Is gold still an inflation hedge?

The gold price has languished over the past year, but what is the outlook from here?

| 6 min read

Having soared to an all-time high of just over $2,000 an ounce in July 2020, the gold price has slid back and currently stands at around $1,800. Some find this price action strange given the extent of loose monetary policy taking place in the form of ultra-low interest rates and quantitative easing (QE). After all, gold should be a hedge against currency debasement – and we are living in a period that represents the greatest global debasement of all time. So, what is going on?

Why has gold struggled?

The first thing to understand is the context. The gold price travelled a long way, and in 2020 alone it surged 30% from the start of the year to its peak. It has since given back about half those gains. Gold performed well in the context of swelling central bank balance sheets, a spike in government spending that seemed almost limitless and an uncertain economic outlook. However, the picture evolved in the second half of the year. Investors increasingly factored in a stronger economic recovery, plus they got a handle on the quantity of extra money being created and when the taps might be turned off. They even began to contemplate higher interest rates to cap runaway growth. A higher growth world with finite QE meant less need for gold in its traditional role as an alternative ‘hard’ currency and store of value.

A resurgent US dollar has also been an impediment. Gold is priced in dollars and weakness in the currency can attract more buyers, notably in India and China, as it becomes cheaper in their local currencies, but the reverse is true when gold becomes more expensive.

This all highlights that gold is an inflation hedge in the long term but not the short term. Other factors such as sentiment play a much bigger role month to month or year to year, but the consequent moves can look like blips when you zoom out to a multi decade timescale. Investors buying gold for an inflation hedge over the past year have been left disappointed – for now.

There is also the argument that gold has new competition from a new form of electronic ‘hard’ money in the form of Bitcoin. While it is a nascent, unproven and divisive asset, many investors that might otherwise be attracted to gold are at least considering the merits of a similarly scarce digital asset. This interest could be ‘crowding out’ gold, which some see as an analogue investment in a digital age.

What now for gold?

has been used as a means of exchange, a store of value and a display of wealth, but it seems more people are questioning the relevance of inert lumps of yellow metal and its status as the go-to an ‘independent’ currency that cannot be debased.

Although gold can be a good diversifier in a portfolio it does also come with several disadvantages. It has little practical use owing to its expensiveness and it yields no income. During ‘normal’ economic times it can become deadweight in a portfolio, or worse because it can be unpredictable and volatile due to geopolitical events or supply and demand imbalances.

Yet where it may come into its own as a true diversifier, which can sometimes defy falling markets in times of uncertainty, and which might offset inflation if the major currencies become more debased. The lack of cashflow from gold means it’s a store of value rather than a productive asset, though. In theory, over very long periods (think decades rather than years) gold should rise (or fall) at roughly the expansion or contraction of the monetary base, though this assumes all else is equal and that any new supply from mining is roughly equal to additional demand.

Gold in a portfolio

On balance, it’s still worth maintaining a bit of exposure to gold as a ‘real’ asset with limited supply, but bear in mind that it will likely be a frustrating one to own with extended periods in the wilderness. For instance, having more than doubled in the three years following the global financial crisis, it gave back half of those gains over the following couple of years. So, although gold is often said to be a ‘safe haven’ asset, in terms of short and medium-term ups and downs it can be anything but – which is why investors generally limit exposure to a modest amount such as 5% of a portfolio.

Options for buying gold

Some gold investors like to buy coins or bars – but this is unlikely to be a valid option for most people due to storage and insurance requirements. Fortunately, there are more convenient ways to add gold to a portfolio.

Such as an exchange traded fund (ETF). We tend to prefer ‘physically-backed’ funds which own gold kept securely in a vault, as opposed to derivatives-based funds where there can be some added risk and complexity. One example is iShares Physical Gold, which is part of the Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors.

A higher risk route into gold is through shares in gold mining companies. These tend to represent a ‘geared’ play on the gold price, meaning they multiply the effect of a rise – but also multiply any fall. This is because profits can be highly sensitive to what the gold price is doing, and the riskier firms could even swing from profit to loss or vice versa on these moves.

The fund on our Direct Investment Service Preferred List specialising in this adventurous area is Blackrock Gold & General. Managed by the well-resourced Blackrock's Natural Resources Team, it invests in gold and other precious metal-related companies on a worldwide basis. The fund holds between 50 to 80 companies, the vast majority of which are established producers of gold, with exposure to pure exploration stocks (typically the riskiest in the area) relatively low compared with some of its peers.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Is gold still an inflation hedge?

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