Looking back on 2021 and 2022, gold produced an average annual growth rate of 1%. On the surface, this seems like a positive rate of return, but compare it with the average annual growth rate of US inflation as measured by the CPI (consumer prices index), which was 6.8%, and things appear less simple.

Since inflation eats away at the returns of any security in which you invest, it follows that gold prices did not even break even with inflation during this period.

For anyone poised to invest and involved in analyzing the returns of securities, if the effects of inflation are not taken into account, an unrealistic picture tends to emerge. Imagine you hear that a certain stock produced returns of 9% last year, but inflation was accelerating at a rate of 5%.

The real, or inflation-adjusted, returns of the stock were really about 4%, which sounds a lot different. This gauge estimates more accurately the financial benefits accrued by those who invest in the stock.

In 2022, the US Federal Reserve waged a sustained battle against inflation by hiking interest rates repeatedly. Now, with an end to the hiking-schedule in sight and a potential recession looming, inflation is still not bowing its head anywhere near the Fed target of 2%.

If the economic environment is still going to be clouded over by inflation, living together with sluggish growth (a combination that’s called stagflation, especially when accompanied by high unemployment), what does this mean for precious metals like gold and silver? Will gold returns be dwindled to nothing by the corrosive power of inflation? In order to answer, we need to understand what drives the prices of silver and gold in the first place.

What Moves Gold Prices?

Some people believe that higher inflation itself pushes up the price of gold. According to them, when inflation gets hotter, investors demand more gold, which pushes up its price. They bring a proof for their theory from data like this: In the eight worst years of US inflation between 1974 and 2008, gold prices rose by 14.9% year-over-year on average.

Others reject this argument on the grounds that there’s no proof the factor drawing up gold prices was inflation, in any direct sense. These analysts bring out data of their own, for example the following: Between 1980 and 1984, annual inflation rates averaged 6.5%, while gold prices actually dropped 10% per year on average.

The chief factors at work behind gold prices are really, according to this view, things like trends in futures markets trading, the forces influencing supply, trader sentiment, and interest rates.

It’s not really true, in other words, that gold is an inflation hedge at all. “A hedge against inflation would typically increase in value in line with the sharp rise in consumer prices”, explained Jason Porter of Scottish Heritage SG in March this year, “However, during some of the most recent, extreme moments of inflation in the US, gold has produced a negative return for investors”.

Stagflation and Gold Prices

If inflation won’t support gold trading prices, what does it mean for them, at least in our case, in 2023? A stagflationary environment, with lower interest rates, lackluster demand, and relentless inflation, “is the most bullish of bullish scenarios for gold”, says Peter Spina of GoldSeek.com, because “real interest rates are negative and there are very few sectors seeing any growth”.

When interest rates are lower, people tend to invest more in gold because the metal doesn’t yield any interest. And if the stock market won’t be stampeding ahead, traders will be looking for a safe-haven address for their funds, and that’s gold. Gold is called a safe haven because it draws investment in times when the economy looks shaky.

The highest gold futures have ever reached is $2,069.40, which happened on August 6th, 2020, but in mid-April this year they threatened to overtake that level. Strategists said the main reasons for this were messages from Fed policymakers that rate hikes should be slowed, the potential for a recession, as well as the weakening of the US dollar. On the presumption these three factors won’t quickly be disappearing, the outlook for gold could be bullish.

Wrapping Up

When April economic data showed the US economy was less robust, with unemployment claims going up, this “reinforced the market’s assessment that the cycle of interest rate hikes is nearing its end”, which may be bullish for gold demand, in the opinion of Heraeus’s Alexander Zumpfe. 

Another element driving demand is the increase in buying on the part of central banks, but also tech companies and jewelers. In the third quarter of 2022, gold demand surged as much as 28% year-over-year. This is also promising news for gold bulls.

Returning to our original point about using inflation-adjusted returns when deciding how to invest, it’s worth remembering that the nominal value of returns (which does not account for inflation) is still useful.

The reason is that, even though, say, gold failed in its battle against inflation back in 1984, it won’t necessarily behave in the same way this time around. Each historical moment is, in many ways, unique.

Sponsored Content