Gold, always a key inflation hedge

It’s normal to be confused about gold’s performance as a global investment asset, especially regarding its much-heralded properties as an inflation hedge. After all, there are so many different agendas and so many different angles one can look at to analyze this historic asset over its long price history. For example, a simple online search produces controversial results claiming gold is “still a poor inflation hedge”, “not the best inflation hedge” or that “it’s losing its status as an inflation hedge”!

Figure 1 - Popular media articles attempting to misrepresent gold's performance as an investment.

That’s why one should dive deeper into the matter, as investing is all about good choices and those can’t be made without good information. So, let’s understand the characteristics that justify gold’s enduring attractiveness against the seemingly inexorable rise of consumer prices around the world.

Firstly, it is true that, especially in America, and since the 1970s, once the gold standard was abandoned, gold has not been correlated with increases in CPI, the popular Consumer Price Index. This explains most of the bad press gold has faced in recent years. But one must understand that the US has seen the launch of specific investment vehicles designed to fight inflation, such as Treasury Inflation-Protected Securities and inflation-linked bonds, as well as an increase in the sophistication of other asset classes traditionally considered inflation hedges, e.g. Real Estate Investment Trusts or digital assets, which experienced whopping returns, attracting a new group of investors to that emergent asset class. But these aren’t available for everyone.

Figure 2 – Bloomberg data shows gold and the US CPI are only weakly correlated since the 1970s.

Moreover, long-term correlation with North American inflation doesn’t mean gold isn’t successfully hedging increases in consumer prices in other parts of the world. Studies in Vietname and Malaysia have clearly proved gold has provided “a complete hedge” against inflation since the 1980s. Additionally, even in the US the performance of gold changes quite a bit if one slightly alters the timeframe under consideration. As shown below, since the early 2000s gold has outperformed both the Nasdaq and the S&P 500 – a clear store of value. And we can’t forget that it’s only natural that gold’s correlation with inflation in the land of the Uncle Sam has been quite weak, given that – at least from the 1980s until 2022 – US inflation was also barely felt.

Figure 3 - Evolution of gold prices compared to the major US stock indexes since 2000.

Secondly, while Warren Buffet ridicules both gold and its digital counterpart, we can’t forget bitcoin is still sexy and hot as a market opportunity, even in the current bear market. Conversely, few investment managers can go bragging about holding the original precious metal while justifying the hefty fees they typically charge to pick stocks, bonds, or alternative tokens. In other words, there are no incentives for the investment industry to promote gold ownership as that’s just not profitable. Alas, those who favor gold are often considered paranoic, overly obsessed with doomsday scenarios and many rejoice when gold prices fall, with the likes of Paul Krugman even admitting seeing such precious metal longs go sour “is a cause for a bit of a celebration”.

Figure 4 - Evolution of central bank's gold reserves since the late 1990s.

Still, central banks have kept increasing their very tangible gold reserves since the 2008 financial crisis for a reason. Are their leaders just gold bugs or do they understand the historical importance of a truly global asset that has appreciated in value for millennia even though it pays no dividends? It’s not only the fact that there’s real industrial and commercial demand backing this metal, but the institutionalized belief that gold is also a highly liquid alternative for those looking to diversify their exposure to foreign currencies or prepare for ever-growing geopolitical crisis.

Lastly, and most importantly, even if you prefer being invested in stocks or in other yield-bearing assets, note that few dispute gold’s role as a safe haven during bear markets and times of heightened volatility. The COVID-induced dip in March 2020 was a perfect example of this inverse relationship in rough periods, showing how gold preserved its value in comparison with all other asset classes bar cash and cash equivalents. Such resilience provides the final argument for adding gold to a well-balanced portfolio, with investors typically allocating 5% to 10% of their holdings to this asset class – with moderate fans eventually going up to 20%.

Figure 5 - Gold's relative performance during the COVID black swan event.

Overall, be it through physical gold or ETFs, gold should be considered as a key ingredient in one’s fight against inflation. Given the complexity of the problem, different assets may prove to be better hedges during particular market conditions. But gold’s reliable history, global availability, and stability during downturns make a solid case for considering allocating part of one’s investments to the popular yellow metal.

Sun Valley is a private equity firm focussed on the precious metals industry with portfolio companies and branch offices in the Americas, Europe and Asia. Sun Valley seeks to invest in sustainable development projects and operations with growth potential, low cash costs of production, or the operating flexibility to insulate against volatility in the commodity markets.