The price of gold hovers around, $1,850 in what seems to be a consolidation below the psychological $2,000 level. After reaching an all-time high above $2,000 in 2020, gold eased from the highs despite other markets continuing to appreciate against the dollar. In a sense, we may say that the price of gold leads and the months ahead are critical to see if this correlation does exist.
One of the reasons why investors turn to gold is to protect against inflation. While inflation did not show its teeth yet, it will in the future. The question now is not if inflation will turn higher, but by how much and is the Fed able to contain it once it exceeds its target?
Gold and Inflation
The price of gold is the best benchmark for measuring inflation. The Consumer Price Index (CPI) or the Personal Consumption Expenditure (PCE) in the United States are the official indices to look at inflation. However, the indices’ composition is such that they do not cover all relevant goods and services in an economy. Some say this is intentional, but that is another story. As such, the price of gold acts as a benchmark against real inflation – the day to day increase in prices.
The Federal Reserve of the United States (Fed) recently changed its mandate. It is now targeting average inflation around the 2% level, but no one knows the period that the Fed will use to average the data. For instance, are we talking about three, six, or twelve months? This is important because if inflation exceeds 3% in a month from now, the longer the period the Fed uses, the lower the average inflation will be. In other words, the Fed won’t do anything to bring inflation down.
In light of such uncertainty, the other way of protecting against the upcoming inflation is to own some gold. This is, perhaps, the reason why the price of gold hovers close to the $2,000 level. Like it or not, the fiscal and monetary policy reactions during the COVID-19 health crisis will end up with higher inflation. How much higher, it remains to be seen, but that is exactly the reason why portfolio managers add gold to their accounts.