HardAssetsInvestor

Written by Brad Zigler  |

December 06, 2010

Deciphering The Inflation Scorecard: Why Gold?

Details

Why use gold to track the strength of the U.S. dollar? Because it works.

Each Friday, the Desktop is given over to an Inflation Scorecard—a checklist of indicators that track the strength of the U.S. dollar.

This compendium often leaves readers scratching their heads, some wondering how these indicators are derived, while others question their importance.

An oft-asked question is, "Why the emphasis on gold?" Well, what better yardstick of dollar purchasing power than this age-old monetary standard? In fact, gold is at the heart of the Monetary Inflation Index that's monitored at the top of each day's Desktop column (more about this later). We offer details on the gold that, while not directly influencing inflation, give some context for the week's trading.

More often than not, readers wonder how to integrate these sometimes-disparate readings into a zeitgeist.

The holiday season's all about giving, so herein is Part One of a tutorial on the Scorecard's more abstruse indicators. In Part Two later this week, we'll provide a methodology that can be used to derive a personalized assessment of inflation risk.

Gold Market Summary: This is pretty much self-explanatory. First, the average pricing of London morning gold fixes is compared to the week's mean COMEX spot settlement. Generally, the average prices are pretty close. A wider spread—or "basis"—bespeaks the greater-than-usual volatility that often accompanies market turmoil. After all, a lot happens in the 11 hours between the fix and the final bell at COMEX. Below is a history of the COMEX gold basis (the red line). The yellow band represents a one-standard-deviation range.

COMEX Gold Basis

The week-over-week change in COMEX gold's average daily trading volume and open interest is offered to give readers a sense of the current depth and liquidity in gold futures. Volume simply represents the number of contracts that change hands in a given trading period. Open interest reflects the number of contracts outstanding. Think of open interest as potential volume—as contracts awaiting liquidation. A market trend is stronger if it's accompanied by increased volume and open interest.

The Scorecard also chronicles weekly changes in the level of COMEX inventories. The degree to which warehouse stocks cover the current market's open interest is tracked; in particular, the metal registered for immediate delivery.