Bernanke On Gold: Higher Prices Reflect Commodity Fundamentals, Not Higher Inflation Expectations

During recent re-confirmation hearings for Federal Reserve Chairman Ben Bernanke, U.S. Senator Jim Bunning – a frequent critic of the Federal Reserve – asked Bernanke several questions about gold prices. Bunning’s questions appear targeted at prodding Bernanke into acknowledging that inflation expectations are much higher than the Federal Reserve’s current estimation. Bunning also uses high gold prices as an indicator of the public’s lack of confidence in the Federal Reserve and paper money.

Bernanke noted that the Federal Reserve does include gold prices in its many indicators of inflation expectations, although it does not have any specific threshold over which gold prices become “worrisome.” Bernanke asserted that the latest run-up in gold prices does not appear related to inflation expectations. Instead, he concluded that gold prices merely reflect the general increase in commodity prices. He also feels that these price increases are in-line with the fundamentals of the global economic recovery.

So, while Bernanke is not part of the consensus that is skeptical about current gold prices, he is also not worried about gold hitting record highs.

Here are the quotes from the exchange between Senator Bunning and Chairman Bernanke. See questions #6, 26, and 47 on pages 5, 14, and 24 of the transcript. (Emphases mine):

Senator Bunning’s first question regarding gold prices:

“Time and energy in macroeconomic analysis is spent attempting to measure business and consumer confidence. Confidence measures are part of macroeconomic forecasting and directly impact monetary policy decisions. Likewise, certain market movements reflect investor confidence or lack of confidence. Gold is at an all-time high because investors have lost confidence in policymakers’ handling of fiat currencies. How is the Fed incorporating this market information into its analytical framework? Does the lack of confidence in fiat currencies have the potential to impact monetary policy?”

Bernanke’s response:

“Gold is used for many purposes, including as a reserve asset, as an investment, and for use in electronics, automobiles, and jewelry. Thus, fluctuations in the price of gold can reflect changes in demand associated with any of these uses, as well as changes in supply. In monitoring the price of gold, the Federal Reserve must attempt to interpret which of these factors is responsible for its fluctuations at any point in time. One of the ways we do this is by consulting other indicators of market sentiment. A number of measures of expected future inflation in the United States, including measures taken from inflation-protected bonds and surveys of consumers and professional forecasters, have been well contained. Accordingly, increases in the price of gold do not appear to reflect increases in the expected future of U.S. inflation.”

Senator Bunning’s second question regarding gold prices:

“In response to a question posed by Chairman Dodd, you stated “we do not see at this point any extreme mis-valuations of assets in the United States.” Does that mean you believe the price of gold is not artificially inflated or out of line with fundamentals? If so, what does the rise in the gold price signify to you?”

Bernanke’s response:

“Gold is used for many purposes. It is an input into the production of electronics, automobiles, and jewelry; it is held as reserve asset by governments; and it represents an investment for private individuals. With fluctuations in the price of gold reflecting changes in demand associated with any of these uses, as well as changes in supply, it is extremely difficult to gauge whether or not price changes are consistent with fundamentals. The most recent increases in the price of gold likely reflect diverse influences, including investor concerns about the many uncertainties facing the global economy; however, it is also the case that the rise in gold prices has not been much out of line with the increases in other commodities. According to the Commodity Research Bureau, after fluctuating in a broad range for the previous 1-1/2 years, the price of gold has risen 22 percent since early July, while the CRB’s index of overall commodity prices has risen 17 percent. These increases appear to reflect the recovery of the global economy, and it is not clear they have been out of line with fundamentals.“

Senator Bunning’s third question regarding gold prices:

“What does the surge in gold mean to you? At what price level would it begin to worry you, if it doesn’t already? Does gold have any impact on the Fed’s policy deliberations?”

Bernanke’s response:

“As mentioned in response to questions #6 and #26, gold is used for many purposes. Movements in the price of gold are determined by changes in the demand for gold for its various uses and changes in supply conditions. Therefore, assessing why gold prices have recently risen and whether the increase is consistent with fundamentals is very difficult. Accordingly, it is also difficult to specify a particular level of the price of gold which, if exceeded, would indicate particularly worrisome developments. As also mentioned earlier, the Federal Reserve looks at a wide array of indicators of market sentiment and inflation expectations. Among those indicators is the price of gold, but for the reasons just noted, its movements are often harder to interpret than those of some of the other indicators. Nonetheless, we will continue to monitor the price of gold going forward.”

Be careful out there!

Full disclosure: long GLD, GG