In addition to the speed at which the global economy is going to recover from the impact of the coronavirus pandemic, the other indicator that keeps analysts and investors around the world on edge is inflation. Its possible growth above 2% per year is a cause for concern and, at the same time, an opportunity for the gold market, an asset that provides excellent protection in times of high inflation. In this post we are going to see what relationship there is between inflation and gold.
The world gold market is currently watching the evolution of the inflation rate in the United States, which may decisively influence the future of the gold price and cause the Federal Reserve interest rates to rise again, after of many months immobilized around zero.
The latest estimates made by the Fed suggest that inflation will close the year at 2.25%, a quarter of a point above previous forecasts. The question is whether it will continue to increase during 2022, and at what rate.
What is inflation?
Inflation is understood as the general and sustained increase in the prices of goods and services in a country over a period of time, generally a year.
This increase causes less goods and services to be purchased with each monetary unit, that is, a loss of the purchasing power of the currency, whose real value as a means of exchange and unit of measurement of the economy decreases.
The level of inflation is measured by the Consumer Price Index (CPI) , which is made up of a ‘basket’ of goods and services that are considered representative of the structure of the economy of the country in question.
The monthly evolution of these prices is measured by a rate, CPI or ‘cost of living’, which generates an annual index that is the inflation rate.
In normal situations, this rate is one digit and less than 3%, which is known as moderate inflation.
The problem is when it starts growing at double or even triple digit levels. In this case, analysts speak of ‘galloping inflation’ , which becomes ‘hyperinflation’ when the index increases by 50% per month (almost 13,000% per year).
The countries that are in this last situation (Venezuela, Zimbabwe, Germany of the Weimar Republic, in the 20s of the last century) suffer a brutal devaluation of the currency, which loses practically all its value.
In fact, some of them had to issue bills worth up to a trillion currency units to offset the drop in currency.
Inflation and gold
What is the relationship between the inflation rate and gold? In a recent report, published on April 21 by the World Gold Council , this body elaborates on the relationship between the precious metal and this economic indicator.
According to the report, “as the global economy and financial markets begin to recover from the Covid-19 pandemic, the main concern for many investors is the new outlook for rising inflation. Especially in the United States, where investors have been accustomed to low inflation for more than three decades .
The reason for this increase is that the rapid recovery of the economy is causing supply tensions in many areas, which influences the price of raw materials.
In addition, the large increase in global debt, the million-dollar economic rescue plans launched by governments such as the United States and the permissive policy of central banks towards inflation suggest that it will grow.
Faced with this situation, the World Gold Council recalls that there are several factors that determine the effectiveness that an element of protection against inflation must have: sensitivity, confidence, cost, liquidity and diversification .
The analysis carried out by this organization between a series of investment assets and their ability to carry out a task of protecting investors’ portfolios in the face of rising inflation reveals that gold is one of the most consistent, always scoring first or second place in the various inflationary periods analyzed.
Gold as protection
The conclusion of this World Gold Council study is that “over the long term, gold acts as a key strategic asset in investors’ portfolios, not only because of its diversification benefits, but also because of its performance. Gold’s relationship to the money supply shows that the metal’s huge appreciation since 1971 makes sense. Its ability to protect against general price increases suggests that its long-term performance is always positive, something that few long-term investment portfolios today can boast .
Therefore, faced with an economic situation in which a rise in inflation above the expected limits is considered as a more than probable scenario, the best form of protection is to entrust part of our assets to physical gold .
The metal, in the form of coins or ingots, constitutes the best protection against rising prices and the consequent loss of purchasing power caused by the devaluation of ‘fiat’ currencies, or based on simple trust in the issuing central bank.
A lesson that many investors have learned throughout history and that should not be lost sight of at this time.
