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The Bank of England Hates on Gold

Written by Luke Burgess
Posted September 4, 2020

One policymaker at the Bank of England has a message for gold investors: The record-high price of gold “tells you precisely nothing.”

Gertjan Vlieghe, one of the nine members of the BOE's Monetary Policy Committee, warned investors last week that gold is a “terrible” leading indicator for inflation.

Talking with U.K. lawmakers, Vlieghe said, “If you look at previous episodes where the gold price is very elevated, you realize very quickly that gold is a terrible predictor of inflation.”

That seemed a bit odd to me.

It's not that Vlieghe is incorrect. There's no error here — the spot price of gold is in fact a poor leading indicator of inflation. (I'll explain in a minute.)

But what's odd is gold is not typically seen as a leading indicator of inflation by investors.

I have seen that from a handful of sources. But I'm not sure if I've heard any real gold expert ever say gold is a great leading indictor for predicting inflation.

The truth is the gold market is dominated by jewelry. More than half of the world's gold demand comes from the jewelry sector. Only about a quarter of gold demand comes from investment. The rest comes from dentistry, electronics, and other industrial applications.

Gold End Use
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In a very low-inflation environment where consumer prices are depressed, we would expect jewelry sales to increase. And an increase in jewelry sales would boost gold demand and could lift prices. In other words, inflation doesn't need to be high or increasing for gold prices to rise. The price of gold could increase in a very low-inflation environment.

So rising gold prices are certainly no indicator of future inflation.

Yet gold prices and inflation are in fact closely related.

The price of gold can increase (but doesn't always) as a reflection of investor expectations of inflation. If investors believe inflation will rise, they'll buy gold. But that sentiment is really a poor indicator.

On the other hand, however, increasing inflation has almost always been met with rising gold prices.

So Vlieghe seems to have it a bit backward. Rising gold prices are not a predictor of increasing inflation. Rather, increasing inflation is a much better predictor of rising gold prices.

I have to speculate here...

Of course I have no way to prove this, but for the Bank of England to say gold is a terrible predictor of inflation seems like a very purposeful message — it was planned.

If Vlieghe intentionally went out of his way to make this statement, most likely he was addressing something specific — a recent debate he had or a paper he read. But there's also a chance this statement is just one of many efforts made by the BOE and other central banks around the world to shed a negative light on gold.

I don't think of central banks much differently than any other business with products and services. The Federal Reserve is just another company that provides its product (the U.S. dollar) and services (monetary policy) to the U.S. government. The BOE is the same for England.

Companies want your business. And they'll pretty much do or say anything to get it, including portraying their competitors negatively. Central banks don't operate much differently.

Central banks produce fiat currency. The dollar in your pocket is, in a very literal way, not a U.S. dollar. It's actually a Federal Reserve Note. That's explictly stated on every single bill.

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The competitor to every product produced by every central bank in the world is gold. Why shouldn't we think central banks don't have motivation to paint gold (its competitor) as a villain?

We should.

And that's what I'm speculating Vlieghe is doing with this statement. It's not untrue that “gold is a terrible predictor of inflation.” It's just a very misleading statement.

We never know if any of the things we hear, see, or read have some underlying agenda. Unfortunately, though, I think that's the case most of the time.

Until next time,
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Luke Burgess

As an editor at Energy and Capital, Luke’s analysis and market research reach hundreds of thousands of investors every day. Luke is also a contributing editor of Angel Publishing’s Bull and Bust Report newsletter. There, he helps investors in leveraging the future supply-demand imbalance that he believes could be key to a cyclical upswing in the hard asset markets. For more on Luke, go to his editor’s page.

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