Gold & Inflation: The Correlation Myth Could Cost You Mightily

Gold soars to 9-month high amidst SLOWING inflation? A one-off? The last 54 years suggests otherwise.

by Nico Isaac
Updated: January 30, 2023

On January 26, National Geographic published a fascinating story about the last Incan emperor Atahualpa. Legend has it, in 1532 Atahualpa was captured by Spanish conquistadors to be executed on the spot.

Realizing the Spanish people's obsession with gold, Atahualpa, whose people used the precious metal more as a decorative prop than a form of currency, offered the Spanish leader a room 22-feet-long and 17-feet-wide filled top-to-bottom, wall-to-wall, with the shiny yellow metal in exchange for his life.

A contract was signed and notarized, ensuring Atahualpa's life be spared by this golden ransom.

(Spoiler alert: The Spanish conquistador's signature was not worth its weight in bullion, and Atahualpa was eventually killed.)

The story reminded me of another promise ascribed by our contemporary financial leaders regarding the gold market; namely, that gold prices are positively correlated with the rate of inflation. It's why every central bank leader going back to the 1970s has been either revered or reviled by gold bugs, depending on their rate policies to manage inflation. To wit: Raising rates to combat inflation causes gold to fall, while cutting rates to encourage inflation causes gold to rise.

In the 1970s, the nearly 7-foot-tall Fed "giant" Paul Volcker took the heat for single-handedly hurtling gold into a prolonged bear market thanks to the "Volcker shock" of hiking interest rates to 20% to thwart inflation. In Volcker's own words:

"Gold was the enemy to me because that was a speculative vehicle, while I was trying to hold the system together."

Four decades later, Volcker's obituary quoted the phrase "Enemy of Gold."

Cut to the last year and that same narrative has gone unchallenged, as these 2022 headlines make clear:

• On June 25, CNBC Mad Money host Jim Cramer shouted, "I believe in gold" as one a few assets that hold their value in times of inflation. The other two being "masterwork paintings" and "mansions."
• On October 19, CBS News wrote, "Why You Should Buy Gold During Inflation"
• And on Dec. 14, Reuters described an "inflation-fueled, new gold rush at ancient Austrian Mint" founded in the year 1194.

The notion that gold is an inflation hedge has been signed and notarized by Mainstream Experts Esq. But should you continue to wager your financial livelihood on that promise?

In February 2022, our Global Market Perspective published a special segment titled "Market Myth -- Gold and Inflation" that made a strong case against doing so. Back then, gold prices were falling, while consumer price inflation was up. "That's not unusual," wrote Global Market Perspective:

"If you believe in gold as a consumer price inflation hedge then, as the CPI is accelerating, the gold rise should be advancing. The green shaded areas show that there have been five occasions since 1980 when the opposite was true, the last year being a good example. On the other side, the Gold-Inflation myth would allude to the price of gold declining as CPI was decelerating. The grey shaded areas show five occasions since 1970 when this was not the case, 2007 to 2010 being a prime example."

"In fact, the correlation coefficient between the two series turns out to be MINUS 0.43, meaning that not only does no relationship appear to exist, if any does, it's a negative one."

"The evidence that, whilst gold might go up over the long-term as the CPI chronically advances, shorter time frames, which can last years, suggest no relationship at all."

"Thankfully, gold is a free market these days, so the Elliott waves should guide us. Stay tuned."

Flash ahead a year. In January 2023, gold prices soared to 9-month highs, even as the CPI has been declining since June 2022.

In fact, gold's upside reversal began in November 2022. Rather using the beacon of inflation, our Metals Pro Service used Elliott wave analysis as a guide to gold's near-term trend. On November 8, Metals Pro Service showed its Elliott wave count for gold, and said the bottom was in:

"The simple view is that 1618.30 marks the bottom of a multi-year flat correction as wave (4). That would make [us expect a] sharp rise..."

From there, gold turned around and embarked on a powerful rally to 9-month highs on January 23.

Atahualpa's story is a tragic lesson in taking our leaders' words at face value. For investors, the truth about the patterned behavior of financial markets is in plain sight, when you're ready!

No forecasting method always gets it right, but in the end, traders and investors can use the old, broken model of "fundamental" market analysis. Or they can carry the weight of their decisions in the new, reinforced vessel of our Elliott wave-based Metals Pro Service (or our monthly Global Market Perspective.)