The World Financial Association warns of stagflation coming? Gold may become a market winner again

Historically, stagflation has dealt a heavy blow to the stock market. Fixed income returns have been erratic, while commodities and gold have performed well. The strong performance of gold in the history can be attributed to two points: restricted inflation and increased market volatility support the motivation of capital preservation. Second, the reduction in real interest rates supports opportunity costs and growth risk motives.

But it is worth noting that the strong performance of gold since 2018 may be a disadvantage. On the other hand, gold has not benefited from the record low real interest rates and high inflation in 2021. The World Gold Council believes that this is related to optimistic expectations for inflation, growth and the stock market. In the event of risk aversion, record low interest rates may limit the hedging potential of bonds. If the impact of stagflation on risky assets becomes a reality, defensive funds are expected to flow to gold.

Data shows the risk of stagflation

After the crazy growth in the first half of 2021, economic growth in the United States and elsewhere may reverse. But inflation continues to cause concern. Economic data in August unexpectedly began to decline, while inflation data maintained an unexpected upward trend (see Figure 1).

Figure 1: As inflation data continues to climb, economic growth data unexpectedly slows down the global economy and inflation unexpected index


GDP is a lagging indicator, so it may be too early to decide on the official measurement of global economic growth. But there are early signs of slowing down from ZEW in Germany to Conference Board indicators in the United States.

This weakness can be largely attributed to concerns about the new coronavirus variants and global supply bottlenecks. These shocks have also led to high inflation in the past few months. Rising commodity prices, fewer workers, shortages of parts, and rigid global distribution channels are all factors that have pushed inflation to multi-decade highs.

On a global scale, the combination of increased price pressure and possible slowdown in economic growth may herald stagflation in the third quarter of 2021.

Since the outbreak, the economy has gone through all four stages of the business cycle (Goldilocks, stagflation, deflation, and reinflation) based on the evolution of output and prices. However, even though the “blonde girls” and the short period of stagflation in early 2020 were mild, in the second half of this year, sharp deflation was followed by an equally strong re-inflation (see Figure 2).

Figure 2: Since the epidemic, the economy has achieved three business cycles. Is stagflation the fourth type?
U.S. Gross Domestic Product (GDP) and Consumer Price Index (CPI) and the four stages of the business cycle


Is the market moving towards a relatively strong stage of stagflation? The World Gold Council divides history into four stages to understand what they mean for past asset returns and what they might mean for the future.

Stagflation damages the economy and financial assets

Stagflation can be defined as a slowdown in economic growth during a period of rising inflation and a relatively high unemployment rate. However, this simple definition creates potential constraints. Since 1969, in every recession that the United States has experienced, except in 2009 and 2015, monthly inflation in the United States has been positive at an annual rate. The lack of deflationary pressure in the United States over the past few decades has complicated the analysis of asset performance in different economic cycles.

According to the definition of the World Gold Council, considering the seemingly unsustainable combination of falling income and rising prices, the frequency and duration of stagflation have exceeded expectations. Looking back at the economic history of the United States in 1971, stagflation was the most common scenario (68 out of 201 quarters were stagflation), and it was also the most durable scenario, which lasted twice for eight quarters (see Figure 3).

Figure 3: Stagflation is frequent and long-lasting, the stagflation stage, the business cycle stage count/length, the decline in the leading index of the U.S. Advisory Chamber of Commerce and the rise in the U.S. core CPI



Historically, adjustments to negative supply shocks during periods of stagflation are harmful to the economy and financial assets, especially when such adjustments are large. As income growth slows, price inflation intensifies, which may cause problems for the real economy. Families have shifted from discretionary expenditures with higher profit margins, such as vacations, cars and refrigerators, to major expenditures with lower profit margins, such as food and cleaning products. This in turn will lead to a reduction in the net contribution to economic growth and economic pressures associated with rising costs of necessities.

Financial assets are also affected in the same way, because their future cash flows will be discounted under lower growth and higher inflation. The impact of "margin compression" on the stock market is particularly serious. But the stagflation environment will not let go of bonds.

How have financial assets performed in the past 20 years?

From a 20-year perspective, gold, the global broad bond index, and inflation-linked bonds are the only asset classes that can provide positive returns in all four economic conditions. However, the weighted annualized rate of return for gold in US dollars is higher, in many cases more than twice that of bonds.

Figure 4: Return on major assets in each cycle stage since 1973: In stagflation, gold is the clear winner
AAAR% of major asset classes since the first quarter of 1973


At the same time, the stock market continues to underperform, even in these milder periods. Emerging market stocks, small-cap stocks, and growth stocks performed the worst. This may reflect the strengthening of the U.S. dollar and the acceleration of policy interest rate hikes, which usually occur during periods of stagflation.

Table 1: Gold in U.S. dollars is the best performing asset in the stagflation period since 1973 since the first quarter of 1973


If stagflation occurs, the consensus of analysts is that it may be short-lived. As the delta variant infection slows and suppressed demand supports economic growth, real GDP in the fourth quarter of 2021 is expected to accelerate again. However, as the supply deadlock is unlikely to be resolved in the short term, prices are expected to remain firm. If this consensus is correct, these developments indicate that the re-inflation environment will be restored in the fourth quarter of 2021, when inflationary pressures and growth will exist.

in conclusion

In the case of rising prices, the stagflation environment of declining income has proved to be frequent and lasting. When they are severe, they can cause damage to the economy and financial assets. Based on historical analysis, a return to more severe stagflation may be good for gold. According to data from the second quarter of 1973, gold has always been the best performing major asset. But this analysis is only a guide. As the world recovers from the epidemic, several things are worth noting.

Since 2018, gold has performed very well, which to a certain extent reflects the many potential and lingering concerns that we still have today. Even if the driving factors of the gold price suggest that the price of gold should go higher, a temporary suspension is normal.

In addition, if the market now predicts that after a brief period of stagflation, reinflation will reappear, then gold may not be the most popular commodity. However, the analysis of the World Gold Council shows that the possibility of such a situation in history is quite low. On the other hand, future bonds are unlikely to provide the same protection against the impact of risky assets, which is limited by negative interest rates. This provides an opportunity for gold to control part of the defensive capital flow in the event of an impact on risky assets.