Inflation is back – good news for gold!

Big Picture Goud Inflation/Deflation Secular Investor Uncategorized

inflation-500

Gold has always been some sort of insurance policy against inflation as it usually is the first (and main) reason why investors want to have exposure to the yellow metal. Unfortunately markets always tend to behave a bit irrational and even though the money supply is continuously increasing, the gold price continued to trend downward in the past few years; as you can see on the next chart. The end date on the chart is the end of Q1 2016, but rest assured, the M1 Money Supply has only been increasing since that date.

Gold 1

Source: monetarymetals.com

Indeed, even though the total M1 money supply increased by approximately 50% in the past five years, the gold (and silver price, for that matter) actually moved down and lost approximately 30% of its value. That’s indeed very surprising and even though you might want to blame the strong dollar for this, the M1 Money Supply is increasing practically everywhere in the world. Let’s have a look at the M1 Money Supply in the Eurozone and in Japan:

Gold 2

Gold 3

Source: tradingeconomics.com

Indeed, the M1 Money Supply is increasing in all western countries, but surprisingly, the gold price moved down. That’s very uncommon, and the correlation between the gold price and the balance sheets of the central banks (which is pretty much directly related to how much ‘new’ money the central banks are creating) has historically always been virtually 1:1, as you can see on the next image.

Gold 4

Source: goldsilverworlds.com

Since 2001, the gold price has moved in the same direction as the size of the balance sheets. Yes, sometimes the gold price is overshooting or undershooting, but as you can clearly see on the previous image, the correlation between the gold price and the global money supply is pretty much 1:1 in the longer run.

That being said, there’s another reason why we aren’t surprised to see gold vigorously defending the $1200 level here. We would almost forget what inflation is after all these years of deflation and free money, but it looks like  the ‘dark beast’ is back.

Gold 5

Source: stlouisfed.org

Whereas the average inflation expectation was just 1.4% last summer, the expected inflation rate has now reached its highest level in almost 3 years, and the St Louis Fed is now expecting the inflation rate to be 2.18%. Indeed, that’s an increase of 50% in just a few months and as the velocity of money in the monetary system starts to pick up again, we wouldn’t be surprised to see the inflation expectations head even higher.

There’s only one way for the Federal Reserve to try to stay ahead of the herd, and that’s by increasing the interest rates to cool down the economy. Another interest rate hike would make total sense, but this could also put more pressure on the economy than what would be desired. After all, the TED spread (which basically measures the default risk on the markets) has been increasing as well.

Gold 6

Source: Stlouisfed.org

Most mainstream investors were always telling themselves gold would crash if the interest rates would go up, because gold doesn’t pay interest or a dividend. Wrong. The higher the interest rates move, the more appealing gold will be, as a protection against inflation (as inflation always is the main reason why interest rates are being raised or cut).

The year is just a few weeks old, but we think 2017 could be a great year for the precious metals.

Read our  Guide to Gold right now, and protect yourself against inflation!

  1. Au
  2. Fed
  3. Federal Reserve
  4. gold
  5. inflation
  6. M1 Money Supply
  7. money supply
  8. TED Spread