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Excerpt reposted from 24hGold
Whilst many may argue that gold is an inflation hedge and therefore inflation is bullish for gold, in reality the dynamics at play here are not that simple.
In our view, gold is a currency. Therefore fluctuations in its price are largely based on its perceived value relative to other currencies. We would not suggest that its role as an inflation hedge is a primary reason for being long gold, since there are far more direct and efficient ways to hedge against inflation risk in this modern financial environment. We do however see currency devaluation as a primary reason to own gold. If one thought the Yen was going to strengthen against the dollar, then one would move USD holdings into JPY. If one thought the Yen was going to weaken against sterling, then one move JPY holdings into GBP. This environment is unique as across the world governments and central banks are trying to lower the value of their currencies. Therefore there is nowhere to go, except for gold which cannot be printed in an attempt to erode its value.
The US Federal Reserve has a dual mandate to both maintain price stability and full employment. This means their job is to prevent deflation and keep inflation in a tolerable range, plus ensure that unemployment is not too high.
Clearly the employment side of this mandate is not being met at present, with the latest US payroll data showing unemployment still at 9%. However the one thing holding the Fed back from further easing is inflation. We can therefore deduce that a drop in inflation would be very bullish for gold prices, as it would increase market expectations of more large scale asset purchases (LSAPs) by the Federal Reserve.
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