gold investment, silver investment

Precious metals investment terms A to Z

GDP (Gross Domestic Product)

The gross domestic product (GDP) is the monetary value of all finished goods and services produced within a country in a specific time period. It is also the most common measure of a nation’s overall economic activity or the size of the economy. It is released quarterly by the Bureau of Economic Analysis.

The GDP is an extremely comprehensive and detailed report, which synthetically gauges the health of the economy. Although more and more economists recognize the flawed character of the GDP (for example, it includes only final goods and services; overstates consumption; it assumes that government spending is productive; it treats imports as something negative; it excludes household work, and so on), governments, central banks, financial analysts and investors still think it is possible to frame the whole economy in just one number. This is why the GDP is still closely followed, also in the gold market. However, data is not very timely – the advance release is published four weeks after quarter end, while the final release is published three months after quarter end, and revisions can be large enough to significantly change the percentage change in GDP. This is why the data on retail sales is used to forecast GDP, and why retail sales are one of the most influential indicators for the gold market, according to the IMF Working Paper “The Effects of Economic News on Commodity Prices: Is Gold Just Another Commodity”.

GDP and Gold

The literature discerns two channels of the GDP’s influence on the price of the shiny metal: the income-consumption channel and the safe-haven channel. Let’s start with the former. The reasoning goes as follows: when the economy grows fast (as opposed to slowly or declining), people’s incomes and purchasing power rise (instead of stagnating or decreasing), so does the demand for gold. We are skeptical of this alleged relationship, because – as we showed in the Market Overview – the price of gold is not significantly driven by consumer demand, but by investment demand (consumers are price-takers, not price setters, hence they buy more when the prices decrease and vice versa).

According to the safe-haven channel theory, the GDP indicates the economic health of a country, while gold is a non-confidence vote in the U.S. economy. Hence, there should be a negative correlation between GDP growth and the price of gold. When the economy expands, investment demand (attracted by the safe-haven character of the shiny metal) falls, and vice versa. Let’s analyze the chart below, which presents nominal U.S. GDP growth and the price of gold (we chose nominal, not real growth, because we compare it with nominal gold prices).

Chart 1: Nominal U.S. GDP growth (green line, left axis, year-over-year changes in percent) and gold price (yellow line, right axis, London P.M. fix) from 1971 to 2015.

Nominal U.S. GDP growth and gold price

As one can see, the price of gold was rising in the 1970s, while GDP growth was declining only during a few years during that decade. In the 1980s and the 1990s, the pace of economic growth was quite high and stable, so gold remained in a secular bear market. In the 2000s, the price of gold was rising both during rises and falls in the pace of GDP growth. And in the 2010s, the shiny metal was again in a bear market, despite the unimpressive economic recovery of the U.S. Although it seems that there is no clear relationship between gold prices and GDP growth, we shouldn’t draw conclusions too quickly. The chart below, which presents nominal U.S. GDP divided by the price of gold, paints a somewhat different picture. As one can see, the U.S. GDP to gold ratio was negatively correlated with the price of gold: U.S. GDP in relation to the price of gold was declining in the 1970s and 2000s, and rising in the 1980s, 1990s and 2010s.

Chart 2: U.S. GDP to gold ratio from 1971 to 2015.

U.S. GDP to gold ratio

Investors should remember two things. First, the GDP is a lagging and often revised indicator. This is why whether the GDP is above or below market expectations (i.e. the surprise component of the news) is more important than the number alone. Gold (as every currency in general) is a leading indicator, which quickly incorporates the investors’ expectations about the future outlook. Therefore, gold does a much better job in predicting recessions. For example, the price of gold signaled a high probability of a recession as early as in the fourth quarter of 2005, while the GDP declined (i.e. GDP growth became negative) no earlier than in the third quarter of 2008 (officially, the recession started in December 2007).

Second, GDP is a very aggregate and complex measure of the economic output of a country. The index itself is often not relevant for investors, who are usually interested in the comparative analysis between different sectors and asset classes. This is why GDP growth may affect the gold market in completely different ways. Much depends on the trend, sources of growth (e.g. when the GDP is boosted by a monetary stimulus or government fiscal deficits, the price of gold may also rise) and how the growth will affect the Fed’s actions. Usually, strong GDP growth warrants restrictive monetary policy (this is why gold prices fall on strong U.S. GDP data), provided this is not jobless growth. This is one of the reasons why the Fed maintained its unconventionally easy stance (which later turned out to be negative for the gold market), even though the Great Recession ended in June 2009 and, overall, economic activity exhibited signs of recovery.

To sum up, there is a negative correlation between the price of gold and the ratio of U.S. GDP to the price of gold. It makes sense, given the fact that gold is a non-confidence vote in the U.S. economy and a currency competing with the greenback. However, since GDP is a very complex and aggregate lagging indicator, the relationship between these two variables should be taken with a grain of salt.

We encourage you to learn more about gold – not only how it is affected by the GDP, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today.  It's free and if you don't like it, you can easily unsubscribe.

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