In the current issue of the International Speculator we presented a thorough-going article on the linkage between inflation and gold. (To receive a copy, click here.)
Included in the article is a chart by analyst extraordinaire, Bud Conrad, showing the long-term linkage between the Producer Price Index (PPI) and the price of gold.
Given the recent surge in both the CPI and the PPI, I asked Bud to do a brief follow-up, presented here. If you’re interested in profiting from precious metals, take a look.
Measuring Gold’s Link to Inflation
The chart plotting the rate of change in the Producer Price Index (PPI) against gold paints a remarkably clear picture. But to understand why that picture is not just a coincidence, consider why gold is always in demand.
Gold is real money, and it’s been real money from the beginning of recorded history. Specifically, while government-printed paper currencies come and go, gold has been respected as a medium of exchange and a store of value throughout countless generations.
But the dollar and other paper currencies have advantages of their own, especially their greater short-term stability of purchasing power. So gold and the dollar compete for the attention of investors and consumers. And when inflation rates rise, the dollar’s appeal versus gold weakens.
Movements in the Producer Price Index (PPI) are a good – perhaps the best –barometer of inflation, because the PPI is free of much of the statistical “noise” that goes into the more familiar Consumer Price Index.
In the chart below, any rate of change in the PPI above 0% means inflationary pressure in the economy. Below 0% means deflationary pressure.
As you can see, with some explainable exceptions, the PPI and gold move together. You can also see that the trend is currently in place for both higher inflation and higher gold prices.
Of course, forecasting PPI inflation is no easy matter. But the chart does tell us emphatically that when we see growing forces for inflation – rapid expansion in the money supply engineered by the Federal Reserve, artificially low interest rates, growing government deficits, unsustainable trade imbalances and currency competition– we should expect rising gold prices.
About the Author: Bud Conrad holds a Bachelor of Engineering degree from Yale University and an MBA from Harvard. Among others, he has held positions with IBM, CDC and Amdahl. Currently he serves as a local board member of the National Association of Business Economics and teaches graduate courses in investing at Golden Gate University.
Conrad’s charts regularly grace the pages of Doug Casey’s International Speculator, a publication devoted to high-profit opportunities in mining stocks. To receive a no-risk, three month subscription to International Speculator, click here.