Imagine a time when you could get 10gms of gold at Rs. 100 or a Reliance Industries share for Rs. 10! It sounds unbelievable, given what they cost today, but the real question is why their prices have increased over time. Also, after witnessing the stock market volatility due to the pandemic and the wars, wouldn't it be better to just stick to bonds? Before you decide, you should know that there is a common factor that affects all three mentioned here, and that is inflation. Whether it is gold glittering at new highs, stocks soaring or stumbling, or bonds yielding steady returns, inflation has a say in all of it. So, how exactly does inflation impact stock markets, gold prices and bonds? Read on to get answers to this question and more, and enhance your knowledge about investment dynamics.
Stock markets and gold prices are common points of discussion in every household. However, do you know the exact meaning of inflation and bond yields? Let us take you through them to proceed with the interrelationship between all these factors.
Inflation means the general increase in the prices of goods and services over time. In simple words, it means that your money slowly loses its buying power. For example, if you could buy 1 litre of milk for Rs. 30 a few years ago, and now the same costs Rs. 50, that difference is due to inflation. Inflation is a natural part of any growing economy, but too much of it can reduce the value of your savings. If your money stays in a savings account that earns 4% interest per year, but inflation is 6%, you are actually losing value in real terms, as what you can buy with your money has decreased. In India, inflation is measured by the Consumer Price Index (CPI), which tracks the prices of everyday items like food, fuel, transport, and clothing. The Reserve Bank of India (RBI) keeps a close eye on inflation and adjusts interest rates to try and control it.
A bond is basically a loan that you give to a company or the government. In return, they promise to pay you regular interest (called a coupon) and return your money after a fixed time (called maturity). The bond yield is the return (or earnings) you get from holding a bond. It is usually shown as a percentage.
Let us understand with a simple example -
Suppose you buy a government bond for Rs. 1,000 that pays you Rs. 70 every year.
The bond yield is 70 ÷ 1,000 = 7% per year.
However, the yield can change if the bond's market price changes. If more people want to buy that bond and its price goes up to Rs. 1,100, but it still pays Rs. 70, then,
The yield becomes 70 ÷ 1,100 = 6.36%.
So, even though the interest amount stays the same, your return (yield) changes based on what you paid for the bond.
In India, many people invest in government bonds (like G-Secs) or corporate bonds for steady income. Bond yields are also linked to inflation and interest rates. When inflation is high, bond yields usually go up because investors want better returns to beat rising prices.
Gold prices have recently reached an all-time high and are constantly making new records. On the other hand, rising inflation is the number one headache for most governments today. Understanding the reasons for their rise is important and can help investors plan their investment strategies.
Some of the common reasons for the increase in gold provinces include,
Gold is a natural resource, which means it is limited in quantity. If more people want to buy gold (high demand), but the amount of gold available is limited (low supply), the price goes up. There can also be an increase in demand for gold in India during the wedding season or festivals like Akshaya Tritiya and Diwali, often leading to a rise in prices.
During times of global tension, like wars, pandemics, or financial crises, people around the world move their money into safer assets. Gold is considered a safe investment because it holds real value even when stock markets fall. Thus, in times of fear or instability, gold prices tend to rise.
A rise in inflation results in a decrease in the value of money. Thus, conservative investors often prefer to invest in gold to protect and build their wealth over time, as gold is seen as a ‘safe asset’. Also, in the event of INR weakening against the US dollar, gold becomes more expensive to import (since global gold prices are in dollars). This pushes up local gold prices in India.
When interest rates are low (like during economic slowdowns), fixed income savings and bonds give lower returns. So, people look for other places to invest, and gold becomes more attractive. Central banks (including the RBI) also buy gold to strengthen their reserves, which further adds to the demand.
Some of the reasons that can lead to an increase in inflation include,
When the cost of raw materials, fuel, or labour increases, companies raise the prices of their products to maintain profits. For example, if petrol or diesel becomes costlier, transportation costs go up, and so do the prices of fruits, vegetables, and other goods.
If too many people want to buy a product, but there are not enough goods available, prices go up. This often happens during economic recovery or festival seasons in India, when people spend more.
India imports goods like oil, electronics, and edible oils. If the prices of these goods go up in international markets, or if the rupee weakens, we end up paying more for them. This cost is passed on to consumers and increases overall inflation.
If the government or the central bank (RBI) pumps a lot of money into the economy (through loans, subsidies, or printing more money), people have more money to spend. This increases demand for goods, but if supply does not match the demand, prices start rising.
As mentioned above, inflation is a single factor that can have an impact on stock markets, gold prices, and bond yields. A rising or falling inflation can change the perception or behaviour of investors and the economy in general, to cope with the loss of buying power and take remedial measures to protect their assets.
The impact of inflation on each factor and their interdependency is explained below.
Stock markets are where people invest in companies by buying shares. When inflation rises, companies often face higher costs for things like fuel, raw materials, and employee salaries.
