Gold price has extended buying momentum on Tuesday, developing the takeoff from $1,500 seen on Monday. I guess the explanation for the move lies primarily in the following chart:

As you might expect, I’m talking about inflation expectations in the United States. I also raised this topic in my yesterday post. Since last Friday, average expected inflation over the next five years has jumped from 0.86% to 1.23%. It is well known that gold and the inflation factor in pricing of the dollar are inversely related, which is based on the simple idea that an asset that loses its purchasing power should become cheaper in relation to the asset that retains it.

The latest jump in gold can be explained by the following factors:

  • Fundamentally determined weak prospects and an increased expected variance of returns on risky assets;
  • Rising concerns of inflation outbreak in the United States thanks to “unlimited” asset purchases by the Fed, which also expanded the range of securities to include corporate and municipal bonds and is now basically in “whatever it takes” mode;
  • Basic supply/demand change: expectations an increase in the money supply in the economy contributed to the currency weakness against other majors (including gold) which outweighed demand driven by “flight into cash” motive;

If you look at how gold behaved during and after the previous crisis, there are some parallels that we can draw:

At that time, there were debates whether QE would lead to an acceleration in price growth or not, i.e. at the beginning of QE, there were expectations of this, which was priced in accordingly in the price of gold. I emphasize that QE’s novelty as a policy measure at that time was a volume of guaranteed bond purchases (the Fed achieves its interest rate targets by the same open market operations – treasury purchases that change supply of bank reserves). The novelty of the current measures, in my opinion, is in their volume again, which has potential to lead to similar gold response.

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