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The Inflation-Gold Connection: A Closer Look


In recent times, gold has surged to a new all-time high, but is this surge justified by inflation? According to a decade-old study titled “The Golden Dilemma” by finance professor Campbell Harvey from Duke University and commodities portfolio manager Claude Erb, the answer is no.

The researchers built upon the core idea presented in Roy Jastram’s book “The Golden Constant” – that gold maintains its purchasing power over the long term. In other words, its real price remains relatively constant. When gold’s real price experiences short-term surges, it is likely to revert back to its average. Conversely, when its real price declines significantly, a rise can be expected.

Harvey and Erb developed a model based on the ratio of gold’s price to the U.S. Consumer Price Index (CPI). This ratio acts as a gravitational force on gold’s real price. When the ratio falls below the average, gold is undervalued and expected to rise. Conversely, when the ratio exceeds the average – as it does currently – gold is deemed overvalued and expected to decline.

Since 1975, the average ratio of gold’s price to the Consumer Price Index stands at 3.9 to 1. However, the current ratio is a much higher 6.5-to-1. If gold were trading at its average ratio, instead of its current price of around $2,000, it would be valued at $1,190 an ounce.

  1. The early 1980s
  2. 2011
  3. Late 2020 and 2021

Investigating Gold’s Price: Looking Beyond Inflation

Harvey and Erb’s study, which gained prominence in 2012, drew attention to gold’s price trajectory in relation to inflation. Notably, over the course of the following three years, gold experienced a significant decline of nearly 50% in real terms.

This research suggests that gold investors should, at the very least, consider the possibility of a similar fate for gold in the coming years.

Alternative Approaches to Evaluating Gold

While you may question the assumption that gold’s price is solely influenced by inflation, other methodologies explored by Harvey and Erb did not outperform their gold/CPI model. In fact, many alternative models fared even worse. For a more comprehensive analysis of these alternate approaches, refer to their study. Here is a brief list of the models they examined:

  • Gold as a hedge against currency devaluation
  • Gold as an attractive alternative to assets with low inflation-adjusted returns
  • Gold as a safe haven during periods of geopolitical turmoil
  • Gold as a wise investment due to the potential return to a gold standard
  • Gold as an underrepresented asset primed for appreciation as more investors allocate portfolios to it

The current state of gold being overvalued relative to inflation shouldn’t catch anyone by surprise. It’s important to recognize that all assets, including gold, go through cycles of over- and undervaluation. Presently, we find ourselves in one of those times where gold is deemed overvalued.


More: Given that gold has just reached a record high in price, one may wonder if it’s too late for investors to add it to their portfolios.

Also read: As optimism about the market grows, with Oppenheimer joining Wall Street’s bullish calls for 2024, the possibility of the S&P 500 hitting a record high becomes increasingly likely.

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