Which Economic Unit’s Inflation Rate Moves the Price of Gold the Most?

It’s not uncommon to see investment bankers check the state of the gold market at least a few times a day. Of all the markets in the world, it’s one of the few that everyone finds fascinating.

Movements in the gold market can signal pending inflation, slowing economic growth, unwise budgetary decisions, and other interesting indicators. The gold market also has a much broader reach than any other market, in that traders, politicians, and many others care about what the price of gold is doing. Given the interest from the investment banking world in general, we thought it might be interesting to see which economic unit’s inflation rate has the greatest impact on the price of gold.

Here is a look at the relationship between the price of gold and four selected economic unit’s inflation rates over the past 15 years.  You might be surprised by which one moves the price of gold the most.

U.S. Inflation and the Price of Gold

First, let’s review the relationship between the inflation rate in the U.S. and the price of gold. Perhaps surprisingly, the two are not as closely related as some might think. At times, the inflation rate in the U.S. moves fairly closely with the price of gold, such as in 2008 and 2009. This conventional wisdom finding breaks down a number of times, though, such as the divergence seen in the most recent years (2013 and 2014).

Inflation Movements and the Price of Gold - United States

Europe’s Inflation and the Price of Gold

The next graphic is a look at the inflation rate in Europe and the price of gold. Interestingly, the two look even less closely related than the inflation rate in the U.S and the price of gold. As with the experience in the U.S., there are times when the two generally moved together (2008/2009 and 2012/2013). There’s also been some divergences, such as the 2005/2006 and 2014 periods.

Inflation Movements and the Price of Gold - Europe

Russia’s Inflation and the Price of Gold

The third graphic is a look at the price of gold and the inflation rate in Russia. Perhaps less surprising, the two look as though they generally don’t move together, with the exception of, for example, the most recent movements in both.

Inflation Movements and the Price of Gold - Russia

China’s Inflation and the Price of Gold

The following graphic is a look at the inflation rate in China as related to the price of gold. Interestingly, this looks as though the two move generally together, with fewer exceptions than the U.S. and Europe.

Inflation Movements and the Price of Gold - China

Which One Wins?

With the four economic units’ inflation rates shown, which one is most correlated with gold price movements? The answer, surprisingly, is Russia on the downside and China on the upside (see the following correlation matrix).

Interestingly, the inflation rate in Russia (and the U.S. and Europe) is negatively related with gold price movements.  This means that, contrary to popular belief, an increase in the inflation rate in Russia (and, again, the U.S. and Europe) is correlated with a decrease in the price of gold (that is, without doing any sophisticated econometrics).

In contrast, the inflation rate in China is positively related with gold price movements.  This means that when the inflation rate in China rises, so does the price of gold (in general).

Correlation Matrix2.fw

Conclusion

If you were asked which economic unit’s inflation rate moves the price of gold the most, you probably would have said the U.S.  Now you can see that the gold market appears to care more about what is going on in China and Russia than inflation conditions in the U.S., at least when looking at the correlation of these economic units’ inflation rates with the price of gold.

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