By Jan Harvey
LONDON (Reuters) – Rising inflation has put gold back on the radar for investors looking to protect themselves from emerging price pressures, but history suggests its reputation has been overstated.
The experience of the last 50 years suggests gold performs better as a hedge against inflation shocks – like the spike caused by surging oil prices in the late 1970s and early 1980s – than the widely anticipated grind higher currently seen.
“If you strip out the 1970s, you find the relationship between gold and inflation is quite weak,” Brian Lucey, professor of international finance at Trinity College Dublin, said. “That is because you have a very different inflation regime in the late 1980s and 1990s than you had in the 1970s.”
“That was a time when inflation rates of double digit and higher were the norm. We’re not going back to that.”
As U.S. consumer inflation surged to nearly 15 percent in early 1980, gold more than kept pace, hitting a then-record $666.75 an ounce after a fifteenfold rise over the previous decade.
However, when inflation rose again in the late 1980s, from 1 percent in late 1986 to more than 6 percent by the end of 1990, gold sagged.
(GRAPHIC: Gold prices vs U.S. consumer inflation – http://reut.rs/2oweMS8)
While recent data suggests U.S. inflation pressures are picking up, central banks are poised to intervene if they start to rise strongly, chiefly through interest rate hikes.
For gold, that is bad news. Rising interest rates lift the opportunity cost of holding non-yielding bullion – why hold gold when you can be paid to hold cash?
Only when inflation runs out of control, holding real rates, or interest rates minus inflation, in check, does gold tend to benefit significantly. Even so, a better hedge can be found in assets specifically designed for the purpose, such as Treasury inflation-protected securities (TIPS), launched in the 1990s.
(GRAPHIC: Gold vs real interest rates – http://reut.rs/2CrEEHk)
“If you want to cover inflation expectations, you just buy a bond – it’s very straightforward,” Campbell Harvey, professor of finance at the Fuqua School of Business, Duke University, said. “However, that doesn’t work for unexpected inflation – this is where an inflation-linked bond is needed.”
Harvey’s research into gold’s link with inflation shows that while the metal holds its value over the extremely long run – Roman soldiers’ wages, expressed in gold, are similar to modern-day U.S. military pay – short-term investors seeking protection are likely to be disappointed.
“The inflation hedging abilities of gold are not measured over months or years, but centuries,” he said. “People mistake the very long term performance for the shorter term, thinking gold is going to protect them. My research is very clear that an investment in gold is not a reliable hedge.”
Indeed, gold has reacted little to recent price pressures. As the five-year U.S. breakeven inflation rate hit its highest in a year last month, gold sagged as the dollar pulled off recent lows in anticipation of higher interest rates.
(GRAPHIC: Gold vs 5-year breakeven inflation expectations – http://reut.rs/2GQa6NO)
Investors have plenty of alternatives to gold if they want to protect against inflation, from inflation-linked bonds and inflation-indexed options to real estate.
But regardless of the alternatives – and even whether gold really does act as an inflation hedge – rising price pressures may be good for bullion prices if enough people are convinced they will be.
“Because gold is a perceived inflation hedge, we will still likely see some allocation into gold leading up to inflation moving higher,” Standard Chartered analyst Suki Cooper said.
(Reporting by Jan Harvey; Editing by Veronica Brown and Mark Potter)