Understanding the Connection Between Gold Prices vs. Inflation
Peter Reagan

Gold is one of the most popular precious metals, as many regard it as a safe haven asset and a hedge against inflation. As a reliable store of value for thousands of years, many turn to gold to safeguard and preserve their wealth, especially during periods of economic instability. But what is the relationship between the price of gold vs. inflation? While no exact science breaks down the connection between gold prices vs. inflation, we can look at gold’s historical performance record to understand how inflationary pressures impacted its price. Continue reading to learn more about gold and inflation and how we can look at gold’s track record as an inflation hedge.

What is Inflation?

Inflation refers to the rate at which the price of goods and services rises over time, which reduces the purchasing power of fiat currencies, such as the U.S. dollar. So, as inflation increases, each unit of currency buys fewer goods, making living costs more expensive. Several government metrics measure inflation, including the Consumer Price Index (CPI) and Producer Price Index (PPI). The CPI measures the average price change consumers pay for a basket of goods, such as housing, food, or transportation. The PPI tracks changes in prices received by producers of goods and services, which reflects inflation at the production level. Understanding these economic indicators can help you gauge the current levels of inflation.

Inflation is typically measured as an annual percentage change. For example, a 3% inflation rate means that prices are, on average, 3% higher than they were a year ago. As noted, inflation reduces the value of money, meaning you’ll need more money to buy the same amount of goods and services over time. There are several common causes of inflation, including:

• Demand-pull inflation: When the demand for goods and services increases and outpaces supply, prices can rise. For example, during economic booms where consumers have more disposable income, demand and prices for goods can rise, causing inflation.
• Cost-push inflation: When production costs rise, such as increased wages or more expensive raw materials, businesses will pass those costs on to consumers. For example, if oil prices increase, transportation and manufacturing costs will rise, raising the price of goods and services.
• Built-in inflation: When workers or firms predict future inflation to rise, they may either demand higher wages or increase the price of goods and services, respectively, to compensate for anticipated losses. In turn, these reactionary expectations can cause inflation.

Various events and factors can lead to these different causes of inflation, such as monetary policies, supply chain disruptions, such as those seen during the COVID-19 pandemic, and global events where changes in international trade and commodity prices occur. Now that you understand the basics of inflation, let’s see how gold and inflation are connected.

Understanding Gold as an Investment

For centuries, gold has been a prized commodity, serving as a reliable store of value due to its unique characteristics. But why is gold valuable? Gold is durable, rare, divisible, and has intrinsic beauty, all of which add to its value. Across the globe, gold has been used as currency, jewelry, and a means for preserving wealth, as well as in various industrial uses for electronics, dentistry, and aerospace, thanks to its ability to resist corrosion and conduct electricity. Overall, gold’s universal acceptance and limited supply have cemented this precious metal as a trusted store of value and hedge against economic uncertainties.

When looking at gold as an investment, it’s important to understand the factors that drive its price. Several factors that impact gold prices include:

• Supply and demand: Gold is a tangible asset harvested from the earth. With a finite supply and a high demand from the jewelry and technology sectors, along with a rising demand as an investment in the form of coins, bars, and rounds, gold prices are heavily influenced by supply and demand.
• Geopolitical events: Along with scarcity contributing to its price, geopolitical events like wars and sanctions, along with periods of economic instability, drive up gold prices as investors seek to protect their wealth from volatility.
• Value of currency: Generally, gold prices are inversely related to the dollar. When the dollar weakens, gold prices can rise.

