RDQ weekly update: The impact of easy money is high gold prices and then general inflation

Consistent with one of our long-held market themes of easy money and the impact of quantitative easing, gold prices hit a new record high in the latest week.

We think gold prices can be understood in terms of Wicksell’s cumulative process by which prices rise when the actual rate of interest is held below the natural rate. Ultimately, we believe higher gold prices will be followed by higher inflation.

Since the Fed’s Phillips-Curve leaning is likely to keep policy ultra easy for several years, we expect that gold prices will continue to rise. It is hard to apply a valuation metric to the price of gold but the Fed’s balance sheet is very large in relation to its holdings of gold. Moreover, although nominal gold prices are at a record, in real terms gold would have to rise to $1,650 an ounce to match the monthly high of 1980.

If monetary policy is inflationary as shown by gold prices, why are Treasury yields so low? We think that while Wicksell’s cumulative process quickly hits gold prices, bond yields are being held down by financial repression that results from the same stance of monetary policy. We remain bullish on gold and bearish on bonds but our bearish feelings towards bonds earlier in the year were premature.

We do not expect the Fed to expand QE at its meeting next week but further Treasury purchases by the Fed at some point cannot be ruled out. In addition, part of the financial repression of bond yields has resulted from the currency policies of several foreign countries (most notably China).

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