Add price alert

What effect does inflation have on the price of gold?

Published by Karl Martin Karus in category Articles on 03.12.2021
Gold price (XAU-SEK)
24225,10 SEK/oz
- 231,70 SEK
Silver price (XAG-SEK)
305,89 SEK/oz
- 1,94 SEK

There are probably few who have missed the fact that today we have inflation in both Sweden and Europe again. In Sweden this is now at 3.1 percent, in Europe at 4.1 percent while it is at a high 6.2 percent in the US, all figures on an annual basis. In the United States, inflation reached its highest level in more than 30 years, and the gold responded by bursting past the previous resistance level of $ 1,835 per troy ounce on November 10, 2021.

Whether inflation is here to stay is still too early to say, but gold has always proved to be a good insurance against inflation. There is no guarantee that this will be the case this time as well, but it is always good to take a closer look at inflation and its impact on both the Swedish krona, the price of gold and the US dollar. The US Dollar is the currency in which gold is traded internationally.

The gold markets are just trying to understand …

The US Federal Reserve (Fed) is about to start phasing out its bond buying program. At the same time, fixed income traders are looking at Fed Fund Futures, which indicates that the market is looking at December 2022 for the next Fed rate hike.

The gold market seemed confused in October, unable to decide

  1. whether a tighter Fed policy poses a risk to the economy; and
  2. whether inflation is transient or long-term.

Inflation uncertainty does not seem to help

Gold reacts clearly to inflationary pressures. However, this has been offset by a belief in the market that a tighter Fed policy will hold back inflation and that the economy is robust enough to withstand higher interest rates.

The confusion in how to interpret gold’s response during this Fed transition period will require patience. Many market analysts believe that there is a significant risk that the liquidity-driven economy and the stock market may fail once the Fed goes to drain liquidity. In addition, many market analysts believe that structural changes in the economy will lead to a multi-year inflation cycle.

Historically, inflation has always benefited those who have owned physical gold.

Support still in place for higher gold prices

A longer view a positive perspective on the gold price. From 2013 to 2019, the gold price was fixed in a range between $ 1,150 and $ 1,360 per ounce. Gold broke out of this range in mid-2019 when the US Federal Reserve began lowering interest rates. The gold market never looked back. While the gold price did not reach such a high that it exceeded $ 2,000 per troy ounce, current levels of around $ 1,800 are a good price.

The gold price has held steady despite the Fed tightening expectations, higher returns, strength in the US dollar, competition from other asset classes and sustained net sales from exchange-traded gold bars. This suggests that gold is backed by a core of investors who see the need for investment that can help protect their wealth from unwanted risks.

The US Treasury Department reported that the budget deficit in 2021 was $ 2.77 trillion, compared to the previous year’s $ 3.1 trillion. The Congressional Budget Office estimates that the deficit will reach $ 1.15 trillion by 2022.

Fear of inflation increases the value of both gold and the US dollar

The stock market is booming and despite uncertainty about the economy, Wall Street is convinced that the stock market can continue to move forward. But as inflation rises, there is also an undercurrent of concern about what the future has to offer.

Do you want proof? Just look at the recent rise in gold and the US dollar. The gold price is now trading at its highest level in five months, while the US dollar has not been this strong since July 2020.

The trigger for the recent rise in gold is data last week which showed that US consumer prices are rising at the fastest pace in three decades. Companies such as food manufacturer Tyson Foods have indicated that they do not expect inflation to ease any time soon, and they are likely to continue to raise prices. Then came information about a new variant of the Corona virus from South Africa that lowered the stock markets around the world.

To break it down: Gold is a favorite among investors who want to protect themselves against the long-term effects of inflation. It is a material asset with a limited supply, which makes it less vulnerable to erosion of the value of money caused by rising prices.

The inflation outlook also drives money managers against the US dollar. Efforts are growing that the Federal Reserve may need to raise interest rates next year to keep prices on track. It could increase returns on assets such as US government bonds – which investors would need more dollars to pour into.

Investors most recently faced inflation risk in the early to mid-2000s, and the most notable inflation occurred in the 1970s. Many investors today may feel ill-prepared and not know exactly how to handle this risk, which also means that they may not be correctly positioned to react to a protracted inflation environment. A quick search on the internet confirms that inflation has been a popular topic during this recent market cycle, which began in early 2020 when the pandemic began.

