Is Gold A Great Inflation Hedge?

In almost all circumstances, no.

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Ryan A. Hughes
October 24, 2022
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Many people lately are talking about gold as an effective hedge against inflation. After all, gold is often touted as an inflation-protected safe-haven asset and a store of value that people have owned for thousands of years.

However, is gold really an effective inflation hedge?

In most cases, no. Not really. But there is one exception. 

The Gold Bug’s Thesis

Many who promote gold are quick to point out that gold has a relatively limited supply, whereas fiat currencies (U.S. Dollar, Euro, etc.) do not and are often diluted.

If the past few years have taught us anything, it is that governments have a bit of a money-printing problem. So, for these reasons, one would think that gold is a slamdunk investment. You cannot print more gold, after all. 

However, the official record is mixed on whether gold is an excellent hedge against inflation. 

Gold’s Track Record

The U.S. started printing money (increasing M2 money supply) in March 2020, but higher inflation levels (anything higher than 5%) did not show until May 2021. 

US CPI has increased since May 2021

Since that time, inflation levels have increased by 11.3%, whereas gold has fallen by -6.6%.

inflation has steadily risen while gold has underperformed

If gold were a foolproof inflation hedge, wouldn’t gold be outperforming in this environment? 

When Gold Works vs. When It Doesn’t

There are periods when gold has provided inflation protection. 

From 1973 to 1979, the average inflation rate in the U.S. was 8.8%. Gold returned an impressive 35% annualized rate, convincing many investors that the yellow metal was THE top inflation hedge. 

But since that time, gold’s track record has been lackluster. From 1980 to 1984, the average inflation rate was 6.5%, but gold returned -10% on average each year. 

From 1988 to 1991, inflation averaged 4.6%, but gold fell -7.6% on average per year. 

Regrettably, gold has flopped during some of the most extreme moments of higher inflation rates. 

One must zoom out to truly appreciate gold’s inflation hedge abilities—a lot.

Zoom Out To See When Gold Works

According to a study by ESI Analytics, gold can be an effective hedge against inflation during long periods of higher inflation rates.

ESI tracked inflation and gold prices from 1790 and noted 39 years of inflation rates higher than 5%. This means that the United States has experienced high inflation levels about 17% of the time.

the US inflation has positive and negative rates throughout its history

Of the 39 years of high inflation, gold outperformed cash in only 13 years or 1/3 of the time. It did not provide any protection the other 2/3 of the time.

More often than not, gold provided negative returns, adding salt to the wound.

gold has produced negative returns during high inflation years

The average performance of gold during the high inflationary years was -8%.

gold returns a negative real return during inflationary periods

It is essential to note that gold did outperform cash in one scenario. When inflation rates remained elevated for more extended periods (think decades, not years), gold outperformed. This makes sense, as investors were probably concerned with the viability of the U.S. dollar as it was being diluted at a high rate. 

However, it is impossible to know whether or not a period of high inflation will be extended or short-lived, making the prospect of gold as a viable investment null.

What To Buy Instead?

Gold is not the only inflation hedge one should consider. There are a few better options out there. 

The best long-term option is plain ol’ stocks. Yes, stocks. 

Investors sometimes seem to forget this. Stocks are volatile during the short term (this year is undoubtedly no exception), but there is no better bet when you look at asset classes across multiple market cycles. Stocks have significantly outperformed just about everything else, especially gold. 

stocks have significantly outperformed gold over the long term

I always write this, but it is too important to ignore. Volatility is the price one must pay for long-term price appreciation. There is no way around this. 

Treasury Inflation-Protected Securities (TIPS) and I-Bonds can also have a position in your portfolio, though these can also be volatile as inflation expectations change. TIPS can sell off if investors believe inflation rates will fall soon. 

Remember that there is no silver bullet when constructing an investment portfolio. One must consider many different risks, and this environment is not lacking any.

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