Gold Behaves Strangely For An Inflation Hedge

Disinflation has begun. Counterintuitively, it's setting the stage for a rally in gold prices. Wait, what, a rally? An inflation hedge?

I have to admit that for an asset that allegedly protects against inflation , gold is behaving strangely. It has been declining when prices were rising and, now, when the inflation rate slowed down further in November, gold jumped. What a strange inflation hedge !

But let’s start from the beginning. The CPI rose just 0.1% in November, after a 0.4% increase in the preceding month , according to the BLS . The core CPI, which excludes volatile food and energy prices, increased 0.2% in November, compared to a 0.3% rise in October. Hence, inflation softened on a monthly basis.

Over the last twelve months, inflation also subsided. The annual rate of growth in CPI declined from 7.8% in October to 7.1% in November. As the chart below shows, it was the smallest 12-month increase since December 2021. The core CPI rate also moved down from 6.3% to 6%.

What’s important is that the softening was greater than expected. To be clear, inflation remains obscenely high, but it seems that the Fed finally took it under control, at least for now. The inflation rate is on the decline since the peak of 9% seen in June. Although annual inflation is slowing in part because the last year’s big increases drop out of the calculation, we can say that disinflation has started.

Softer Inflation Implies More Dovish Fed

The slowdown in inflation will be welcomed by the monetary policy doves within the FOMC who would like to scale back the size of interest rate hikes. According to the CME FedWatch Tool , the odds for the 50-basis points hike at today’s meeting have risen from 73.5% to 79.4% after the release of the CPI report. For me, the Fed officials would reduce the pace of tightening anyway, but the softer-than-expected inflation could make them aim for a lower terminal rate.

Implications for Gold

What does it all mean for the gold market ? Well, the expectations of a more dovish Fed boosted both the stocks and precious metals (gold and silver ). Indeed, as the chart below shows, the price of gold jumped again above $1,800 yesterday after the release of the CPI report.

Although it might seem to be a strange reaction to slower inflation, it’s actually perfectly understandable. Softer inflation implies a less hawkish Fed and lower real interest rates than otherwise. The Fed’s tightening cycle will end sooner, the same applies to the U-turn in the monetary policy . This year, gold remained under the downward pressure of interest rate hikes. When they end, gold should have a lot of room for its next rally .

Arkadiusz Sieron, PhD