Stagflation and Gold: How Economic Conditions Impact Value

Stagflation—an economic condition marked by slow growth, high inflation, and rising unemployment—creates uncertainty for investors. Traditional assets like stocks and bonds often struggle in such periods, leading many to seek alternatives that can maintain value.

Gold has historically been viewed as a safe-haven asset during economic turmoil. Its performance, however, is shaped by factors beyond inflation, including monetary policy, supply constraints, and currency fluctuations.

Gold in Low-Growth, High-Inflation Environments

When economic growth slows and inflation rises, traditional investments lose purchasing power. Gold, unlike stocks or bonds, does not generate earnings or interest, but its role as a store of value makes it appealing when inflation erodes real returns. During the 1970s, a decade of persistent inflation and weak growth, gold prices surged from around $35 per ounce in 1971 to over $800 by 1980 as investors sought protection from a declining dollar.

Periods of weak growth also hurt corporate profits, leading to lower stock market returns. When equities struggle, investors often shift capital into assets perceived as more stable. During the 2008 financial crisis, as global markets collapsed, gold prices climbed from approximately $800 per ounce in early 2008 to over $1,900 by 2011, reflecting increased demand for stability.

Market sentiment plays a key role in gold’s valuation. Economic uncertainty drives demand for gold-backed exchange-traded funds (ETFs) and physical bullion. The SPDR Gold Shares ETF (GLD), one of the largest gold-backed funds, saw significant inflows during the COVID-19 pandemic, pushing gold prices above $2,000 per ounce in 2020. This illustrates how investor psychology influences gold’s appeal in turbulent times.

Monetary Policy Influences on Valuation

Central banks influence gold prices through interest rate decisions, balance sheet policies, and liquidity measures. When interest rates rise, the opportunity cost of holding gold increases since it does not generate yield. When rates are cut or remain low, gold becomes more attractive as an alternative store of value.

The Federal Reserve’s actions illustrate this relationship. In 2022 and 2023, the Fed raised interest rates from near zero to over 5% to combat inflation, temporarily pushing gold prices down as higher yields on bonds and savings accounts made non-yielding assets less appealing. However, by late 2023, expectations of future rate cuts and concerns about economic slowdown reignited demand for gold, demonstrating how market anticipation of policy shifts can influence its valuation.

Beyond interest rates, central bank asset purchases and liquidity injections affect gold’s appeal. During periods of quantitative easing (QE), when central banks expand their balance sheets by purchasing government bonds and other securities, the increase in money supply can weaken confidence in fiat currencies. This was evident after the 2008 financial crisis and again during the COVID-19 pandemic, when aggressive QE programs coincided with significant gold price rallies.

Foreign central banks also impact gold prices through reserve management strategies. Countries like China and Russia have steadily increased their gold reserves over the past decade to diversify away from U.S. dollar holdings. These purchases create additional demand, influencing global prices. Conversely, when central banks sell gold to stabilize their currencies or meet fiscal needs, it can put downward pressure on prices.

Supply Constraints and Mining

Gold supply is tied to mining operations, which face increasing challenges that impact production. Extracting gold is costly, requiring substantial investment in exploration, equipment, and labor. As high-grade deposits become harder to find, mining companies must dig deeper and process more ore, raising costs and limiting output growth.

Regulatory restrictions further complicate supply dynamics. Governments in major gold-producing nations, such as South Africa, Canada, and Australia, impose environmental and labor regulations that affect mining operations. Stricter permitting processes and higher royalty rates can slow new project approvals, delaying fresh supply from entering the market. In some cases, regulatory uncertainty discourages investment altogether, reducing future output.

Geopolitical instability also disrupts supply. Many of the world’s largest gold reserves are in regions prone to political unrest, such as West Africa and Latin America. Strikes, government interventions, and resource nationalism—where countries seek greater control over their natural resources—can lead to mine shutdowns or production cuts. In 2023, for example, protests and regulatory changes in Peru, the world’s seventh-largest gold producer, disrupted operations at several major mines, tightening supply.

Currency Shifts in International Markets

Gold’s valuation is closely tied to global exchange rates, particularly movements in the U.S. dollar. Since gold is priced in dollars on international markets, a stronger dollar makes it more expensive for foreign buyers, often leading to weaker demand. When the dollar depreciates, gold becomes more affordable worldwide, driving increased purchases. This inverse relationship was evident in 2020 when aggressive fiscal stimulus in the U.S. weakened the dollar index, contributing to gold’s surge past $2,000 per ounce.

Shifts in foreign exchange reserves also impact gold’s appeal. Central banks in emerging economies frequently adjust their reserve compositions in response to geopolitical tensions or economic uncertainty. When confidence in fiat currencies declines, some nations increase their gold holdings to reduce reliance on traditional reserve currencies like the dollar or euro. China’s ongoing accumulation of gold, aimed at diversifying away from U.S. dollar exposure, exemplifies this trend and adds upward pressure on prices.