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How is the price of gold reacting to increased inflation?

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With global economies now reopening after various Covid-related lockdowns, inflation has become a major concern for central banks. Whilst the rate of inflation in the UK eased in July, it is widely expected to accelerate towards 4% by the end of this year. In the US, inflation reached a thirteen-year high of 5.4% in June.

As we looked at in June, this inflation has partly been caused by heightened consumer spending. Many people are expending greater amounts on retail and leisure with the savings they accumulated during the coronavirus lockdowns. The result of this is that demand has been unable to keep up with supply, pushing up prices. In the UK, rising costs of fuel and clothing have also contributed to upward inflationary pressures. Similar developments worldwide mean that many central banks, including the Federal Reserve and the Bank of England, are now beginning to talk openly about tapering the huge quantitative easing programmes they introduced in response to the pandemic in a bid to prevent runaway inflation.

Usually, we would expect increased inflation to drive up the price of gold. Gold is, after all, traditionally considered to be a hedge against inflation. This is partly owing to the fact that during inflationary periods, gold has historically performed significantly better than equity and debt securities. Inflation, which erodes the value of money in its effect on prices, has, in the past, also made some bonds and fixed income assets less lucrative compared to gold. When inflation is undermining the value of paper assets such as cash, many people also prefer to retreat into physical assets like gold, which holds an intrinsic value in many cultures.

Despite high levels of inflation globally, gold has not performed as strongly as we might have expected. Looking at the market over a five-year timeframe, the price of gold (XAU) peaked at 2035.55 in July 2020 as it benefited from its safe-haven demand during the pandemic. Since then, the price has dropped – just as inflation is on the rise. At time of writing, XAU is trading at 1788.14 on the markets when most would expect it to be comfortably above 1800, at the very least.

What explains this? One argument is that, in both inflationary and generally tumultuous times, gold is in competition with other safe-haven and counter-inflationary assets like US Treasury bonds. Products such as these are attractive both because of the increased certainty they offer, and because they are inflation-linked. That is to say, they are tied to the cost of consumer goods and so rise in line with inflation. In other words, institutional investors can be confident that, when they purchase a ten-year US Treasury bond, they will receive back the full value of their original investment, adjusted to reflect inflation, hopefully with a small return. The same cannot currently be said for gold. This may be one reason why assets such as US and Japanese bonds are currently performing better than gold on the global markets.

Retail investors who may once have hedged their savings with gold are also increasingly looking to the world of decentralised finance (DeFi) as opposed to more traditional products. Ethereum, for example, is currently trading at over $3000. With Bitcoin trading at over $45,000 at time of writing, this means that we currently have two cryptocurrencies valued more than an ounce of gold.

Jason Cozens, Founder and CEO of Glint, argued that gold and cryptos have similar roles. They are both alternative stores of value that are not subject to inflationary pressures in the same way as fiat currencies. For Glint, however, cryptos are simply too volatile and do not offer the same security as an investment in gold:

“Out of control inflation is forcing consumers and savers to search for not only a hedge, but also an alternative currency. Glint has digitised gold and our recent growth [the value of total transactions processed by Glint has increased by 15% since May] indicates the consumer appetite for an asset that has proven itself over time and is still seen by many as the premier long-term store of value.

“A viable alternative to government-backed currencies has long been necessary after consumers have been punished for saving for decades. Fiat currencies have demonstrated that they do not maintain their long-term purchasing power as their value erodes due to rising inflation – forecast to hit 4% in the UK this year, already at 5.4% in the US and producer prices reaching a terrifying 9% in China – minuscule interest rates and record levels of national borrowing and debt. Just one of these factors would be problematic but the combination of them all is crippling. With national debt to GDP ratio at over 99% for the UK and 108% for the US, this is a long-term problem that will likely take decades to resolve, if ever.

“To counteract the declining value of fiat currencies and cash savings, consumers are searching for value elsewhere. Cryptocurrencies have rapidly increased in popularity but the volatility of many of these assets make them unreliable stores of value over the long-term. Although Bitcoin’s value is up around 50% over the last month it is still down 28% on its April peak after a collapse which saw its value halve in just two months. While we understand that the value of gold can also go down, which may affect its purchasing power, many people believe that it is still the fairest and safest way to protect their savings over time.

Glint’s mission is to create a global payments ecosystem that gives everyone an equal opportunity to prosper. Until the launch of Glint, gold was not a viable means of everyday exchange and couldn’t be used for electronic payments – which held it back from re-establishing itself as a premier global currency. Through our app and card gold is accessible to all, can now be used anywhere that accepts Mastercard, plus, unlike many other firms offering physical gold, Glint’s clients legally own their gold.” 

Jason is certainly right to point out that the volatility of crypto makes investing in this asset an uncomfortable prospect for many. Drops of 5% or more in a single day are far from uncommon in the crypto markets. In January, the value of Bitcoin dropped by over 20% over a single weekend. In light of incidences such as this, the Financial Times has argued that “the volatility factor […] remains bitcoin’s nemesis with respect to wider public adoption.” Gold will always be more attractive to those seeking stability and steadiness, as Jason will be discussing further at the Money Metals Summit in Dallas.

Yet the fact remains that, despite these undoubted benefits compared to crypto, gold is underperforming. Its price on the market is testament to that. At a time of significant upward inflationary pressure, one would expect gold to perform strongly as both institutional and retail investors seek to hedge their assets and savings against the threat of inflation. This is the traditional role that gold has played during such periods. The reasons for gold’s underperformance are unclear and, of course, debated. But it does seem that, for now, gold is losing a battle against both government bonds and cryptos, which are picking up more institutional and consumer investors attempting to protect the value of their assets from inflation.

Whether gold will reattract interest as this period of inflation continues, and accelerates, remains to be seen.

Author: Harry Clynch

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