus Recession

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Gold hit its second highest price ever yesterday. Interestingly, the U.S. dollar is not close to its all time low. For any given dollar level, gold prices have been rising over time. Inflation is when a currency decreases in value and this has been happening for the dollar when measured against gold. Looking at the value of one currency versus another can obfuscate that inflation is taking place. All fiat currencies are declining in value against gold and this indicates that a widespread global inflation is taking place.

The trade-weighted dollar fell as low as 77.02, but closed at 77.19 yesterday. This is well below the 78.33 breakdown level. The dollar is at an 11 month low and even if it stays at current levels or rises somewhat will hit a yearly low within 3 weeks. This will be very bearish. The U.S. dollar is already at a yearly low against the euro and Australian dollar, both of which hit new highs yesterday.

While inflation is taking place, the same thing can't be said about an economic recovery. Consumer spending accounts for 72% of U.S. economic activity and under current conditions can not improve in the foreseeable future. Consumer Credit for July was released yesterday and it fell by $21.55 billion or at a 10.4% annual rate. Credit card debt fell at an 8.5% annual rate. It was the 11th straight monthly drop. While consumer credit is contracting, so is consumer income. At the same time, the savings rate is rising. All three indicate less consumer spending and ongoing contraction in almost three-quarters of the U.S. economy.

The one-month drop in consumer credit in July was four times greater than the entire consumer debt in the U.S. in 1944. The 60 plus year post World War II expansion was fueled by ever increasing consumer credit. Like all expansions inevitably do, this one has come to an end. Initially, there was real growth that went along with the expansion, but in the last three decades U.S. growth has been based on increased spending made possible through excess credit. Going forward inflation is going to make this impossible.

NEXT: CFTC Kills Off DXO

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.