Catch the Golden Goose

This article is published with permission from InvestmentU.com.

Gold got goosed 2 weeks in a row. Last week, it shot up $39 an ounce. That came on the heels of a $24 move the previous week. Could gold go higher from here?

Yes. I'll show you why.

Blame the Fed

Last week, the Fed signaled that it would stick with a near-zero interest rate policy for a good, long time. This means the Fed will likely continue to keep rates lower despite strong signs that inflation could be around the corner. This disappointed some traders (mostly gold bears) who thought the Fed would start to "normalize" its interest rate policy.

And so that provided the spark for gold's $39 move. But many forget that gold moved the week before the Fed announcement as well. So why'd that happen? The reason is counterintuitive. It's because sentiment got incredibly bearish.

I'll explain: The weekly Commitment of Traders report released by the Commodity Futures Trading Commission showed that the number of speculative shorts in gold was very high. When speculators bet all on one side, it's usually a sign that a bottom has formed, and gold will rebound from there. That's because when everybody turns bearish, there is no one left to sell.

Stoking the fires of inflation

And there's another good reason traders are buying gold now. I'm talking about fear of inflation.

Inflation is low—currently 2.1%, according to the Bureau of Labor Statistics. This is actually an uptick from the 1.1% hit in February.

Now, here's the scary news.

There are signs there is more inflation percolating in the system. Just look around you—anyone with eyes can see it. Airline fares are up 17% since February. Home prices have jumped 13.3% since January. Food prices are up a whopping 23% since December, using the Thomson Reuters/Jefferies CRB benchmark.

The biggest inflation risk is in energy prices. Gasoline prices are up 10% since December.

The price of Brent crude, to which the US gasoline price is linked, broke out last week giving us a target of $121. The rule of thumb is that an increase of $10 in the price of Brent crude oil tends to lead to an increase of $0.25 in the price of a gallon gas. And this breakout could mean we'll see the price of Brent crude rise nearly $20 in a little over a year.

So, heck yeah, that's inflationary.

This is why traders have suddenly rediscovered gold. They see inflationary forces heating up all around them. They see a Fed that is willing to keep interest rates lower for longer than anyone dreamed possible. They believe this is potentially rocket fuel for inflation. And historically, one of the ways people hedge against inflation is with gold.

Sentiment remains incredibly bearish

Now that we've seen gold jump, the move must already be priced in, right? Nope, I don't think so. The Perennially Wrong Boy's Choir of Wall Street still hates gold. Hates it!

Just weeks ago, French mega-bank Société Générale lowered its gold price target to $850. And it's in good company. Goldman Sachs issued a $1,050 gold target in January and has stuck with it. Moody's has a target of $900. And in April, Morgan Stanley said, "Gold won't see $1,300 again."

Oops! Gold closed at $1,314.70 on Friday.

Yet, those bearish forecasts are still on the table. Those banks, if they follow their own advice, are racking up losses. Boy, I'd hate to be a gold bear tossing and turning in a flop-sweat right about now. That ruins a good night's sleep. Eventually, they'll have to cover.

Hmm… I wonder what could happen to the price of gold when they do cover?

To the moon, Alice!

Sean Broderick is a resource strategist with The Oxford Club. To read more articles by Sean, visit here.

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