February 16, 2012

Is Gold Really An Inflation Hedge?

By James Picerno of The Capital Speculator

Earlier 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, recentlypublished 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.

About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008.  James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator(EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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