- Gold hit new nominal highs this week, with folks assuming higher inflation the cause.
- Certainly, gold's recent run can be tied to higher inflation expectations today, but that doesn't mean higher inflation always means higher gold.
- Gold rose recently during a short period of deflation as well.
- Over time, gold's just a commodity and not a great long-term investment.
Gold touched new highs this week, leading many to surmise gold's rise is at least partially caused by a falling dollar and renewed inflation jitters. Not a bad hypothesis. But before you pledge yourself to gold forever as your go-to inflation indicator, remember there's an important distinction between "interesting observation" and "reliable indicator."
Short term, something's movement can always be observed as tied to another's. But is there evidence of a lasting causal relationship? Or at least a coincident one? With gold and inflation, the answer is no. We certainly think the greater probability is higher inflation down the road—but not because higher gold is signaling it. Why? Here are some other interesting observations: Gold's nominal record high this week came even as inflation has remained practically nonexistent. The US core consumer price index (ex-food and energy) rose only 0.8% y/y in September, way below normal. Food prices got a bit more attention thanks to their 1.4% uptick, but the increase is still slight by any historical standards. No matter how you slice it, overall inflation is benign. Yet gold's up 28% in 2010. Now, some would argue higher gold signals future inflation. Fair enough! But remember gold also rose while we were experiencing true (though short-lived) deflation during the past recession. As an inflation indicator, gold's fickle at best in the short term—and falls apart over the long haul.
Equally shaky is the idea rising gold signals major currency weakness around the globe. Gold, like oil and a number of other commodities, is priced in dollars, so a weak dollar can contribute to higher gold prices, all else equal. The problem is, all else is rarely equal. A weak dollar might boost gold prices temporarily, but the many other forces influencing gold prices can easily overwhelm the dollar's influence. Gold has done just fine during periods of dollar strength and struggled when the dollar has been weak. The relationship between the two is frequently fleeting. And don't forget, currency moves are zero sum. If one weakens, another strengthens on a relative basis. So if expected weakness in one area were pushing gold up, the expected strength in another should counter it, with little-to-no net effect over time. See it this way: All currencies can't tank at once. Perhaps more importantly, as we've said in this space before, relative currency strength doesn't dictate market direction. The same holds true for gold.
So if gold isn't an inflation or currency hedge, what is it? Just a commodity. A shiny one, to be sure, but still historically not a great long-term investment. Sure, there are notable short-term jumps, like its 17% run in the last two months, but global stocks are up just as much since the end of August. And while both gold and stocks had a terrific 2009, stocks outperformed—a fact few notice. Longer term, stocks have proven an even better bet, annualizing 9.1% compared to gold's 6.8% since gold truly began trading freely after Bretton Woods controls were dropped in 1973.* And let's not forget gold was down cumulatively from 1982 to 2005 and is still well off its January 21, 1980 peak when adjusting for inflation.
We're not in the business of making formal gold predictions and tend to prefer the odds of equities over Au. And while gold (like any commodity) can move on jitters of any kind, its history as an inflation indicator is not so shiny.
*Source: Thomson Reuters, as of 12/31/09