The gold market is heating up again as the price of gold climbs past $1,250. Moreover, shares of SPDR Gold Trust (NYSEARCA:GLD) rise to $120. With the Federal Reserve expected not to raise rates this month, interest rates continue to slowly come down. And even though headline inflation remains low - mostly due to low oil prices - the core inflation is slowly increasing. Is there a reason for concern over inflation? And is GLD the right vessel to invest in times of growing inflation?
According to conventional wisdom, gold bugs tend to stock up on gold or gold investments such as GLD when they are concerned over a possible spike in inflation - even though U.S. inflation is still very low. But over the past few months core inflation - inflation sans food and energy - has started to pick up again: The core CPI has risen to its highest level since 2012 - 2.3% in annual terms as of last month. And in the upcoming report for March, the market expects the core CPI to pick up again by 0.2%, month over month. This rate is a bit higher than the Fed's target inflation of 2%. But keep in mind, however, the FOMC follows core PCE, which tends, on average, to be around 0.5 percentage points below the core CPI. In terms of wages, they are also starting to slowly pick up: In the last NFP report, wages rose by 2.3%, year on year. Even the inflation expectations, as derived from the bond's market, have rallied to 1.41% - the sharpest gain in years. So higher wages and rising core CPI suggest U.S. inflation is on an upward trajectory. And considering the FOMC revised down its dot plot chart and plans to raise rates no more than twice this year - as opposed to four possible hikes as presented at the December meeting - some investors may worry about a possible inflation bubble in the works. But even if inflation were to start rising to higher levels, the FOMC still has ample tools to curb down inflation: Since interest rates are near zero, the FOMC could always raise rates and even reduce its balance sheet, if needed. And when it comes to gold's performance in times of high inflation: Back in the early 80s when inflation was at double digits, the price of gold did spike. But as the Fed moved forward and raised interest rates, inflation came slowly back down while gold prices plunged. Considering the volatility of gold prices are much higher than that of the headline or even core inflation, gold doesn't act like a conservative hedge against inflation.
For now, the devaluation of the U.S. dollar and slowly rising core inflation helps drive up the demand for gold. Moreover, analysts at RBC Capital Markets are still bullish on gold and revised up the gold price outlook by 9% to $1,250 - albeit it's the same current price, which means these analysts don't think the price of gold will climb much higher than its current level.
In summary, for now, GLD continues to benefit from the weaker dollar. And as the Fed maintains a dovish/bearish tone, the chances of a rate hike will continue to slowly decline. These trends will keep boosting up the demand for gold, which will also behoove the price of GLD in the short run. But as the year progresses, if the Fed were to start raise rates - as currently expected - and the U.S. dollar starts to strengthen again, GLD's rally will come to a halt. For more please see: "Gold and Inflation - Is there a relation?"
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