Gold as Inflation Hedge – Gold Price vs. Inflation

You’ve likely heard about using gold as an inflation hedge. It’s a strategy many investors use to protect themselves against inflating prices, treating gold as a safe haven amidst the fear and uncertainty inflation wreaks on financial markets.

And true, gold has proven itself multiple times as an effective protection against inflation. However, that hasn’t always been the case. There are periods when gold offered little to no protection against rising inflation. Indeed, once you analyze the history, gold has a rather mixed record here.

Still, to this day, many investors turn to gold in uncertain times. But is gold a good hedge against inflation? Or are there better investments to consider? Let’s find out.

Gold vs. Inflation – How Does Inflation Affect Gold Prices?

Although there’s a strong correlation between inflation and gold prices, inflation’s effect on gold is more indirect than direct. Essentially, it’s more about inflation’s effects on other financial areas rather than its direct impact on gold prices.

In simple terms, as prices grow across the economy, investors buy commodities like gold or other precious metals to preserve their dollars’ purchasing power. That increases the demand for gold, driving up its price.

That, however, isn’t always related to inflation but also volatile periods, such as financial crises. In such periods, investors move their money away from volatile assets, such as stocks or bonds, and invest them into “safer” assets, like gold or silver.

For example, many investors turned to gold as a more solid investment option during the 2007-08 Financial Crisis or the recent coronavirus pandemic. This caused the price of gold to skyrocket despite the low inflation rate.

The price of gold is also heavily affected by other factors, such as its supply and interest rates.

And sure, inflation also plays a significant role here. Often, even the mere expectation of inflation can drive up the price of gold. To say it’s the only factor, though, would be a stretch.

Is Gold a Hedge Against Inflation?

The concept of gold being an inflation hedge dates back to the 1970s when oil price shocks and energy shortages increased average annual inflation to almost 9% from 1973 to 1979.

These six years cemented gold’s role as an inflation hedge due to an impressive 35% annual return on investment. Since then, however, its performance hasn’t been that impressive.

For example, in the first half of the 1980s, when the annual inflation averaged 6.5%, gold prices fell 10% annually on average. This caused returns to fall short of the inflation rate. They even underperformed commodities, real estate, and S&P 500.

U.S. annual inflation rate since 1970 (source: macrotrends.com)

The same happened between 1988 and 1992 when gold prices decreased despite the annual inflation averaging approximately 4.5% during this period.

On the other hand, the recent rise of US inflation based on the Consumer Price Index (CPI) was followed by the increase in the price of gold, especially in 2020/21, when the annual inflation rate rose from 1.23% to 4.70%.

For instance, in 2020, gold prices rose by 24.43%. This, however, has been followed by a slight decline despite the average annual inflation rate increasing to reach 8% in 2022.

Historical gold prices since 1970 (source: macrotrends.net)

Based on that data, one must ask whether gold is a hedge against inflation. After all, in theory, an inflation hedge should increase in value in line with the rise in consumer prices. Gold hasn’t always performed like that, in many instances producing negative returns for investors.

That’s over short periods, though. When considering gold as an inflation hedge over a long horizon of time, some studies suggest that it can be an effective protection against inflation.

Should You Invest in Gold During Inflation?

Although gold’s performance against inflation has been somewhat inconsistent, it doesn’t mean you shouldn’t invest in it. Gold offers investors numerous advantages that go beyond its supposed inflation-hedging properties.

First of all, gold has historically had a low or negative correlation to bonds and stocks. That makes it an excellent diversification tool.

Secondly, gold has always performed well during economic turmoils. Gold and other commodities offer investors a “safer” investment than volatile assets such as stocks and bonds. It did so during the 2007-08 Financial Crisis and the 2020 pandemic.

Thirdly, gold has excellent long-term investment benefits. As covered, while it doesn’t always perform well against inflation in shorter periods, it’s more effective over a long time horizon. That, combined with gold’s relatively high resistance to market volatility, makes it a good retirement investment.

There’s the case of gold’s liquidity. Unlike bonds, stocks, or real estate, which are considered illiquid, gold can be quickly sold and exchanged for cash.

And finally, investing in gold isn’t complicated. Furthermore, there are several options to invest in gold (gold IRAs, gold stocks, gold ETFs, and gold bars, to name a few), and all of them are relatively straightforward, making gold investments a good choice for those who don’t have time to do extensive market research.

