If you tell a hyperinflationist that their thesis has been entirely wrong over the last few years (which it has) they inevitably respond in one way: “look at a chart of gold”. This is a reasonable response. The only problem is, it hasn’t been entirely true over the course of the last 10 years.

Since the early 70′s US inflation and gold prices have actually maintained a fairly high correlation. Figure 1, which shows the year over year rates of change, shows that gold prices have tended to track the CPI:

(Figure 1)

There has been a notable divergence over the last 10 years though. This is seen more clearly in figure 2 where we clearly see that gold prices have soared nearly every year during a period of stagnant economic growth in the USA that has generally been characterized by low inflation (the low inflation is easily confirmed by dozens of other independent variables including wages, bond yields, ISM price index data, ECRI Future Inflation Gauge, etc).

(Figure 2)

So what gives? Why do gold prices continue to soar as the USA continues to suffer through a period of low inflation and general economic malaise? The answer lies not in the “central planning” of the US government, but everyone else’s favorite “central planners” – China.

As we all know, China’s economy has roared to life over the last 10 years. Their government has increased the money supply at a 17% annualized rate as they try to sustain growth. Their inflation concerns are well documented.

Figure 3 shows the correlation between China’s CPI and gold prices over this period. As you can see, it tells a dramatically different story than the US CPI data does:

(Figure 3)

About a year ago I described three bullish trends in gold prices. The third trend was explained by UniCredit:

CR: I think the previous two trends are largely unfounded (though that doesn’t mean they won’t persist), however, the third trend is very real. UniCredit cites China’s surging demand for gold:

Unicredit: “The Chinese government has encouraged consumers to invest in gold, and with great success. In the last 12 months, demand for gold totaled 532 tons. While jewelry demand is merely stagnating, investors are increasingly discovering the gold market. While as recently as 2008 only 17 tons of gold were purchased, in 2009 the figure was already 73 tons. In the last 12 months, demand was even 143 tons! Although China has evolved into the world’s largest gold producer in recent years, the annual production of most recently 330 tons is by no means sufficient to satisfy this demand.

China announced important gold market reforms at the beginning of August. Foreign companies are now permitted to offer their gold coins at the Shanghai Exchange, more banks are permitted to import gold from abroad, and more domestic, gold-based investment products are to be developed. As a result, demand of Chinese investors will increasingly be felt on the global market. But the Chinese government also has an ever greater interest in gold imports. In April 2009, China had reported an increase in its gold reserves from 19.29mn to 33.89mn troy ounces. Nevertheless, they are still at a very low 1.7% of the entire foreign exchange reserves. If China is targeting a gold reserve of, for example, 10%, it would have to purchase 6,130 tons of gold or 2.4 times global annual production. If China were to meet the demand only from domestic producers, it would take 19 years to achieve this objective. Since the gold market is per se only a very small market, further increases in the price of gold are pre-programmed.”

This powerful trend can also be seen in the correlation between Chinese wages and gold prices:

(Figure 4)

I’ve built all of this into my reasoning for thinking that gold is entering an irrational bubble. And I believe one of the primary drivers of this inevitable bubble is this misconception that the USA and the Federal Reserve are the primary causes of inflation and gold prices. The reason the hyperinflation theory in the USA has been so wrong (aside from misunderstanding how the modern monetary system works) is because the hyperinflationists have misunderstood the actual cause of their inflation worries. They’ve no doubt been right (in terms of gold), but they’ve been right for the wrong reasons. In my opinion, it is not the “central planning” of the USA that is causing this fear trade. Rather, the true fundamental driver is the Central Bank of China.

The key for investors will be understanding the point where the gold market reaches disequilibrium based on these misconceptions (the Euro crisis and the Fed contribute significantly to this misconception) and undergoes the inevitable collapse that always follows a bubble. I personally don’t think we’re there yet. In the meantime, when someone points to the Fed, the US government and their “central planning” or “money printing” as the primary cause of the surge in the price of gold and justification of their USA hyperinflation theory, you might do them a favor and let them know that they’re right about the flaws of “central planning” and excessive “money printing”. You just might want to also let them know that they’re focusing on the wrong central bank.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Gold is not an industrial commodity. Whatever was mined in the past is still here. There are (all figures from now on will be rough) 165,000 tons in existence. Annual mine production 2500 tons. Jewellry demand 1800 tons. Etf holdings 1600 tons. 2500 tons (mine production) would be turned over in trading in less than a week on the London bullion market and keep in mind that’s not counting what’s traded at other major financial centers around the world. An ETF buying 50 or 100 tons wouldn’t even blip the radar screen. China could buy their 6000 tons over several months and not even blip the screen.

