While not always the case, more inflation tends to boost gold prices, while reduced rates of inflation tend to bring it down, shaped by a myriad of factors such as supply, demand, and the behavior of investors. Because gold tends to rise in value as economic conditions deteriorate, it is seen as an effective instrument for portfolio diversification.

Gold is often touted as being among the best safe-haven assets, and as a result, people flock to it during times of economic instability. Gold’s historical significance as a measure of wealth and store of value has stemmed in part from the fact that it possesses a number of unique characteristics that are not shared by most assets. Because gold does not deteriorate in value, it has unique features as a very long-term store of wealth when compared to other commodities like silver.

The market supply of gold has been relatively stable throughout the previous century, with yearly mine production accounting for a modest proportion of the overall stock of gold in circulation. In addition, annual mine production has had a generally limited ability to increase in reaction to fluctuations in the price of gold. Over the medium term, this differentiates it from other commodities, which are more susceptible to significant supply responses to price changes.

When assessing the factors that influence the price of gold, we can see that the metal is driven by two types of drivers: these are established movers such as inflation and the jewelry market and newer forces like central bank demand.

Often, inflation is an indication of economic expansion. It is common practice for central banks to increase the volume of money circulating in an economy in times of economic boom. The cumulative effect of increased currency volume in an economy is a reduction of the value of money. This results in assets considered as an alternative store of value, such as gold costing more money. Therefore, quantitative easing initiatives that often result in increased money supply are regarded as beneficial to physical gold prices.

Gold demand

The sentimental, cultural, and economic worth of gold is inherent in the world, with different individuals buying gold for various reasons, frequently impacted by various national socio-cultural elements, local market conditions, and global macro-economic drivers.

The numerous applications of gold, which include jewelry, technology, and the holdings of central banks and investors, result in the precious metal gaining importance at different times during the world economic cycle. The demand diversity and self-balanced structure of the gold market reinforce the sturdy attributes of gold as an investment asset.

Gold and inflation

Generally speaking, the actual gold value tends to keep steady over the very long term; nevertheless, short-term factors can cause gold to deviate from its long-term equilibrium for significant periods of time. Financial stress, political unrest, real interest rates, inflation, central bank action, and the value of the USD are some of the aspects to consider.

Inflation occurs when there is a significant rise in the prices of “normal” consumer goods such as food, fuel, and houses. Gold, on the other hand, can act as a buffer against the weakened purchasing power of paper money that results from consumer inflation.  

It’s for this reason that gold is commonly referred to as an inflation hedge.  Inflation fears fuel a surge in demand for gold, which causes gold prices to rise as investors seek to secure the value of their holdings. However, inflation and gold do not always move together, although the inflation rate and the gold price may rise or drop at the same time.

Gold has an established track record as a long-term inflation hedge, but its record in the near term has been less impressive. Nevertheless, most analyses show that gold is a reliable instrument to cushion one’s portfolio against inflation.

Because it is tethered to the money supply, gold can help cushion investors against a spike in inflation and even depreciation.

Gold price bubble

Gold is a speculative tool just as inventories, commodities, and their derivative products are, and the naive confidence expressed by many individuals in the brilliance of the metal is hardly justifiable.

Can gold become overvalued at some point? That is something that very few would disagree with. While this has indeed happened before, and there’s nothing to prevent it from happening again.

To be clear, none of this implies that gold will not continue to rise. In the next several years, there is a good chance that gold prices could soar to several thousand dollars per ounce. However, this may not necessarily be a consequence of smart investors using it as a cushion against inflation. It is the old-fashioned, aggressive speculation that ultimately contributes to the overvaluation of gold.

In a nutshell

Without a doubt, inflation has a direct impact on the value of gold. If you believe that inflation is likely to rise significantly in the future, investing in gold is certainly a good thing to consider.

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