how does gold react to changes in inflation

Gold is closely intertwined with human history, being in turn flesh of the gods, catalyst of trade, vector of migration and monetary anchor. Today, while it no longer plays an official role in our monetary systems, gold continues to attract the interest of investors.

Some see it as a refuge when the economic-financial climate deteriorates, others as a hedge against fluctuations of the American dollar, and still others as a means of protecting oneself against inflation.

The Historical Significance of Gold

As inflation once again endangers the purchasing power of Western countries, we look back at moments in history marked by rising prices in order to determine its origin and understand its evolution.

Inflation Explained: Causes and Effects on the Economy

The inflation levels recorded in the United States and Europe in 2022 were among the highest since the 1980s.

We speak of high inflation when CPI inflation is above 3.5%. Inflation is low when the CPI is below 1.5%. Growth is high when the CLI is above 101.4 for high inflation scenarios and 100 for low inflation scenarios (the CLI threshold is lowered for the latter due to the low number of observations with lower inflation to 1.5 and a CLI greater than 101.4). Growth is considered low when the CLI is below 98.6. Historical performance is not an indication of future performance and any investment may lose its value.

The Role of Gold in an Inflationary Environment

With economic uncertainty and rising inflation on the horizon, investors and retirees are looking for better ways to protect their retirement funds in the case of market turmoil. Gold has been considered a safe haven and a hedge against inflation for centuries, but can gold really protect your savings from inflation?

Gold generally acts as a hedge against inflation in the (very) long term, but with certain exceptions depending on the overall economic context and the stage of the Fed’s monetary policy.

Hedging inflation by investing in gold is only theoretical though, especially in the short term. The price of gold often reacts to inflation figures, but this is not always the case. Although gold generally gains ground when the cost of living increases, this relationship has weakened somewhat since the 1970s. The relationship between the movement of gold and variations in price increases is indeed increasingly weak since that date.

Historical Analysis: Gold Prices vs. Inflation Rates

Why Gold is Considered a Hedge Against Inflation

Comparing Gold with Other Inflation Hedges

Professional investors believe that the main raw materials, gold and industrial metals are the best tools to protect themselves against inflation. Commodities are one of the best hedges against inflation. If we analyze historical data over the long term, commodities appear to be one of the asset classes most sensitive to inflation.

Segmenting inflation into its expected and unexpected components (the Treasury bill interest rate is commonly used to calculate expected inflation), unexpected inflation is the realized inflation rate minus the Treasury bill rate. Very few assets rise with unexpected inflation. In this context, commodities and gold are undoubtedly in a league of their own, with industrial metals excelling as a hedge against unexpected inflation. It is worth emphasizing that the inflation we have experienced over the past two years has largely been unexpected in nature.

Major commodities are also effective in protecting against expected inflation. Only U.S. Treasuries have as high a sensitivity to expected inflation as commodities. So, if inflation surprises subside, we may find that commodities remain an important tool for protection.

If inflation remains high, we may be stuck in a high inflation/low growth phase for longer than expected. This assumption is not bad for commodities. With the US dollar no longer appreciating, major commodities and gold have one less obstacle. Additionally, as US bond yields appear to have peaked, gold has also lost a hurdle.

Commodities are not just a protection against inflation

While inflation has been a major concern for investors over the past few years and may remain a significant factor in the near future, there are more reasons to allocate into commodities than inflation alone. Commodities generally have a low correlation with most other assets. It is therefore an interesting asset to use to diversify.

In fact, these low correlations persist even in times of crisis (i.e. when U.S. stocks fall more than 5% ). On average, in all the months that U.S. stocks have lost more than 5% since the 1960s, commodities have lost just 0.65%. In all the months in which U.S. stocks gained more than 5%, commodities gained 1.13%. These figures compare to -7.8% and 7.5%, respectively, for US stocks themselves. So while commodities are cyclical (meaning they tend to lose and gain broadly at the same time as stocks), the magnitude of these gains is significantly smaller. Investors fearing a decline in stocks can therefore protect themselves with a position in commodities.

Risks and Limitations of Relying on Gold

The Future of Gold in a Changing Economic Landscape