The widespread assumption that gold protects investors against excessive inflation because gold prices rise as inflation surges has come under attack in a research paper published earlier this week.
A trio of university academics from Australia, the U.S., and Ireland questioned the conventional wisdom that gold acts as a hedge against inflation, and argued that that wisdom relied heavily on data from before 1985, and on 1982 data specifically.
But tracking the correlation between gold prices and the consumer price index over decades leads to the conclusion that gold didn’t work especially well as protection against inflation in the 1990s, said the paper. How sensitive gold prices are relative to inflation rates varies significantly, with gold becoming more sensitive if the U.S. dollar depreciates.
“Our analysis shows that a stable link between these variables [gold prices and inflation rates] does not exist,” reads the paper.
Still, the authors noted that gold prices and inflation rates have maintained stronger links in the years since 2000.
“The gold-inflation relationship is not stable,” said one author, Dr. Cetin Ciner of the University of North Carolina, to International Business Times. “There was a time, especially in the 1980s and 1990s, that gold markets did not care about inflation.”
“Gold sometimes is not sensitive to inflation at all, in times where markets believe that central banks have it [inflation] under control,” he continued.
But in extraordinary monetary conditions, where central banks print more money for economic stimulus, gold markets become hypersensitive to indications that inflation may spiral upwards, said Ciner.
Gold and inflation rates are part of a larger complex relationship, which also involves U.S. interest rates and the strength of the dollar. The paper found that interest rates predict exactly how sensitive gold prices are to inflation, a key point for market traders.
Previous research by the World Gold Council, however, has questioned how tightly U.S. interest rates and gold prices will stay connected, especially as emerging markets snap up a lot of physical gold over the coming decade.
Still, gold markets are now more concerned about potential Federal Reserve slowing its bond-buying activity, known as "tapering," and the latest U.S. unemployment figures than anything else.
Gold recently has fallen below the key $1,400/oz threshold, partly over brightening prospects for the U.S. economy, as shown in the Federal Reserve's Beige Book remarks earlier this week, said a recent HSBC Holdings PLC (LON:HSBA) research note.
If tapering works out, Cetin predicts that the gold market will care much less about inflation rates, given normal monetary conditions.
“The gold market will go back to more of its fundamentals, like central bank purchases, jewellery applications, and so forth, rather than focusing on the government printing money,” he said.
“We’ll go back to more normal times, and inflation will not be the only factor in that case, in my opinion,” he said.