What Is Gold Looking For?

While there are a variety of technical factors at work in the recent movement of gold, its inability to break out beyond the year's limits is indicative of an uncertainty about inflation.

One can simplistically pin this on fears about what the Fed might or might not do concerning interest rates and about the further wind-down of QE3. Let's start with the latter first.

The supply of money - the stimulus that has been the hallmark of QE3 - has been declining steadily but modestly since its peak at $85 billion per month in paper buybacks. It stands currently at $35 billion per month. So accommodation has moved from "outrageously easy" to "easy." Yet, as we have seen, and as The Gold Forecast predicted, tapering has been good for gold (and recently for silver).

At first blush this seems counterintuitive. It is, on the contrary, perfectly explicable. The Fed is not acting in some sort of vacuum, or according to a set formula. It is reacting to forces in the economy, many of which it has little or no control of beyond being able to give a nudge this way or that.

What the pooh-bas at the Fed are seeing - and translating into action - is a recovering economy. It's too slow for most of us, but it is tangible. A growing economy means that there are more jobs, which in turn means there is more buying activity by consumers in the marketplace. That leads to inflation, or at least the worry about inflation. And, as we noted above, money is still pretty easy via QE3. If we had never heard the number $85 billion, we would think $35 billion is pretty hefty.

Interest rates are a bit trickier because they have been kept so low for so long. It's best to keep in mind that in 2005-06 inflation raced from around 2% per year to over 4% in a very short time. The Fed could not raise interest rates fast enough to quickly counter the trend, so inflation hedges became very attractive.

In fact, it was in early-to-mid 2005 that gold began its historic rise to 1900 with only one significant setback in the middle of 2008.

That is the fundamental scenario that we must keep an eye out for. And, since we can only view inflation through our rear-view mirror, (and our own sense of how much things are costing - gasoline right now, for instance), we have to look at other key movers of inflation.

The first is the creation of jobs. For investors in precious metals, that means looking for very robust growth. ADP, the private labor data surveyor, said today that the U.S. added 281,000 jobs in June. Let's say that number holds in the "official" Department of Labor numbers.

That means, if the trend continues, at least 3.3 million new jobs will be added in the next 12 months. Multiply that by roughly $40,000 per year and you'll see how much more income will be added to the consumer stream. And we can make some sort of guesses as to how much will be spent fast due to pent up demand by those workers. Additionally, less government costs will be involved in helping those people and the social costs of unemployment or underemployment will decline.

Harder to gauge is the level of wages among those already working. If demand for labor in the form of new openings is rising rapidly, chances are wages are rising too.

So, the core questions are: How many news jobs and how ell are they paying?

Meanwhile, gold today is still in the hands of technical resistance and the imminent July 4th holiday in the U.S.

As always, wishing you good trading,