Gold should benefit from higher inflation

Fed chairman Jerome Powell lowered investors' hopes on Friday, August 26th, by saying the central bank will have to raise policy rates to curb inflation. The yield on a two-year US Treasury bond rose to 3.38%, higher than the equivalent 10-year rate (3.11%), indicating that the bond market is pricing in a recession in the US. This is in line with Powell's observation that a weaker economy and labour market are needed to bring down the rate of inflation and that this could be painful for some households.

The fall in stock prices has erased some of the earlier gains in July in the stock markets, especially in Europe (save the FTSE index in London). Technically, the chart for the leading S&P500 index in New York looks ugly now, with a continued decline looking more likely than vice versa. Buyers need to come into the market and prove otherwise, and it didn't happen on Monday, August 29th.

The HYG ETF, which reflects investors' risk appetite for US junk bonds, is, like equity markets, still in a downtrend.

US HYG ETF (in USD), a daily five-year price chart

On Thursday, 1 September, the August Purchasing Managers' Index will be released from the US, but also from Japan, China, the UK, Germany, France, Italy, Spain, etc. The Purchasing Managers' Index should be above 50 to indicate continued growth in the economy. In the case of the United States (ISM for manufacturing), expectations are 52.0.

This will be followed on Friday, 2 September, by the US employment report for August and an unemployment figure. Last time (in July), the US labour market over-performed. This time, the forecast for Non-Farm Payrolls is for 285K new jobs, which would be just over half of the 528K new jobs posted in July. Expectations have come down, and there may be a chance for a positive surprise again. At the same time, there is a risk that a strong labour market could trigger further increases in interest rates.

Hence, it can be challenging to see the stock market turning from Bear to Bull in the short term. Rising interest rates seem to be preventing that. Therefore, we suggest an investment in gold, a classic hedge in times of high inflation. Notably, the gold price performed very strongly in the early 1970s in the context of the oil crisis linked to the Yom Kippur War and the high inflation that followed, which given low GDP growth during the same period, became stagflation.

GOLD Spot (in USD per troy ounce), a daily one-year price chart