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Is Gold Really an Inflation Hedge?

Earlier today I wrote that macro history raises serious questions about returning the monetary system to a gold standard, a goal that some pundits (and a few Republican candidates for president) advocate. Looking to gold as a cure for economic volatility rests partly on the assumption that the metal is a reliable inflation hedge through time. But as it turns out, gold’s inflation-hedging attributes may not be as durable as conventional wisdom claims. As The Free Exchange at Economist.com notes, there’s a “gold puzzle” in them ‘thar hills.

Because of gold’s finite supply and long history as a medium of exchange, Free Exchange reminds, “it’s often cited as a good inflation hedge.” Not necessarily:

The thinking goes that if a central bank prints too much money, unleashing rampant inflation, gold will retain its value. Or imagine the mother of all tail events: if civilisation collapses we can still barter with gold. I don’t have any evidence concerning whether or not gold will hold up in the latter scenario. But when it comes to the former claim, London Business School authors Elroy Dimson, Paul Marsh and Mike Staunton, in collaboration with the Credit Suisse Research Institute, recently published a report which shows that gold was not such a great hedge over the last 111 years.

If it were gold’s value would be fairly stable over time and realised inflation. The figure below demonstrates that’s not the case.

Its price may be correlated with expected inflation, but if you’re looking for a hedge, gold’s relationship with realised inflation is what’s important. Gold’s real value usually does not decrease during bouts of inflation. But what strikes me, other than by historical standards how overpriced gold looks, is how volatile it is. In finance volatile assets are considered risky; it’s baffling that gold is considered a safe haven for anything. If an investor is looking to speculate in the commodities market, investing in gold may be a fine idea. But if you’re looking for safety, inflation-linked bonds, or even equity, is probably a better way to go.

Gold, it seems, may not always glitter.

This post originally appeared at The Capital Spectator and is posted with permission.

One Response to “Is Gold Really an Inflation Hedge?”

LUISFebruary 16th, 2012 at 3:36 pm

Gold is an inflation hedge for rampant money printing and when used to back up a currency offers a means of constraining the idea that one (that is a government) can NOT make "money" put of thin air. The concerns about commodity fluctuations are irrelevant since using a gold standard would pull gold away from the ideas people have about speculating with it in the first place. That would then leave silver for plenty of speculation and short selling by the big banks (oh wait that is already happening)

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