Which Is the Best Inflation Indicator: Gold, Oil, or the Commodity Spot Index?

Gold Maintains Its Purchasing Power over the Centuries

Dr. Skousen is an economist at Rollins College, Department of Economics, Winter Park, Florida 32789, and editor of Forecasts & Strategies, one of the largest investment newsletters in the country. The third edition of his book Economics of a Pure Gold Standard has recently been published by FEE.

The editors don’t agree with your claim that gold is a best indicator of inflationary expectations and economic stability.

—Dan Hinson, Managing Editor,

The Wall Street Journal[1]

This column developed out of a running debate I’ve had with the editors of the Wall Street Journal and the New York Times. In the financial news, the Times highlights the price of oil as the best indicator of commodity prices and inflationary expectations. The front page of the Wall Street Journal publishes nine prices and indices, including oil and the Dow Jones Commodity Spot Index, to reflect activity in the financial markets. But neither the Times nor the Journal highlights the price of gold as an important barometer of inflation or monetary stability. Apparently they believe that oil and the commodity spot index are better indicators.

Gold Is Watched Carefully

Despite these misgivings by the establishment media, gold is not ignored. It is well known that members of the Federal Reserve Board and other central banks monitor the price of gold carefully and consider it a good estimate of inflationary expectations. Moreover, some financial observers and economists are convinced that central banks may intervene from time to time to maintain a steady gold price. According to this view, a rising gold price is undesirable because it suggests increased inflationary expectations and a potential monetary crisis (such as a run on the dollar). Thus, when the price of gold moves up too much, central banks sell gold. At the same time, a falling gold price is undesirable because it may imply deflation and recession. When gold falls below a certain price, central banks buy or simply stop selling.

How long central bank interventionism can last is anyone’s guess. But eventually the market will reassert itself, just as it does whenever a form of price-fixing occurs, and gold prices will start rising again.

A Test to Find the Best Indicator

Are the Times and the Journal right in highlighting oil and commodities in general rather than gold as a barometer of inflationary expectations? Are they justified in their anti-gold bias?

To test this theory, I constructed a simple econometric model to test how well gold, oil, and the Dow Jones Commodity Spot Index have anticipated changes in the Consumer Price Index (CPI) since 1970. In each case, I developed a least-squares regression analysis, testing the CPI against gold, oil, and the Dow Jones Commodity Spot Index for each year with a one-year time lag. (I thank Professor John List, economist at the University of Central Florida, for helping me develop this econometric model.) Even though the CPI has come under criticism as a measure of price inflation, I have selected it as a simple, consistent measure of price inflation.

The question to answer: Do changes in either of these commodity prices anticipate a rise or fall in the Consumer Price Index?

At first I tested to see if any of these three commodity prices predicted changes in the CPI on a monthly basis since 1970. For example, did the change in the price of oil in January anticipate the change in the CPI in February?

No Commodity a Good Short-Term Indicator

The results were discouraging. It is clear that none of the commodity prices—oil, gold, or the commodity spot index—were able to anticipate changes in the CPI from one month to the next. R-squared was 0.02 or less for each test, indicating no correlation at all. As a short-term indicator, gold, oil, and the commodity spot index are all lousy predictors of next month’s CPI.

Gold Turns Out to Be the Best

However, the results were much better when we tested average annual commodity prices as a predictor of the following year’s CPI since 1970. All three commodity prices showed predictable power over the long term (one year). However, it is clear from the regressions that gold was the best indicator of inflationary expectations (R-squared, 0.42), followed closely by the Dow Jones Commodity Spot Index (R-squared, 0.37), and oil was a distant third (R-squared, 0.18). In fact, it could be determined that oil was a poor indicator of inflationary expectations as measured by the CPI. This view falls in line with the work of energy economist Douglas Bohi, whose historical work concludes that oil has far less impact on the world economies than most economists believe.[2]

Gold as a Measure of Price Inflation

Historically, we can see how gold has significantly anticipated the rise and fall in purchasing power. When the world went off the gold exchange standard in 1971, the price of gold rose sharply from $35 an ounce to $200 an ounce, reflecting the sharp rise in commodity and consumer prices in 1973-74. Then gold suddenly topped out in 1975, about the same time the CPI rate started dropping. When consumer price inflation started moving up again, reaching 14 percent in 1979-80, gold moved in sympathy, rising from $100 an ounce in 1976 to $850 an ounce in January 1980. The long disinflationary era of the 1980s and 1990s saw a declining trend in both consumer price inflation and the gold price, although that trend may be changing again soon.

In short, it appears that the price of gold does a good job of reflecting the inflationary environment as measured by the Consumer Price Index. It is certainly a better indicator than the crude oil price.

Research by the late Professor Roy Jastram (University of California at Berkeley) suggests that gold maintains its purchasing power over the centuries. After investigating the purchasing power of gold over the past 300 years, Jastram concluded that, despite major inflations and deflations, Nevertheless, gold maintains its purchasing power over long periods of time, for example, half-century intervals.[3]

Based on the above new evidence, wouldn’t it be appropriate for the New York Times and the Wall Street Journal to add gold to their summaries of the financial markets?


1. Private correspondence, April 14, 1995. I first raised this issue in my column, What’s Missing from This Picture? (The Freeman, August 1994). This column was reprinted in The Lustre of Gold (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995).

2. Douglas R. Bohi, On the macroeconomic effects of energy price shocks, Resources and Energy 13 (1991), pp. 146-162. See also my column, The Freeman (August 1994), pp. 457-458.

3. Roy Jastram, The Golden Constant (New York: John Wiley & Sons, 1977), p. 132.