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October 7, 2014

Gold Slumps on Low Growth and Low Inflation

By Economy Watch

Gold dipped below $1,200/oz. last week before recovering above that level in trading Monday, as inflation hedges lose favor amongst investors fearing low growth and lackluster monetary policies could yield deflation in the world’s most advanced economies.

Gold recovered as U.S. equities floundered on Monday, but it remained roughly flat for 2014 as an earlier rally in winter quickly reversed course over the summer amidst greater fears of disinflation in the U.S. economy. The 10-year U.S. Treasury yield lost 4 basis points on Monday, reaching 2.42% as investors speculated that low growth would continue long enough to keep the Federal Reserve from raising interest rates.

Low Growth, Low Inflation

In a recent Goldman Sachs report, the investment bank warned speculators that a low growth and dovish Federal Reserve Bank would keep rates low. In a note released to investors, Goldman Sachs said the Fed was likely to keep its benchmark low, with interest rates remaining near zero for a “considerable time” after the end of the central bank’s quantitative easing policy, which is slated to end this month.

The call ran counter to a separate view by BlackRock’s chief investment officer, Rick Rieder, who said the Fed was probably going to raise rates earlier than expectations. “We have an economy today that’s going, we think, quite strong,” he said, adding that this would motivate the Fed to raise rates sooner rather than later.

However, futures on the 30-day federal funds rate expiring in October 2015 remained low, at 0.565%. That would still be a roughly doubling from today’s rate, which remains below 0.25%.

Commodity Glut, Gold Malaise

With monetary policy remaining weak, market expectations for inflation have remained lackluster, and a slowdown in emerging markets has accelerated the trend.

Prices for a large basket of commodities have continued to slide in recent months. The Dow Jones Commodity Index has fallen 9.53% year-to-date, after commodities peaked in late June. Most losses to commodity prices have come since then.

Analysts are blaming a rapid increase in natural gas and oil reserves, combined with lackluster demand from China as its middle class fails to accelerate spending on consumable goods. In a recent study, The Economist noted that raw materials may be on a path to erase gains that caused commodity prices to triple between 2000 and 2011. At the same time, technological improvements and innovations in fracking have made energy cheaper and more plentiful, which has lowered concerns of an inflationary spiral caused by diminishing resources.

With less demand for commodities, traders are finding less justification to buy gold as an inflation hedge, particularly as the metal has seen continued price declines since peaking in 2011. Some analysts have recommended aggressively bearish bets on the metal throughout 2013 and 2014, arguing that overblown inflation fears shortly after the financial crisis caused artificial demand, which has proven unsustainable in more recent years.

Prices remain growing at a slowly accelerating rate in the United States, but more economists are predicting deflation in the European Union as monetary policy remains relatively tight. Mario Draghi has recently attempted to cause prices to rise by beginning a Federal Reserve-style quantitative easing program, but the plan has met strong resistance from German politicians.

Courtesy Economy Watch

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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