How Gold Acts As A Hedge For Inflation

Understanding how gold acts as a hedge for inflation relies upon a historical and predictive analysis of its importance as a precious metal commodity. If you’re looking for information about how gold acts as a hedge for inflation, you’ve come to the right place.


Frank J. Fabozzi CFA et al. (“The Handbook of Commodity Investing,” 2008) report that between the years of 1973 to 2006, gold’s superior performance as a hedge against inflation in U.S., U.K., Japan, France and Germany is proven. Precious metals’ ability to add diversification while protecting portfolio purchasing power prompts some investors to view gold as a leading inflation indicator. Gold prices have appreciated more than 40 percent in the past five years.



Buy and sell timing of gold. When investors purchase and at what average price investors purchase gold determines how well it protects the portfolio against the ravages of future inflation. Research by Kolluri (1980) tracks gold’s performance as an inflation hedge from 1968 to 1980; and 1974 to 1980. Gold price anticipated inflation by returning an average five percent nominal return from 1968 to 1980. From 1974 to 1980, investors anticipated hyperinflation: an average 9 percent nominal return occurred for every anticipated one percent rise in inflation during the period!


Rae Weston (“Gold (Rutledge Revivals): A World Survey,” 2013) recaps the importance of timing when buying and selling gold. For example, gold purchased in January 1969 returned -29.9 percent by July 1969. Holding gold through January 1970 returned +2.4 percent. Holding assets at this cost basis through January 1972 returned +105.0 percent! By July 1972, volatile price movements showed a modest loss (-1.7 percent), but by January 1973, the original 1969 purchase returned +237.3 percent. A long-term buy-and-hold strategy makes best financial sense when considering precious metals as a hedge for inflation.
Inflationary performance of commodities. According to the author of “Why Gold, Not Oil, Is the Superior Predictor of Inflation,” (D. Ranson, 2011) gold’s price change movements best track inflation changes. Most of the world’s gold supply is already above the ground. Price movements of oil reflect the commodity’s consumption rate, not only the supply of oil stores. Investors accumulate (hold) precious metals rather than consume them. The static quantity of known global gold supply also makes correlations like the Dow-gold ratio meaningful to investors.


Falozzi writes that historical performance of gold as an inflation hedge is a linear calculation. As financial markets continue to become more complex, non-linear relationships (e.g. the response of precious metals’ prices to crisis) will be examined.



Gold vs. gold-related assets. History shows that performance of gold-mining stocks, mutual funds and exchange-traded funds doesn’t precisely correlate with direct purchase of gold. Ownership of physical bullion or coins’ price performance demonstrates gold’s long-term ability to hedge against inflation (including the impact of foreign exchange and currency volatility).


Affect of interest rates. Investors seek to understand a direct relationship between interest rates and gold prices. Declining interest rates are often considered a deflation signal. Rising interest rates signal an inflationary environment: goods and services cost more. According to research by Abken (1980), the correlation between interest rates and precious metals’ price movement isn’t reliable on a short-term basis. Investors purchasing tangible assets like precious metals shouldn’t anticipate short-term trading opportunities.


History shows that declining interest rates tend to encourage investors to sell gold and bonds and purchase stocks. Alternatively, rising interest rates (especially rapidly rising interest rates) prompt investors to buy gold for its potential to protect against financial crisis.


Precious metals vs. stocks. Weston says that research shows a negative correlation between gold prices and stocks between 1973 and 1978. In 1980, as stock prices started to rise, investors sold commodities to invest in liquid financial assets like stocks and bonds. High bond coupon rates for AAA-rated assets prompted investors to invest in debt securities.


Research of Nelson and Bodie (1976), Fama and Schwert (1977) and others show that financial assets like stocks don’t hedge against long-term inflation. When investors buy and sell financial assets, including gold, it’s crucial to hedging against inflation.

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