GGold Remains Soft in Range, Despite Weak Dollar and Inflation Hints

Gold is maintaining a weak tone within the recent range after failing to regain the $1400 level yesterday. This softer tone emerged in the wake of decent bond auctions in Portugal, Spain and Italy this week, which have seemingly reduced the perceived risk of imminent default or bailout. That has taken some of the European risk premium out of the metals market. However, the downside in gold may prove to be limited for several reasons.
Most analysts seem to agree that this week's European auctions haven't fundamentally changed anything. I've said it before, and I'll say it again; 'countries don't extract themselves from debt crises by incurring more debt.' At best they have bought themselves some more time; a kick of the can as it were. There still seems to be a fairly broad consensus that Portugal will ultimately have to tap the EFSF bailout fund, like Greece and Ireland before it. At that point, the market will turn its attention to Spain, with Belgium perhaps providing and intervening diversion. Nevertheless, the euro has rebounded sharply, reaching a 4-week high. Euro strength has weighed on the dollar and a weak greenback tends to have a supportive affect on gold.
There is unquestionably rising concerns about inflation globally, which too tends to be supportive to gold. Today Dec HICP inflation in the eurozone was confirmed at an above-target 2.2% y/y. German and Spanish inflation were confirmed at 1.9% y/y and 2.9% y/y respectively, with accelerations in core inflation noted. I commented on the implications of hotter inflation in Spain in the 03-Jan Morning Report. ECB President Trichet expressed heightened concern about inflation on Thursday and those sentiments were echoed by Axel Weber today. The implication being that tighter monetary policy within the EU may be on the horizon. However, I'm having a hard time reconciling if inflation risks really do trump periphery default risks. If the ECB hikes, borrowing costs for the debt laden PIIGS would rise as well, pushing them closer to default or bailout.
UK PPI for Dec came in higher than expected, with input prices +3.4% m/m, +12.5% y/y. With output prices up a comparatively low 4.2% y/y, its abundantly clear that corporate profit margins continue to get squeezed. Given the still sorry state of the UK economy, companies remain reluctant to pass along higher input prices to cautious and price sensitive consumers. However, something has to give: Either prices must rise at the consumer level, or share prices must suffer due to reduced profit margins.
US CPI for Dec came in higher than expected as well at +0.5%. Core remained relatively tame at +0.1%, in-line with expectations. These data were tempered somewhat by a better than expected industrial production print for Dec.
China continues its efforts to tamp-down inflation, raising its bank reserve requirement another 50bp. This was the seventh such hike since early-2010. That pushed the yuan to a new record high versus dollar, a week before Chinese President Hu Jintao visits President Obama in Washington, DC. Well, isn't that convenient? Undoubtedly, further yuan appreciation will be a topic of discussion, which should contribute to weight on the dollar. Additionally, given China's recent efforts to single-handedly save Europe, one can imagine President Obama encouraging President Hu to keep the 'love' coming our way as well.
Inflation, specifically food price inflation, has taken a rather violent turn in a number of countries recently, reminiscent of the 2007/2008 global food crisis. Riots have broken out in Algeria, Tunisia, Bangladesh, India, and China. Unrest is North Africa has now reportedly spread to Morocco, Yemen and Jordan. Many countries are considering price controls and other measures to quell the unrest, but as we've seen in the past, various forms of price suppression can have a negative impact on supply, exacerbating the problem.


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