Inflation could lead to a surprise boom in gold prices.MICHAEL DALDER/Reuters
A glimmer of hope is emerging for gold bugs from something we haven't seen much of in quite a while: inflation.
Sure, U.S. consumer prices have been mostly subdued since the financial crisis – the rate of gain actually eased over the past three years, most recently because the cost of oil plunged. But crude prices rebounded last month, the U.S. dollar's rally stalled and investors, who in December were unloading bullion and bracing for deflation, are now stepping up bets that inflation is returning.
And it's more than just oil. Wages are rising, and Federal Reserve policy makers point to improved labour markets as a reason inflation will climb to their 2 per cent target. That would be a boon for gold, which through April was headed for its third straight annual decline. Holdings in funds backed by the metal are rebounding, and speculators are getting more bullish.
"Is runaway inflation coming back? No, but could concerns that inflation has bottomed out come back? I think it is coming back this year," said Jim Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management Inc. "That would be enough to bring interest to gold."
Since dropping to this year's low in mid-March, gold futures were up 4.5 per cent Tuesday to settle at $1,193.20 (U.S.) an ounce on the Comex in New York. The metal will increase to an average of $1,248 this year, and reach $1,338 in 2016, Bank of America analysts reiterated in a May 1 report. HSBC Securities (USA) Inc. and Commerzbank AG are also bullish.
The precious metal climbed 70 per cent from December, 2008, to June, 2011, as the U.S. central bank fanned inflation fears as it bought debt and held borrowing costs near zero per cent in a bid to shore up growth.
But the surge in consumer prices that many gold buyers feared never materialized, and the precious metal tumbled 29 per cent in the two years ended Dec. 31. Inflation risks took another blow when crude-oil futures that topped $100 a barrel in June slumped to a six-year low of $42.03 in March.
The outlook began to change after Fed economists on March 18 trimmed their expectations for how quickly the central bank will raise interest rates. Before then, expectations of the first increase in borrowing costs since 2006 helped send the dollar up 22 per cent since June.
Now, the U.S. currency has pared this year's gains, and bond investors have increased purchases of Treasury Inflation Protected Securities, or TIPS. Crude oil surged 25 per cent in April, the most since May, 2009, and settled at $60.40 on Tuesday.
A gauge of inflation expectations that closely tracks gold is trading near the highest since September. Declines for U.S. jobless claims and gains for manufacturing show why those expectations are increasing, according to Mike Pond, the head of global inflation market strategy at Barclays PLC in New York.
"We see inflation rising later this year," Mr. Pond said in an April 30 telephone interview. "There is evidence within the data that the labour market is tight enough. There is also anecdotal evidence, particularly in the retail sector. Within the construction industry, businesses are reporting that they are finding it difficult in hiring skilled labour."
Investors are returning to global exchange-traded funds backed by gold, increasing their hoard by about four tonnes in April, the third gain in four months, data compiled by Bloomberg show. While holdings were up just 1.8 per cent this year to 1,626.8 tonnes as of Monday, the increase comes after a 39-per-cent decline in the previous two years.
Because inflation has been so low, even small gains for prices will help to boost gold in the months before the Fed raises rates, according to Jeff Sica, president of Circle Squared Alternative Investments in Morristown, N.J.
"Inflation expectations are heading higher, and it's playing into the yield curve," said Jim Russell, a Cincinnati-based portfolio manager at Bahl & Gaynor Inc. "It puts in a floor for gold and establishes a lower boundary that help prices move higher. Probably nothing spectacular, but still will be supportive."