Gold is the traditional hedge against inflation. Yet, despite rising inflation in the United States, the price of gold is unable to make a new high when compared to 2020. What’s next for the price of gold?
A widening inflation gap between the United States and other developed economies (e.g., Euro area, Japan) fuels fears of a further rise in price. While inflation in the Euro area declined in June, as shown by the annual CPI Flash Estimate this week, inflation in the United States continues its march higher.
Moreover, the price of oil traded yesterday above $75 for the first time in years – just $1 shy of a seven-year high. Traditionally, higher oil prices lead to higher inflation, so investors have all the reasons in the world to expect inflation to run even hotter in the period ahead.
This is where the curious case of gold comes in. Gold has been traditionally used as a hedge against inflation. The price of gold has historically tracked the increase in the M2 money supply over the past fifty years, as shown in the chart below.
Why would this time be different?
A Bullish Case for Gold
The increase in the money supply and the vertical rise in the price of oil call for higher inflation. Hence, a bullish case for gold is that the price will eventually catch up with the developments in the markets and especially with the increase in the M2 money supply.
For those discounting the case of higher inflation, here is an example. As summer started, beer consumption increased. But the cost of moving a truckload of beer six hundred miles has approximately doubled to about $2,000, according to a recent article by the Wall Street Journal. Moreover, aluminum prices have increased by about 70% in one year, further putting pressure on beer costs.
Thus, rising inflation and an increase in the M2 money supply bode well for the price of gold. History tells us that it will eventually catch up with the trend.
A Bearish Case for Gold
The bearish case comes from rising yields. As the economy recovers, so do the yields. The US 10-year yield recovery triggered a move lower in the price of gold – the two are inverted.
Finally, the Fed’s upcoming tapering may boost the US dollar. If that is the case, gold will have a hard time making a new high when compared to the one in 2020.