Capital Econ: Gold Headed Higher As Inflation Moves Up

Don’t look now but the price of gold is approaching $1,150 per ounce, just weeks after analysts were predicting imminent collapse, a research note from Capital Economics observes. In fact, they say the headwinds for gold could be behind us – pointing to tighter labor markets and even, dare it be said, inflation.

Headwinds for gold are behind us, as $1,200 per ounce gold by year end is reasonable

The headwinds for gold will not last and other metals, such as the “industrial indicator” copper should rise as oil prices pick up and labor slack further tightens. “Headline inflation should snap back in most economies over the next few months as the big falls in oil prices in late 2014 drop out of the annual comparison,” Julian Jessop wrote, saying these factors should support further gold gains and targeting a 2016 year-end forecast of $1,400 per ounce.

Gold prices have benefited from a perceived delay in Fed interest rate lift-off, which many economists are now saying won’t happen until 2016. For Jessop this makes their 2015 year-end forecast of $1,200 per ounce “look well within reach.”

Given such jubilation, gold’s performance has lagged expectations, particularly given renewed declines in US government bond yields and the dollar, he wrote.  Such a correlation divergence might be due to two factors.

Two factors in correlation analysis: could inflation hedges come back in vogue?

The first factor is negative sentiment toward the general metal asset class, which can be seen in the tight correlation between gold and copper prices. Gold and copper, while both metals, have different purposes. Gold is most often an adornment, some consider it a store of value but one with little intrinsic economic value.

This leads to the second factor: demand for inflation hedges. The lack of demand for an inflation hedge is apparent when considering the decline in US breakeven inflation rates, which is derived from the prices of inflation-linked bonds, Jessop notes. This can be attributed to the weakness of oil prices and wage growth. “Put another way, the renewed declines in bond yields are driven by falling inflation expectations rather than lower real yields.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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