The gold price opened the week near unchanged at $1,132 per ounce as rising concerns of inflation kept a lid on the price of gold and the rest of the commodity complex. The gold price also fought off strength in the U.S. Dollar Index (DXY), which traded higher by 0.69% to 77.599 as the opening bell rang. Gold mining stocks, as represented by the Market Vectors Gold Mining ETF (GDX), also opened relatively unchanged alongside the price of gold. As the global economy recovers, investors and traders continue to grapple with the question of whether the massive infusions of money into the system from central bankers will spark inflation. The potential policy response to this question has implications for the price of gold and gold mining stocks as well as the broader investment landscape.
Overnight news out of London showed preliminary signs of accelerating inflation in the United Kingdom, as the Office for National Statistics reported December 2009 consumer prices rose 2.9% year-over-year, a full percentage point more than in November 2009 and greater than the 2.5% rate expected by economists. This was the first time since May 2009 that the consumer price report showed inflation above the Bank of England’s 2% target rate. On the back of these inflationary pressures, the British pound advanced to a four-month high against the euro currency.
This inflation report is the latest in a series of economic data that suggests Britain’s economy is continuing to recover from its longest recession on record. Moreover, it appears that the easy monetary policies utilized by the Bank of England (BOE) - including reducing interest rates to all-time lows and implementing a 200 billion pound ($328 billion) quantitative easing program - have helped to resuscitate the British economy. However, the longer term inflationary consequences of such policies may be beginning to appear and expectations of hawkish language from the BOE are rising in front of its Monetary Policy Committee meeting on February 4.
Along with the U.K., India’s economy is also showing early signs of increasing inflationary pressures as it too continues to recover from the global recession and financial crisis. India’s Chief Statistician, Pronab Sen, recently commented that the nation’s monthly inflation rate may reach 10% by March 2009. Its central bank - the Reserve Bank of India - is scheduled to review monetary policy at its upcoming meeting on January 29. A note from Barclays Bank Plc suggested there is a considerable likelihood the central bank will raise reverse repo and repo rates by 25 basis points at this upcoming meeting.
Despite statements from government officials remaining wary of tighter monetary policy and potential impediments to economic growth this might pose, central bank officials have become increasingly concerned about the inflationary consequences of renewed credit growth in the Indian economy. If the country’s inflation rate does indeed reach double digits, pressure will build for the Reserve Bank of India to begin to raise interest rates - a further potential headwind for the price of gold and gold mining stocks.
While inflationary pressures have risen across the globe as policymakers have flooded the financial system with liquidity, few central banks have yet to respond by raising interest rates. In the U.S., pressure has increased on Chairman Ben Bernanke and the Federal Reserve to tighten monetary policy, but several recent economic data points - including the monthly employment report and various housing sales data - have curtailed this pressure to some extent. Nevertheless, at some point, the inflationary effects of easy monetary policies have the potential to pick up steam, forcing central banks around the world to respond with higher interest rates.
Such a scenario would provide a meaningful roadblock for continued strength in the gold price and gold mining stocks as the opportunity cost of holding an asset which pays no interest such as gold increases. A resurgence of inflation is certainly a non-consensus view given the deflationary pressures that continue to weigh on the global economy, but such a scenario does represent a risk to gold-related investments.
