High inflation expectations (the Expected CPI) [are] associated with a low for the gold/commodity ratio and a low for inflation expectations is associated with a high for the gold/commodity ratio.

The Expected CPI is determined by subtracting the yield on the 5-year TIPS (Treasury Inflation Protected Security) from the yield on the 5-year T-Note and, as such, is the average annual ?inflation? rate that the market expects the U.S. government to report over the next 5 years .

On the chart below the commodity/gold ratio (as opposed to the gold/commodity ratio) is compared to the ProShares Inflation Expectations ETF (RINF). The correlation clearly is strong, with commodities consistently outperforming gold when inflation expectations are rising and underperforming gold when inflation expectations are falling.

An implication of the above chart is that if inflation expectations are close to an intermediate-term bottom then the financial world is close to the start of a 6-12 month period during which the industrial metals perform better than gold. Alternatively, a further decline in inflation expectations (increasing fear of deflation) would lead to additional relative strength in gold.

The above message is the opposite of what most people believe about gold - that gold is a hedge against ?price inflation?. While gold tends to perform relatively well during periods when financial-system and/or economic confidence is on the decline…it isn't reasonable to expect gold to be a useful hedge against what generally is considered these days to be normal ?inflation?. In fact, part of the reason for the strong INVERSE relationship between the gold/commodity ratio and inflation expectations is the general view that ?inflation? of 2%-3% is beneficial.

Conclusion

Our view is that the next three months could be dicey, especially if there's another sharp decline in the stock market. However, we think that by the end of this year inflation expectations will be significantly higher and industrial metals such as copper and platinum will be significantly more expensive relative to gold.

Editor's Note: The above excerpts from the original article by Stephen Saville have been edited ([ ]) and abridged (?) for the sake of clarity and brevity. The author's views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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