Precious Metals Climate Poised to Improve as Inflation Signs Reappear

Considering they’re supposed to be alternative assets, precious metals have enjoyed a solid enough performance recently to get the attention of even the most devoted traditional asset owner.

The metals bull began his most recent run toward the end of 2018, when acute fears about the consequences of the U.S.-China trade war rattled financial markets and signaled the very real possibility the global economy would sink back into recession. 

The same bull received an additional jolt of energy in June 2019, when the Federal Reserve announced interest rates would be heading back down after they’d been hiked four times the previous year. The decision by America’s central bank to lower rates sent a clear and worrisome message: Despite all of the expansionary monetary policy initiatives thrown at the world’s economies the previous decade in the wake of the 2008 financial crisis, profound weakness remained.

As crisis assets, however, gold and silver responded favorably to the news. From December 2018 through the end of 2019, the price of gold climbed 24% and silver was up 26%.

Not long after the beginning of 2020, the bull received still another shot in the arm (if that’s, in fact, where bulls receive their shots) with the onset of the global pandemic. Concerns about worldwide financial stability grew at a rapid pace, and there was even talk of another depression as the U.S. unemployment rate reached its highest level since the early 1930s.

Gold and silver surged not only as risk-off assets but also as perceived monetary hedges when the Federal Reserve and U.S. government made a commitment to “anything goes” monetary and fiscal policy in their efforts to help right America’s economic ship. The metals bull continued trotting at a healthy clip. From December 2018 through December 2020, gold and silver appreciated 55% and 86%, respectively.

But notably absent from the economic environment the last couple of years has been inflation. That means the precious metals bull has been making his charge since December 2018 without the assistance of one of his favorite fuel sources. But it now appears inflation may indeed be making a comeback after many years missing in action. 

According to the Labor Department, the April Consumer Price Index (CPI) – the nation’s principal inflation metric – jumped a startling 4.2% year-over-year…the biggest upward move in the rate since September 2008. 

Even professional observers were caught off guard; just prior to the figure’s release, a Dow Jones survey of economists revealed their expectation the CPI in April would rise a more modest 3.6%. So does this mean big-time inflation is back? Are we on the way to reliving the 1970s, when inflation averaged more than 7% for the entire decade and precious metals soared to then-unimaginable heights?

It’s too soon to tell just yet. But if it turns out that a significant inflation problem finally has re-emerged and now is a part of what already has been a decidedly pro-metals economic landscape, the outlook for gold and silver could be particularly bright.     

Analyst: Inflation Factor Can Drive Gold “a Lot Higher From Here”

It’s important to clarify that some inflationary environments are better suited than others to potentially providing helpful upward momentum to gold and silver. One example is when signs of inflation are not quickly and vigorously addressed by central banks, a temperament which the Federal Reserve seems happy to maintain presently.

In the past, the Federal Reserve often moved right away to contain inflation by raising interest rates. However, for the last decade, the U.S. inflation rate has fought to climb above the Fed’s 2% target – a rate of inflation the central bank considers representative of genuine economic growth while not “rising” to the level of being problematic. 

Because the inflation rate has been so tepid for so long, the Federal Reserve announced a change last year to the manner in which it would address inflation going forward. In August 2020, Fed Chairman Jerome Powell said the central bank would embrace a policy it calls “average inflation targeting.”

The upshot of this change is that rather than immediately raising rates at the first sign of real inflation, the Federal Reserve instead will keep rates where they are and let inflation run hot until such time it appears to be a sustained problem. The idea is that the Fed is looking for an average inflation rate of 2%, and therefore is willing to accept rather significant upward spikes – such as April’s 4.2% – if it remains convinced those are more singular, “transitory” increases and that average inflation will remain at or right around 2%.

Here’s why that posture potentially can benefit precious metals. Inflation by itself tends to generate greater interest in perceived safe-haven assets such as gold and silver. But when the Federal Reserve raises rates to keep pace with inflation, it means interest-bearing assets can become more appealing and precious metals therefore have more competition for savers’ money.

However, as long as rates remain unchanged, metals have a greater opportunity to “shine” amid inflationary signs. This is especially likely when those static interest rates are as low as they are currently and savers are faced with negative real interest rates when accounting for inflation (e.g., a nominal interest rate of 1% minus an inflation rate of 3% equals a real rate of -2%).

Tim Hayes is the chief global investment strategist at Ned Davis Research, and he’s not so sure about the Fed’s ability to “manage” inflation without consequences. “The Federal Reserve has said it wants inflation to run above their target, and the risk is that as they let inflation run, they will end up behind the curve,” Hayes recently told Kitco News. “Inflation is the genie in the bottle, and once it is let loose, it is difficult to get back in.”

Hayes is, in fact, so bullish on gold’s prospects that he expects the metal to climb well above its record high on the strength of the additional momentum he anticipates inflation will provide through the foreseeable future. “Gold can go a lot higher from here; we’re not just looking at record highs,” Hayes projects. “Once we get a breakout, it will bring in a whole new group of investors who will start to buy into the idea that they need gold as an inflation hedge.”

Inflationary 1970s: Will Gold and Silver Repeat Their Epic Performance?

Earlier in this piece, I made a reference to the 1970s, when high inflation characterized much of the decade and precious metals strengthened significantly. But I did not specify just how much gold and silver climbed. As it happens, from January 1970 to January 1980, gold appreciated a remarkable 1,500% and silver – if you can believe it – performed even better, skyrocketing more than 2,000%.

To be clear, the overall economic and geopolitical environment of that decade was very complex. There were a number of metals-positive drivers in place that could be seen as playing a part in the 1970s gold and silver surge, including an oil crisis, weak dollar, political unrest and numerous overseas conflicts, including ongoing instability in the Middle East. But a chronic inflation problem most definitely was also part of the mix. 

Does this mean retirement savers should expect gold and silver to appreciate as robustly today as they did nearly a half-century ago?

No one knows, of course, partly because it’s not clear how high inflation might climb this time around. Beyond that, I would suggest fixating on whether gold and silver could post those sorts of numbers again is not so important. What is important, in my opinion, is recognizing the solidly metals-favorable composition of the current environment: historically low rates to which the Federal Reserve seems firmly committed; a new presidential administration devoted to mammoth spending initiatives; and clear signs that suggest inflation could become much more than a mere incidental issue in the foreseeable future.

Ned Davis’s Tim Hayes does not have a specific price target in mind for gold. For him, the composition of the current economic/monetary environment is enough to conclude the outlook for gold is excellent. I would suggest, as well, that astute retirement savers won’t get sidetracked by specific price predictions for gold and silver, but instead will see the ever-improving climate for metals for what it is and ponder if now might not be a good time to include the assets among their holdings on that basis.