Inflation refers to the increase in the cost of goods and services over time and affects the value of commodities, including gold and silver. But the relationship between inflation and bullion prices is complex and influenced by various factors, including central bank actions, currency devaluation, and investor sentiment.
Understanding the effect of inflation on bullion prices is vital for those looking to invest in precious metals to diversify their portfolios.
Inflation and Precious Metals Prices
Currency loses its buying power when prices increase on goods and services. This weakening of currency occurs in the open market over time and is called inflation. Inflation is measured by the Consumer Price Index (CPI), which is assigned a percentage value to show the change in prices paid by consumers for goods and services.
However, gold, silver, and other precious metals have industrial and symbolic value, so they are affected differently by inflation. For example, the manufacturing industry relies on precious metals, but because they are scarce, they retain their value even when the industry experiences a slump.
When inflation rates are high, fiat currency value weakens, resulting in declines in the stock market and sluggish retail sales. Investors turn to precious metals as a low-risk way to diversify their portfolio because the metals retain their value due to their limited supply. The more investors turn to precious metals as a safe haven investment, the smaller the supply gets, resulting in higher trading prices.
Positive correlation refers to a connection between two variables moving in tandem, so that as one variable increases, so does the other.
During periods of high inflation, the demand for precious metals like gold and silver increases as investors look for safe havens to protect their wealth. This increased interest drives up bullion prices, resulting in a positive correlation between inflation and bullion prices. This relationship can be attributed to the perception of bullion as a good hedge against inflation and the historical performance of bullion during times of high inflation.
For example, during the 1970s and early 1980s, the United States experienced skyrocketing inflation, with a rate of 13.29% in December 1979. The price of gold increased by 133.41% in 1979 because of the increase in demand.
Inflation hedging refers to using investments to protect against the negative effects of inflation on a portfolio. Precious metals like gold and silver are often used as inflation hedges because they provide a store of wealth that increases in value as the cost of goods and services increases.
Investors concerned about the potential for inflation may allocate a portion of their portfolios to bullion to protect against the eroding effects of inflation on their wealth. Bullion can help investors maintain the purchasing power of their wealth and provide stability to their portfolios.
Central Bank Actions
Central banks, such as the Federal Reserve, play a significant role in influencing bullion prices. Central banks can adjust interest rates and print money, which can directly impact the economy and, in turn, bullion prices.
Central banks can also directly impact bullion prices by buying gold to achieve price stability for their national currency and prevent the banking system from collapsing. According to data from the World Gold Council, gold demand reached 28% in 2022, and the top three largest investors were the central banks in Turkey, Uzbekistan, and India.
Other central bank actions, like lowering interest rates, can lead to increased demand for bullion as investors look for alternative investments to provide higher returns. However, if a central bank takes actions that are seen as inflationary, such as printing more money, this can lead to increased demand for bullion as a hedge against inflation.
Central banks can also indirectly impact bullion prices by regulating a currency’s value. For example, if a central bank devalues a currency, it can make bullion more attractive as an investment as investors look for ways to protect their wealth.
Currency devaluation refers to a decrease in the value of a currency compared to other currencies or a benchmark, such as physical gold. This typically results in reduced purchasing power, leading to higher living costs, skyrocketing interest rates, and a drop in credit ratings. Currency devaluation can also impact the demand for precious metals like gold and silver.
Investors may turn to bullion to protect their wealth if a currency loses value due to inflation or other economic factors. Increased demand can drive up bullion prices, resulting in a positive correlation between currency devaluation and bullion prices.
In addition, bullion is often used as a benchmark for currency values, and currency devaluation can make bullion more attractive as an investment. If a currency is losing value compared to bullion, this can increase the demand for bullion and drive up its price.
Supply and Demand Imbalance
Supply and demand imbalance refers to a situation in which the supply of a commodity is either greater or less than its demand. If the supply of bullion decreases while demand is high, this can drive up its price. Conversely, if the supply of bullion increases while demand is low, this can drive down its price.
Factors such as changes in mining production, geopolitical events, and investment demand can all impact the supply of bullion and influence its price. If a mine experiences decreased production due to a natural disaster, this can reduce the bullion supply and drive up its price. Similarly, increased demand for bullion due to investor concerns about inflation or other economic factors can drive up its price.
For example, global supply chain disruptions during the COVID-19 pandemic and an increase in physical gold and silver investment to buffer against economic volatility resulted in a surge in bullion prices.
Invest in Bullion Today
Investing in precious metal bullion is a financially-savvy move to diversify your portfolio and protect your assets against economic uncertainty. With AU Precious Metals, investing in bullion has never been easier. We offer secure wire transfers and postal services for stress-free transactions.