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Precious metals gained on Friday amid the G-20 weekend summit, geopolitical concerns, and inflationary pressures. Gold traded at $1390 per ounce while silver was at $32.65 per ounce. So far, February has been an interesting month for gold. The development in emerging markets, inflationary pressures in the United States and lingering geopolitical worries have all contributed to its rally.

Gold prices held steady as the People’s Bank of China did what it can do combat inflationary pressures at home. The price of gold was almost unchanged after reports confirmed that the PBOC raised its reserve ratios to 50 points which will become effective on Feb. 24, 2011.

It should be noted that the gold prices were firm despite the fact that policymakers in China implemented a series of tactics, even interest rate hikes, to contain inflation and cool its overheating economy. Food prices in China are of particular concern because an average working class Chinese allocates a high proportion of their income to buy food.

Fed Keeps Its Cool amid Inflation Concerns

While Chinese policymakers are ramping up their fight against inflation, Fed Chairman Ben Bernanke doesn’t seem to think that deviating from his current policy of quantitative easing and zero interest rate would be a good move at this time. Aside from buoying gold prices, it also helped maintain the price of almost all asset classes.

In the United States, precious metals are doing well because the Fed is keeping its commitment to keep monetary policies loose in spite of skyrocketing commodity prices. Silver performed better than gold this month, appreciating by 13%. Meanwhile, gold price only increased by 4% in February. At its current rate, silver is trading at its peak level since 1980 when the Hunt Brothers tried to dominate the market, pushing the price of silver to $50.

High inflation brings one of George Washington’s statements to mind, ‘paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” Around a century afterwards, the effects of inflation are distinctly apparent. Today, a dollar is worth less than 2 cents in purchasing power than in 1913.

As the wholesale prices rose broadly in January, the fear of inflation is once against stoked. According to the Bureau of Labor Statistics, the producer price index of finished goods, excluding energy and food, rose to 0.5% last month. This is significantly higher than the 0.2% increase that economists had expected in October 2008. The overall index for finished products (goods delivered to retail stores) increased 0.8%.

Inflation in the West will be ‘Subdued”

Right now, concerns about inflation in the West are mainly centered on rising energy and food crises due to the demand from emerging markets. Poor harvests limited agricultural output, further contributing to price volatility. The Federal Reserve has focused more on core inflation due to the volatility of energy and food prices. Paper products, jewelry, pharmaceuticals, and jewelry saw some of the largest price increase last month. Joel Naroff of Naroff Economic Advisors said that, ‘What’s worrisome is the accelerating increase in non-energy and non-food prices.”

Although pharmaceuticals accounted for an estimated 40% of wholesale prince increases, Paul Ashworth of Capital Economics said that the trend is unlikely to result to sustained rise in inflation because drug prices can be volatile. Core finished product prices are only up 1.6% from last year. Ashworth further added that retailers cannot pass along these price increases to consumers at this point despite strong retail sales the previous year.

However, Eugenio Aleman, a Wells Fargo economist, said that consumers will see higher prices eventually. There are already grocery, fashion, and other sellers who intend to raise prices to offset their costs. If this happens on a large enough scale, the Fed may need to raise short-term rates sooner or sell some of the Treasury bonds it has been hoarding to decrease long-term rates. If the Fed takes either course of action, recovery may be dampened.

In its January 25-26 meeting, the Fed reported that it projects inflation to be ‘subdued”. It expects the inflation to stay at 1.3-1.7% for 2011 and 1-2% through 2013. The economic growth forecast also increased to 3.4-3.9% from 3-3.6% in November. Some of the reasons cited include rising business investments, consumer spending, and factory output.

Despite this growth, the Fed said that unemployment will still be high at around 8.9%. Prevailing weakness in the construction sector, employer’s cautious hiring, and tight credit would hinder higher economic growth. Some Fed policymakers said that the recovery may prompt the Federal Reserve to shelve its plans to buy $600 billion worth of Treasuries by June. But other policymakers believe that the current outlook is not likely to change ‘enough” to prompt this action.

Gold and Silver Prices

In the short term, the correlation between the dollar and gold indicates that the strength of the greenback is one of the primary drivers of increasing gold prices. Take note of the medium-high 0.59 coefficient found on the 30-day column. Silver is correlated with stocks as is indicated by the 0.61 coefficient.

However, Fed’s low-interest-rate policy is not a short-term phenomenon, it’s a long-term one. As such it has implications for the precious metals market in the long run. In this case, let’s take a look at the long-term column – the 1500 trading day one. The correlation coefficients are negative and below -0.5 for gold, silver and mining stocks which means that weakening dollar will likely to influence these markets in a positive way over the following years.

Overall, the signal for precious metals at this time is bullish.

In the stock market, large-cap gold firms are raking in their earnings after a quarter that propelled gold prices to high highs. The CFO of Barrick Gold, Jamie Sokalsky, said ‘we’re not inclined to view gold price as being anywhere near the top.” Gold prices have recovered over half of its $118.72 slide from the all-time high last December 7, 2010 at $1,432.50 to its multi-month low of $1,313.78 on January 27, 2011. The price of gold is expected to experience its third weekly gain. It is poised to breach the $1,400 per ounce level once again.

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Thank you for reading.

Rosanne Lim

Sunshine Profits Contributing Author

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