    What would blip the screen is if the market found out China was buying that much. The price would definitely jump. The analogy in the stock market would be if Warren Buffett took a large position in Apple. He could easily do it and not even ripple the price but let the market find out…

    Someone mentioned negative real interest rates. I agree. I think another big reason can be found in the Z1. Total credit market debt in the U.S. in 1980 – 4.5T. In 2000 – 24T. Now 52.5T. Contrast that with GDP which went from 3T to 15T. Anyway, that is some massive debt inflation which the bullion market ignored for 20 years until 2000. Gold was in a bear market.

    Mistrust in government and the monetary system definitely plays a role among a few other things like the desire to increase savings.

    Gold appears to behave like money to me and if it walks like a duck…

  2. Apologies for the double post. My first one didn’t show up on my screen.

  3. 1 january 1999
    1 january 2002

    Its the Euro…… what happens when not enough fiscal money is provided to pay off private credit , people engage in energy austerity to pay their debts – but where does this austerity flow to ?
    It flows to Gold which is freefloating on the Euro balance sheet.
    Europe is draining the US of its gold reserves…..I think

  4. Check out the excellent Aug 16th programme on the Irish VB channel.
    My guess is that there is a massive amount of euro periphery bank credit deposits flowing into the Euro GOLD CB balance sheet , knocking down the dollar reserves status.
    This is a war between the US treasuary & the BIS – Ireland is at the focus of these tectonic plates.
    There was a shit load of credit deposits in Ireland and we ain’t drinking stout no more – we are in lock down mode here.
    There is more then one Dork in the euro periphery with 100s if not 1000s of ounces of the precious each.

  5. One of your better posts.

    I think some of the Johnny come lately’s to the precious metals space have to get their brains beat in. This bull hasn’t downticked since 800/oz really.


    But the hot money HAS to get hurt. Its a metaphysical certitude.

    The when is the tricky part.

    Party on, surfs up!

    • The key to the argument there:

      “The first and perhaps the most significant is that gold isn’t tied to inflation. “

      Which add builds perfectly into the myth that low interest rates will necessarily equal high inflation….

      • 70s with stagflation would not necessarily match this. That conclusion is valid for the time period he looked at which was the decline of interest rates post volker’s hiking to crush stagflation.

    • I didn’t write that piece. I provide a pretty broad set of perspectives here. We have 40 different authors and not all of us agree on everything. My message is generally pretty consistent, but that doesn’t guarantee that every piece will be along the same lines. I am not oblivious to other perspectives and while I know readers are familiar with my perspectives, I am not afraid to expose them to other perspectives in order to broaden horizons.

  6. Since all fiat currencies fail with 100% predictability, I’m 100% confident that the price of gold will go to “infinity” (in US dollars.) Whether its price tracks CPI for a decade or not doesn’t bother me at all… There’s a lot of noise in both numbers but the smart “money” knows where the dollar ends up. All fiat currencies do.

    Gold has a 5,000+ year history as a store of value. The number of ounces to buy a house, or a high quality outfit, or whatever has been generally constant over a VERY long period of time. If you have a better proxy for inflation, I’m all ears. Using CPI certainly isn’t the answer.

    I think the divergence in your graph more aptly illustrates the desperation of CPI-massaging government officials.

    • Since all fiat currencies fail with 100% predictability, … GoldBugger

      Yes indeed! English tally sticks only lasted 726 years.

  7. surprise surprise………….

    The government modified the CPI calculation in 1998. Due to this change of algorithm, according to economists, the new CPI formula basically underweights those goods with fast price growth and overweights the goods with slow price increases. As a result, it effectively underestimates the real inflation impact on people. If we use the pre-modified CPI formula prior to the change in mid-1990s, the average difference is about 3% higher (please refer to

  8. I’ve always been of the opinion that precious metal prices really don’t have anything to do with inflation or deflation, they have to do with instability.

    In an economy with high, but steadily high inflation, that is maintained for a long period, there is no reason to buy precious metals as there will be higher yielding options available (eg, equities).

    People pile into precious metals when there are shocks to the system and every other investment looks suspicious. PMs are a fear barometer, and this can be true during both shock inflation and shock deflation. It was evident during the Great Depression, a period of deflation, in which gold mining stocks went to the moon (until gold was diddled by the government).

