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Is It Rational To Invest Gold As An Inflation Hedge?

Inflation is a common phenomenon in economic development, but it can reduce the purchasing power of money to a certain extent and can also cause an actual loss of assets. In this context, some people believe that buying gold as an asset can be a good offset to the losses caused by inflation, but it is worth considering whether gold can be used as an inflation hedge. This article broadly describes past and present inflation, anticipates future inflation, describes how gold can be a hedge, and finally whether gold can be a sustainable investment as an inflation hedge.

Firstly, inflation is a relatively broad measure of the increase in prices over a given period, such as the measurement of an increase in the cost of living in the UK. At the same time, inflation can be described and observed through indicators such as the CPI, which is a measure of consumer price inflation, and it is a good indicator of inflation. Besides, as the graph below shows, the CPI has only been extremely close to zero in three phases over the last decade or so, roughly during the severe inflation of 2008 and 2015, and the COVID-19 pandemic of 2020. Apart from these three phases, the value of the CPI has been zigzagging up and down but has mostly varied from around 2.5%. A noteworthy point is that the value of the CPI increased dramatically during the pandemic, from about 1% in late 2020 to about 9% in May 2022. As a result, the anomalous changes make people more aware of the seriousness of inflation at the present time. However, some academics predict that inflation will continue to grow in the near future but will ease in the middle of 2023 and that the value of the CPI will fall back to around 3% to 4%.

Source: Office for national statistics

Historically, inflation has often been associated with gold and it has been seen as a hedge against inflation. During the period of the gold standard, a certain amount of money corresponded to a certain amount of gold and therefore gold's value preservation properties were able to protect against the risk of inflation. For example, inflation causes the purchasing power of a currency to fall, but the price of gold increases as inflation rises. Therefore, buying gold during inflation enables it to act as a hedge, reducing investors' losses and maintaining the value of the asset. However, with the abolition of the gold standard, the relationship between gold as a direct correlate to money broke down. Moreover, most of today's price fluctuations in gold share prices are due to other factors such as investor sentiment and are not directly related to gold production, so gold's position as an inflation hedge has been shaken.

In terms of historical price performance, gold is 50 times more expensive than it was in 1971, but the stock market has outperformed gold's growth by a wide margin. Assuming investments were made since 1981 and dividends reinvested, the annualised returns on the S&P 500 and gold would be 12.2% and 3.6% respectively. In addition, the price of gold has played a different role in inflation over time. For example, from 1988 to 1991, when inflation was 4.6%, gold returned -7.6%, but from 1973 to 1979, when inflation was 8.8%, gold returned a whopping 35%. Therefore, based on the performance of the historical data, it is a precarious gamble for investors who want to prevent inflation to attempt to hedge their risk by investing in gold. To conclude, gold can be a beneficial investment class in the long term, but it is not sensible to use it as a hedge against short-term inflation.


Edited and reviewed by Tanish Bagga.


Reference/Wider Reading

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