Impact of Inflation on Gold: Is it Good or Bad?
Is inflation good or bad for gold? While we know exactly about the effect of inflation on other products of daily use, we have very little knowledge about the effect of inflation on gold and its prices. Do they increase or decrease? Gold has been the most sought-after asset for ages. Some smart investors see gold as a hedge against tumultuous waters of economic crises that may arise due to any unforeseen event like a worldwide pandemic, the Russia-Ukraine war, etc. Investors believe in investing in gold to balance the negatives of their investment portfolio that may arise on account of inflation. So, does that mean inflation is good for gold prices? Let’s find out the impact of inflation on gold through this article.
What is Inflation?
Inflation is the rate at which the prices of daily goods and services increase over a period of time. We measure inflation by taking into consideration the prices of such commodities which are extremely essential to keep daily life going for human beings. Such commodities may include food, grains, crude oil, cooking oil, clothing, shelter, and so on. Inflation occurs whenever there is an increase in the price of raw materials, reduction in the supply, increase in the demand of the products (in case of overpopulation), etc.
Causes of Inflation
There are three main factors that contribute to inflation. These are increases in the costs of production, increases in the demand for products and services, and fiscal policy. The inflation that arises because of rising production costs is known as Cost-Push Inflation whereas the one that happens due to an increase in the demand of products is known as Demand-Pull Inflation. Let’s discuss these three inflation types in a little more detail.
Sometimes, when the production cost of a product or service increases, its buying price also increases. The production costs may arise due to the unavailability of cheap labor, scarcity of raw material in the local areas. This pushes the manufacturing companies to import the raw materials. This is known as cost-push inflation, that is, when the inflation occurs on account of increased production costs.
When the long-term demand for a product or service increases, it leads to an increase in the prices of a wide basket of goods and services. So the strong demand for a product increases its price, indicating towards the onset of the inflation period.
When the government implements expansionary fiscal policy, the taxes on the companies are no more applicable. The company uses this money to pay incentives to the employees. Also, it used the money to hire new employees or buy resources for the working of the company. This leads to increased expenditure and an increase in the demand for goods and services. Now, as the demand increases, prices also increase leading to inflation in the economy.
Secondly, when expansionary monetary policy is implemented by the central banks, the interest rates of lending money to the customers decrease. As a result, the banks can lend more money to the customers. The flow of cash in the market increases leading to more spending and increased demand for goods and services. This, in turn, opens doors for inflation.
Who Benefits from Inflation?
Different participating elements of the market benefit from inflation in different ways. While some companies may suffer losses because of inflation, some on the other hand will profit from it. Then from the consumer point of view, there is very little advantage to the consumers from inflation. It is because the purchasing power of their money decreases due to the rise in the prices of goods and services.
However, some specific types of companies may benefit from inflation. For example, as the prices of crude oil and fuel increase, the company dealing in these products profit from inflation. In addition to this, the price of their stocks also increases. In turn, the investors holding the shares of such companies benefit from inflation as their share price increases.
On the other hand, companies that have a high consumption of electricity and fuel to run their offices in different locations may suffer high losses due to inflation. This is because, as the price of fuel increases, the cost of running the business increases against a constant supply. The share prices of such companies fall considerably in times of inflation.
Furthermore, talking about companies dealing in gold production and selling, they do not bear any losses due to inflation. This is because inflation results in high demand for gold. This leads to an increase in gold prices. Also, if the supply of gold runs out, the gold production companies can always increase their production to push out more gold into the market. Therefore, in one way or the other, companies dealing in gold and gold products benefit from inflation.
Impact of Inflation on Gold: Is Gold Affected by Inflation?
Yes, inflation affects gold in more than one way. Inflation causes gold prices to increase. This happens because the purchasing power of the dollar reduces because of an increase in the prices of basic commodities. Since we know that the value of the dollar dominates the price of gold, therefore, the prices of gold increase with inflation. So when the purchasing power is slowly decreasing with inflation, no one wants to hold cash so they begin buying gold. It is because history shows that the prices of gold keep increasing in the long run even after facing a downfall at certain points in time. This rise in the demand for gold during the inflation season further increases the price of gold against a limited supply.
In conclusion, we can say that inflation may have a negative impact on traditional fiat-money-based assets. However, inflation has a positive impact on gold demand and its prices. So, in uncertain times when there is a strong likelihood of an inflation hit, the investors must always have gold in their portfolios. If you don’t have a diversified investment portfolio with 10-15% gold in it, it is the best time to start investing in gold.