This post is the second in our Macro Research Bites series, which breaks down evolving macroeconomic trends into short, digestible pieces. Each post will also exist in thread form, shared on Twitter/X. As always, we’d love to hear your feedback — and, remember, none of this is financial advice. More below!
Gold and Inflation: A Closer Look
With rising inflation concerns, many suggest buying gold as a hedge, with the asset’s performance in the inflationary 1970s often serving as the primary supporting evidence. This thesis, however, merits a closer look. Does this singular focus on inflation really tell the whole story?
The run up in inflation during the 1970s coincided with a remarkable bull run in gold.
The 1970s: An Era of Change
The 1970s were a decade like no other. A closer look suggests the end of the gold standard and extreme geopolitical uncertainty likely played a more important role than inflation alone in driving gold’s performance.
First: the lifting of the gold standard. In 1971, the United States under Nixon shifted from the gold standard, allowing the price of the metal in U.S. dollar terms to become freely discoverable for the first time in decades. The ban on private gold ownership was fully lifted in December 1974, allowing Americans to once again own and trade bullion, coins, and other forms of gold. This cessation of artificial price suppression allowed market forces to determine gold’s “true” value and helped directly lead to its upwards price trajectory.
The dropping of the gold standard in 1971 and launch of the first U.S. gold ETF catalyzed a gold bull run.
The dollar simultaneously experienced a precipitous decline in value, dropping 30% in the ensuing decade. Rampant inflation was the defining economic phenomenon of the 1970s, leading to persistent flight from the U.S. dollar into assets perceived as safe havens — gold among them.
The dollar experienced a precipitous decline in value in the 1970s.
Geopolitical uncertainty, energy crises, and heightened Cold War tensions accentuated perceived U.S. weakness and investor appetite for safe haven assets. During the first oil shock in 1973, for instance, OAPEC (an OPEC subset) imposed an oil embargo on the U.S., leading to a quadrupling in the price of oil. Iranian regime change and Soviet action in Afghanistan, both in 1979, further highlighted the energy and geopolitical uncertainty of the time.
Why does this matter? The lifting of the gold standard and geopolitical tensions all played a role in pushing investors into safe haven assets, contributing to gold’s meteoric rise. A singular focus on inflation as the source of gold’s rise in the 1970s misses the bigger picture in favor of a reductionist one — one which investors interested in hedging against inflation would do well to understand.
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Since 1980
What’s happened since that defining decade?
While other factors evidently played a central role, the correlation between gold and inflation in the 1970s is clear nonetheless. However, this correlation drops to a mere -0.07 if measured from the 1980s onwards. Is the folk wisdom wrong? Is the inflation indicator uncorrelated, with gold offering no inflation protection at all?
Well, not quite. A plausible explanation for this data is the conditional nature of inflation hedges: only when inflation expectations surpass a certain threshold — say, 3%, or some standard deviation above a moving average — do investors begin piling into inflation hedges. For most of the period since the 1980s, inflation and expectations thereof have stayed below 5%. With such low inflation figures, a strong U.S. dollar, and relatively strong growth, there has been limited motivation to invest in gold as a prophylactic. The correlation between gold and inflation likely only applies conditionally under circumstances of persistently high inflation expectations.
1-year inflation expectations have declined consistently and remained largely below the 5% mark from the mid-80s through 2020.
Another likely explanation for the diminishing correlation between gold and inflation since the 1980s lies in the evolving landscape of gold investment options. Before the 2000s, options were limited, with non-institutional investors mainly purchasing physical gold, gold mining stocks, or navigating complex gold futures and options. The introduction of gold ETFs in the early 2000s (SPDR Gold Shares ETF launched in 2004) revolutionized this landscape, providing a simple and liquid way to invest in the asset. This greater accessibility attracted a surge of capital, both retail and institutional, increasing demand and likely contributing to the run-up in gold prices, further diminishing its direct correlation with inflation trends. It’s worth noting the potential parallels to Bitcoin here (ETF bulls rejoice).
Looking Ahead
Many market beliefs are reflexive. While the popular focus on inflation as the source of gold’s outperformance in the 1970s is likely disproportionate and overshadows stronger drivers — geopolitical uncertainty, dollar weakness, and the decline of the gold standard — this popular belief may ultimately be self-fulfilling. Enough belief in gold’s role as an inflation hedge may be enough to make it so.
Nevertheless, a more nuanced reading suggests gold is best regarded as a safe haven asset, with inflation expectations as only one component of that equation. Today’s growing geopolitical uncertainty alone may be enough to propel gold to new highs, even as inflation cools.
We’ll be back in the next weeks with another edition of our Macro Research Bites, this time focused on breaking down inflation drivers.
Read the original version of this post, published on our Medium blog Oct 31st, 2023, here.
