Is Gold Really an Effective Inflation Hedge?

For decades, buying gold or gold-based funds has been the classic hedge for investors who either fear worsening inflation or extreme disruption in the markets or the economy. And during the current challenges posed by the coronavirus pandemic, we have witnessed a strong reminder of this strategy, as gold rose almost 30% in value, blowing past the $2,000/ounce barrier in August. Then the price dropped again, and the selloff included the biggest single-day decline in seven years. Gold is presently at about $1,900/ounce.

Historically, the less you trust the stability of the economic system, the more of a lure there is to put more of your money in something tangible with a gleaming luster. The theory is that you can simply put your net worth in a very strongly reinforced pocket and ride out the bad times—although, of course, almost all investors actually buy gold through funds or ETFs, which would theoretically collapse in that same disastrous scenario.

In more common scenarios, gold should become more valuable in times of high inflation, in periods when the dollar is losing value, or when the government is running high federal deficits, thereby cheapening the value of the dollar. Gold should also do well when the global economy is ravaged by something like the coronavirus.

On the other hand, gold is subject to market whims; for example, its price fell 45% in the relatively calm economic climate between 2011 and 2015, possibly because investors viewed the mostly positive environment for stocks as weakening the case for buying gold. And market strategists point out that gold has actually been somewhat ineffective as an inflation hedge. In January 1980, the precious metal closed at a then-record $850 an ounce. In today’s dollars, that would represent about $2,800 an ounce—well above today’s sub-$2,000 price—which means, of course, that after inflation, people who invested in the historical high experienced considerable losses.

By contrast, that same $850, in January 1980, would have been enough to purchase seven shares of an S&P 500 index fund. Today, those seven shares would be worth more than $22,000.

So, is gold really an effective inflation hedge? It would seem that there is, at the very least, recent evidence to the contrary. Can gold be an important part of your portfolio? Certainly, as long as you have carefully evaluated its characteristics and considered the opportunity cost of holding gold as opposed to other asset types. But gold, like every other asset, has strengths and weaknesses that should be carefully considered in light of the investor’s long-term goals, risk tolerance, diversification profile, and stage in life.

If you have questions or concerns about the place of gold or any other investment in your portfolio, we can help you get the answers you need; please contact us. And to learn more about how we work with investors to structure well-diversified, individually designed portfolios, you can read our philosophy of investment management by clicking here.

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