So yes, given all these advantages, investing in gold can be a good idea when searching for a way to diversify your investment portfolio. Its price stability and high liquidity make it a smart investment during down periods.

And while it may not provide you with the short-term inflation-hedging advantages you seek, it can effectively protect against inflation over a long period, making it a good option for a retirement investment.

How To Buy Gold?

It’s also important to note here that if you decide to use gold as an inflation hedge, you have several options on how to buy it. We won’t dwell on that too much here, as we’ve already covered this topic in more detail here.

In short, you can either buy physical gold, such as coins, bars, and jewelry, or invest in gold stocks, gold ETFs, gold mutual funds, or gold mining stocks.

All these options come with their distinct pros and cons, so be sure to do your research before deciding on one. Also, when investing in gold, make sure you purchase from a reliable Gold IRA company, such as Augusta Precious Metals or Fidelity Investments.

What Is the Best Inflation Hedge?

So yes, while gold can work as a hedge against inflation, it’s not the most viable option. As covered, gold has a rather turbulent history with inflation. In some instances, it even provided investors with losses during inflationary periods.

Of course, it doesn’t mean gold can’t perform well against inflation. In the long term, for instance, it can provide significant returns over inflation. One should treat it more like a diversification asset rather than the primary source of potential future income, though.

So, if not gold, what asset is the best inflation hedge? Is there even a bulletproof option?

Long story short – no. However, it doesn’t mean there aren’t any effective ways to protect yourself from the effects of inflation, many of which have a better performance record than gold, for that matter.

First things first, commodities. And yes, that includes gold, but also other precious metals, as well as things like copper, petroleum, oil, metals, etc. The reason for this is that commodity prices are part of the inflation rate’s calculation (although not all).

When the prices of raw commodities rise, so does the price of end products, and, as a result, so does the inflation rate. Therefore, investing in certain commodities can generate excellent returns during inflationary periods.

The next potential inflation hedge is real estate, especially rental. The rising inflation is followed by increased rents, providing investors with a steady, growing income.

Another asset some inventors deemed as a potential inflation hedge was Bitcoin. Indeed, many cryptocurrency investors believe that crypto is the best inflation hedge due to its fixed supply. However, Bitcoin hasn’t performed too well recently despite the growing inflation. The fact is that it’s been outperformed by gold in that matter.

And last but not least, we have the stock market. That’s something many investors fail to consider as a potential inflation hedge, deeming the stock market too volatile and unpredictable. And sure, that’s true when looking at it over short periods of time. In the long term, however, the S&P 500 has proven itself to offer steady returns over inflation.

Indeed, if you look at the S&P 500’s performance since 1926, its rolling annual 30-year return has remained between 8-15%. This is more than enough to protect against inflation, even in its most extreme periods.

Key Takeaways – Can Gold Protect Me Against Inflation?

Yes, gold can protect you against inflation. Gold has several times proven itself to be a good inflation hedge. However, it’s important to note that this has not always been the case. In many instances, gold prices were dropping with the inflation rate rising, producing losses instead of expected returns.

For this reason, you shouldn’t base your investments merely on gold to protect yourself against the effects of inflation. As any savvy investor will tell you, gold can work brilliantly when diversifying your portfolio to make it more inflation-proof, especially in the long term.

You should also consider other investments, though. When looking for assets that may work as inflation-hedging tools, one has to mention commodities, such as oil or other precious metals, real estate, and stocks.

So, wrapping up investing in gold can be an excellent idea, especially over the long time horizon. And when looking for gold investment opportunities or tips, you can always count on Gold IRA Blueprint.

Through our gold investment guides and reviews, you’ll be able to learn everything you need about protecting your wealth with gold IRAs and precious metals in general.

Browse our knowledge base or download our Free Gold IRA Guide and learn how to protect your future against inflation!

Article Sources

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https://www.macrotrends.net/

https://www.economist.com/finance-and-economics/2023/07/13/the-mystery-of-gold-prices

https://www.forbes.com/advisor/investing/gold-inflation-hedge/

https://www.investopedia.com/financial-edge/0311/what-drives-the-price-of-gold.aspx