If Russia continues its invasion, its likely inflation levels will not diminish

Ever since gold hit a high of $2078 on March 3 traders and investors, viewing the market as overbought reacted by selling the precious yellow metal taking it lower. By Wednesday, March 16 gold futures traded to a low of $1896 before moving up slightly and consolidating between $1946 on the high side and $1910 on the low side. On Thursday of last week, gold regained some strength, trading to a high of $1960. On Friday it traded with a lower low and to a lower high. However, the selling pressure accelerated overseas in Australia yesterday and carried over into New York trading.

As of 5:21 PM EDT the April futures contract is currently down by $32.10 and fixed at $1922.10, after factoring in today’s decline of 1.64%. Chart 1 is a 240-minute candlestick chart beginning at the end of January. This chart contains two distinctly different data sets used for Fibonacci retracements. The longest of the two sets begins at the end of January when gold was trading at $1776 and concludes at $2076 the high achieved during the second week of March.

Currently, gold prices are just below the 50% retracement from this long data set. The second data set is based upon the second leg of this rally which began during the third week of February when gold was at $1877 up to the highs achieved at $2076 during the first week of March. The 78% retracement level occurs at $1921 which is one dollar below current pricing. Because these two different data sets have important levels approximately five dollars apart, creating a Fibonacci harmonic. Simply defined a harmonic is when different time cycles contain levels that are close to each other as seen in chart 1.

This recent price decline is the direct result of recent statements made by Federal Reserve members including Chairman Powell indicating an extremely aggressive and hawkish demeanor in regards to raising interest rates. Last week Chairman Powell opened the door for rate hikes of ½%rather than ¼% in an attempt to bring the current level of inflation down.

While it is true that rising interest rates will cause the economy to contract, individuals and companies reduce demand as they purchase fewer goods and services. There is a basic problem with this strategy. According to the CPI inflation index, inflationary pressures are close to 8%. The next report will be released on March 31 when the government reports on the inflationary numbers vis-à-vis the PCE index (Personal Consumption Expenditures). This is the preferred index used by the Federal Reserve because it omits both energy and food costs. Many analysts including myself believe that this index is unrealistic because it strips primary goods and services that are at the core of the current high inflationary numbers. However, the March report will almost certainly indicate that inflation is continuing to spiral higher.

The primary reason for this is the additional pressure placed on the production of food and energy, which are primary exports from Russia and Ukraine. As I spoke about last week it is highly unlikely that we will see inflationary pressures decline, given the current geopolitical tension between Russia and Ukraine and the demand for agricultural and energy products that the European Union imports from those two countries.

While the Fed can attempt to reduce the demand, it is the supply side that is at the root cause of recent spikes and inflation. Consumers will continue to need to buy food and continue to need the energy to heat their homes and drive their vehicles.

Until the geopolitical conflict comes to some sort of resolution, there is no possibility that we will see inflationary pressures diminish. I hope that it doesn’t spiral out of control to the levels of 1979 when inflation hit over 13%. The sad truth is that without a resolution to the conflict in Russia and Ukraine, that is highly likely.

Wishing you as always good trading,