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Chart In Focus

Bernanke Should Listen To Gold

Chart In Focus
April 08, 2011

Ben Bernanke needs to wake up and listen to gold's message. 

Late in 2010, Fed Chairman Ben Bernanke was confident that inflation would remain low, and that the Fed could "remove policy accommodation" at the appropriate time.  But rising food and gasoline prices are forcing him to start changing his tune.  Here is a sampling:

"Overall, inflation remains quite low." February 3, 2011

"The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation." March 1, 2011

"I think the increase in inflation will be transitory." April 5, 2011

Bernanke's complacency seems to be weakening, and it may have come from an over reliance on the Consumer Price Index (CPI) numbers.  The CPI data have continued to show low inflation in spite of the evidence that is all around us.  Part of the explanation for that is the huge weighting of housing prices in the form of "owner equivalent rent".  The weighting of all housing items is 42% in the main CPI, and even more in the "core" rate which subtracts out food and energy.  Housing prices have remained depressed due to oversupply in the wake of the housing bubble. 

This week's chart looks at the relationship between gold prices and the CPI inflation rate.  It is important to note that the price plot for gold is shifted forward by 15 months to reveal how it used to give a really good leading indication for what the inflation rate would do.  It does not show gold's most recent zoom up above $1400/oz. 

The correlation in the 1980s and 1990s was very high, except for a couple of instances when OPEC and Saddam Hussein but their thumbs on the scale.  But then something strange happened starting in 2006.  The once-great correlation seemed to suddenly break in 2006, and it has not gotten itself restarted.  My guess is that rather than a breakdown in this relationship between gold and inflation, something else is happening to explain this: all of the heuristic adjustments, reweightings, and other monkeying with the calculations of the CPI have resulted in a huge misreporting of the actual inflation that we are all noticing. 

John Williams of Shadow Government Statistics has done a lot of work on unwinding all of the adjustments that the US government statisticians have done over the years to "improve" the CPI calculations.  He finds a much higher inflation rate of 9.6% for the 12 months ending in February 2011, versus the BLS version at 2.1%.  So it just may be that the relationship between gold and inflation has not really broken down. 

The breakdown is instead in the way that our government keeps track of it, which is sad, but not really a surprise.  It is time for Bernanke and others to wake up to the message that gold is screaming to anyone willing to listen. 

Tom McClellan
Editor, The McClellan Market Report

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