Inflation vs. the Price of Gold: What To Know Before Investing

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Inflation and gold are often linked together by investors. The prevailing wisdom suggests that in times of inflating prices, investors choose tangible assets over financial ones, preferring to hold on to “real” assets like gold instead of stocks, bonds or mutual funds, which essentially only exist on paper. Inflationary periods can also cause fear or even panic in the financial markets, and gold is often seen as a safe-haven asset that investors can flock to during uncertain times.

See: 3 Things You Must Do When Your Savings Reach $50,000

But is gold really a good hedge against inflation? How have gold prices and inflation interacted historically? Here’s a look at whether or not gold makes a good investment during inflationary times and how it has performed against other assets like stocks and real estate. 

What Happens to Gold When Interest Rates Rise?

Interest rates often move in tandem with inflation. Part of the reason is that America’s monetary policy is controlled by the Federal Reserve. One of the Fed’s mandates is to keep inflation at a modest level, so it typically hikes interest rates as inflation moves higher. The idea behind this is that rising interest rates dampen economic demand, which in turn ultimately contains inflation. Thus, when inflation is high, interest rates are often high as well. 

It can be hard to determine whether gold prices are responding to high inflation, high interest rates or other factors. For example, in early 2022, when inflation was rising and the Fed was raising interest rates, the price of gold actually fell. But in early 2023, as inflation and interest rates were even higher, gold rallied as well. Supply and demand, macroeconomic factors and investor sentiment can be major influences on the price of gold, in addition to interest rates and inflation.

What Investments Do Perform Well During Periods of High Inflation?

Commodities are typically among the very best investments during periods of high inflation. The reason is that commodity prices themselves are part of the calculation of the inflation rate. Commodities include things like orange juice, oil, wheat, soybeans, copper and cotton. Rising prices in these raw commodities translate to inflation that consumers actually feel.

Imagine that you’re going out for a day of shopping and running errands. First, you stop at the gas station, noticing that oil prices are skyrocketing. Next, you go to your favorite clothing store and are shocked at how much clothing now costs. Then, you go to the grocery store and see that the price of orange juice has risen 20%. 

The rising prices of all of these end products are the result of more expensive raw commodities. This often makes investing in commodities during inflationary periods profitable.

Real estate has often proven to be a hedge against inflation as well — particularly rental real estate. This is because when inflation rises, rents generally go up as well. A rising income stream is particularly helpful to investors who are seeing their cash flow squeezed due to higher prices for goods and services.

Real estate investors also benefit because their mortgage becomes less expensive on a real basis as time moves on. As inflation rises, it makes the money of today less valuable than the money of yesterday, meaning you’re paying your mortgage using cheaper dollars. This can attract investors when inflation rises. 

Isn’t Gold a Commodity? Doesn’t It Rise With Inflation as Well?

It’s true that gold is a commodity as well, and that is one of the reasons it has a reputation as being a good inflation hedge. And over short (and sometimes random) periods of time, gold has moved up in value along with inflation. However, it has often had no correlation at all — and sometimes even a negative correlation. In 2021 and 2022, for example, inflation was at multidecade highs, but the price of gold was flat to down, according to Darren Colananni, a wealth management advisor for Centurion Wealth Management, as reported by Forbes Advisor.

In fact, the trading patterns of gold relative to the consumer price index have been volatile. According to Forbes Advisor, the ratio of the price of gold to the consumer price index has averaged 3.6 since 1972. But as of early this month, that ratio was closer to 6.4. If there was a direct correlation between inflation and the price of gold, that ratio would be more stable.  

Similarly, from 1980 to 1984, as noted by Forbes Advisor, inflation averaged 6.5% annually, but gold fell an average of 10% per year. A similar negative correlation occurred from 1988 to 1991.

However, for the years between 1974 and 2008 when inflation ran over 5% annually, gold rallied as well, averaging 14.9% on a year-over-year basis, according to an article in The Journal of Wealth Management.

Where Is the Price of Gold Headed?

As of May 10, the price of gold is up about 11% on a year-to-date basis. But whether gold prices will go back down in 2023, or where they will be in five years, is a speculation.

The price of gold can be even more difficult to project than the price of stocks, or even the stock market in general. This is because stocks are actual companies that have to make quarterly reports as to their real-world revenues and earnings. Gold doesn’t have such hard data behind it, which makes it difficult to value.

While it’s true that companies and analysts can only offer their best guesses as to a company’s future growth rate, a company with a consistent earnings trend will always attract investors, which can grow its stock price. Gold doesn’t have these types of hard numbers to support it, only external factors such as inflation, production levels and consumer demand. 

The Bottom Line

Over short periods of time, gold can indeed move in lockstep with inflation. However, historically speaking, it has also often had no correlation at all, or even a negative correlation.

Some studies have suggested that inflation does have an effect on gold prices, but only over extremely long periods of time, such as over a century. As this exceeds the entire lifetime of most investors, it can be a hard principle on which to base an investment strategy.

Gold is certainly a diversifying asset, typically non-correlated with the stock market, and that can make it a great defensive hedge in a stock-heavy portfolio. But the data is mixed at best when it comes to the success of investing in gold solely based on the rate of inflation.

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