This Week's Inflation Report Could Change Everything For Gold

by: Tim Iacono


Trouble in Ukraine and a weaker dollar could support higher gold prices over the short term.

Investment banks are bearish, but others are bullish as tests of important technical levels lie ahead.

If last week's surge in wholesale prices carries over to consumer prices this week, the outlook for precious metals could change dramatically.

Renewed tensions in Ukraine, a weaker U.S. dollar, and a faltering domestic stock market combined to support precious metals prices last week as most risk assets declined. Dollar weakness appears to be the biggest short-term driver for gold while steady demand in China and India continues to be one of the most important long-term factors and recent news from Asia has been encouraging during what is a seasonally weak time of the year.

While some gold market analysts are again bullish after recent gains, big investment banks are still mostly bearish, while U.S. investors remain largely uninterested in precious metals, neither buying nor selling. That could soon change, however, as surging U.S. import/export and wholesale prices have suddenly rekindled inflation concerns with more data available this week when the Labor Department releases the March consumer price index.

For the week, the gold price rose 1.2 percent, from $1,302.30 an ounce to $1,318.40, and silver rose a penny, from $19.95 an ounce to $19.96. The gold price is now up 9.4 percent for the year, some 31 percent below its record high of over $1,920 an ounce in late 2011, and silver is 2.7 percent higher so far in 2014, still 60 percent below its all-time high near $50 an ounce three years ago.

The technical picture for precious metals has seen a major improvement in recent weeks but, according to this Bloomberg report, big investment banks such as Goldman Sachs and Morgan Stanley remain very bearish. Better looking charts were a key reason why respondents to Kitco's weekly gold survey were surprisingly positive with nearly two-thirds of those surveyed seeing higher prices in the week ahead as shown below.

To be sure, the failure to convincingly break through key resistance levels at $1,320 an ounce for gold and $20 an ounce for silver is cause for concern, but a number of factors are working in favor of higher metals prices over the short term, all of which seem likely to continue.

Geopolitics in Eastern Europe was a key factor behind rising metal prices early last week as government buildings in several cities in Eastern Ukraine were occupied by protestors who seek to follow the path of Crimea in conducting a secession referendum.

Some had believed that the trouble in Ukraine was all but over, however, with Russian President Vladimir Putin threatening energy supplies and ongoing unrest in the part of Ukraine that borders Russia, this could drive demand for safe haven assets for some time to come.

The weakening dollar has been another important factor for commodity markets in general and precious metals in particular. On Thursday, the U.S. Dollar Index dipped to its lowest level in three weeks at 79.4 and, now, a fresh six-month low is not far off.

More importantly, multi-year lows for the trade-weighted dollar loom at below 79.0 for this index and this would be very bullish for the overall natural resource sector due to the strong inverse correlation between the dollar and hard assets.

Unimpressive economic data in the U.S. and talk by central bankers around the world have combined to drive the dollar lower in recent weeks and that trend seems unlikely to reverse course in the period ahead. The March labor report released ten days ago was widely seen as disappointing since analysts were expecting a much bigger spring bounce after a severe winter and the Federal Reserve was surprisingly dovish in last week's release of the minutes from their March 18-19 policy committee meeting. Meanwhile, there were signs that the European Central Bank may not opt for more stimulus as previously believed and the Bank of Japan was similarly reluctant to take additional measures to spur their economy.

The recent reversal in U.S. share prices was also cited as a key factor behind the recent support seen for gold, however, the on-again, off-again inverse correlation between U.S. stocks and gold appears to be off-again as shown below.

When U.S. stocks struggled early in the year, this was widely acknowledged as being a key factor behind a rising gold price and the two moved opposite each other to a degree not seen in many years as indicated in blue. But, the stocks-gold relationship has recently reverted to its normal condition that, basically, is no correlation at all (actually, just a very slight positive correlation going back a few years).

It seems the falling dollar has been the primary driver for metal prices lately as the historically strong inverse correlation between the two is now unusually strong. And with a full docket of U.S. economic data in the week ahead, traders will be closely watching the dollar index.

One of the many economic reports that will be released this week is the government's latest data on consumer prices and, if last week's inflation data is any indication, there could be some unpleasant surprises in store.

March import/export and wholesale prices increased at a rate of about three times what analysts expected (i.e., roughly 0.6 percent for the month versus expectations of about 0.2 percent) and, if the retail inflation figures show a similar result, all of a sudden rising inflation will be back on the radar of many investors.

It's worth repeating here that, while inflation has been largely irrelevant in recent years (and this has been a major contributor to falling gold and silver prices), it is generally accepted that inflation has the potential to return very suddenly. There have been multiple warnings on this subject recently and this would certainly shake financial markets that have, understandably, ignored this particular piece of economic data for some time.

We'll find out soon enough if the current complacency toward inflation changes and, if it does, there will surely be a corresponding change in how U.S. investors view precious metals. Based on recent flows into and out of the major gold and silver ETFs, investors in the West could care less about the metals as the SPDR Gold Shares ETF (NYSEARCA:GLD) shed almost five tonnes of gold last week, putting its holdings up just six tonnes for the year. Similarly, holdings for the iShares Silver Trust ETF (NYSEARCA:SLV) trust were flat for the fourth time in the last five weeks and they remain up 270 tonnes so far in 2014.

In the East, gold buying jumped in India last month as Mineweb reported that demand rose to a 10-month high of nearly 50 tonnes. After implementing draconian import curbs last year to narrow their trade deficit, these measures are already being dialed back with more easing of restrictions expected to come and renewed demand from India could be one of this year's biggest stories in the gold market.

In this Reuters story, gold premiums in China last week were said to have briefly turned positive before turning back into discounts of about $2 per ounce, down sharply from premiums of more than $10 an ounce earlier in the year. Koos Jansen reported that China gold demand, though down from the record pace seen in recent months, was still quite strong during the last week in March and it will be interesting to see how this data, derived from withdrawals from the Shanghai Gold Exchange, match up with the weakness reported by other more recently.

It could be an interesting few days for precious metals, especially if this week's inflation report is anything like last week's.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own gold and silver coins and bars along with precious metal ETFs other than GLD and SLV