Conventional wisdom suggests that there is a strong correlation between gold and inflation. When inflation goes up, gold follows suit. Likewise, a drop in inflation would lead to a fall in the gold price. This is because in times of high inflation, gold becomes a better option for investors. How true is this line of thinking?
Let’s look at two charts. They track the gold price in US$ per ounce and the monthly US Consumer Price Index, which is a gauge for inflation. The first chart goes from 1974 until 2001. The second chart shows the last ten years (2001 until 2011). A visual inspection of both charts does not necessarily provide evidence of a positive relationship between gold and inflation. What was the development of the gold price and the inflation rate during the three major gold periods:
Fact 1: Bull Market, 1976 until January 1980, gold went up from US$ 129 (monthly averages) to US$ 675 per ounce at the end of the period. This is an increase of 523%. During the same time, the consumer price index, a measure of inflation increased by 167%. Here, gold strongly outpaces the inflation development.
Fact 2: Bear Market, between 1980 and April 2001, gold went down from US$ 675 to US$ 260 per ounce, which is a decrease of 67%. In contrast, the consumer price index increased during the same period by around 226%.
Fact 3: Bull Market, from 2001 to February 2011, the gold rate experienced huge gains of 530 per cent. The overall inflation rate was only 125 per cent.
Especially remarkable is the inflation decrease in the middle of 2008. If the theory of a positive correlation held true, the gold price would also go down. But the opposite was the case: inflation went down, and gold went up. This rather points to an inverse correlation between gold and inflation.
All of this points towards a weak or even non-existing relationship between the gold price and the inflation rate.
What do banks and research firm say about a possible correlation:
First, the Wall Street Journal commissioned a study from the research firm Ibbotson Associates. According to their research, between 1978 and 2010 gold and the inflation rate have a correlation value of 0.08. This is nearly no correlation (on a scale ranging from -1 to 1, where 1 is perfect correlation, and -1 perfect negative correlation, and zero is the absence of a relationship).
Second, also Citibank comes in 2009 to the conclusion that “there is no obvious relationship between the gold price and inflation”. Sometimes the development of gold follows inflation, at other times there is an inverse trend or just on obvious pattern at all.
Therefore, it can be concluded that there is no, or only a weak, relationship between the gold rate and inflation levels.