Inflation Fears To Support Gold Once Stocks Stabilize

Gold may be poised for further gains due to growing inflation fears, especially once equity markets stabilize and with the U.S. Federal Reserve speeding the pace of easing its monetary policy, traders and analysts said.

One observer compared the Fed’s recent rate cuts to a doctor administering medicine in an attempt to save the life of a patient – in this case the economy – before worrying about possible side effects, such as inflation.

As it is, the gold was already drawing some buying even when it was hit earlier in the week by long-liquidation pressure from investors needing to raise cash as stocks sold off.

“Silver and gold have done a good job of holding together as the stock indices fell apart,” said Ira Epstein, chief executive with Ira Epstein & Co. Futures. “They’ll do a phenomenal job to the upside once they believe the economy is on better footing. The rational for that is all these rate cuts will lead to inflation.”

Precious metals are likely to draw safe-haven buying due to some of the uncertainties in the financial and credit markets, said Gijsbert Groenewegen, managing partner with Gold Arrow Capital Management.

“On the other hand, precious metals have also been an inflation hedge,” he continued. “If you look at food and energy prices, there is inflation. Wheat is at all-time highs. Look at corn. You’re having an acceleration of the world population having access to ‘better foods.'” With oil at historically high prices, demand for biofuels has added to rallies in food commodities such as corn and sugar, he added.

A trader said it seems that inflation is already running higher than is reported in official government data. “People are concerned about inflation, and they ought to be,” he said.

Meanwhile, even when gold pulled back this week, buying appeared to emerge around the $875-an-ounce region, Groenewegen said. “I don’t think this run is over,” he continued, suggesting $950 or $960 is possible in the foreseeable future if equities hold up.

With global equities in the midst of a sharp sell-off, the Federal Reserve cut the federal-funds target and the discount rate by 75 basis points each early Tuesday, an even bigger inter-meeting reduction than most economists were expecting. The move came just one week ahead of a regular meeting of the Federal Open Market Committee, with economists expecting yet another cut.

The creation of additional money supply to help stave off a feared recession can only lead to more inflation, several observers said. “Think of (Fed Chairman Ben) Bernanke as the doctor,” Epstein said. “The doctor has to save the patient right now. You don’t really worry about the side effects of the medicine. The goal is to get the patient to stay alive. “After that, you start addressing what you have to do withthe medicine, so the patient gets on a better road to recovery.”

Epstein said he looks for “runaway inflation” down the road. “Right now, the Fed is not ahead of the curve,” he said. “They have to cut another half point to get themselves ahead of the curve at the next meeting.” Thursday morning, the February federal-funds futures were factoring in a 100% probability of a 25-basis-point easing at next week’s Fed meeting and an 84% likelihood of an additional 25 basis points. “The Fed figures it has a green light to not be too concerned about the inflation story at the moment, so the Fed is going to feel comfortable with a weaker dollar and stronger metals prices as long as the stock market goes up,” said Ralph Preston, senior market analyst with Heritage West Financial.

“They want to reinflate assets, everything from houses to the stock market.” Larry Bilello, managing director of B&C Trading, suggested Bernanke is “between a rock and a hard place,” but probably will have to lower interest rates again. “Those things work for gold’s benefit – the distrust of dollars and ultimate inflationary ramifications of printing money,” he said.

Several observers suggested gold buying based on inflation fears may pick up particularly whenever equities recover. Besides the liquidation pressure in gold triggered by recent stock-market declines, sagging equities have a disinflationary effect, since it means less money for investors to spend, Groenewegen said.

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