How Will Inflation Affect the Gold Price?

The Spotlight

10 minutes read

Nov 9, 2021

growing investor fears about higher inflation and its impact on the gold price and the economy depicted in a calligram

More and more physical gold investors are starting to ring the alarm about rising inflation, potentially turning back to gold as a safe-haven asset.

If a pollster surveyed the least popular word of 2021, “inflation” would probably make the top of the list.

It has been hard to miss inflation in the news, and the numbers speak for themselves: inflation in the U.S. is now at 30-year high, and has just hit its highest level in 13 years in Europe.

No wonder market fears are rising, not only among billionaires like Bill Ackman and Paul Tudor-Jones, but also with many physical gold investors.

Let’s see how inflation is changing the way investors think about the market, and most importantly, how it could affect the gold price.

What do investors think about inflation?

So inflation has been all over the news lately, becoming a major stumbling rock for the Fed and Co. who have kept deliberately ignoring the situation for months.

But now there’s more and more evidence that inflation is going to linger around a lot longer than the Fed would like.

Speaking at a presser last week, Fed chair Jerome Powell admitted that inflation is uncomfortably high and is likely to last until perhaps the second half of 2022.

But then, for the zillionth time, Powell repeated the Fed’s “transitory inflation” mantra, arguing that price pressures will eventually ease, paving the way for economic growth.

But that’s not what investors and market analysts seem to think, though.

So let’s see how investors feel about inflation and how their sentiment about the market has changed over the past couple of months.

“Inflation is persistent and you’ve got to start thinking about moving your policies more aggressively towards tightening. None of these central banks want to do that. They’re in denial that the markets are telling them that."

The Fed’s inflation narrative is losing investor support

Just a few months ago, investors were largely buying into the Fed's view of "transitory" inflation.

But it now seems that they’re feeling less and less reassured by the Fed’s position and how they are handling the situation.

Let’s look at the numbers.

In October, Morgan Stanley’s E-Trade platform interviewed 119 savvy millionaire investors to see how they feel about the Fed’s “transitory inflation” mantra.

Unsurprisingly, in just a few months, the following had happened:

  • the number of those who supported the Fed’s view of inflation fell significantly from 72% to 53%.
  • the number of investors who “strongly disagree” with the Fed’s view went up from 9% to 19%.

The bottom line of this survey is simple:

Investors have not been this concerned about their stock market holdings and the economy since March 2020, when the Covid-19 pandemic erupted.

This pretty much says it all.

Or, as Mike Loewengart, managing director of investment strategy at E-Trade, summarized: “we’re definitely seeing a downtick in optimism. They are starting to see some cracks in the economic recovery and it’s dampening bullishness.”

The era of transitory inflation is over

In fact, most investors now see inflation as “persistent” while there is growing evidence that inflation has widened its grip not only in the U.S. but globally.

Germany, for example, now has reached its highest inflation level in 30 years, while central banks from New Zealand to Mexico, were forced to increase interest rates.

And yet some central banks, including the Fed, still seem to be ignoring the situation, making many investors even more worried.

“Inflation is persistent and you’ve got to start thinking about moving your policies more aggressively towards tightening. None of these central banks want to do that. They’re in denial that the markets are telling them that,” explains Jim Bianco, President at Bianco Research.

The Fed usually has to “go through the five stages of grief” before they accept a message from the market, he says.

Right now that message appears to be that the era of transitory inflation is over. We are now entering an era of more persistent inflation. If the market continues to push its current narrative, expect periods of denial, anger, bargaining, depression, and then finally acceptance from the Fed,he adds.

And while the Fed is still in the denial stage, and has a long way to go to acceptance, investors are finding it increasingly hard, if not impossible, to keep ignoring the elephant in the room.

As Michael Sonnenfeldt, founder of the investing network Tiger 21, puts it, “no practical business person” he knows would now be able to argue against the fact that inflation has been heating up for some time. And he continues:

“To most of our members it feels like something more than transitory and the start of a secular trend. There is more consistent evidence of inflation coursing through the economy than we’ve seen in a decade, or longer”.

To sum up, the key message from investors is that inflation is here to stay, and that the Fed might be making a mistake ignoring it.

