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Is Gold the Canary in the Coalmine?

27/06/2014 10:54 BST | Updated 26/08/2014 10:59 BST

Anyone with the slightest exposure to markets is currently engaged in a rather nerve-wracking game of chicken, as they try and keep 'skin in the game', whilst at the same time living with a nagging fear that at any minute some asteroid may arrive to smash the market out of its extraordinary lethargy and apparent complacency.

Gold added 3.35% the day after Fed Chair Yellen's recent dovish post-FOMC meeting news conference, at which she described the last few months' acceleration in inflation as "noise" and commented that "broadly speaking, inflation is evolving in line with the Committee's expectations". Ironically, last year's famous comment from Bernanke that tapering could start "within a few meetings" caused inflation breakevens, which were already moving down, to collapse and maybe that's why the Fed surprised the market by NOT tapering in September. This time around, conversely, one wonders whether Yellen will be able to continue paddling back from her earlier statement, (made in error?), that suggested a gap of around only six months between the end of QE tapering and the first rate hike.

Otherwise, maybe we will have to conclude that the Fed has in fact introduced either de facto Nominal GDP targeting or so-called Optimal Control theory by stealth, without telling us. In other words, the Fed will be quite blasé about the level of inflation, so long as nominal growth or unemployment were looking good.

Some relief came for the Fed in the shape of May's core PCE inflation reading of 1.5%, up from 1.4% the previous month, but short of the potentially worrying level of 1.6% that some had predicted. The divergence in CPI and PCE behavior can probably be explained by the lower weighting given to surging rents in the PCE calculations.

Gold is probably also receiving some support from the Iraqi crisis, as the implication of severe oil production disruption there could be a double positive whammy for gold-either inflation takes a hike because of an oil price blow-out, and/or global growth gets hit, leading to looser monetary policy for even longer-maybe even putting a halt to, or reversing, Fed tapering. Copper has also turned on a sixpence this month, and started rallying, maybe in response to better news out of China, but maybe also driven by a perception of a policy of benign neglect of inflation on the part of the Fed.

Right now we are just at the start of a journey to higher, more 'normal' inflation, and the road ahead may make many twists and turns, but recent data has brought a couple of outsize surprises; the 0.4% drop in unemployment we saw in April and the 0.26% rise in core CPI in May-the fastest pace of increase for ten years. Maybe potential output is far lower and the output gap much smaller than most people, including the Fed, think it is.

So, (to use and mix far too many metaphors), could gold be warning us that the asteroid is just entering the solar system?

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