Here Is How Inflation Will Help Gold Get Its Glitter Back
(Kitco News) - Inflation played a key role in “stabilizing” gold prices over the last couple of years and it is now at a point where it can be of great benefit to the precious metal, according to Leuthold’s chief investment strategist.
“Inflation pressures have been ‘slowly’ building, helping to stabilize the price of gold, and an important indicator recently suggests that inflation has reached a point which should prove much more beneficial to the yellow metal,” Jim Paulsen wrote in the Paulsen’s Perspective report published on Monday.
Paulsen uses the Citigroup’s U.S. Inflation Surprise Index in his analysis, pointing to an important connection between inflation and gold prices.
“During the last 20 years, the level of this index at each month-end has been importantly related to the performance of gold in the ensuing month,” Paulsen said.
The vital connection here is when investors underestimate inflation risk, gold prices go up, the report pointed out.
“Since 1998, when the Inflation Surprise Index has been below zero (i.e., inflation has mostly been lower than expected), in the next month the price of gold has risen at an average annualized rate of 5.8%,” Paulsen noted. “However, whenever the Inflation Surprise Index has been above zero (inflation reports have been outpacing investor expectations), the price of gold has produced an average annualized return of 15.5%!”
Paulsen explains the nuanced relationship further: “As shown in Table 1 … the price of gold tends to rise substantially once inflation surprises reach the 3rd quintile (even though the sign of the Inflation Surprise Index is negative in the 3rd quintile) and performs even better as the Surprise Index rises into its 4th quintile.”
The sweet spot for gold is when the Inflation Surprise Index is within quintiles three and four, which is where it has been since the beginning of the year, Paulsen explained.
“Since the economy has returned to full employment, at a minimum, inflation fears appear likely to persist until the next recession. Consequently, should the Inflation Surprise Index hover in quintiles 3 & 4 in the next year, 20%+ returns represent a reasonable forecast (with negative monthly outcomes only about one-third of the time),” he added. “Maybe it’s time for a little yellow metal in your equity portfolio?”