Column: Is gold over inflation? No impact so far from surging CPIs

4 minute read

Gold bars are displayed at a gold jewelry shop in the northern Indian city of Chandigarh November 4, 2009. REUTERS/Ajay Verma/File Photo

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LAUNCESTON, Australia, Dec 14 (Reuters) - Gold has so far failed to rally in the face of the highest U.S. inflation in almost 30 years, suggesting that a long-held market orthodoxy may be breaking down.

The price of spot gold ended at $1,786.94 an ounce on Monday, down from a recent high of $1,876.90, reached on Nov. 16.

That peak was more about the emergence of the new Omicron variant of the coronavirus, which stoked fears about renewed travel and other restrictions hitting the global economy as countries battled the ongoing pandemic.

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The subsequent easing of those fears has seen gold drop back below $1,800 an ounce, while the mounting worries of a global inflation breakout have had minimal impact on the price.

The consumer price index (CPI) in the United States rose an annualised 6.8% in November, the largest annual increase since June 1982, as the cost of goods and services jumped amid supply chain constraints. read more

But the CPI data release on Dec. 10 resulted in virtually no reaction from the spot price of gold, with the precious metal remaining in a fairly tight range during the trading day, although it did close 0.5% up at $1,782.51 an ounce.

The market view that higher inflation is good for the price of gold is based around its use as an inflation hedge. In other words, gold is an asset that will hold its value better than others as the value of currencies are eroded by price rises.

This shibboleth largely dates back to the late 1970s and early 1980s when gold rallied strongly amid a surge in U.S. inflation to the highest levels since the 1940s.

Spot gold went from $226 an ounce at the end of 1978 to a peak of $666.75 by September 1980 as U.S. CPI surged to hit 14.73% in April 1980.

U.S. inflation then trended down to just over 1% by the end of 1986, while gold spent the next 27 years meandering before it broke above its 1980 peak in mid-2007.

CHINA, INDIA

However, gold's extended rally from about 2000 onwards wasn't driven by inflation, or even by interest rates, rather it appeared more related to the rise of China and India as the two top consumers of the metal.

Increasing wealth in the world's two most populous countries, coupled with a cultural affinity for the precious metal, boosted demand to the point where China and India represent about half of global physical demand.

Gold did receive further boosts from the 2008 global financial crisis, and more recently during the height of the coronavirus pandemic last year, when it reached a record $2,072.49 an ounce on Aug. 6, 2020.

The point worth noting is that the last two major spikes for gold were more driven by fears of a global economic and financial crisis, and were entirely unrelated to any inflation issues.

For inflation to play a role in boosting gold, it will likely have to be far worse and sustained for an extended period.

This may still happen, but in the meantime it's probably more likely that gold will have to overcome the likelihood of higher interest rates, which increase the opportunity cost of holding the non-yielding metal.

There are encouraging signs in the physical market, with both China and India boosting consumer demand. World Gold Council data shows Chinese consumers bought 221.5 tonnes in the third quarter, up 26% from the same period in 2020, while India's consumer demand rose 47% to 139.1 tonnes.

However, total gold demand fell 7% in the third quarter to 830.8 tonnes on lower bar and coin demand, as well as a drop in exchange-traded fund holdings.

In recent years the ETF holdings have had a solid correlation to the spot price, and it's worth noting that the biggest such fund, the SPDR Gold Trust has seen a declining trend this year.

It held 31.59 million ounces at of Dec. 10, down from the 2020 peak of 41.12 million, reached in September.

Perhaps keeping watch on the movements in ETF holdings and the state of China and India demand will provide stronger cues for the gold price than worrying about inflation.

GRAPHIC-Gold demand: https://tmsnrt.rs/311omm9

The opinions expressed here are those of the author, a columnist for Reuters.

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Editing by Richard Pullin

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