Stagflation Is On Tap: What Will Happen to Gold Prices?


Happy Friday! A warm welcome to both loyal and new viewers. Today's topic of conversation, is about Stagflation and its implications on Gold prices.

Economists and strategists are now starting to warn about stagflation, which combines a stagnant economy with inflation. While the number of disappointing economic reports continues to grow, it's also looking like inflation is less transient than the Federal Reserve has claimed. So what happens to gold prices during stagflation? Such an environment is usually suitable for yellow metal. Still, there's much more than meets the eye this time around.

Data Indicates Stagflation

Economic growth was roaring along in the first half of the year, but more recently, it has slowed while inflation has taken off. Financial data started disappointing in August as inflation data points surprised to the upside.
The World Gold Council attributes much of the economic weakness to fears about new Covid-19 variants and global supply shocks, contributing to growing inflation.

Other factors driving inflation include increased commodity prices, worker and parts shortages and problematic global distribution. Inflation has now risen to multi-decade highs. The combination of slowing economic growth and increasing inflation suggests stagflation for the current quarter.

The council noted that since the pandemic began, the economy has already moved through all four business cycle phases, from goldilocks through stagflation, deflation, and reflation. The goldilocks and stagflation periods early last year were mild, but the deflationary and reflationary periods later in the year were sharp.

How Assets Fare During Stagflation

Between the first quarter of 1973 and the second quarter of 2021, gold was the clear winner of the major asset classes during stagflationary periods. Other defensive assets and tangible assets also did well, but not nearly as well as gold.
For example, the problem for Treasuries is that they face a tug-o-war during stagflation between the negative impact of inflation and the positive impact from the flight to safety. Corporate bonds did worse than Treasuries, although they were still in the green during stagflationary environments.

The World Gold Council believes that fixed income did well because equities did so poorly during stagflationary periods. It noted that average equity returns during times of stagflation had been the worst during such times. Rising costs and falling revenues squeeze equity investors.
Gold does well during stagflationary environments because it benefits from high risk, inflation, and falling real interest rates. Interestingly, the U.S. dollar is usually strong during stagflation, which is typically bad for gold. However, a stagflationary environment creates the perfect combination of factors to drive strong gold and dollar performances.

The Last 2 Decades

Over the last 20 years, gold, global broad bond indices and inflation-linked bonds are the only assets to offer positive returns across all four economic phases. However, the World Gold Council states that gold's annualized average weighted returns in U.S. dollars are often double bonds.
If stagflation does occur, the consensus calls for it to be short-lived. Real GDP is expected to accelerate during the fourth quarter amid slowing infections with the delta variant and pent-up demand to support economic growth.
However, the World Gold Council expects prices to remain "sticky" due to the ongoing supply chain issues, which it doesn't expect to be resolved anytime soon. If consensus ends up being correct, reflation could resume in the fourth quarter, bringing both inflation and growth.
Reflation tends to be positive for risk assets, driving solid returns for commodities and equities. Gold usually does well during deflationary environments as well. However, Treasuries usually do poorly during reflation.



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