Gold: The Ultimate Inflation Hedge?

Finding assets that protect purchasing power is the primary concern of investors aiming to hedge. These individuals are focused on stability as opposed to returns that not only keep in step with inflation, but also outpace it.

The Credit Suisse Yearbook says that if gold were a reliable hedge against inflation, its real price would be relatively unwavering. However, gold is volatile and its purchasing power fluctuates.

With gold’s bull run spanning more than a decade, some investors may be unaware, some may have forgotten, or others may even deem irrelevant the metal’s broader history, as it often seems that we are experiencing unprecedented economic conditions.

But, covering 112 years and 19 countries, the Credit Suisse report brings times passed back into focus and reacquaints investors with the reality that gold has not always traveled up. On the contrary, 1980 to 2001 was a period of significant decline for the metal, which lost four fifths of its value during that time.

Prices during that 21 year span dropped from $850 to about $300, which translates into a loss of value exceeding 60 percent. To put this into perspective, one only needs to imagine the impact such a decline likely had on retirees who may have had significant portions of their wealth stored in the form of gold.

Though bullish on the metal, Goldman Sachs has said that though gold is purchased en masse as an inflation hedge, its performance in this capacity has not been consistent.

According to a research note from the firm, in 60 percent of the episodes when inflation surprised to the upside in the post-World War II period, gold has underperformed inflation.

Economist Nouriel Roubini, Chairman and co-founder of Roubini Global Economics, has a similar view, and warned that gold prices only rise in two conditions: when inflation is high and rising and when there is a fear of near depression and investors fear the security of their bank deposits.

Furthermore, there is a price to be paid for hedging. According to the Yearbook, the cost for insuring against inflation is a lower than average investment return in deflationary or average conditions, as hedging assets tend to underperform in these scenarios.

Gold is an investment metal, but it is also a commodity. However, unlike its precious kin, it isn’t particularly relied upon for any industrial purposes. When gold is not needed as protection from fears or crises, it can face significant risks of correction, according to Roubini.

Hedging strategies

Hedging reiterates the importance of a diversified portfolio. That diversity should apply to asset categories since none is without risk, and also to markets since inflationary conditions can be local and better protection can lie within distant borders.

When outlining hedging strategies, investors would be wise to weigh the benefits in addition to the potential to protect against inflation.

Equities, for example, can play a partial role in hedging.

“The real case for equities is that, over the long term, stockholders have enjoyed a large equity risk premium,” the Credit Suisse report says.

Housing was found to be relatively insensitive to inflation and to appreciate at similar annualized rates as gold. Plus, ownership satisfies the need for shelter, often provides tax advantages, and can eliminate the pricing volatility that often occurs in rental markets.

Gold, though often preferred, can put up impressive gains during a bull run such as we’ve seen in recent years, but it fails to provide a flow of income and can have low real return over the long term, the Yearbook points out.

Over the 112-year period analyzed, the real return on gold was 1.07 percent (in GBP).

Therefore, gold can play a partial hedging role in an investor’s personal portfolio, but Credit Suisse does not find it suitable for institutional investors.

Securities Disclosure: I, Michelle Smith, do not hold equity interests in any companies mentioned in this article.