Gold as safety towards inflation? Historical past suggests in any other case

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Gold is often touted as a means of hedging against inflation – a risk that is most important to investors right now.

But gold doesn’t live up to the hype. According to historical data, his balance sheet was mottled.

An inflation-proof investment would generally increase with the rapid rise in consumer prices. However, gold has provided negative returns for investors during some of the highest inflationary periods in the US in recent times

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Investors worried about rising consumer prices should consider other asset classes instead, said Amy Arnott, portfolio strategist at Morningstar.

“Gold is really not a perfect hedge,” says Arnott, who has analyzed the returns of various asset classes during times of above-average inflation.

“If inflation rises, there is no guarantee gold will generate above-average returns,” she said.

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For example, gold investors lost an average of 10% from 1980 to 1984 when the annual inflation rate was around 6.5%, according to Arnott’s analysis.

(The Federal Reserve tries to keep inflation at around 2% a year.)

Similarly, gold achieved a negative return of 7.6% from 1988 to 1991, a time when inflation was around 4.6%.

However, investors gained from 1973 to 1979, when the annual inflation rate averaged 8.8%. Gold returned a whopping 35%.

The mixed balance sheet suggests that investors worried about inflation would take a risk by using gold as a hedge in their portfolio.

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Gold’s correlation to inflation has been relatively low at 0.16 for the past half century, Arnott said. (This metric shows how closely gold and inflation go together. A correlation of 0 means there is no relationship, while a correlation of 1 means they are in harmony.)

“I wouldn’t buy it just because you think inflation is coming,” said Michael McClary, chief investment officer for Valmark Financial Group in Akron, Ohio.

Other inflation options

Instead, investors might consider increasing the allocation to four asset classes: stocks, inflation-linked treasury stocks (known as TIPS), real estate investment trusts, and commodities (e.g. oil) for better inflation protection, McClary said.

Consider a portfolio that is 60% equity and 40% fixed income (i.e., bonds and investments).

An inflation-linked portfolio could allocate 5 to 15% of the stock bucket to REITs and commodities, McClary said. (Mutual funds or exchange-traded funds invest in a wide range of each.) The fixed income portion could have a 25 percent allocation in TIPS, he said.

According to Arnott’s analysis, these asset classes have a more consistent track record than gold during periods of inflation.

REITs, for example, achieved returns of 11.5%, 20.4% and 9% in 1973-79, 1980-84 and 1988-91. Commodities returned 19.4%, 2.3% and 21% over the same period.

Of course, these analyzes looked at periods of less than five years. Gold’s long-term balance sheet – spanning several decades – is more in line with its reputation for protecting against inflation.

“In the long run, gold should hold its value against inflation. But in shorter periods of time it may or may not be a good hedge,” said Arnott.

Inflation rose 4.2% yoy in April, the fastest acceleration since 2008.

Of course, while consumer prices have risen in the short term, inflation will not necessarily last. Most Wall Street economists assume it will only be temporary. However, in a non-consensual forecast, Deutsche Bank warned that rising inflation could be a global “time bomb”.

And investors might see gold as a beneficial asset class despite the inflationary argument. For example, proponents often view the asset as a safe haven in times of turmoil.

Gold proved resilient during the market flight in the early days of the Covid pandemic. The S&P 500 stock index lost 34% from its February 19 high to its March 23 low last year. The SPDR Gold Shares Fund only lost 3.6% over the same period. (These percentages are based on market close prices.)

Investors whose gold investment thesis is intact regardless of inflation shouldn’t necessarily change their allocation given its mixed track record, McClary said.

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