This can cause -
Lower profits for companies
Reduced investor confidence
Falling share prices, especially in sectors that depend heavily on fuel or raw materials, like transport or FMCG
The RBI may need to step in to control inflation by raising interest rates. This will make borrowing more expensive, which can slow down business activity and hurt company profits. This often leads to a negative impact on the stock market.
Gold is considered to be a safe and traditional investment in India, as the majority of investors are conservative in the country. The demand for gold also increases during festivals, weddings, or when they fear economic trouble. Rising inflation can lead to fear of loss of money and savings. Hence, investors turn towards gold as it is seen as stable and reliable. This eventually increases the demand for the yellow metal, driving the prices up.
For example, when the prices of daily items rise quickly (like vegetables, gas cylinders, or milk), people often turn to gold. During the COVID-19 pandemic or global tensions like wars, gold prices went up sharply because gold is seen as a ‘safe place’ to keep money during uncertain times.
Bonds are also considered to be a relatively safer investment option and are preferred by many conservative or traditional investors in India. Bonds give the benefit of fixed interest to the investors. However, when there is a rise in inflation, the value of that fixed return drops as the purchasing power of the money is reduced. The result of this on the bond market is that the existing bonds become less attractive. This leads to a reduction in their market price due to lower demand in order to attract more investors, resulting in the bond yields going up.
For example, consider a government bond in your portfolio giving a 6% interest. If the inflation goes up to 7.5%, there is a loss of the purchasing power of this income. Thus, new investors will avoid this bond as it is no longer attractive or gives inflation-beating returns. This scenario will change only if the interest rates go up or the bond prices go down, which will increase the bond yields.
Let us summarise the impact of inflation on stock markets, gold prices and bond yields as follows.
After understanding the impact of inflation on stock markets, gold prices and bond yields, let us now focus on the interdependency of the bond yields, stock markets and gold prices.
Bond yields represent the returns investors earn from fixed-income instruments like government securities (G-Secs) or RBI savings bonds, and they fluctuate based on interest rates and market conditions. Rising bond yields, often triggered by RBI interest rate hikes to combat inflation, make bonds more attractive due to their safer, higher returns, prompting risk-averse investors to shift funds away from equities. This reduced demand for stocks can lead to a decline in stock prices. Conversely, when the RBI lowers interest rates to stimulate the economy, bond yields typically fall, making bonds less appealing. In such cases, investors often turn to the stock market in search of better returns through capital appreciation and dividends, pushing stock prices higher. Thus, bond yields and the stock market frequently compete for investor attention, with their movements influencing investment flows and overall market sentiment.
The stock market and gold often have an inverse relationship, especially during times of economic uncertainty. When the stock market becomes volatile, investors typically turn to gold as a safe haven, driving up its demand and price. A clear example was during the COVID-19 lockdown in 2020, when Indian stock markets crashed and gold prices soared to record highs. On the other hand, when the stock market is performing well and the economy is stable, investor confidence grows, and more funds are directed toward equities and mutual funds for higher returns. In periods when the markets are on a steady rise and the inflation is low, gold becomes less attractive, leading to weaker demand and more stable or even declining prices. Thus, gold often gains prominence when equities falter, and vice versa.
The relationship between inflation, stock markets, bond yields and gold prices is fluid and often shapes the economy. Understanding this relationship can help investors devise better investment portfolios that can meet their investment goals effectively.
The importance of understanding the relationship between these factors is explained below.
Helps Protect the Value of Money - By understanding inflation, investors can choose assets that grow faster than rising prices, helping to preserve their purchasing power.
Enables Better Investment Decisions - When investors know how stocks, gold, and bonds react to inflation and interest rate changes, they can make smarter investment choices.
Improves Potential Returns - Understanding market movements allows investors to shift funds to options offering better returns, such as moving from bonds to equities or into gold when needed.
Supports Balanced Portfolios - Investors who grasp these relationships can build a balanced portfolio of stocks, gold, and bonds that performs well even during uncertain times.
Helps Avoid Panic During Market Volatility - With the right knowledge, investors are less likely to react emotionally during market downturns, leading to more stable, long-term decisions.
Creates Opportunities - Understanding trends allows investors to act early and benefit from changing market conditions.
Inflation, gold prices, stock markets, and bond yields are all closely connected and affect where investors put their money. When inflation rises, bond yields often go up, making bonds more attractive than stocks. At the same time, gold becomes a safe choice, especially during market uncertainty. If inflation is low and the stock market is performing well, investors prefer equities for better returns, and gold demand may fall. By understanding how these factors influence each other, investors can make smarter, more balanced investment decisions and protect their money from changing economic conditions.
This article talks about key macroeconomic factors and their impact on investors’ portfolios. Let us know your thoughts on this topic or if you have any queries on the same, and we will address them.
Till then, Happy Reading!
Read More: Corporate Governance and Its Influence on Stock Performance
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
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