IS THE RISE IN GOLD NON-INFLATIONARY?

Has gold’s meteoric price rise impacted today’s high inflation figures?


 
The chart highlights a correlation of +0.95 between gold and UK Retail Price Index since 2000. The question is whether gold appreciation leads to inflation, inflation drives gold prices or are they affected by other factors?

According to a 2008 report by the World Gold Council, 52% of the metal is used for jewellery, 18% held by central banks, 16% for investment purposes and 12% for industrial use (2% was unaccounted!).  At current market prices ($1,770/oz) the total value of gold mined is roughly $9.3trillion.

Unlike oil, silver, copper, wheat and iron ore, gold has few (affordable) industrial uses. Instead, demand is largely based on a desire for bling, as gifts for various gods or as an alternative to holding cash. The last point becomes more important should the value of ‘fiat’ currencies be diluted by money printing, as is happening today and likely to continue in 2012. There have been few, if any, viable solutions to the financial crisis which do not involve printing new money to repay old money.

Gold and Inflation

The basket of goods used to calculate UK inflation now includes the cost of smartphone handsets, apps and dating agency fees but does not account for gold, directly anyway. Within the UK CPI basket, “Jewellery, clocks and watches” (item 12.3.1) has a weighting of 7 parts out of 1000 – a doubling in the price of gold would have a smaller inflationary effect than meat prices rising by one-third (meat accounts for 22 parts of the basket).

Of course, gold price appreciation will have multiplier effects via additional revenues for gold dealers/mining companies/investors but I wonder how much of the gains are reinvested/held rather than spent in the wider economy. After all, the supply of gold is limited by its production and its production is limited by, well, I’ll let Professor Brian Cox explain:

“Stars cannot in the normal course of their lives build anything heavier than iron because this process does not release energy and does not help the star in its fight against gravity.

If you are wearing a wedding ring or gold jewellery, look at it now. Gold is heavier than iron, so it is not made in the hearts of stars.

So where did it come from? The answer is that gold is made in the last seconds in the lives of the most massive stars in the universe, the supernova explosions.

Gold is so rare because the conditions needed to make it are rare. On average, in a galaxy of a 100,000million stars, there will only be one supernova explosion per century, and the explosion itself is only hot enough to make gold for about a minute.
The Sun, 22/2/11

Economic Ramifications

If it holds valid that a rise in gold’s price does not directly increase inflation, a couple of policy implications come to mind:
 
          Fewer hyperinflationary fears from QE 
Money printing which pushes up the price of gold would offset some of the inflation worries created by said money printing. Indeed, gold inflation may be deflationary for the economy as the cash is not invested in ‘productive’ assets, such as housing, capital expenditure or buying stocks/bonds to finance a company’s activities. (This assumes a non-collapse in the currency, which would be inflationary)
 
          Gold as a monetary policy tool
Globally, if further QE is the agreed crisis solution, central banks could sell some of their gold holdings should inflation move higher. Part of the reason for driving interest rates lower is to encourage lenders/investors to shift money to riskier asset classes than government bonds, many of which are direct drivers of inflation. By increasing the amount of gold available for investors in the market, could central bankers use it as a tool to tame inflation?

[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice.  Click here for full disclaimer]