Wednesday, March 3rd, 2021

Gold vs Inflation: A historical perspective and the current environment for gold and inflation.


From a general standpoint of reference, gold prices and inflation is something that many investors consider when making portfolio decisions. The historical relationship of gold and inflation holds up from a general contextual point of view but is complicated by factors that remove the purity of the relationship. For this reason an investor needs to exercise discernment for investment timing decisions.

During times of uncertainty and panic gold does tend to appreciate when fear grips the marketplace because control mechanisms are unable to counteract short term emotional swings. Over the longer term there are many competing variables that further muddy the gold prices and inflation equation.  One of the major forces that is difficult to factor is the actions of central banks, governments and large institutions who hold reserves of gold. These institutions tend to hold massive reserves and if they decide to sell a portion of these reserves it can place downward pressure on the gold markets. Even during difficult times, a large quantity of gold hitting the marketplace at any one particular time can suppress gold prices. A good example of this is the selling that took place recently to fund central bank actions, bailouts and the offsetting transaction that occurred when Lehman Brothers was absorbed.

Gold Prices and Inflation

Gold Prices and Inflation

Many of the world’s hedge funds relied to a certain extent on the structural advantages of the carry trade to borrow at low interest rates and invest in higher yielding opportunities such as commodities. The subsequent actions of central banks whereby interest rates were lowered, a liquidity imitative, when in fact it is a solvency issue, resulted in an interest rate convergence that negated the advantages provided by enacted carry trade transactions. The selling that followed and the policies of Wall Street of credit denial to many hedge funds, and the release of oil from the strategic petroleum reserve prompted an unwinding of positions in order to free up available funds to meet operational and margin requirements. Situations such as this can impact gold prices tremendously when liquidation takes place.

Current economic policies also have an effect on the price of gold and inflation. The present policies in the US, and many western governments of low interest rates and money printing in response to the economic crisis have many people concerned about the future implications for gold value and inflation. With global macroeconomic events favoring investments in commodities, led primarily by the perceived Chinese demand, there is concern that rising prices and the devaluation of the US dollar in response to monetization polices provides a favorable environment for gold investing. Whilst there are deflationary forces to contend with, structural considerations, the usual shadow shenanigans, and the Bretton Woods issues, how well and to what degree money velocity can be limited is something for gold investors and traders to think about.

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[1] Gold is a “crisis hedge” not an inflation hedge

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