Gold and Inflation Analysis

Gold has proved itself to be a competitive investment across the millennia. In the current unsteady global economic climate, investors looking to hedge their portfolio may look to gold futures, gold royalty, and streaming stocks – or physical bullion – to create a defensive buffer against volatile inflation.

Here we will look at the current drivers for inflation, delve into what happens to the gold price during inflation spikes, and discover what experts say about the gold inflation rate. If you are thinking about the safest way to invest in gold, read on as we delve into the question; Is gold an inflation hedge?

Inflation

Inflation is a hot topic as 2022 draws to a close. The cost of living has skyrocketed in recent months, and in New Zealand, food and fuel prices affect consumers in highly visible ways.

Additionally, around 50% of the country’s homeowners are set to see their fixed mortgage rates enter refinancing over the next year. Many of those people are currently sitting on the 2019 rock bottom rates. This spells potential hardship, with substantial increases in payments for already stretched mortgagees looming on the horizon.

Inflation is sitting at 7.2% in New Zealand and surging globally. The US hit a record high of 9.1% mid-year, and many investors worldwide are looking for ways to hedge their bets from now on. The Reserve Bank predicts the cash rate will peak at 5.5% in 2023, and recession is predicted to hit NZ shores shortly and stretch into 2024.

The cost of housing, particularly new builds – which are up by 17% per cent – plus rising local rates, skyrocketing utility prices, and inevitable mortgage rate rises are all driving inflation. 

Although we know inflation is important and that it affects the cost of living, it may be fruitful to take a look at a definition of what it is and how it is measured.

What is inflation?

In simple terms, inflation is the way we describe the increase of average prices within an economy. When average prices increase, money becomes less valuable because your purchasing power is reduced.

Economists like it when inflation rises slowly, and the US Federal Reserve (Central Bank) aims to have it increase at a rate of around 2% a year so that consumers don’t stop spending while they spend more time hunting for bargains and comparing prices. Rapid rises in inflation can lead to a loss of productivity and stress on the economy.

Three types of inflation may affect the gold inflation rate. These are demand-pull, cost-push, and built-in inflation.

Demand-Pull Inflation

Demand-pull inflation is about the way demand drives prices. When a product or service is desirable but rare, consumers are likely to pay more. This is occurring currently in the US as wages have risen, and consumers are also dipping into savings to buy items that are in high demand at inflated price points.

When firms struggle to keep up with demand, prices are affected by this type of inflation.

Cost-Push Inflation

Oftentimes when demand-pull is occurring, cost-push inflation kicks in. This is the type of inflation that drives, for example, prices per plate at restaurants and cafes. If raw materials, fuel, and staff wages are rising, the business owner will need to pass that cost on to the customer to some degree to stay afloat.

If a business decides not to bow to cost-push inflation, they will likely take a hit to their profit margin – this can lead to a delicate balancing act and increased stress.

Built-in Inflation

Built-in inflation may occur as a result of demand-pull and cost-push inflation. This is the idea that workers who are struggling to keep up with the cost of living go to their employers to request a raise. In order to keep their team intact, businesses pass the rising cost of wages on to the consumer in order to maintain their profit margin.

You can see that inflation works in a somewhat circular or domino fashion. Gold works as a hedge against inflation because more gold can be purchased when the dollar drops in value. 

How is inflation measured?

You can measure inflation in a few different ways; however, the simplest way to understand it is via the Consumer Price Index (CPI).

The CPI records the shift in the price of a weighted ‘basket’ of goods and services likely to be purchased by an ‘average’ New Zealand family/household. This basket is revisited periodically to account for shifts in the types of goods and services, which may form an average spend to ensure the accuracy of the statistics.

Source (Stats NZ)

The rumour of gold as an inflation hedge

Gold is rumoured to be an inflation hedge, with Forbes Advisor Wayne Duggan recently relaying that real-world uses in jewellery and electronics, plus its relatively limited supply compared to fiat currencies, have seen it keep its place as a traditional safe haven investment option.

Duggan explains that while gold may have been affected by inflation over the past few years, it has consistently outperformed Bitcoin, becoming a go-to for many investors looking at hedging.

Forbes relays, “Gold prices held up pretty well during the Covid-19 pandemic market sell-off in early 2020. For example, from February 1 to April 1 in 2020, the S&P 500 declined 23% while the price of gold dropped less than 0.1%.”

Empirical literature reveals that econometric analysis carried out around gold and inflation between 2016 and 2019 yielded results which indicated that the US and many OECD countries may still be looking at gold as a viable route out of hyperinflation. 

Academic studies into gold prices during inflation reveal that gold may serve as an effective hedge when it comes to the shifting value of foreign exchange to some degree – and that this is likely dependent on events of a political nature. Capie et al. (2005) describe how people turn to gold when inflation is high and discuss the homogeneity of gold as an asset that may be easily traded.

So, is gold an inflation hedge? Central banks answer the question positively, diversifying out of paper currency and into gold as a matter of course. Indeed, many nations around the world have gold as their primary reserve.

