Central Banks Find Silver Lining in Gold Plunge

The price action in gold over the past week has attracted a great deal of attention. The precious metal suffered its worst decline in decades, and has investors and analysts wondering if the great run is over. However, central banks are using the move as another reason to keep monetary easing policies very accommodating.

Gold’s winning-streak of annual gains appears to be in jeopardy for the first time in twelve years. Over the course of only two days, gold plunged $200 to reach its lowest level since February 2011. In the process, it logged its worst one-day percentage drop since 1980, and the largest fall in dollar terms on record. On a technical basis, gold reached its most oversold reading since, at the latest, 1975.

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Since gold is often considered to be an inflation hedge, central banks are likely to take the plunge in gold prices as another sign that their policies are not sparking inflation, despite what the Average Joe’s bank account may be indicating.

“Central banks can be opportunistic and proceed with quantitative easing now the gold market is surrendering with regards to its hyperinflation fears,” Edward Yardeni, president and chief investment strategist at Yardeni Research, tells Bloomberg. “They could also argue the weakness in commodity prices suggests a growth concern and so all the more reason to keep QE going.”

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St. Louis Fed President James Bullard confirmed this view by telling reporters at a Levy Economics Institute event, “Inflation is running pretty low right now, and its been drifting down. If it doesn’t start to turn around soon, I think we’ll have to rethink where we stand on our policy,” according to CNN.

The latest report from the Labor Department also shows inflation slowing. The consumer-price index fell 0.2 percent month-over-month in March, below estimates calling for no change. The index is up 1.5 percent from the same period last year, while the core reading on consumer costs, which excludes food and energy prices, increased 1.9 percent. It was the fourth time in five months that both inflation gauges were below the Fed’s 2 percent inflation target. The Commerce Department also reports the personal consumption expenditure price index, which is tracked more closely by the Fed, only gained 1.3 percent in February from a year earlier.

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Recent chatter about the Federal Reserve ending or scaling back its bond-purchasing programs appears to be premature by the latest inflation readings. Jon Hilsenrath, a writer from the Wall Street Journal known as the Fed Whisperer, also notes the likelihood of bond purchases continuing. Hilsenrath writes, “The latest reading on consumer prices could give the Federal Reserve a new reason to keep its easy-money policies intact, inflation shows signs of slowing.” He adds, “If inflation readings are low, the Fed might feel it has more leeway to try to stimulate economic growth.”

The race to debase currencies is taking place around the world. When converted to U.S. dollars, the four major central banks have expanded their balance sheets to more than $13 trillion, according to Hayman Capital. In comparison, the amount was $3 trillion ten years ago. Central banks now account for at least a quarter of all global gross domestic product, a sharp increase from only 10 percent in 2002.

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While the Federal Reserve is currently purchasing $85 billion worth of bonds per month, the Bank of Japan announced earlier this month that it will inject more than $1 trillion into its economy to almost double its monetary base to 270 trillion yen. It also set a goal of 2 percent inflation for the first time. Due to a lack of growth, the European Central Bank also appears to be moving closer to another interest rate cut.

Although many would agree that the official inflation gauges underestimate real price increases for Americans, they offer an easy excuse for central banks to say their policies are not causing rapid inflation. The plunge in gold prices is simply the icing on the cake. When combined with a global economy that is still trying to recover from the financial crisis, massive central bank intervention appears to be here to stay.

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Disclosure: Long EXK, AG, HL, PHYS

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