Why gold doesn’t need high inflation to perform well

Concerns about high levels of inflation are front page news again in 2022, not only in Australia, but in Europe, and in the United States, with consumer prices in the latter rising by more than 9% in the 12 months to end June 2022.

Across most of the developed world, inflation rates are now sitting at their highest level in decades. For most businesses, investors, and most importantly, households, it has been a rude awakening, with this inflation spike coming after a roughly 20-year period since the turn of the century in which, officially at least, inflation almost ceased to exist.

Indeed, so entrenched had low inflation become that some worried it would never return, with this sentiment best summed up in the below magazine cover from an April 2019 cover of Bloomberg Businessweek:

Yearly changes in inflation rates would go onto bottom barely 12 months after this magazine cover was published, with rates climbing ever since.

Inflation and gold

Gold has always been seen as an inflation hedge, and rightly so, given it has historically performed very well in periods where consumer prices are rising sharply.

Indeed, analysis conducted by The World Gold Council earlier this year found the gold price has risen by an average of 14% in USD terms, and 20% in AUD terms in years that inflation has averaged 3% or more.

Given it appears that we are in for several years of above average inflation, these historical performance figures bode well for gold demand, and for gold prices in the immediate future.
But what about when, or if, inflation dies away again? Will gold fail to perform? Is gold only an inflation hedge?

Gold and low inflation rates

The chart below shows the USD gold price, and the rolling 12-month change in inflation rates in the United States between 1970 and June 2022.

Chart: Annual changes in US inflation rates and the USD gold price 1970 to 2022

Source: US Federal Reserve, London Bullion Market Association

The table below uses the same data, highlighting annualised inflation rates and gold price movements over decade long periods, with the period from end 2010 to June 2022 combined.

Table: Change in gold prices and consumer prices by decade 1970 to 2022

Source: US Federal Reserve, London Bullion Market Association

The data highlights the fact that gold can do very well during periods of low inflation.

This stands out most notably when looking at the first decade of the new millennium (greyed area in table). In that ten-year period, the gold price soared from less than USD $275 per troy ounce to more than USD $1,400 per troy ounce, a return of almost 18% per annum.

This occurred despite average inflation rates that were barely above 2% per annum in that decade.

Indeed, if we take the entire time period from the turn of the century through to the end of June 2022, we find the gold price is up by more than 500% (+8.9% per annum), even though inflation has increased by just 2.6% per annum since the year 2000.

If gold was only meant to do well in periods of high inflation, it should have sunk, not risen strongly, over this time period.

World Gold Council studies reinforce the above analysis, with their 2022 “relevance of gold as a strategic asset” finding the precious metal has on average risen by over 7% in years inflation rates have been 3% or lower.

Why does gold do well when inflation is low?

Periods of low inflation, and indeed periods that see deflationary shocks, often bring problems of their own.

For example, during the bursting of the NASDAQ bubble some 20 years ago, through to the Global Financial Crisis of 2007 to 2009, and the initial stages of the COVID-19 pandemic, inflation rates fell.

But that wasn’t all that happened. Unemployment spiked, the stock market plunged, and the US economy fell into recession.

Given these developments, it’s no surprise gold prospered through these periods, even though they put downward pressure on inflation rates.

Conclusion

This blog is not attempting to say that inflation isn’t a relevant factor for gold, or that the higher inflation that we’ve started to see come into the market in the last twelve to eighteen months won’t support higher gold demand and higher gold prices going forward.

It almost certainly will.

Instead, the data in this blog highlights the fact that gold is not only an inflation hedge, and that the precious metal can still perform well in periods of low inflation.

Rather it is a zero-credit risk, highly Iiquid asset that has generated strong long-term returns and has proved to be an effective hedge against a range of unpleasant economic outcomes, of which high inflation is just one.

Even if inflation eventually eases, the precious metal can still play a valuable role in a portfolio.

Warm regards,

The ABC Bullion Team

Disclaimer: This document has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this document or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it. Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, ABC and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances. To the extent possible, ABC, its associated entities, and any of its or their officers, employees and agents accepts no liability for any loss or damage relating to any use or reliance on the information in this document. It is intended for the use of ABC clients and may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.