Great expectations

not the novel, for inflation

The New York Fed published the results of their inflation expectations survey this morning. They have been doing this survey since 2013, so we have less than a decade’s worth of data to reflect upon. This being the case, it shouldn’t surprised anyone here that expectations are moving up. In fact, this is the 10th straight month of inflation expectation increases.

We continue to have new all-time highs in both short- and medium-term inflation expectations. The increase was driven by food (+0.8%), rent (+0.2%), medical care (+0.2%), and gas (+1.1%).

If you recall from Friday’s post last week, expectations mean a lot. Especially for gold. Gold is an emotionally driven investment. When investor fear losing capital, gold looks attractive. That is why the Fed has to be very careful managing inflation expectations. Which makes today’s report from the NY Fed is so important. It shows that people are beginning to expect higher inflation.

From Friday’s post:

If traders can roughly predict future inflation rates, they can plan for them and all is well. It is when inflation becomes unpredictable that investors fear for their portfolios and turn to gold.

On the heels of that post on Friday, Lance Roberts of RealInvestmentAdvice.com put out a post this morning talking about gold as an investment. He did some great analysis. His primary concern was that gold was not acting as the inflation hedge it was meant to be. Ultimately he came to the conclusion that there is nothing wrong with gold. That it is acting as it should. He stressed that the most important factor in owning gold is when to buy it. He is confident that the market for gold will change once investors realize their error in trusting the Fed to maintain control.

This is the reason having liquidity in your portfolio is so important. I never go all-in on anything. Having dry powder ready to go when an opportunity comes along is extremely important to me. If I’m all-in and an opportunity arises, I have to sell something in order to take advantage. When gold’s time comes, I want to be ready to get in.

Friday I said I was working on recreating Norman Fosback’s gold price model. I convinced the best mathematician I know (my sister) to help. I collected the data and she ran the regression model. The model’s predictability is based on a number called r-squared. The closer the model’s r-squared value is to 1.0, the better predictive value it has. With a value of 1.0, the model would be able to accurately predict 100% of all price movements.

Our initial run of Fosback’s model came in with an r-squared value of 0.50. This means the model is only so-so. It would not be of great predictive value. My sister was able to adjust some of the variables and improve the model to an r-squared of 0.61 but that still isn’t great. Running a model based solely on the M2 data resulted in an r-squared of 0.83. Now we are getting somewhere. Adding back in a few of the adjusted Fosback variables, the r-squared value hit 0.84. Here is a graph of the model over the actual gold price.

This modified Fosback gold price model is still 10 points below the model David from Live Better Now created. While it has good predictive value, it still misses a lot of the run-up from late 2010 through 2012. Currently this model predicts the value of gold today to be $2,000 per ounce.