Is Higher Inflation Really Bad for Gold?

News of hotter than expected inflation numbers caused gold to sell off Tuesday. The markets seem to think rising inflation is bullish for the dollar and bearish for gold.

But is it really? Is higher inflation really bad for gold?

As Peter Schiff points out in his latest podcast, this whole notion is rather absurd.

The news of the day Tuesday revolved around import/export prices.

Import prices were expected to rise 0.5 and were up 0.7. Export prices also came in stronger than expected, rising 0.8 compared to an expected increase of 0.4. Year-over-year, import prices are up 2.7%. This is well above the 2% level the Federal Reserve is looking for.

Of course, the Fed fixates on the consumer price index, but obviously, import/export prices have a major impact on overall consumer prices. In fact, Peter says he thinks the import/export price number represents a better gauge of inflation than the CPI because the methodology is more objective.

The immediate market reaction to the import/export numbers was to buy the dollar and sell gold. But Peter raises an important question: Why is higher inflation bad for gold?

After all, the main reason to buy gold is an inflation hedge. If you think there’s going to be more inflation, you buy gold. But perversely, the way the markets work now, you sell gold if you think there’s going to be more inflation. In fact, you buy the currency of the country that is experiencing more inflation, which is kind of counter-intuitive because inflation by definition is the currency losing value. So, if the currency is losing its purchasing power, why would you want to buy more of it?”

As Peter pointed out, speculation about what the Federal Reserve may or may not do now drives the market more than this fundamental truth. Everybody thinks higher inflation increases the likelihood the central bank will raise interest rates and embark on tighter monetary policy.

It is the expectation that these higher numbers will produce a tighter Fed – that is what rallies the dollar. That is what hurts gold. It’s the anticipation of higher rates to fight off the inflation.”

This also explains why we’ve seen some headwinds in the gold market and a strengthening dollar as speculation swirls around who Trump will tap to serve as Fed chair when Yellen’s term ends next year. Many analysts think the president will pick a “hawkish” policymaker” who will hold interest rates higher.

Peter says fixating on the Fed and inflation is a mistake.

Reality is the Fed will ignore the higher inflation numbers and do nothing. Whatever it’s going to do with rates, it’s going to do it regardless of these numbers. And ultimately, if the Fed has to make a choice between fighting inflation and unemployment –  because the Fed believes in this Phillps Curve tradeoff between inflation and employment – the Fed will always choose to fight unemployment or to prop up the labor market and sacrifice its inflation goal. It doesn’t care if inflation goes up. It’s more concerned about employment, or the economy, or maintaining asset bubbles, or propping up the US government and making it so it doesn’t have to default on its debts. The reality is higher inflation is not going to produce a tighter monetary policy.”

Peter compared inflation to a fire. The Fed is going to have to ignore the fire. That means it will get worse. The fire will get bigger because the central bank thinks putting it out will do more harm than letting it burn.

If traders understood this – that higher inflation just means that it’s going to get even worse – then they would be dumping the dollar. They would be buying gold.”

The real interest rate equals inflation minus the nominal interest rate. So, even if the Fed pushes up nominal rates, the real rate can continue to fall in a high inflation environment. Peter said even if the Federal Reserve does push interest rates higher, it probably won’t be able to keep ahead of the inflation curve.

So, the markets have got it completely wrong when it comes to how to react to inflation. Inflation is good for gold and bad for the dollar. So, when you see these kind of selloffs like we saw today – these are buying opportunities. This is an opportunity to buy from people who don’t know what they’re doing because they’re just focusing on this short-term relationship that is wrong.”

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