Inflation Confusion (1)

Today, the Federal Reserve reported that CPI prices rose 0.4% in July, double the 0.2% increase in June.

[http://news.yahoo.com/s/ap/20060816/ap_on_bi_go_ec_fi/economy]

The media, in its latest spin, painted the report as a positive since the "core" CPI, which excludes food and energy, rose just 0.2%, after four straight months of 0.3% gains. According to AP economics writer Martin Crutsinger the lower core inflation "was likely to encourage officials at the Federal Reserve, who are counting on a slowing economy to reduce inflation pressures". Although the "core" CPI came in slightly lower than expected, it is worthwhile noting that a 0.2% monthly rate of inflation is 2.4% annualized, which is well above the 1 to 2% range targeted by the Fed.

It is important to remember that traders these days appear to be confused about inflation and its implications for the US Dollar and Gold. In a bizarre twist, during the last few weeks evidence of inflation was seen as being Dollar-positive and Gold-negative as traders focused more on the "cure", i.e., interest rate hikes, than on the inflation itself and its Dollar-destructive implications. During the last few months when inflation reared its ugly head in the official statistics, Dollar bulls harped on the interest rate differentials with other currencies that a Fed response to inflation would likely continue to support.

While it can be expected that this insanity of interpreting inflation as Dollar-positive should sooner or later dissipate, it is at least encouraging that Gold is up today on the news of the milder than expected inflation. At least the market is being consistent in its insanity.

Nevertheless, this "milder than expected" inflation data, combined with yesterday's PPI data which actually showed retreating inflation and the seeming outbreak of peace in Lebanon, may set the stage for some further declines in Gold in the short term. That wouldn't be a problem however as prices may need to fall to entice physical demand back from its recent slumber just in time for the annual "September Rise".

Current PM Exposure: 24% of portfolio.
Sentiment: Wait & See