Pity the goldbugs. Inflation, depending on your point of view, is climbing higher, or topping out. The price of gold of late arguably reflects a little of each. After a four-year rally that carried the precious metal to over $450 an ounce last December, gold has moved sideways in 2005, reflecting the back and forth that has become the inflation debate.
The metal now changes hands at roughly $438. That’s up a tidy 58% from 2001’s close. Thus far in 2005, however, gold’s unchanged from last year’s final trade. And to judge by the action in the year-over-year change in the monthly consumer price index this year, the lack of movement in the metal looks eminently reasonable. For July, the CPI advanced 3.2% relative to 12 months previous, a middling performance based on recent history.
Price trends for wholesale prices, otherwise known as producer prices by way of government reports, reveal a similar trend of no particular bias. July’s producer price index is up 4.6% over the year-earlier figure, or slightly below the 5% posted in March.
It’s easy to dismiss the inflation fear, to judge by pricing trends in 2005, and the gold market has effectively done just that. But before we toss away the inflation story completely, it’s instructive to step back and consider the historical perspective. Reviewing year-over-year monthly data for the CPI and PPI from 1970 suggests that pricing trends remain caught in a range that’s held for much of the past 10 years. In fact, the 12-month changes in CPI and PPI of late reside in the high end of their respective range.
The momentum that previously carried CPI and PPI 12-month changes to the current atmosphere was born in 1999 and 2000, a moment in time when an equity bull market in general, and tech stocks in particular, raged. The arrival of the bear inevitably took its toll, exacerbated by the extraordinary effects thrown off by September 11, 2001. Disinflation, in other words, quickly took center stage in 2001 and 2002, pulling out the rug out from the upward pressure on prices that was formerly evident in 1998-2000.
But while the mounting pricing pressure was derailed, it wasn’t killed. With the rate of 12-month increase in the CPI and PPI now revisiting the former high ground occupied in 2000 and early 2001, the question necessarily becomes: What next? Will the range currently occupied prove to be a ceiling once more? If so, what reasons can a thinking investor cite to expect such an outcome?
The natural forces of deflation sweeping the global economy are the obvious citations. The Federal Reserve, argues one school of thought, has tried, and so far successfully kept the forces born of the workforces in China, India and all the rest from exporting outright deflation into the American economy. As a result, the inflationary efforts of the central bank are meeting with the deflationary forces of the global economy. The outcome has been a compromise in the form of modest inflation, as recently witnessed in the CPI and PPI.
But these two opposing forces are not immune to change, either economic or political. As such, one can rightly wonder what might vary going forward that would produce a different result from the recent past. Here’s where it gets tricky since the variables that can trigger a breakout in inflation’s recent range, or keep the beast contained in familiar terrain, are numerous and more than a little slippery.
What, for instance, is the path of least resistance in the rate of growth in the economy? The answer will depend in no small degree on the where the price of oil’s headed. Who among is prepared to say with any confidence what crude’s value on the near-term futures contract will be, say, six months from now? We don’t need specifics—a mere “higher” or “lower” relative to today will suffice.
Alas, that’s tougher that it sounds. Indeed, gold bugs and bond investors aren’t natural allies, and as history suggests they typically see the future quite differently. Inflation is good news for gold bugs while the opposite is true for owners of debt securities. But by the standards of year-to-date total returns in two representative ETFs, that historical distinction is less than obvious in the waning days of summer.
The StreetTracks Gold Trust (Amex: GLD), which tracks the price of bullion, has slipped by around one-half of one percent through August 19. The iShares Lehman 7-10 Year Treasury Bond ETF (Amex: IEF) fares better, with a total return of 2.3% through August 19. But if gold and bonds are designed to be something less than fully correlated asset classes, the similarities in year-to-date performance far outweigh any differences.
We have no doubt that events will conspire, and perhaps quite soon, that will re-emphasize the distinctions between gold and bond returns.
In the meantime, the lazy days of summer prevail. Sit back, have a drink, and imagine what life might be like in the autumn. Just don’t fall asleep. The times will be a changin’.