U.S. Inflation Goes Ballistic. What will gold and silver do?

Alert the media — three key measures of U.S. inflation have exceeded the Federal Reserve’s threshold of 2%.

What?!?!?!

Here’s a chart.

Trimmed Mean CPI (blue line), Cleveland Median CPI (gray line) and Core CPI (black line) are all above the 2% line.

The only one not above 2% is the core personal consumption expenditures (red line). But that’s near 1.75% and rising.

Last Thursday was the second time I’d come across that chart. This time, it included commentary along the lines of "The dollar will collapse; buy gold!"

Will it?

Should we?

Well, in light of last week’s Fed minutes, I think it’s worth exploring those questions … especially since the conclusions drawn in that commentary seem so rudimentary.

***

The thinking goes like this …

Inflation undermines the purchasing power of a currency. Indeed, as prices go up, things get more expensive. My 6-year-old can understand that.

But does inflation mean the price of the dollar will collapse?

I mean, the value of the U.S. dollar relative to other foreign currencies … or even the U.S. Dollar Index — does inflation mean that measure of the U.S. dollar will collapse?

Hardly.

Even if inflation continues higher, as the trajectories in the above chart suggest, there are many other variables to consider for the U.S. dollar.

The value of foreign currencies is perhaps the biggest wild card and difference-maker. Risk appetite ebbs and flows in global asset prices are another. And what about trade, where U.S. import prices don’t seem to be foreshadowing deflation at the moment?

Then, of course, there is monetary policy in the United States.

Fed minutes out last week showed an FOMC that was much closer to hiking rates in September than previously believed. Since the minutes were released, the odds of at least one rate hike through December 2016 have reached nearly 75%.

Yeehaw!

Right?

Well, if inflation is really an issue — which I suppose it is if it’s above 2% and the Fed has yet to normalize interest-rate policy — is it a stretch to believe the Fed will begin to normalize interest-rate policy?

Not really, unless other growth and activity measures implode. (That’s possible.)

Of course, rate hikes and/or expectations thereof will support the U.S. dollar … at least so far as it is valued relative to foreign currencies and other asset prices.

And that moves us nicely to the second question about whether to buy gold and precious metals to play the impending dollar collapse.

Answer: Don’t.

At least, not because you think the U.S. dollar is going to collapse.

I’m an advocate for using precious metals as strategic investments. But I am not an advocate for an imminent U.S. dollar collapse.

So throw that narrative out the window for now.

Instead, the narrative that includes the dollar and precious metals should hinge around two things, which could actually become one thing:

1. The reversal in Fed rate hike expectations (again)

2. A global market collapse

About that second item …

A global market collapse — let’s define it as an exodus of capital from risk assets — will produce safe-haven flows. Historically, the dollar and precious metals have served that role as safe-haven beneficiaries. Sometimes at the same time. Sometimes not.

You want to know what will happen this time …

As I said, the global market collapse has implications for Fed rate hike expectations. And vice versa.

A global market collapse would probably compel the Fed to backpedal yet again on its rate-hike pursuits, since its control over global dollar-based liquidity is the lifeblood of the global financial system. Conversely, a Fed rate hike could catalyze a reversal in capital flows. Considering that China is all of a sudden back on investors’ radar screen of worry, and emerging markets are still riding high on speculative capital flows this year, the likelihood of the Fed doing nothing remains high.

It is in that environment, a tentative Fed and uncertain global macro environment, where I think gold and silver could shine.

Actually, it’s precisely the environment we’ve been in all year. Gold and silver are up about 19% and 37% respectively because everything everywhere seems vulnerable to policy normalization.

So yeah, watch inflation. If U.S. inflation happens simultaneously with global growth stabilization expectations, then the Fed has a case … and the U.S. dollar will find yield support.

But if the Fed is pushed back onto its heels again (most likely), then look for a continuation of gold and silver’s strong performance to date.

Two weeks ago, the precious metals sold off rather sharply as the Fed rate-hike expectations were ratcheted higher. Have we been given a buying opportunity with precious metals?

You best consider it.

Do right,

JR Crooks

“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…