The long arm of inflation: The US dollar and gold
Many have called for the return of inflation as a result of these rising debt levels and increase of “money printing” by central bankers. But sparking inflation through accommodative monetary policies has proven to be a true Sisyphus-like dilemma for policymakers in the past, as they’ve unsuccessfully tried to push the inflation boulder uphill over the past decade – primarily due to a drop in the velocity of money. Additionally, with the continued structural deflationary headwinds of aging global demographics, rising impact of technology, and the now inevitable deleveraging cycle, inflation in the form of traditional price measures will likely remain tame.
Instead, inflation may emerge in the form of currency devaluation, particularly with the US dollar, as a result of continued accommodative policies. A weaker dollar is inherently an inflationary action because it reduces the purchasing power of US consumers and investors. Monetary and fiscal policies geared toward a weaker dollar could greatly aid in reducing debt burdens through this inflationary effect – with a weaker dollar supporting growth through exports and reducing nominal values of debt outstanding.
This environment could prove powerful for gold – which may provide the role of a store of value by keeping up with broad price fluctuations in conjunction with weakening currencies. An outlook for a weaker USD environment is a good sign for gold which holds an average correlation of -0.36 to the USD since 1971 and a current 12-month correlation of -0.65 (as of May 31, 2020). But it is not always a straight line with gold and the USD. Gold and the USD have also exhibited brief periods of synchronization and even positive correlations in the short run. This can typically occur during outlook extremes – with gold and the dollar being sought with flight-to-quality motives during extreme downturns. Positive correlation has also been supported during periods when higher cyclical demand for gold jewelry and technology rose with extreme increases in real GDP alongside rising demand for dollars to invest.
What’s bad for the US dollar may be good for gold
Heading into 2H 2020, a significant jump in volatility – or severe risk-off sentiment – could see USD support in the short term. But there are several reasons to expect the USD remains softer over the medium to longer term – an outcome that potentially supports continued gold demand and price outlook.