Exploring how Gold Investments Can Depend on Inflation



Inflation and gold

Inflation and gold have a long-sought relation with each other. Investors perceive gold as a hedge against rising inflation. The relationship may not necessarily hold in the short run, but over a little longer run, say 10–15 years, investors may buy gold to protect themselves from rising commodity prices. One of the major concerns around the hike in the interest rates has been the lower inflation.

Even with such lower inflation concerns, the Federal Reserve raised interest rates for the first time in almost a decade on clues of labor market improvement. Higher interest rates, coupled with sticky downward inflation, erode the investor appeal for gold. Let’s not forget that gold is a non-interest-bearing asset, unlike Treasuries.

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The US ten-year break-even spread

We use the yield spread or the break-even spread to depict inflation in the US economy. This measures the difference between the ten-year US government bond yield and TIPS (Treasury Inflation-Protected Securities).

The principal invested in TIPS is adjusted in line with the CPI (consumer price index). The yield spread, therefore, seems to be a good proxy for the US inflation measure.

As the graph above shows, a close link between gold and inflation developed right after the 2008 crisis. As inflation continues staying low, the hope for a significant bounce back in gold prices remains dependent on the inflation move. The direction in gold prices will also determine the direction of ETFs like the iShares Gold Trust (IAU) and the VanEck Vectors Junior Gold ETF (GDXJ). The mining companies are majorly price takers and look out for gold price fluctuation. Stocks like Agnico Eagle Mines (AEM), New Gold (NGD), and Aurico Gold (AUQ) may depend on gold price fluctuations. These three make up 8% of the VanEck Vectors Gold Miners ETF (GDX).


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