Gold as an Inflation Hedge: A Closer Look
Gold often wears the badge of being a reliable inflation hedge, and enthusiasts frequently point out its ability to maintain value over time. There’s a bit of folklore that suggests an ounce of gold could be roughly equated to the price of a quality men’s suit, which gives you an idea of its perceived worth.
The recent uptick in gold’s popularity seems to be linked to its status as an inflation shield. Other factors also play a role, like central banks diversifying their reserves beyond solely relying on the US dollar and investors seeking shelter amid rising geopolitical and economic concerns.
Yet, the question remains: are investors making a smart move by flocking to gold as an inflation hedge? A historical perspective on gold’s performance during periods of high inflation reveals a mixed bag, especially when compared to other commodities. Spoiler alert: while gold hasn’t always performed consistently, other products tend to offer more reliable outcomes.
Lessons from History
In general, products—often seen as raw materials that can be traded—include everything from energy sources like crude oil to agricultural commodities and metals such as gold and silver. Both gold and these other commodities can serve as investment vehicles through direct ownership or via various funds.
Looking at historical data, commodities have proven to be more stable as inflation hedges. They managed to outpace inflation across five distinct periods, while gold lagged behind in two instances. Notably, gold performed well during bouts of inflation in the late 1970s when oil prices spiked, labor markets were tough, and the financial supply surged. Interestingly, during a milder inflation phase from September 2007 to July 2008, it also did quite well when consumer prices escalated, driven by rising oil and food costs along with demand from emerging markets.
However, in the late 1980s, when consumer prices rose significantly, gold’s performance was less impressive. More recently, between mid-2021 and March 2023, while gold prices did climb, they still lagged behind a broader commodities index by around 13 percentage points.
This reliability of commodities as inflation hedges can be attributed to a straightforward reason: commodities like oil are integral to the consumer price index. It follows that their prices are likely to rise in tandem with inflation. Furthermore, demand for commodities tends to increase during strong economic growth, which often coincides with inflation, particularly when labor markets are tight.
Gold, on the other hand, has a less direct correlation with inflation. Its price is influenced by various factors, including geopolitical tensions, interest rate shifts, central bank policies, and changes in supply from mining or recycling. Take the late 1980s, for example—gold prices stagnated as investors were attracted to higher yields available on bonds, raising the opportunity cost of holding gold, which doesn’t generate income.
Other Issues to Consider
There’s also the issue of overlap when it comes to different product funds and gold-focused investments. Many commodity funds, like the Bloomberg Commodity Index, include physical gold futures, meaning that if you already own diverse commodity funds, you’re likely exposed to gold as well.
Both gold and commodities can struggle over longer durations, experiencing cycles in performance that go through ups and downs. For investors looking at gold or commodity ETFs tied to futures contracts, roll yields can significantly affect returns, particularly if a future contract is priced higher than the current market price—a situation known as “Contango”—which can lead to lower returns as contracts expire.
Finally, it’s worth keeping in mind that both gold and commodities come with notable volatility and drawdown risks. Overall, when considering risk-adjusted returns, neither asset appears particularly convincing over the long term.
In light of this, many long-term investors may want to limit their exposure to these assets within their portfolios. However, for those specifically aiming to hedge against inflation, commodities seem to present a more promising option compared to gold.