What is causing this recent period of inflation?

Current inflation is caused by several factors converging at the same time. Unmatched monetary and fiscal policy to push the global economy to pre-pandemic levels combined with pent-up demand and supply constraints has led to current inflationary pressures.

To go back to the most basic, there are three general types of inflation: demand (pull), cost (push) and built-in. What primarily started as a demand environment due to the reopening of the economy after the pandemic can now turn into a cost scenario as restrictions in the supply chain and rising input costs for producers become more prominent. Elements of both that occur simultaneously help to fuel the persistent inflation fire.

The bigger question, and the one that may well determine the long-term effect, is whether the buying behaviour has already been adjusted when price increases are reflected in everyday life. This is called built-in inflation. If consumers believe that prices will continue to rise, they can psychologically go and buy products in surplus today and, in addition, they can demand higher wages to reflect these inflation expectations. As this mindset becomes more pervasive for both consumers and producers, it is likely to prolong inflationary pressures.

Consumer expectations point to inflation concerns

Source: New York Fed Survey of Consumer Expectations. Data as of 31 July 2021.

What do the latest figures indicate?

Inflation is widening, and this challenges the transitory inflation narrative. Over the past year, US inflation (measured by the CPI) increased by 6.2%, the US producer price index (PPI) rose by 8.6% and the EU CPI (measured by the harmonized consumer price index) reached a 13-year high of 4.1%. The price index for personal consumption expenditure rose by 4.4% compared with the previous year, the highest level in 30 years. Core PCE, which removes volatile energy and food components, is the Federal Reserve’s preferred measure of inflation and has set 2% as the target level. The Core PCE Index is up 3.6% from last year.

Where does the Fed stand on inflation at the moment?

Over the past year, ongoing comments from the Fed have largely presented the transitory perspective, and only recently has the Fed changed its message somewhat. While the idea of downsizing and raising interest rates has been discussed as anti-inflationary measures in more explicit terms in recent times, it seems that the Fed has not completely abandoned its transitory inflation stance.


Federal Reserve Chairman Jerome Powell told a congressional committee on September 27, 2021: “As the economy continues to reopen and spending recovers, we see upward pressure on prices, especially due to supply bottlenecks in some sectors. These effects have been greater and longer than expected, but they will slow down, and when they do, inflation is expected to fall back towards our long-term target of 2%.

Historically, gold has been a store of value. We now see a high inflation rate in the US, while others say that the so-called core inflation in Sweden is not quite as high. Since the gold price is set in dollars and not in kronor, this means that dollars that are invested in gold, all other things being equal, have a good inflation hedge in the form of gold.

Where does the Swedish Riksbank stand when it comes to inflation at the moment?

Swedish inflation is now at its highest level in thirteen years, fueled by rising food prices, higher costs for electricity and fuel. However, this is not sufficient for the interest rate to be raised, says the Riksbank. Despite the fact that the Swedish economy is now almost back at pre-pandemic levels, the Riksbank believes that the economy needs further stimulus. For that reason, they do not release the accelerator pedal. The Governor of the Riksbank, Ingves, commented that he sees that the inflation rate will fall by the turn of the year. On the other hand, it is his job to try to calm the market, and he can under no circumstances say otherwise.

Note that everything else being equal, an investment in gold means that your savings retain their purchasing power. With inflation, the crowns lose purchasing power, and then gold serves as a protection of purchasing power.

If inflation is here to stay, how should investors adjust their portfolios?

Real assets, including natural resources and raw materials, have historically performed well in these market environments. Gold is one of the simplest real assets that can be traded for an individual.

Let us examine the last two major periods of high inflation, in the 1970s and early 2000s.

Average 12-month real return when the CPI is at or above certain levels (1969-1981)

Source: Bloomberg. Past performance is no guarantee of future results

The lack of a long index history limits some of the data availability for certain asset classes when looking at the 1970s period. But commodities and gold clearly outperform equities and bonds above rising inflation levels. Extended data are available for the next inflation period, which took place in the early 2000s.

Average 12-month real return when the CPI is at or above certain levels (2003-2007)

Source: Bloomberg. Past performance is no guarantee of future results

After a long period of dormancy, commodities such as precious metals have recovered significantly and are one of the best-performing asset classes in the recent market cycle. Despite this excess return, many investors are still underweighted and therefore may not be properly positioned to offset inflation. In fact, the weighting of energy and materials in the S&P 500 has decreased as the commodity market has recovered.

