Gold price bounces back on inflation worries

On Thursday, gold built on its solid gains since the end of a dismal May capitalizing on a weaker US dollar and real interest rates dipping to a one-year low as inflation picks up in the the world's largest economy.

In brisk afternoon trading on Thursday gold futures in New York for delivery in August, the most active contract, were trading at its high for the day of $1,274.40 an ounce, up 1% from yesterday's close. Year to date the metal is higher by just over 20%, the best start to a year in a decade.

The $70 an ounce leg up was sparked by Friday's non-farm payroll numbers which resulted in one of the biggest one-day jumps for the metal this this year.

The jobs numbers which showed the slowest gains in new positions in almost six years have postponed the likelihood of a rate cut at least beyond the summer. Higher interest rates raises the opportunity costs of holding gold as the metal provides no yield and any gains for investors is through price appreciation. The jobs data also hurt the dollar which usually moves in the opposite direction of the gold price.

"Markets may become increasingly concerned about the outlook for inflation should the Fed fall behind the curve"

In a research note Capital Economics analyst Simona Gambarini forecasts gold reaching $1,350 by the end of 2016. The independent research firm says while favourable currency movements have boosted the dollar gold price, higher inflation expectations is the main driver of the rally in the metal.

Gold price bounces back on inflation worries

Source: Capital Economics

The gold price has a close correlation to real interest rates (i.e. after adjusting for inflation – see chart) and with core inflation in the US now above 2% thanks in part to higher oil prices, real interest rates are forecast to stay at lower levels.

Gambarini says markets "may become increasingly concerned about the outlook for inflation should the Fed fall behind the curve":

"10-year Treasury Inflation-Protected Securities (TIPS) yields have fallen to their lowest level in over one year this week.

What’s more, elsewhere real interest rates have turned negative as Japan, Switzerland and the euro-zone embraced negative interest rate policies to stimulate their economies."