    In the charts above, huge spikes occur in 1973 and 1979. This is *not* in response to shock inflation, it’s in response to shock geopolitics that threatened the world economy (oil shocks).

    While our lords and masters continue to meddle with their incompetent hands in the world economy, creating shock after shock, people will run to precious metals. When the fog of war disappears and the future seems more predictable, PMs will be dumped (regardless of the state of *flation).

    • Mediocritas,

      I’ve always been of the opinion that precious metal prices really don’t have anything to do with inflation or deflation, they have to do with instability.

      Completely agreed. I think very much along the same lines: see this post

  9. inflation is irrelevant…..and the CPI, now there’s an convuloted irrelevant number.

    gold will continue to go up until the asset bubble of private and public credit expansion that began in 1981 and accelerated in 1995 is completely washed out…..2-4 years.

    but all we had to do was juggle this or that paper the CORRECT way….not

    hell of a world hangover coming.

  10. If you missed the boat on Gold you are asking why and try to rationalize the move as irrational but If you got in early you don’t care why. All you know is you can get a lot more of that paper for the same quantity of Gold.

  11. 1. Anyone who looks at the CPI as a measure of inflation is fooling him/her-self.
    2. One should look at the Gold to CRB ratio.
    3. If anyone wants to see inflation then one should look at e.g. Dow Jones, Nasdaq, or the CRB.

  12. the bls made the following change to prevent overstatement of inflation in 1999.

    1. Before 1999, CPI used only Laspeyres indices, measures of the price changes in a fixed market basket of consumption goods and services of constant quantity and quality bought on average by urban consumers, either for all urban consumers (CPI-U) or for urban wage earners and clerical workers (CPI-W). It is argued that Laspeyres index systematically overstates inflation because it does not take into account changes in the quantities consumed that may occur as a response to price changes. The Laspeyres formula works under the assumption that consumers always buy the same amount of each good in the market basket, no matter what the price. The geometric mean price index formula used to calculate many of the elementary indices, in contrast, assumes that consumers will always spend the same amount of money on a good and shift the quantity they buy of that good based on the price. Critics argue that if due to price increases consumers shift from preferred goods to less preferred goods their standard of living has declined and therefore the geometric mean price formula understates inflation.

    to base any argument on the cpi is just plain silly.

  13. Core CPI excludes energy and food. A better comparison would be the money supply. The people who are saying gold is in a bubble have been saying it for years. Well maybe it is now but it doesn’t matter to me and the rest of the smart money because we got in when you were too scared because you read a similar article. In my opinion gold may have a significant pullback but the bull market has a bit to go yet.

  14. 1. QE2 created inflation in food prices worldwide. That is why they had to stop printing for the time being. It created stagflation. Deflation in housing and unwinding of debt and inflation in commodities and food. Or why do you guys thing Arab spring came upon?
    2. Gold was quite sideways during that time. it is very seasonal, too. Right now it is supposed to take off. So, gold really did not respond THAT strongly to money printing by the US.
    3. What gold does react to is the realization by the people that there is now a sovereign crisis and that their paper assets may not be as safe as previously thought. This is not just the US dollar, but much more the Euro. Aka there is almost no place to run for safety. Money went into the Yen and Swiss Franc. But mostly into gold. I really don’t care whose web site is better and who is hyperinflationist or deflationist. It is beyond that at the moment. People are scared shitless and that’s why gold is bought. And treasuries. Gold will be a bubble eventually, but not anytime soon. Or do you people really thing everything in Europe will be just peachy four weeks from now? Come on people, travel the world a bit. US centric is dead. We are shifting away from the US to a new superpower.
    4. CPI is laughable. Food and gas is nothing, housing is everything. Of course there is no inflation since housing is still on its way down.
    5. Zerohedge is a very good site. There is a lot of stuff there published that is forgettable, but there are articles that saved my behind in this downturn as they got me out of the market in time. The world is right now crashing without me.

  15. Eddy Elfenbein of and Jake of EconomPic Data developed a quite-interesting relationship between gold prices and short-term real Treasury rates (levered). The charts are very well corelated over the past 50 years.

    Clearly shows that the market thinks of gold as a alternative currency (without yield, but also without currency devaluation risk). Close but not quite the same as comparing gold to U.S. inflation.


    Eddy’s original comment: “Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%.”