Impact of Inflation on Precious Metals?

Precious metals investors were a bit surprised recently when the latest inflation rate at 5% was announced with no apparent significant impact on gold and silver prices. Since it is normal for higher inflation expectations to boost gold and silver prices, it makes sense for investors to be confused at the lack of reaction in the precious metals. But perhaps there is an explanation. Let's analyze it.

In this situation we may have a case of markets simply shrugging off this news for now pending more info later. For one thing, higher inflation rates were expected and perhaps already priced in by markets. We all know that in 2020 the economy was shut down and prices dropped in many cases in Q2 2020. So, as the economy reopens we would expect to see higher demand putting upward pressure on many prices. Markets expected all this and were not surprised at the higher inflation rates.

Going forward there is much debate about whether this jump in inflation is sustainable or just due to the economy coming back to life from very low levels. The Fed wants markets to believe that this sharp rise in inflation is temporary and will drop back over time. Jim Rickards, normally a strong critic of Fed analysis, wrote this article in May saying the Fed might be right this time.

On the the other hand, some Fed critics believe the Fed is just trying to jawbone the markets into accepting that this jump in inflation is transitory to deflect attention away from the massive money creation policies used by the Fed (and the US government stimulus programs) to fight the economic slow down from the pandemic.

So, who is right? 

It's too early to tell right now. Only time will tell us if sharply rising inflation is here to stay or will start trending back down once the economy stabilizes at a higher level. So far, markets believe the Fed, so there is no significant upward pressure on gold and silver prices. If inflation persists higher well into Q3, we could see markets reflect less confidence in the Fed's inflation forecast as transitory. If that happens, I would expect to see both gold and silver break upwards into new higher trading ranges in the months ahead. 

If we see inflation rates start to trend back down (even if inflation looks set to exceed the yearly 2% Fed target), we can expect the Fed will use any downward trend to say inflation has peaked and is heading back down into an acceptable (to the Fed) range. In that case, I would expect to see gold and silver prices continue to stay in their current trading ranges until some other new event impacts the precious metals markets. 

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