And this wake-up call for the Fed is not only coming from millionaires…

Billionaire investors are calling for action

The world’s richest investors have been sounding the alarm about rising inflation too, warning central banks, markets, and the general public, that things might end up badly if no action is taken.

“I think to me the No. 1 issue facing Main Street investors is inflation, and it’s pretty clear to me that inflation is not transitory. It’s probably the single biggest threat to certainly financial markets and I think to society just in general,” billionaire hedge fund manager Paul Tudor Jones said.

Jones further stresses that the trillions of dollars in the Fed fiscal and monetary stimulus will only push inflation to run hotter for longer.

For those who remember, Paul Tudor Jones became famous after correctly predicting the 1987 stock market crash, the one that saw U.S. markets fall more than 20% in a single day.

Meanwhile, fellow billionaire Bill Ackman, called on the Fed to act and start tapering ASAP, arguing that stakeholder capitalism will make inflation “persistent and growing.”

Caption: Bill Ackman’s Tweet calling on the Fed to start tapering

“The bottom line: we think the Fed should taper immediately and begin raising rates as soon as possible,” he Tweeted.

Billionaire Bill Ackman urges the Fed to start tapering to curb runaway inflation
Bill Ackman’s Tweet calling on the Fed to start tapering to curb inflation

Warren Buffett, too, has had plenty of things to say throughout his career about the negative impact of inflation on the market. And his take on the runaway inflation of the 1970s could also describe the current situation quite well:

“Inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. ... If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker — but not your partner,” Buffett said in 1977.

You get the picture. Even the world’s top investors think the Fed should make a move to address inflation before it’s too late. But so far, Jerome Powell has been circling around the issue, to say the least.

Now that we know the general sentiment from investors about inflation, let’s focus on what gold investors want to know: what impact inflation could have on gold.

"Gold – being the emotional asset as well a scorecard on the Fed – is internalizing a broad-based acceptance that Powell will seamlessly navigate a tough exit of their extraordinary measures."

What inflation means for gold

The long-lasting relationship between gold and inflation started 50 years ago, when U.S. President Richard Nixon officially ended the gold standard, meaning that the U.S. dollar was no longer convertible into physical bullion.

Over the past 50 years, investors have usually seen gold prices soar and the stock market plunge during years of high inflation.

Indeed, because the gold price is measured with currencies, when rising inflation drives up prices and lowers the purchasing power of paper currencies, gold often sees its price rise along with everything else.

This is why gold has historically been considered a good store of value to turn to when a currency ends up losing its value.

Nonetheless, despite almost every investor and media outlet ringing the inflation bell, the gold price has stayed rather flat lately. Why so?

Gold reflects investor sentiment

As mentioned above, just a few months ago, a vast majority of investors supported the Fed’s “transitory inflation” mantra. And it looks like this sentiment has been well reflected in the gold price, analysts say.

“If Gold is right, this is only transitory inflation. Period. […]That’s the current thinking and Gold – being the emotional asset as well a scorecard on the Fed – is internalizing a broad-based acceptance that Powell will seamlessly navigate a tough exit of their extraordinary measures,” Nicky Shiels, head of Metals Strategy at MKS PAMP GROUP, wrote.

In other words, the gold price didn’t react to higher inflation as much as some might have expected simply because the majority of investors still believed inflation was going to fade away.

But with inflation fears growing and the market sentiment now changing, the price of gold could start moving up. Or as Nicky Shiels puts it:

"If there's a FEAR of inflation, that’s likely associated with little confidence in the Fed's ability to control it […] only then do we see runaway Gold/Silver pricing”.

So what’s the bottom line?

To sum up, we now see changing investor sentiment on inflation and growing pessimism about how it could affect the market.

A growing number of investors, including big-name billionaires like Paul Tudor Jones and Bill Ackman, are finding it harder to ignore that inflation is here to stay for perhaps much longer than they had initially expected.

Even though investors were largely supporting the Fed’s “transitory inflation” view only a few months ago, they are now calling on central banks to take action to prevent inflation from running even hotter.

When it comes to gold, as an “emotional asset” it has been reflecting investors' mood about inflation quite well. Its price hasn’t moved up largely while investors thought inflation worries were going to fade away, and that the Fed was handling the situation well enough.

But now that more and more investors believe inflation is here to stay and fears are growing stronger, it looks like the time for gold to shine might be here soon.


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