Gold Isn’t Linked to Inflation as Much as Most Think

Gold prices rise when the dollar weakens and inflationary pressures mount, but that's not the only driver, says Barron's columnist and blogger Brendan Conway.

Gold prices are up 9 percent in 2012 thanks to the Federal Reserve's stimulus measures, which were intended to spur investing and hiring by pushing borrowing costs down and keep the economy flooded with liquidity but have weakened the dollar.

Easing measures at other major central banks have pumped up gold prices as well.

Investors have injected $8 billion into gold exchange-traded funds (ETFs) this year alone, with the four largest gold funds, which together account for about 99 percent of assets in gold ETFs, have more than $90 billion in them, Conway pointed out.

That doesn't mean the correlation will also last, if history is to serve as a lesson.

"If you think that the Federal Reserve will keep rates low far into the future, then gold is a buy," Conway wrote.

"Gold often is considered an inflation hedge, but that only pans out in a severe crisis. Gold's correlation with inflation was just 1 percent in the 25-year period of 1986 to 2011," Conway added.

Money flows quickly into ETFs when fears that inflation mount, though central bank demand is also driving the yellow metal.

"The stealth catalyst for gold may be emerging-market central banks. China is just one country that could ramp up its gold purchases as it seeks to diversify its central-bank reserve holdings, especially if the yuan is to be a global currency," Conway wrote.

"China's gold stock is estimated at less than 2 percent of its total reserves; a surge in Chinese gold imports has sparked talk of an unofficial binge."

Gold investors have noted a pickup in Chinese activity in the global gold market.

"Chinese buying has been picking up," said Dick Poon, general manager of Heraeus Metals Hong Kong Limited, according to Reuters.

"The banks want to keep some inventory and prepare for the holiday demand around the Lunar New Year."

Gold refineries close around Christmas and New Year, creating supply shortages.

"There probably won't be much supply around until mid-January," said Ronald Leung, a dealer at Lee Cheong Gold Dealers in Hong Kong, Reuters added.