Gridley Associates Inc


Gold: Inflation Hedge or Speculative Tool?

Whenever there is talk of inflation investors tend to think of gold as a good inflation hedging tool. But is it? The short answer is no. While the price of gold has increased faster than inflation, it’s hardly been a good hedge, in fact over most periods other than the last few years you’d have been better off with a simple S&P 500 index. Over the period from 1960 through 2005 gold posted an average annual increase of 5.8%, well above the CPI index increase of 4.2%. That sounds pretty good until you consider that the S&P 500 tallied a 10.5% average annual increase over the same period.* Ahhh, but you argue that this isn’t a fair comparison because gold has far outperformed stocks in the last 5 years. True, but stocks still win over the long term. If we include the last five years and look at 1960 to mid 2010, gold is up about 7.4% annually while the S&P is up 9.5%. So even with the spectacular relative returns of gold over the past few years it still lags stocks over the long term. None of this of course factors in the costs associated with holding and safeguarding your gold stash.

Gold’s price performance over the last few years actually sheds a great deal of light on what it does do well, which is act as a speculative "safe harbor" in times of extreme uncertainty. This is especially true for investors who want to avoid currency risk. The past few years illustrate this point nicely. As investors around the globe panicked with the economic meltdown, many chased US Treasuries and gold as relatively safe places to park their assets. However, as uncertainty grew about the fiscal health of the US and more specifically the dollar, gold alone seemed to offer the only refuge. Interestingly, this is not an entirely new phenomenon. In fact, gold has been a refuge for investors trying to avoid the dollar for some time. In a recent study done by Ibbotson Associates for The Wall Street Journal**, Ibbotson pegged the correlation between gold and the dollar over the last 30 years at -0.65. For those who are not students of statistics, this means gold and the dollar very much tend to move in opposite directions. Interestingly, the study also noted that over the same period Gold and the CPI where almost completely uncorrelated at 0.08, which rather settles the argument about gold as an effective inflation hedge.

My purpose here is not to discourage the use of gold in a portfolio but rather encourage those who use it to use it properly. Gold isn’t a great inflation hedge, in fact there’s effectively no statistical relationship at all, however, owning gold can be a useful bet against the dollar. If inflation is your worry stocks will quite likely serve you better than gold in the long run. But if it’s weakness in the dollar you fear then gold may be just the hedge you’re looking for.


Randy Gridley

August, 2010

* Gold price data from World Gold Council and Kitco. S&P data from Dimensional Fund Advisors

** The Wall Street Journal, Rethinking Gold, August 28, 2010