Gold Price and the Inflation Connection

Gold is often considered a hedge against inflation, but that has not always proved to be the case. When real inflation rates experienced by the person in the street and by investment funds are distinctly negative, as they are at the moment, then this tends to be strongly positive for gold.

stacked gold coins with stock market screen

That is why the latest gold price weakness should not be a longstanding concern for the gold buyer.

Gold is a non-interest generating asset – a fact that is often seen as price negative when the economy is strong and real rates are positive. This tends to make other assets more attractive.

For the time being, the US Fed’s Federal Fund Rate is set at 0 to 0.25 percent, and could even become negative as in some European nations (probably unlikely) despite inflation trends seeming to be upwards, while the Fed continues to maintain that current high, and possibly even rising, inflation rates are only ‘transitory’.

Transitory they may well be as the world tries to get to grips with an exit from the economic rigors of the COVID-19 virus pandemic. Meanwhile costs associated with safety precautions will also be rising, and need to be compensated for in rising prices.

This is something of a ‘double whammy’ and a major contributor to cost inflation, which is not always picked up by some of the official inflation data statistics, but is very real nonetheless for the average consumer. These price increases may well be temporary in terms of ever-rising Index data, but prices are also unlikely to fall once increases have been implemented, and the rises may go on for much more time than the Fed had initially thought, as more businesses resume operations.

To an extent at least, the Fed has recognized that these inflationary pressures are likely to go on for longer than it had first suggested. But some well-respected observers have predicted that these pressures will accelerate and get worse before they begin to get better.

Some respite might come due to the new virus wave currently hitting parts of the USA, though, which could well slow the virus recovery situation down a little.

But it has to be recognized that Fed-imposed interest rates are remaining ultra-low while the inflation rate, according to most national data releases, is running at between 4 and 5 percent.

Some observers have suggested the real inflation rate is, in reality, upwards of 10 percent rather than what they see as the government-massaged lower figures announced in official data releases.

Be this as it may, both government data and unofficially calculated inflation statistics all put real interest rates into substantially negative territory and I am not sure why gold has not reacted accordingly and moved up, rather than stuttering as it seems to be at present.

Current buyer psychology, though, could tend towards ignoring even obvious downside risks and equities keep rising, while even the somewhat dubious (in my opinion) bitcoin phenomenon recovers some of its recently lost ground.

This is all something of a two-edged sword. The Fed is enormously reluctant to start raising interest rates until perhaps 2023 for fear of derailing any economic growth we may have been seeing and thereby precipitate a recession.

Interestingly, recent research by a well-regarded metals consultancy – New York’s CPM Group – has shown that buyers are unlikely to move away from gold unless and until real interest rates exceed around a positive 3 percent.

The way things are going at present that point may not be reached for several years yet. So gold may be seen as a good choice for the foreseeable future.

A degree of tapering of the Fed’s bond buying program may provide a short term downside for the yellow metal, but any delay in such could be positive for gold sentiment also. The recent coronavirus infection and mortality rate growth seen in the USA could well see this pushed out beyond current expectations.

If the American pullout from Afghanistan prompts some of the nation’s rivals on the world stage – notably China and Russia – to flex their muscles, then a degree of uncertainty arising from that might be another positive factor in favor of gold being seen as a safe haven.

All in all things thus look positive for the gold price going forwards, although current buying conditions could yet put a damper on the yellow metals’ short term growth prospects.

by Lawrence Williams

Lawrence Williams

Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.

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