Breakdown in gold and inflation link leaves more questions than answers

Has modern-day monetary policy broken gold’s link to inflation?

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ASX gold inflation gold bull figurine standing on stock price charts representing rising asx share price

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There are questions about gold’s long track record of being an inflation hedge that will leave ASX gold investors wanting.

The precious metal has offered good protection against rising prices in the past. But some experts believe the game has changed, reported the Australian Financial Review.

If so, this will have implications for ASX gold shares as we head into a higher inflationary environment.

These include the Newcrest Mining Ltd (ASX: NCM) share price, Evolution Mining Ltd (ASX: EVN) share price and Northern Star Resources Ltd (ASX: NST) share price – just to name a few.

Gold’s inflation credentials being questioned

Worries that central banks will lose control of inflation have rocked the S&P/ASX 200 Index (ASX: XJO) and global equities.

Historically, that gives gold a big reason to shine. But modern-day monetary policy may have broken gold’s link to inflation.

“Over the past 40 years, gold has been the textbook inflation hedge, but times have changed,” The AFR quoted Chris Weston, head of research at broker Pepperstone.

“With central banks so willing to change financial conditions using their balance sheets, what we’ve seen over the last decade is that in periods when bond yields fall due to deflationary pressures, gold has worked incredibly well.”

Best time to invest in gold

He isn’t the only expert that has voiced a counter-consensus similar view for gold. And if this theory is proved right, gold is a better investment during periods of disinflation and panic.

The COVID-19 market meltdown last year certainly supports the thesis. The yellow metal surged to a record high above US$2,000 as central banks pumped cash into the financial system as disinflation risks grew.

But gold started retreating as economic conditions rebounded and inflation worries started appearing.

Weston pointed out that some of gold’s biggest bull runs in the last 15 years have occurred during periods of disinflation and not inflation.

Don’t throw ASX gold shares out with the bathwater

However, correlation is not causation. I can think of instances where gold could rally in an inflationary environment.

If central bankers want to deflate asset bubbles as gently as possible, they will likely want to cap the rise in bond yields. This is regardless of inflation as we know these monetary gurus are not worried about that.

In other words, if inflation is allowed to run on a long leash and government bond yields are kept on a short one, gold could get a new reason to shine.

ASX gold miners can still prove to be rich pickings

Another interesting point is that even the experts who believe the link between gold and inflation has been cut don’t necessarily see much downside risk for the commodity.

And with gold trading around US$1,900 an ounce, ASX gold shares are still making a very pleasing margin.

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Brendon Lau owns shares of  Newcrest Mining Ltd and Evolution Mining Ltd. Connect with me on Twitter @brenlau.

The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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