Gold touched a nine-month high this week. Is this a sign that inflationary fears are again moving to the fore? Perhaps, although news of gold’s improving allure from a fashion perspective may have something to do with the latest leg in the metal’s bull market.

The public’s appetite for things golden has reached a record high, according to the metal’s trade group. “Consumer demand for gold jewellery has rocketed to over 2,600 tons,” the World Gold Council (WGC) reports. “The 12 months to June display a surge in the popularity of gold and the past nine months have seen double-figure gold consumption growth.” Much of the demand surge comes from India, China, and the Middle East. Meanwhile, “jewellers have been stocking up on gold ahead of the Indian festival season and investors have also been flocking to the market,” WGC also notes.
Worries of higher inflation may be secondary, but secondary doesn’t mean forgotten. As the WGC observes, “investors are taking a keen interest in gold due to speculation that the U.S. will not raise interest rates in the aftermath of hurricane Katrina.”
Indeed, courtesy of Hurricane Katrina, the prospect that the Fed may pull the plug on the rate hikes that began over a year ago is becoming the talk of Wall Street. What’s more, some say there’s a chance that the Fed may embark on a fresh round of lowering rates. Such talk is gaining the attention of even the bond bulls. For example, in an interview today with CS, Van Hoisington, who manages $4.5 billion of Treasury bond portfolios at his ownHoisington Management, says: “If the Fed began to ease aggressively over the next 12 months we’d become very nervous. But we don’t know, so we have to wait and see.”
The first warning flag that the central bank is rethinking its tightening policy would likely be an acceleration in the growth rate of the M-2 money supply, says Hoisington, who manages the Wasatch-Hoisington U.S. Treasury Fund, which Morningstar gives high marks to as a long-term performer in its class. Last year, M-2 expanded by 4.5%, well below the long-term average of 6.7%, he advises. In the last six months, M-2’s pace of change continues slowing, down to 2.5%. But if the pace of money creation starts to move higher to any degree, implying lower interest rates, Hoisington says he may reduce the 20-plus-year average maturity in his Treasury portfolio in anticipation of higher inflation down the road.
Why would a bond manager fear a Fed that’s no longer tightening the money supply? Because in the long run, which is Hoisington’s investment horizon, higher short rates suggest a slowing economy and lower inflation, both of which promote higher prices for bonds, he explains. As such, he concludes that if the Fed is willing to stop raising short rates, inflationary worries will return, taking a toll on long-dated fixed-income securities.
Nipping inflation in the bud may not be the high priority at the moment, however. Katrina has reordered Washington politics. Indeed, the hurricane claimed its first political casualty today with news that Federal Emergency Management Agency chief Michael Brown was taken off the Gulf Coast operations and recalled to Washington, Reuters reports. Is the current monetary policy slated to be the next casualty?
Yes, inflation may be a lesser threat these days, but the potential for something more still lurks. Consider today’s import price report for August from the Labor Department: for year through last month, import prices jumped 7.6%. Although that’s down about from the highs of around 10% last year, it’s still lofty enough to suggest that America’s appetite for imports could be a recipe for raising inflation. Indeed, import prices on a yearly basis are running about twice as high as domestic inflation rates, as measured by consumer prices.
Perhaps it’s time to resurrect a favorite spectator sport from the Volcker-era by paying closer attention to the Fed’s Thursday updates on money supply.