Inflation is the rate at which the general level of prices for goods and services rises subsequently eroding purchasing power. Central banks attempt to limit inflation and avoid deflation to keep the economy running smoothly.
Gold has long been considered a hedge against inflation. This means that as inflation rises and the purchasing power of currency declines, the value of gold typically increases.
During the 1970s, the United States experienced high inflation and gold prices soared from about $35 per ounce at the beginning of the decade to over $800 by 1980. During the 2008 financial crisis and later years of economic stimulus, gold prices increased significantly as investors sought protection against potential inflation.
During the COVID-19 pandemic governments released liquidity into the economy and gold prices surged to over $2000 per ounce in 2020. This was due to economic uncertainty and fears of inflation. The average price of gold has been rising ever since, with a peak of $2446 in June of 2024.
Overall, you can usually expect gold prices to rise during times of inflation.
Causes of Inflation
Inflation is a complex topic, but there are a few generally agreed upon contributors to inflation.
Demand-Pull Inflation
Demand-pull inflation occurs when the demand for goods and services exceeds supply. This imbalance drives prices up.
- Economic Growth: During periods of strong economic growth, consumer confidence and spending increase, leading to higher demand.
- Government Spending: Increased government spending on infrastructure, defense, and social programs can boost economic demand.
- Monetary Policy: When central banks lower interest rates or increase the money supply, borrowing becomes cheaper, leading to higher consumer and business spending.
Cost-Push Inflation
Cost-push inflation arises when the costs of production increase, leading to higher prices for finished goods and services.
- Rising Wages: Increases in wages, especially if not matched by productivity gains, raise the cost of production for businesses.
- Higher Raw Material Costs: Increases in the prices of raw materials such as oil, metals, and agricultural products can lead to higher production costs.
- Supply Chain Disruptions: Natural disasters, geopolitical tensions, or other disruptions can constrain supply chains, increasing production costs.
Gold as a Safe Haven Asset
Gold has been regarded as a safe haven asset for centuries, prized for preserving wealth and providing security in times of economic uncertainty such as inflationary periods. Unlike fiat currencies, which can be printed in unlimited quantities by central banks, gold has a limited supply. Gold is a physical commodity with intrinsic value, unlike paper assets whose value can be influenced by external factors like interest rates or market sentiment.
When real interest rates are negative (interest rates adjusted for inflation), holding gold becomes more attractive, further supporting its value. Including gold in an investment portfolio can reduce overall risk. Gold often has a low or negative correlation with other asset classes like stocks and bonds.
Gold and Hyperinflation
While economists may differ in their specific definitions, most agree that hyperinflation occurs when prices increase by more than 50% within a single month. Typically, hyperinflation is identified when the annualized inflation rate exceeds 14,000%.
Imagine your expenses skyrocketing in just one month while the value of your cash remains stagnant. In such scenarios, the average person would quickly deplete their savings and face severe financial hardship. However, those who hold gold fare better, as gold has consistently maintained its value throughout history.
Gold ETFs
Investing in ETFs is a way to take advantage of the gold market without having to physically hold the gold. A Gold ETF is an exchange-traded fund that aims to track the price of gold. It offers investors a way to invest in gold without the complexities of purchasing, storing, and insuring physical gold. This is a smart way to combat inflation in a simple way.
Gold ETFs are traded on major stock exchanges, making it easy for investors to buy and sell shares like any other stock. These ETFs are managed by financial institutions that handle the acquisition, storage, and insurance of the gold.
Global Acceptance
Gold is recognized and valued globally, making it a highly liquid asset. Investors can buy and sell gold almost anywhere in the world. Across different cultures and economies, gold is trusted as a reliable store of value, enhancing its appeal as a safe haven. Gold often performs well during geopolitical uncertainties, such as wars or political upheavals, when traditional markets may be underperforming.
Liquidity
Gold markets are highly liquid, allowing investors to convert their holdings into cash quickly. Gold is accessible to many investors, from small retail buyers to large institutional investors.
Gold’s track record during high inflation highlights its role as a safe haven asset. From the inflation of the 1970s to the economic challenges of the 2008 financial crisis and the COVID-19 pandemic, gold has shown it can preserve value and provide security for investors. In short, to conclude, when inflation rises, so does the price of gold.
