CPI (Consumer Price Index)
The Consumer Price Index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households, such as food, transportation, electricity etc. The CPI is calculated by taking price changes for each item in the basket of goods and averaging them with weights reflecting their shares in the total of the consumer expenditures covered by the index. There is also core CPI which excludes high volatility items, such as energy.
The CPI is one of the most important inflation indicators (others include the PPI or PCE Price Index) and one of the most closely watched national economic statistic in general. This is because the annual percentage change in the CPI is used as a measure of inflation and as a means for indexation (for example, Social Security benefits are tied to the CPI to keep them in line with changing prices). It used to be cautiously studied by the Fed, which targets inflation in its monetary policy, however, the U.S. central bank began favoring the PCE Price Index in 2000. Nevertheless, the CPI still counts for the gold market, as it is released earlier than the PCE Price Index, so it offers insights into what the latter index might be, provoking a stronger reaction among investors.
CPI and Gold
Gold is often seen as an inflation hedge which protects investors against the loss of purchasing power. In this context, the nominal price of gold is often adjusted for the CPI to show that the yellow metal preserves value in the long-term. Although gold is an inflation hedge in the long term (for example, in the period from 1895 to 1999, the real value of gold over a one-hundred year period was practically unchanged), its effectiveness seems somewhat controversial for short- and medium-term horizons (which can last decades, actually). The best example is the “medium-term” period of 1980 to 2001, when the price of gold adjusted for the CPI decreased more than 80 percent. As you can see on the chart below, the real price of gold calculated as the ratio of the nominal price of gold to the CPI index was declining from 1980 up to 2001.
Chart 1: Gold price adjusted for inflation (calculated as the ratio of the nominal London morning fixing price of gold to the CPI index) from 1968 to 2018.
The reason why gold does not always react to the rises in the CPI is that the yellow metal is affected primarily by strong increases in inflation, while moderate increases in inflation or declining inflation do not materially impact the price of gold in either direction.
Summing up, gold is often seen as a hedge against a rise in the CPI, however, data challenges this opinion, at least regarding the short and medium-run (which, however, may last decades). Nevertheless, the CPI is a useful inflation indicator which provides insights into the PCE price index and thus, future Fed actions. The increase in the CPI may also lower real interest rates, which can be positive for the price of gold, and/or spur safe-haven demand for the yellow metal if there is high inflation accompanied by the fear about the current state of the U.S. dollar and the global monetary system. This is why the CPI should be watched closely by gold investors.
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