Gold and inflation rate: A complex relationship

Gold is often seen by investors as a hedge against inflation, but the correlation between the two is often much more divergent than many would expect.

After the U.S. released its weakest initial jobless claims report since 2021 on Thursday, gold prices increased as investors searched for a haven asset. More importantly, the weak jobs report all but guarantees the Federal Reserve will cut interest rates at its meeting later this month — which should benefit gold as fixed-income securities become less attractive.

A lesson learned from 2020

The COVID-19 pandemic, which killed millions across the globe and caused financial havoc within the markets, was an event that many precious metals investors had long predicted — an event that would cause worldwide disruption and shake the foundation of fiat currency.

It didn’t exactly happen that way. 

At a time when world governments were printing more money than ever before, periods of deflation resulted largely because consumers had nowhere to go to consume. Americans were sitting on the largest savings balances in years, yet the price of precious metals remained flat.

Now years later, with pandemic concerns long gone, gold is rallying to all-time highs as U.S. money supply continues to increase.

Looking back further

A Forbes report says that between 1974 and 2008, there were eight years when the U.S. inflation rate was considered high. During that period, prices rose by an average of 14.9% year over year.

From 1980 to 1984, annual inflation averaged 6.5%, but prices fell 10% each year on average, the Forbes report states. Those returns underperformed real estate, commodities and the S&P 500 during that time.

Again, from 1988 to 1991, inflation averaged 4.6% but gold prices fell about 7.6% each year.

Inflation or fear hedge

One of the best inflation hedges historically has been in equities markets. The S&P 500, like most diversified assets, tends to rise with inflated prices and drop when prices drop. However, gold has strongly correlated with hedging against panic, fear, or economic and geopolitical unrest. When compared to the MSCI World Index, losing 34% in 33 days at the onset of the pandemic, gold’s breakeven performance during a time of turmoil showed where its true value lies.