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Inflation is an ever-present force in most economies, and numerous factors contribute to it, ultimately reducing the purchasing power of fiat currencies. As a result of persistent inflation over the past several years, more investors have been turning to gold as a safe haven asset, and that's worked out quite well.
Over the past five years, gold has rallied by more than 80%, comfortably outpacing the returns for other low-risk investment vehicles like bonds and high-yield savings accounts. The precious metal can rise with stock market rallies, but its lack of correlation also enables gold rallies during market corrections.
Gold — like any other asset — doesn’t always go up, but periods of higher inflation are frequently touted as price drivers for the alternative asset. But how much of a role does inflation really play in gold prices? Here’s what the data says.
Gold gains can outpace inflation growth
Gold’s 80% gain over the past five years comfortably exceeds inflation’s growth rate during the same timeframe. Inflation was up by the following percentages from 2019 to 2023:
- 2019: 1.81%
- 2020: 1.23%
- 2021: 4.70%
- 2022: 8.0%
- 2023: 4.12%
Full-year 2024 data will soon be available, but inflation has been cooler this year compared to last year. Gold enjoyed a tremendous run-up from March 20, 2020, to Aug. 7, 2020, gaining more than 35% during that stretch. However, gold wasn’t alone. Many assets enjoyed strong runs as the Federal Reserve injected more money into the economy while maintaining record-low interest rates.
Interestingly, the price of the precious metal remained relatively unchanged from Aug. 7, 2020, to Feb. 16, 2024, using the SPDR Gold Trust — a gold ETF that tracks the price of gold bullion — as a gauge. Gold also didn’t enjoy a good year in 2022 despite record inflation, proving that the correlation between inflation and gold prices isn’t absolute.
Why high inflation isn’t enough for a gold rally
Even during periods of elevated inflation, gold prices can still struggle to achieve meaningful movement. That’s because higher inflation is often coupled with higher interest rates, which are intended to counteract inflation.
The Federal Reserve hiked interest rates substantially in 2022, which impeded gold’s rally. Without the interest rate hikes, gold could have produced a banner year in 2022 amid 41-year high inflation.
However, the Fed’s decision to begin reducing interest rates in the second half of 2024 has now resulted in a banner year for the precious metal. Gold is up by 37% over the past year, so the delayed gains from elevated interest rates are starting to show up. That’s because as interest rates fall, gold faces less asset competition as investors shift away from yield-producing instruments like certificates of deposit and bonds.
Still, higher inflation can create an environment wherein gold can perform well. The 1970s featured multiple years of double-digit year-over-year inflation growth rates, and that trend extended into 1980 and 1981. Even with interest rates much higher than they currently are, gold soared from $35 per ounce in 1971 to $850 per ounce in 1980.
Why inflation rates matter for gold
Gold is a physical asset that will always hold intrinsic value. The precious metal has been a medium of exchange since 1,500 BCE and has played a vital role for civilization. The metal has numerous industrial and commercial uses. It is used in aerospace, dentistry, electronics, jewelry and other high-demand products and services.
Not only does gold have a high intrinsic value, it’s a finite resource. The only way to discover more gold is to mine it. Meanwhile, governments can easily print fiat currencies at will, which ultimately devalues those currencies over time.
Gold doesn’t become less valuable just because more fiat currency is in the money system. As money loses its purchasing power and inflation rises, investors must pay more to obtain the same amount of gold.
This trend doesn’t just apply to gold. Inflation makes the U.S. dollar less valuable against all types of goods and services. For example, in 1971, Americans could purchase 17 oranges for $6.39. In November 2024, 17 oranges could set a consumer back $20.23.
Money’s intrinsic value continues to diminish thanks to inflation, and purchasing power drops faster during periods with high inflation. Meanwhile, gold is a store of value. Just as groceries cost much less in nominal dollars decades ago, gold also cost much less decades ago.
Is gold a better inflation hedge than stocks?
Gold has performed well, but it lags the S&P 500 and the Nasdaq Composite over the past five years. Whereas gold has risen by more than 80% during that period, the S&P 500 has gained more than 92% and the tech-heavy Nasdaq Composite has gained more than 126%. Some investors may look at those numbers and assume that index funds are the better option for hedging against inflation.
However, gold’s value as an inflation hedge is less complicated than each corporation that composes an index. Businesses can struggle during inflation, as customers have less available cash to make non-essential purchases. They may even have to cut back on essentials, causing slowdowns for many companies — even those operating in the consumer staples sector.
As costs of living continue to rise, workers will also demand higher wages, which can put pressure on companies’ margins and limit potential employee pools. Too much inflation can hurt corporations, their employees and their customers, and ultimately can hurt their stock valuations.
On the other hand, too much inflation is never a bad thing for gold. The precious metal will continue to gain value, especially as fiat currencies crumble around them. Elevated interest rates kept gold flat in 2022 despite high inflation. However, stocks were crushed in the same year, with the S&P 500 falling by roughly 20% and the Nasdaq Composite falling by 33%.