Inflation Expectations Continue to Firm

I have mentioned in the past that I would keep the readers up to date on the TIPS spread action, especially as it compares to the gold price. I have the data through Thursday of this week ( the Federal Reserve is always a day behind in getting the fresh data) but it does continue to confirm the idea that the broader market is still continuing to see inflationary pressures increasing, albeit at a controlled rate. I believe that this is linked directly to the recently dovish attitudes of three Western Central Bank heads - ECB President Trichet, who got the ball rolling with a reduction in rates in the Eurozone as well as engaging in negative rates for bank reserve deposits, Fed Chair Yellen and BOE Head Carney.

The TIPS spread remains near the highest level in 6 months, a positive key that is keeping gold supported recently. We need to also keep in mind that another of the factors that goes into determining the gold price is also a premium due to the geopolitical factors that might or might not be present. At the current time, the chaotic events in Iraq are undergirding the price of the metal. Lurking around also, although much less of a factor, are events in Ukraine.

The point I want to make here is that inflationary expectations might actually be falling at some point as signaled by the TIPS spread, but geopolitical events could be dominating trader/investor sentiment and such concerns could supercede any signal from the TIPS spread. If figuring out which way markets are going to go, or what the sentiment might be at any given time, were as easy as just looking at one input, we would all be living on our own S. Pacific islands.

Here is the chart update through Thursday.

Along this line, here is the current chart of the Goldman Sachs Commodity Index. As of the close of trading this week, the index is up almost 8% on the year.

From a broader perspective, it continues range bound as noted by the shaded rectangular region on the chart.


That brings me to the US Dollar. It too is range bound. Notice that there exist two defined trading ranges on this longer-term weekly chart. The first and large range has been in effect for a year now. It extends up towards 84 on the top and down towards 78.60 on the bottom. Within this range, is a shorter and narrower one which extends towards 81.50 on the top and near 79 on the bottom. The latter range has kept the Dollar confined for the past 8 months or so.

The relationship between the US Dollar and the broader commodity complex remains fairly consistent which is why the chart pattern for the commodity index and the Dollar index are both showing range bound markets for the time being.

The stock indices did what they have done for so long now - every time they appear to be rolling over, back up they spring. Equity bulls are not going to give up without a fight. The benchmark Russell 2000, a good indicator of investor sentiment towards risk, was up nearly 0.75% today and managed to close higher on the week, after looking like it was finally going to show some downside follow through from weakness earlier in the week.

The index remains well above its 50 day moving average after dipping down into that level last month.

While one can make the case for bearish divergences showing up, this index has continued to shrug off one divergence after another for over a year now!

One last thing ( for now ) I believe it was last week when I mentioned the Gold Commitment of Traders report noted that there was a considerable amount of short covering that occurred in the drive higher coming off of Janet Yellen's dovish remarks back then. Hedgies were caught off guard by that ( as was nearly most everyone else!) and headed for the exits in a big way. They covered around 16,600 short positions against only adding around 1700 new long positions.

I remarked last week that if one is bullish gold, they want to see any move higher in the market accompanied by the infusion of new money from powerful speculative interests and not merely short covering, which while it can be impressive, tends to fizzle out as quickly as it starts.

This week was a welcome change therefore for the bulls in that department. The buying from the hedge funds became much more balanced this week. Short covering was still the dominant feature among that category to the tune of some 24,800 shorts being lifted but here is the noteworthy development - they added nearly 23,000 new long positions. Can you see the difference from the previous week?

Also, this new buying ( dip buyers ) are the reason that gold is currently hanging quite tough up here. It has been stymied at the $1320 level but it is not setting back much at all. This is what steady determined buying does. It keeps a market supported on dips in price. Bulls will want to see this pattern continue. The last thing that one wants to see if they are bullish is for the longs to STOP BUYING these dips. We will know it very quickly if they do just that by the price action.

The events in Iraq, the rising TIPS spread, the lack of strong bullish conviction in the US Dollar at the moment, are all providing some wind at the back of the bulls.

That being said, gold seems to be looking for a catalyst to power it up through $1320 and allow it to maintain its hold ABOVE this key level.  With today's momentum driven markets, any sign that the upward momentum has stalled will get touchy, jumpy short-term oriented longs very nervous. Gold bulls will therefore need to prove their meddle next week. Lacking a fresh catalyst, gold's inability to quickly put $1320 in its rearview mirror, is going to embolden the bears. While bulls are certainly digging in on these dips, bears are also digging in here at this level.

In spite of the strength being shown by gold, some of the big investment banks and their advisory services are still coming out with bearish second half of the year calls on gold. The reason - they expect the economy to continue to improve and interest rates to rise early next year. I am not sure about that prediction but it is basically the same expectation that stock market bulls are relying on. We'll see if it is correct or not.

Lastly, here is the current chart of the GLD holdings. The reported holdings at 785.02 tons has not changed since the beginning of this week. Maybe we will get something new over the weekend or early next week. I sure hope so - these guys are slower than molasses on a winter day in getting us new data to work with.

Compared to exactly one month ago, total reported tonnage is down .26 tons. For the year, holdings were at 798.22 at the start of 2014. Doing the math we get gold tonnage down 13.2 tons for the year thus far. Western-oriented gold bulls are going to need to do much better than this.