How Inflation Rates Affect the Price of Gold

While many gold investors might not be able to explain how inflation rates affect the price of gold, they all know that investing in the precious metal is a hedge against inflation. Just what does that mean? A hedge against inflation is a way of protecting one’s purchasing power. When the price of a loaf of bread goes up by 50 cents, it takes more dollars to buy the same loaf of bread. In an inflationary environment, the price of gold generally goes up with the rate of inflation. A Troy ounce of gold will still buy the same number or maybe more loaves of bread as it would have bought before it went up by 50 cents.

The Psychological Effect of High Inflation Rates

While the above example shows how an ounce of gold will always buy about the same amount of a given product, it does not completely explain why people turn to gold when they expect inflation to rear its ugly head. People are psychologically impacted when they go to the gas station and find it now takes $10 more to fill their tank. They worry that it may take $20 more to fill their tank next month. It is the fear that prices will continue to rise indefinitely into the future that causes so many people to invest in gold.

Gold is a Physical Asset

Physical assets always have some value. A house will still be worth something even if there is a Great Depression and the dollar becomes worth little more than the paper upon which it is printed. The limited supply of gold and the worldwide acceptance of it as a valuable commodity makes it inconceivable to think that it will one day be worth nothing more than a lump of coal.

The Influence of the Federal Reserve

While the President is in charge of fiscal policy, the Federal Reserve is in charge of monetary policy. The Fed has the power to print money and influence interest rates. When the Fed exercises its power to print money and increase the money supply, they are increasing the chances that the rate of inflation will also increase. Inflation rates are strongly tied to the strength of the dollar. When the Fed prints more money, they weaken the dollar. The Fed’s actions directly affect the inflation rate. The inflation rate directly affects the price of gold.

Worldwide Inflation

Gold is a global asset. As such, the effect of inflation on gold prices is not confined to the rise in prices only in the United States. Inflation in Europe or any other part of the world also affects the spot gold and gold future prices. When oil prices go up, the entire world is affected. Investors, speculators and anyone that fears that there will be an increase in the rate of inflation; will turn to gold for both potential price appreciation and as a way to protect their purchasing power when the rate of inflation rises.

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