Gold’s role as inflation hedge changing, analysts say
Gold is being put forward as a possible hedge to inflation, but analysts say the correlation may be weaker than the general view suggests.
The dollar price of gold has risen dramatically over the past decade. And it could be heading higher: recently, some analyst notes forecast the Troy ounce cost of the precious metal will push on past the $2,000 or even $2,500 level.
But what are the drivers of this price appreciation, and what is the strength of the correlation between inflation and gold? Certain data suggests that from the time the US moved towards the abandonment of the gold standard in the late 1960s through to about 2000, there was a clear correlation between rates of US consumer price inflation and the price of gold.
But since 2000, there has been a divergence, particularly in recent times, between the direction of US CPI and the price of gold. The former has been heading inexorably down since the global financial crisis and weakness in the US economy, while the latter has continued to rise.
One explanation put forward is China, whose economy has not only soared, but who has become a massive buyer of gold.
Charts now point to a far tighter correlation between Chinese CPI and the price of gold, while the correlation between US CPI and the price of gold continues to slip. Even this, however, is not necessarily enduring.
Gold and currencies
Angelos Damaskos (pictured), chief executive of London-based Sector Investment Managers and fund adviser to the Junior Gold fund, agrees that the relationship between inflation and gold is not straightforward.
Instead, he sees the rise of gold as more deeply connected to the issue of currencies being battered by monetary policy. Debt problems in Europe, the US and elsewhere have forced central bankers towards quantitative easing and other measures, often with tacit support from politicians who see inflation as “the easy way out”, Damaskos says.
US Federal Reserve chairman Ben Bernanke has pointed to US job creation rather than inflation as the current top target. But the inflationary aspects for commodities such as gold are more complex than simply being able to say gold is a way to hedge out inflation risk, Damaskos says.
“I am not really of the camp that correlates gold very closely to inflation. But certainly, as inflation rises it could be another factor contributing to investors liking gold as a hedge. Some investors might buy into it for that. But the main investment case is the diversification away from devalued currencies.”
Esty Dwek, investment strategist at HSBC Private Bank says that any weakening of the dollar will lead investors towards “hard assets” like gold. If anything, demand among emerging market buyers will increase, because the price in local currency terms will improve as their own currencies strengthen.
The inflation hedging properties of gold remain important, Dwek suggests, with data for US bonds showing that investors expect QE to result in inflation.
There is, however, an additional factor affecting demand: record low real interest rates. For many countries, these are actually negative, which reduces the opportunity cost of holding an asset that does not generate income, such as gold, to zero.
Ultimately, the case of inflation affecting gold may be a non-issue for investors in gold funds, who have seen their values drop, even as the spot price of gold has increased.
Jesper Strandberg, fund analyst at Sweden’s Avanza Bank, notes that these funds generally are invested in companies that mine gold. When investors leave the values of underlying holdings go down, affecting the performance of fund units.