Is Gold Following Expected Inflation?

As I wrote last week, following the climatic-type selling we saw in gold/silver, you typically get a reflex-rally that occurs out of the vacuum left by selling exhaustion. This rally is then met by further selling and a retrace ensues to the prior extreme low -- holding above this low (higher low) for it to be a bullish sign. The rally then continues and a double-bottom (W-shaped) is formed.

Note in the hourly futures chart for gold below, it shows what looks to be a W-shaped bottom forming.

Source: Finviz.com

However looking at the daily chart for gold, you can more clearly see the extensive technical damage inflicted on the metal:

Source: Finviz.com

Based on rough approximations in the above chart, the decline from 1550 to 1350 puts the 50% retrace at 1450, the half-way point often being where a rally rolls over. But the 1550 level itself, which as you can see above was prior support, has now become resistance or another headwind.

I would add that in the Fibonacci chart below, when considering gold’s high of 1795 last year and low bid of 1320 last week, the 50% retrace is 1558, or very close to that 1550 level.

Source: Bloomberg

The bottom line is 1) what we’re seeing occurring with the price of gold over the last several days is not surprising and is often what occurs after a big selloff, and 2) gold faces much overhead resistance from here. I would expect declining retracements off any rallies as these resistance levels are met and even broken – all part of the technical mending process.

As for expected inflation, I thought the charts below were interesting. The upper inset is gold and the lower is expected inflation based on 5yr5yr forward breakeven rates. In January, future inflation expectations broke down through the 2.90% level and continued to decline below the 2.80% level. At the same time, gold weakened but then finally broke down.

Source: Bloomberg

I’m not sure of the degree of correlation between this inflation metric and gold, but looking at the multi-year chart below, they do look positively correlated. Interesting to see the recent spike in expected inflation with gold’s recent rally.

Source: Bloomberg

Judging from history, as long as this 5yr5yr inflation trend remains down or declining, it's not good for gold. However, I believe the Fed has upped its target inflation rate from 2% to 3% and as I've shown before, we know the Fed's balance sheet continues to expand. That said I have to think Bernanke is keeping a close eye on this 5yr5yr inflation chart, definitely preferring that expected inflation reverts back to the 3% level -- which would be bullish for gold. 

But -- and it's a big "but" -- expected inflation had been declining since late January in conjunction with Fed balance sheet expansion going through the roof. Question: can the Fed do enough to get expected inflation back to the 3% level, or is it pushing on a string?