One of the more common questions I receive is, "Should I buy gold as a hedge against inflation?" Many, if not most, investors seem to think of the metal as a good way to protect themselves against unexpected price hikes. And they're dead wrong.
Gold can help offset some economic and geopolitical risks, but it's a poor hedge against inflation, as the following example illustrates.
On Jan. 21, 1980, the price of gold hit the then-record high of $850. By the end of the year, it had fallen to $590, a drop of more than 30 percent. By March 19, 1982, it reached just $316, a fall of 63 percent. On March 19, 2002, gold traded at $293, below where it was 20 years earlier.
The inflation rate for the period 1980-2001 was 3.9 percent. A gold investor who was unlucky enough to have bought at that $850 peak not only would have seen the investment fall by 65 percent in nominal terms by the spring of 2002, but also would have experienced a real loss in purchasing power of about 85 percent. Given this abysmal performance, gold cannot possibly be considered a good hedge against inflation.
The rapid rise in the price of gold in the 1970s was fueled by easy monetary policies, with negative real interest rates. When the era of loose money ended, the bubble burst. Easy money is also behind the surging gold prices since 2003. While I'm certainly not predicting that gold prices are set to collapse, it's possible. Just as a change in monetary policy led to a change in gold prices in 1980, a move by central bankers to raise interest rates could cause a repeat performance of that precipitous decline more than three decades ago.
Since that remains well within the realm of possibility, let's look at other investments considered by many to be good inflation hedges.
Image courtesy of Flickr user covilha