Over the last week commodity prices has dropped quite a bit – and especially the much watched gold price has been quite a bit under pressure.

A lot of the alarmists who seem to be suffering from permanent inflation paranoia have pointed to gold prices as a good (the best?) indicator for further inflation. Now gold prices are dropping sharply (in fact much in the same manner as prior to the collapse of Lehman Brothers in 2008). So shouldn’t the inflation alarmists now come out as deflation alarmists? Of course they should – at least if they want to be consistent.

While I certainly agree that market prices – including that of commodity prices – give us a lot of information about the stance of monetary policy (remember money matters and markets matter) I would also argue never just to look at one market price. So if a numbers of market indicators of monetary policy is pointing in the same direction then we can safely conclude that monetary policy is becoming tighter or looser, but one or two more or less random prices will not tell us that.

All prices – including the price of gold – is determined by supply and demand. By (just) observing the drop in gold prices we can not say whether it is driven by a shift in demand for gold or a shift in the supply of gold. Furthermore, if it indeed is driven by a drop in demand we can not say that this is a result of a drop in only the demand for gold or a general drop in overall demand (monetary tightening).

So while there is no doubt that the move in gold prices is telling us something and surely indicating that monetary conditions might be tightening further I would like to warn against drawing to clear conclusions from this drop in gold prices.

I hope the inflation alarmists will think in the same way once and if gold prices again start to rise.