(Kitco News) – Inflation is at a 40-year high, which is significantly impacting U.S. consumers. According to the University of Michigan, the number of consumers blaming inflation for eroding their living standards has risen to the highest level in 20 years.
Many gold investors are asking why gold prices have dropped for the last five consecutive weeks in this environment where inflation is out of control and the world is on the brink of a recession.
So far this month, gold prices have fallen more than $100, dropping nearly 6% and are looking to test critical long-term support below $1,700. There is a lot of frustration in the gold market and it is understandable.
However, there is one simple reason why gold is suffering. The market believes the Federal Reserve when as it maintains its stance that it will bring inflation under control. Despite all the evidence, the Federal Reserve’s credibility is intact. Of course, the Fed will bring inflation down by pushing the economy into a recession, but that is a topic for another week.
The market expects the Federal Reserve to continue to aggressively raise interest rates to slow the economy, to destroy demand in commodity markets to cool inflation. After the U.S. CPI data was released on Wednesday, markets started to price in the chance of a full 1% rate hike at the end of the month.
The Federal Reserve’s stance on inflation is driving real yields higher even as consumer prices rise to a 40-year high. We can see the Fed’s impact on markets; breakeven rates, the difference between nominal yields and real yields, have seen their sharpest decline in two years.
Gold is a traditional inflation hedge but investors don’t need a hedge is there is not inflation threat and that is exactly what markets are telling us.
The Five-Year/Five-year forward breakeven rate has fallen to around 2.5% this week, in line with the central bank’s long-term inflation target. This isn’t an anomaly either; The University of Michigan’s consumer sentiment survey shows that consumers see inflation hovering around 2.8%.
Although gold may be down, it is certainly not out. The U.S. central bank may have solved its inflation crisis for now, but with a recession on the horizon, it faces whole new issues.
Many analysts have said that gold will find its luster again if investors start to requestion the Federal Reserve’s credibility and commitment to inflation when economic growth starts to falter and the labor market loses significant momentum.
For now, though, keep and key on $1,700.
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