By Brian S. Wesbury, Chief Investment Strategist
and Bill Mulvihill, Senior Economist

We are not diehard gold bugs, but that does not mean we don't watch its price very closely. Gold is a highly accurate, but not perfect, measuring stick of Fed policy. Gold prices declined from $400/oz. in 1996 to $255/oz. in early-2001, foreshadowing US issues with deflation early in the decade. Today, with prices over $500/oz., the gold market is signaling inflation.

Ridiculous, the bond bears say, "if gold is right, why are 10-year Treasury bonds yielding just 4.5%?" To them, a flat yield curve signals a tight monetary policy, while the spread between TIPS yields and regular Treasury yields remains stable near 2%. These bond bears think gold is wrong and bonds are right.

So, which market should we believe? The short answer is: gold. History shows that gold is a much better forecaster than the bond market. During previous periods of divergence between the two indicators, gold has been a more sensitive indicator of Federal Reserve policy.

Between December 1975 and December 1977, the 10-year Treasury bond yield fell from 8.0% to 7.7%, while gold prices increased from $130/oz. to $161/oz. The Fed held the funds rate relatively steady, near 4.75% for the first 16 months of this period and then lifted it sharply to 6.5% during the final eight months of 1977. This flattened the yield curve sharply, but gold prices continued to climb.

In other words, the 1976-1977 period looks a great deal like today. Gold was right, bonds were wrong - inflation surged, and eventually so did bond yields.

In 1999 and 2000, the opposite occurred. Gold prices fell, while bond yields rose, yet deflationary fears swept the nation in the early 2000s. The 10-year Treasury yield eventually fell to a low of 3.1% in early 2003.

Since then, following very aggressive Fed ease, gold prices have surged to their recent highs. If gold were the only price to have risen, we might be able to ignore it. But, "core" inflation has climbed from roughly 1% to 2%, oil and housing prices have surged, and the Journal of Commerce commodity price index (which does not include oil), hit a record high in October.

Low bond yields remain a conundrum that we can only explain by pointing to the Fed. As we saw in the 1970s, when the Fed holds real interest rates artificially low, long-term bond yields are also suppressed. As the Fed lifts rates, we expect bond yields to rise across the duration spectrum, even as the yield curve remains flat.

In the end, gold prices have been a much better indicator of Fed policy than bond yields, and gold is signaling more inflationary pressures ahead.

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IMHO, US ne očekuje značajniji porast inflacije, u utorak će FED dignuti kamate na 4.25%, ali i najaviti kako je to posljednje podizanje kamata, te time potaknuti lagani santa clause rally. Ekonomski podaci ne pokazuju tendenciju porasta inflacije, makar nije zgoreg znati informacije koje iznose navedeni financijski analitičari.