2010-12-15

The Fed wants higher inflation

Breakeven inflation in the US, as implied by the US bond market, is edging higher. 2-year breakeven inflation is now at 1.02%, up from 0.65% less than a month ago. The Fed wants higher inflation. However, US unemployment is also edging higher which the Fed doesn’t want. While higher long-term rates are negative for precious metals and gold specifically, in relative
terms real interest rates remain very low and monetary conditions very accommodative.

We believe, using the Taylor rule as guidance, inflation must be close to 2% and unemployment closer to 7% before the Fed would even consider tighter monetary policy. In the mean time, gold especially should find good support. In the gold physical market buying remains absent. In fact, scrap and other selling are still outpacing buying interest. But as pointed out in our physical flow note last week, the physical market appears to start buying at "higher lows" than before. We
believe gold is still a buy on dips.

Gold support is at $1,388 and $1,370. Resistance is at $1,416 and $1,426.

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