Inflation is a constant force in most countries and is fueled by numerous factors that ultimately reduce the purchasing power of an economy. paper currencies. As a result of persistent inflation over the past few years, more investors have become… turning to gold as a safe haven asset and it worked quite well.
Over the past five years, gold has risen more than 80%, significantly outperforming other low-risk investment vehicles such as bonds and high-yield savings accounts. precious metal may rise with stock market rallies, but the lack of correlation also helps gold rise during market corrections.
Gold, like any other asset, does not always rise in price, but periods of higher inflation are often touted as price drivers for an alternative asset. But what role does inflation actually play in gold prices? Here’s what the data says.
Gold gains could outpace inflation
Gold’s 80% gain over the past five years is significantly higher than the rate of inflation over the same period. From 2019 to 2023, inflation increased by the following percentages:
- 2019: 1.81%
- 2020: 1.23%
- 2021: 4.70%
- 2022: 8.0%
- 2023: 4.12%
Data for all of 2024 will be available soon, but inflation this year has been lower than last year. From March 20, 2020 to August 7, 2020, gold skyrocketed, gaining more than 35% during that period. However, gold was not the only thing. Many assets were in strong demand as the Federal Reserve pumped more money into the economy while keeping interest rates at record lows.
Interestingly, the price of the precious metal remained relatively unchanged from August 7, 2020 to February 16, 2024 using the SPDR Gold Trust – gold ETF which tracks the price of gold bullion – as an indicator. Gold also had a bad year in 2022, despite record inflation, proving that the correlation between inflation and gold prices is not absolute.
Why High Inflation Isn’t Enough for a Gold Rally
Even during periods of increased inflation, gold prices may still struggle to make meaningful moves. This is because higher inflation is often combined with higher interest rates, which are designed to counteract inflation.
The Federal Reserve raised interest rates substantially in 2022, hampering gold’s rally. Without interest rate hikes, gold could have had a record year in 2022 amid 41 years of high inflation.
However, the Fed’s decision to begin cutting interest rates in the second half of 2024 has now led to a record year for the precious metal. Gold is up 37% over the past year, so the delayed benefits of rising interest rates are starting to show. That’s because as interest rates fall, gold faces less competition among assets as investors move away from income-producing instruments such as certificates of deposit and bonds.
However, higher inflation could create an environment where gold could perform well. The 1970s saw double-digit annual inflation rates, a trend that continued into 1980 and 1981. Even though interest rates were much higher than they are now, gold skyrocketed from $35 an ounce in 1971 to $850 an ounce. in 1980.
Why Inflation Rates Matter for Gold
Gold is a physical asset that will always have an intrinsic value. The precious metal has been a medium of exchange since 1500 BC. and played a vital role for civilization. The metal has many industrial and commercial uses. It is used in aerospace, dentistry, electronics, jewelry and other high-demand products and services.
Not only does gold have a high intrinsic value, but it is also a limited resource. The only way to find more gold is to mine it. Meanwhile, governments can easily print fiat currencies at will, which ultimately devalues those currencies over time.
Gold does not become less valuable just because there is more fiat currency in the monetary system. As money loses its purchasing power and inflation rises, investors have to pay more to get the same amount of gold.
This trend is not limited to gold. Inflation makes the US dollar less valuable in relation to all types of goods and services. For example, in 1971, Americans could buy 17 oranges for $6.39. In November 2024, 17 oranges could cost a consumer $20.23.
The intrinsic value of money continues to decline due to inflation, and purchasing power falls faster during periods of high inflation. Meanwhile, gold is a store of value. Just as food was much cheaper decades ago in nominal dollars, gold was also much cheaper decades ago.
Is gold a better inflation hedge than stocks?
Gold has performed well but is lagging behind S&P 500 Index and Nasdaq Composite over the past five years. While gold is up more than 80% during that period, the S&P 500 is up more than 92% and the tech-heavy Nasdaq Composite is up more than 126%. Some investors might look at these numbers and assume that index funds are the best option for hedging against inflation.
However, the value of gold as an inflation hedge is less complex than the value of each corporation that makes up the index. Businesses may struggle during inflation as customers have less cash to spend on non-essential purchases. They may even have to cut spending on essentials, which will slow the growth of many companies, even those in the consumer goods sector.
As the cost of living continues to rise, workers will also demand higher wages, which could put pressure on companies’ profits and limit the potential pool of employees. Too much inflation can hurt corporations, their employees and customers, and can ultimately hurt their stock prices.
On the other hand, too much inflation will never hurt gold. The precious metal will continue to rise in value, especially as fiat currencies collapse around it. Higher interest rates have kept gold steady in 2022 despite high inflation. However, stocks crashed that year, with the S&P 500 falling about 20% and the Nasdaq Composite falling 33%.
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