The Connection Between Gold Prices vs. Inflation

Gold is often deemed a safe haven asset due to its ability to retain its value, or even appreciate, during times of crisis and economic downturns. This is where the relationship between gold prices vs. inflation comes in. When inflation weakens the value of fiat currencies, such as the dollar, gold often maintains its purchasing power, serving as a hedge against inflation. We can see this when looking at historical gold price movements and how gold has responded during periods of inflation. Below are a few notable examples:

• Stagflation of the 1970s: With the end of the gold standard in 1971, gold was no longer linked to the U.S. dollar at $35 per ounce. After Nixon broke free from the gold standard, inflation spiked globally, with gold prices rising sharply between 1971 and 1980, reaching $900 per ounce in 1981.
• 2008 financial crisis: During the Great Recession, gold prices rose dramatically between 2008 and 2012, as many investors turned to gold to protect their savings from failing banks and the volatile economy.
• COVID-19 pandemic: Most recently, gold prices rose during the COVID-19 pandemic as global uncertainty skyrocketed, resulting in investors purchasing gold to protect their wealth.

Looking at the historical performance of gold shows the connection between gold and inflation. During some of the highest periods of inflation over the past several decades, gold’s annual returns rose and outperformed other assets, proving its ability to hedge against inflation.

What Economic Mechanics Link Gold with Inflation?

There are several economic mechanics that link gold with inflation, which help explain why gold is seen as an inflation hedge.

• Gold as a store of value: Perhaps the strongest mechanism that connects gold with inflation is gold’s ability to retain its value during economic turbulence. When fiat currencies lose value, tangible assets like gold are considered a store of value due to their limited supply, becoming a preferred investment to protect against the devaluation of other assets.
• Real interest rates: When real interest rates drop, which are the nominal interest rates adjusted for inflation, gold becomes more appealing to investors, as gold doesn’t earn interest.
• Currency devaluation: When a country’s currency weakens due to inflation and prices of goods and services rise, gold prices tend to rise due to demand for preserving wealth.
• Central bank policies: Central banks may increase their gold holdings during times of rising inflation, which, in turn, can drive up gold prices.

Gold vs. Inflation FAQs

Does gold always go up during inflation?

While the price of gold generally correlates with the rise of inflation, like any asset, it’s not guaranteed. For example, during the 1980s, gold prices fell more than the annual inflation rate due to strong economic growth and rising interest rates that made other assets popular. However, several factors are at play that can impact gold prices during inflation, such as monetary policies, geopolitical events, and investor sentiment.

What is the best way to invest in gold to hedge against inflation?

There are many benefits of precious metals like gold, such as the ability to hedge against inflation and preserve wealth. If you’re interested in taking advantage of gold’s benefits, you can make a cash purchase of gold for physical possession by buying gold from a reputable gold dealer. Through a cash purchase, your gold, whether you choose coins, bars, or rounds, will be sent directly to you, giving you the freedom to store and manage it how you’d prefer.

Another option for investing in gold to hedge against inflation is opening a precious metals IRA, which is a type of self-directed individual retirement account that allows you to purchase alternative assets like gold. Similar to conventional IRAs, you can open a Traditional Gold IRA, where you can enjoy tax-deferred growth, or a Gold Roth IRA, where you can enjoy tax-free growth and tax-free withdrawals during retirement.

Navigating Gold and Inflation

The relationship between gold prices vs. inflation is complex and shaped by various geopolitical, market, and economic factors. Historically, gold has served as a hedge against inflation during key periods like the stagnation of the 1970s, the financial crisis of 2008, and, most recently, the COVID-19 pandemic. This is because gold is seen as a store of value that can preserve purchasing power during periods of economic instability. As a tangible, finite asset, gold offers both security and stability, making it an attractive asset for those looking to safeguard their wealth. At Birch Gold Group, our Precious Metals Specialists can work with you to buy gold and other precious metals for placement in an IRA. Request a free information kit today to get started.

 

 

Peter Reagan is a seasoned financial market strategist at Birch Gold Group with over 15 years of experience in the precious metals industry. He has been featured in several leading publications, including Newsmax and Zerohedge. At Birch Gold Group, Peter leverages his deep market insights to help educate customers on how they can diversify their savings into gold and other precious metals. His commitment to education has made 

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