How does the concern affect the slowdown in global growth in natural resources and raw materials?

There is concern that global growth is slowing. In October, the International Monetary Fund (IMF) revised its global growth forecast downwards from 6% in July to 5.9% and from 7% to 6% specifically for the United States. In addition, the US jobs report for September was below expectations for the second month in a row.

Of course, the simultaneous occurrence of declining global growth together with rising inflation, or stagflation, is an important factor that investors should consider. But if history is any evidence, the most recent period when this occurred was in the 1970s, and as mentioned above, these asset classes performed well.

Core inflation, which excludes energy and food, rose by 4.6%, the fastest pace in 30 years. Food prices rose by 5.3% year-on-year, the largest increase since January 2009, while petrol prices rose by 6.1%, the largest increase since March.

Inflation is not transitory

It looks more and more like the Federal Reserve is making or can make a political mistake. The central bank has claimed that inflation is transient, but the October CPI print indicates that the perception is incorrect. Analyst Edward Moya from OANDA said in an email that it may take a few hotter inflation reports than expected before the Fed will reverse its view that current inflation is only transitory.

Analyst Ole Hansen at Saxo Bank noted that US 10-year real interest rates supported the gold rally and fell to the lowest ever at -1.25%. But gold’s ability to move higher despite the dollar reaching its highest level in 16 months has caught the market’s attention.

Hansen said that this may be a sign that the market is finally waking up to the realization that inflation is a long-term problem rather than a temporary one. As a result, gold has some catching up compared to current real return levels.

Following the recent FOMC meeting, market watchers began to believe that the Fed would ignore soaring inflation and focus instead on the labor market. Moya said in an email that more than 4 million jobs still need to be filled for the economy to reach levels before the pandemic. However, Hansen believes that inflation in October was warm enough that it will shake the market and increase expectations of an interest rate hike by the Fed next year.

Where is the gold price going now?

Gold had been in the $ 1,800 per ounce range for some time and had not broken above $ 1,835 since July. According to Hansen, this fact supported a dislocation between falling real returns and interval-bound gold. Although the dollar remains strong, he claims that gold has a lot to catch up with. Hansen believes that the gold price can top $ 1,900 per ounce with real returns around current levels.

For now, gold seems to face some resistance at about $ 1,865 per ounce, as the price has gone up to that level a few times in trading on Thursday but has consistently failed to break through that level. Colin Cieszynski told Kitco News that he sees the gold price rise to $ 1,920 per ounce.

Hansen added that too high inflation increased the number of expected interest rate hikes next year to two and a half. ”

Hansen added that too high inflation increased the number of expected interest rate hikes next year to two and a half. ”

The dollar also rose across the board, and the euro versus the dollar fell below the psychological level of 1.15 euros for the first time since July 2020. In addition, Hansen pointed out that the gold’s newfound strength and ability to climb despite the strong dollar helped the yellow metal reach a year maximum in euros of 1,625 euros per ounce.

Inflation hedging

Thanks to the new inflation concerns, gold prices are trading at the highest level of around five months. Bob Haberkorn from RJO Futures told Kitco News that inflation is here to stay and that it will only get worse. He also said that if gold were to pick up, it would be due to the new fear of inflation.

Inflation, which peaked in 30 years, was music to gold traders’ ears,” Moya said in an email. “The way the gold trade is developing looks mostly bullish. The recovery in the labor market is likely to take longer than a few months for the Fed to say the mission has been achieved with maximum employment, and price pressures will continue to trigger inflation hedging for precious metals. If the Fed makes a political mistake and must quickly raise interest rates and send the economy into a recession, it should be an environment where gold surpasses equities. ”

He expects the gold momentum to remain in place if real interest rates continue to fall, but gold is not the only inflation hedge. Analysts also point to price measures in bitcoin as a sign that investors are also turning to the cryptocurrency as an inflation hedge.

Although both US interest rates and the dollar have risen recently, gold seems to have found its way and is focusing on the worrying inflation picture instead,” said Ed Meir, a metal-focused consultant at brokerage firm ED&F Man Capital Markets, in a comment.

Gold price (XAU-SEK)
24225,10 SEK/oz
- 231,70 SEK
Silver price (XAG-SEK)
305,89 SEK/oz
- 1,94 SEK

You might also like to read