Measuring Gold's Link to Inflation

by Bud Conrad

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.

Editor’s Note: 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 the International Speculator, click here.