Forex Trading Library

Gold Headed for $2,500/oz? Inflation Matters

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Wednesday’s Fed decision effectively kept everything in place, which was largely interpreted by the market as dovish. Particularly Fed Chair Jerome Powell’s post-rate decision pressure. Sure, there were media headlines about the long-term rate forecasts being higher than initially assumed. But generally the market doesn’t consider forecasts that far into the future as all that reliable, so they typically don’t contribute to price action.

In response, the price of gold jumped to $2,200/oz for the first time ever! Well, at least nominally. For traders, the nominal price is what’s most relevant at any given moment, because that’s how much gold is worth in dollars that can be used to buy things right now. But, gold is primarily an inflation hedge. So, when considering where the price might go (ie, is gold over- or under-valued) the evolution of inflation is important. And from that perspective, gold is kind of cheap at the moment.

Inflation, Growth and Gold

Gold doesn’t pay interest or dividends, so it’s not something that investors typically hold as a way to generate income. It is, however, a great asset to hold when investors think that things that typically generate revenue (such as bonds and stocks) will be in trouble. Therefore, there is an inverse correlation between gold and economic health. When the US economy is doing good, the gold price remain depressed. When the economy is in trouble, the price of gold trends higher.

So, even though gold recently hit an all-time high in prices, if we backtrack the price of gold and adjust it for inflation to the current dollar value, then gold is far from its peak. That was back in the late 90’s following an extensive period of stagflation, in which gold shot up over $3,500/oz when measured at current dollar value. But that was a somewhat extraordinary circumstance, coinciding with the start of Volker’s famed rate hikes and subsequent recession to get inflation under control.

What’s the New Ceiling?

The early 80’s came with its own period of economic turmoil, with the price of gold fluctuating around the $2,500/oz level (again, in current dollars). The price trended lower over the next couple of decades of generally good economic performance, only to bottom out when the dot-com bubble burst. The subsequent period of low interest rates helped keep the price of gold elevated, with it moving again up to $2,500/oz twice more – after the great financial crisis and after the pandemic.

So, if we are talking about “all time highs” for gold, factoring in inflation, the price of the yellow metal is still a good $300/oz away from reaching where it has gone in the past. That means there could be some more upside for the price (potentially with a few corrections along the way). Periods of lower interest rates (as the Fed is set to start easing later this year) typically coincide with a higher price for gold. But, it should also be read with a heavy dose of caution: The Gold price tend to only go that high when there is substantial economic turmoil that necessitates central banks to cut rates drastically.

Solid, broad-based economic growth typically leads to higher interest rates as central banks try to keep inflation under wraps. That puts downward pressure on gold, both from a nominal as well as inflation-adjusted perspective. The recent higher prices in gold imply that there are still quite a few investors who are still betting on the real risk of a recession in the near term.

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