Do you ever wonder if you should add gold to your portfolio? Do you hold some gold now and wonder if you should keep it or sell and invest those assets?
Any of these three beliefs might motivate an investor to hold gold. Spoiler alert – none of them stand up to scrutiny.
- In some future crisis, gold might become money.
- Gold is often said to be a good inflation hedge.
- Gold is an interesting speculative investment – its price has risen a lot recently.
In the first article in this series, I delved into whether gold should ever be used as currency in the US. Hint: It shouldn’t. If you missed that article, you can read it here.
For this article, I will delve into the concept of using gold as a hedge against inflation.
Gold as inflation hedge
Belief 2: Gold’s value is stable. When inflation is high, gold will retain its value. If we suffer high inflation, my gold will protect me against loss of purchasing power better than my money will.
An inflation hedge is an investment that protects you against a decline in the purchasing power of your cash, bonds and other investments in the event of unexpected inflation. To be an effective hedge, this investment must at least maintain its purchasing power when inflation surprises.
If gold were an effective inflation hedge, we would expect the price of gold to change to match inflation – the inflation-adjusted gold price should be stable.
For example, suppose that the price level doubled, and it took $2 to buy what $1 would have bought. A good inflation hedge would double in price to match.
Let’s look at the recent history of gold prices – did gold maintain its purchasing power?
In December of 1980, gold cost $590 per ounce. In June of 2024, gold’s price was $2,330 per ounce.
Since 1980, inflation has been significant, however. The price level has increased from 86.3 to 314.175, or a 264% increase. The increase in the gold price has been 295%. That sounds pretty good!
The chart above illustrates that experience. The brown line traces the price of gold in (December) 1980 dollars. The blue line shows what a stable real or inflation-adjusted price of gold would have looked like.
The price of gold has kept up with inflation since 1980. However, there were long periods of time when the shortfall was significant. For example, during 1999, the price of gold in 1980 dollars hovered around $150 vs $590 in 1980. That’s about a 75% drop in purchasing power! At least during the last 44 years, gold has been a poor inflation hedge, at best.
What might be a better hedge? TIPS (Treasury Inflation-Protected Securities) are bonds whose face amount adjusts to match inflation. A short-term TIPS mutual fund should match inflation well with limited investment risk. TIPS are US Treasury bonds, so they have minimal credit risk, and a mutual fund holding TIPS with maturities between 0 and 5 years has limited interest rate risk, as well.
The chart above compares the Bloomberg 0-5-year TIPS index against gold between 2003 (the year the TIPS index became available) and 2023. I’ve set each of them to 100 in December 2003. The TIPS index has done an excellent job of maintaining purchasing power since 2003 – notice that the green line stays very close to 100.
At first blush, you might say that gold has done better. After all, $100 worth of gold at the end of 2003 rose in purchasing power to nearly $350 at the end of 2023! However, we must think about what asset we are hedging, what asset we are going to replace with the hedge. We want the hedge to reduce the risk of our position. If that hedged asset is cash, we want a hedge with stable value. Gold has not had a stable value and has lost value over significant time periods. For example, after gold reached its peak value of $350 around 2011, it dropped to $250 in late 2013, and then to between $200 and $250 for most of the next decade.
Since 2003, the short-term TIPS index has maintained its value a lot better than gold. That index is also easy to access – there are numerous short-term TIPS mutual funds.
In my next article, I’ll discuss gold as an investment.
This article appeared originally in Forbes.com.