Recent buy ups by the US, Turkey, Russia, Poland and China totalled 650 tons in 2019, down by only 5 tons from 2018. This is the second-highest buy-up by Central Banks in 50 years and indicates strongly that a gold inflation hedge is very much part and parcel of Central Bank portfolios around the globe.

Source (Trading Economics)

Inflation over 100 years & the Price of Gold Analysis

While inflation is currently hitting highs worldwide, gold prices are slightly down from a few years ago. If we look back over the last century, we see that in November 1922, gold sat at $369.31, and as the year finishes up in 2022, gold is selling at $1768.61 an ounce.

Source (Macrotrends)

It’s a fairly good rule of thumb that when inflation rises, so too do gold prices – this can be driven by geopolitical tension, risk and uncertainty and central bank and consumer buy-ups. In New Zealand in 1980, inflation peaked at a whopping 17.05%, while gold prices in March of that year mimicked this rise, reaching the highest-ever price of $2046.65 per oz.

How is gold holding up comparatively?

Stocks/shares

While investors may be talking about the apparent lack of performance by gold as inflation soars in the post-pandemic economy, it is pertinent to note that gold is performing more strongly than many major assets in 2022. Gold has outdone major assets, including inflation-linked bonds and global equities. Its performance against negative investor sentiment, weak positioning in the futures market, and substantial gold ETF outflows indicate endurance.

When recession rears its head and stocks go down, gold often displays a negative correlation with stocks. This spells profit for investors who are diversifying into gold as an inflation hedge.

Source (interest.co.nz)

Property vs Gold

Looking at properties vs gold under inflation over the last few years throws up some 

interesting statistics. If measured in dollars, gold has increased in value by 386% since January 2020. These stats indicate the value of the dollar is going down as a result of inflation rather than a fivefold increase in the value of gold.

Over the same period, property rose by 416%, nudging a little ahead of gold. However, if you account for the correction adjustment over the past decade (around 35%), buying gold looks to be a smarter move in New Zealand than property at this juncture.

Forecast

While New Zealand’s inflation rate history usually runs fairly parallel to other Western economies, it has risen above the Central Bank’s target range since the end of 2021 – the CPI hit 3.3%. 

The Reserve Bank of New Zealand has responded to inflation with a series of aggressive hikes to the Official Cash Rate (OCR), shifting the rate from 0.75-3% throughout 2022 in hopes of pulling inflation down by making borrowing more expensive.

These rate hikes are not yet showing up as real-world numbers, and the inflation rate is noted by the Bank of New Zealand (BNZ) to look likely to rise another 5% through 2023. 

BNZ forecasts that it’s likely that the CPI will stay higher than the RBNZ’s original estimate for the foreseeable future and that “The only good news on this front is that business pricing intentions do appear to have turned the corner albeit remaining at highly elevated levels.” (Hogg, R. 17 Nov. capital.com).

Will inflation go down? And when?

While prices fell slightly in the third quarter of 2022, investors are still feeling the effects of the Ukrainian invasion, a domestic labour market crunch as an ongoing hangover from Covid-related border closes, and the residual effect of the astronomical shift in house prices during the initial stages of Covid.

While inflation continues to be a volatile force and the global market shows signs of ongoing stress, many investors may work on creating a gold inflation hedge as part of their portfolio. 

Gold may often be viewed as a long-term hedging strategy, and diversifying while a potential storm looms on the horizon may be considered risky, but historically gold has lent balance and stability to portfolios during times of economic recession.

We should not put too much hope in a pressure drop for inflation in the near future as the huge currency injections via Central Banks across the pandemic are working to keep rates high, with spillovers occurring between price and wages as a matter of course.

As we move forward, it is likely there will be multiple waves of inflation. If Central Banks pause interest rate hikes over 2023/24 to provide a buffer for the inevitable recession, there could be a period of substantial disinflation. However, historically when inflation runs as high as it is currently, a double-top kicks in.

Founder and CEO of Steno Research, Andreas Larson explains, “As soon as disinflationary trends get clearer and clearer, everybody (including politicians) will be screaming at the Fed and the ECB to pivot. Central banks will likely cave in under immense external pressure, no matter what they are saying currently.” 

Gold and Inflation: Is it time to buy, hold or sell?

So, is gold a good hedge against inflation in the current economic climate? Whether investors prefer to buy shares of Exchange Traded Funds (EFTS) or reach out to NZ gold merchants to buy and hold physical stock, gold definitely has a place in your portfolio as an inflation hedge.

The time is right to buy and hold, as gold provides a safe haven in uncertain times and has been historically proven as a good hedge against inflation. Before you buy, do your research for current gold rates in NZ, and think about whether you want to engage a broker or buy gold online.

Is there another great time to invest in gold?

Because of its trackable history as a good hedge against inflation, there is always a place for gold as a way to diversify your portfolio. It pays to check the gold price forecast any time you are looking at buying, and read here about the safest way to invest in gold.