Is gold the best inflation-fighting asset? Maybe not.

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I've been using Simba's backtesting spreadsheet to explore various portfolio allocations that have done OK in terms of hedging inflation. Of course gold is often mentioned as an important asset in this regard. When I looked at the real returns of gold and stocks (TSM) during the 1972-2012 time period here's what I found:

1) Gold had a negative real return in 44% of 41 years. Stocks in 32%
2) Gold had a negative real return in 50% of the rolling 3-year periods. Stocks in 24%.
3) Gold had a negative real return in 49% of the rolling 5-year periods. Stocks in 26%.
4) Gold had a negative real return in 61% of the rolling 10-year periods. Stocks in 13%.
5) Gold had a negative real return in 58% of the rolling 15-year periods. Stocks in 0%

Based on the real returns of gold over the last 41-year period, it would be difficult to conclude that gold is an effective inflation-hedging asset. It actually had greater negative real returns over longer rolling time periods. By comparison, stocks had fewer years of negative real returns, and negative real returns declined over longer rolling time periods. Based on these data, you would have to conclude that stocks are actually a better inflation-fighting asset than gold, particularly over long holding periods.

[wesleymouch]

Gold does well when there are negative real interest rates. When this is the case it has positive real returns. When you get positive real interst rates of 2 percent or more, gold does poorly.

[nisiprius]

Gold is a wildly speculative asset that undergoes huge changes in price dependent on crowd psychology. Broadly speaking, it spikes in value whenever the crowd believes that gold will hold value and that other assets will not. What drives the price behavior is the belief. The belief may be true, or it may not be, but that is what drives it. This then creates the usual self-reinforcing phenomenon of drawing in more of the crowd whose belief is not based on fundamentals but simply on the observation that people who are holding gold are getting rich.

The point is that you cannot make simple reliable rules about the behavior of gold. To predict the behavior of gold is to predict crowd psychology. Do you believe in "the wisdom of crowds?" Do you believe in "the madness of crowds?" I don't know, I'd say some of both--but I do not believe in the predictability of crowds.

The stock market includes a bit heaping dose of crowd psychology, but that is also mixed in with the discounted present value of future dividends, the Gordon equation, etc. Gold is pure 100% speculation and crowd psychology.

Gold is also subject to unpredictable changes in government policy, to a greater degree than other assets. One of the worst periods of inflation in U.S. history took place just after World War I. The stunning effect of Ford's $5/day wage was completely wiped out by inflation within about five years. During that period of time gold had no inflation-fighting power at all. Gold advocates use the alibi that things were different because the dollar was on the gold standard. All well and good, but it doesn't matter. The actual fact is that neither dollar currency nor gold was an inflation-fighter in that time frame. (It only just occurs to me that perhaps that was a factor in the rise of interest in stocks from 1920 to 1929?).

[Browser]

Here are the real return data for three other assets that are also mentioned as inflation fighters. The table below shows the percentage of 1, 3, 5, 10 and 15-year rolling return periods in which there were negative real returns for each asset. I included Gold and Total Stock Market so all are together in one table.

_____________1Yr____3Yr____5Yr_____10Yr____15Yr

Commodities...34%.....29%.....23%.......13%.......4%

TIPS..............29%.....26%.....20%.......19%.......0%

REITs............22%.....18%.....14%.......0%........0%

Gold..............44%.....50%.....49%.......61%......58%

Stocks (TSM)...32%.....24%.....26%.......13%.......0%

As you can see, the real returns of commodities and TIPs were similar. Each had negative real returns in about 1/3 of the 41 years between 1972-2012, and the number of negative real return periods declined over longer rolling return periods. TIPs were effective in hedging inflation only over longer holding periods, and were not uniquely effective over periods of 10 years or less. REITs were somewhat more effective than either commodities or TIPS, especially over time periods longer than 5 years

It is interesting that neither Commodities nor TIPs did especially better than just holding a Total Stock index fund in terms of rolling real return data over the last 41 years. Gold is clearly the runt of the litter.

[Clive]

Gold does well when there are negative real interest rates. When this is the case it has positive real returns. When you get positive real interst rates of 2 percent or more, gold does poorly.

I was trying to figure a method of estimating modified duration for gold the other day and as part of that this was one of the things I looked at.

(those 5 year averages are arithmetic averages)

[hafius500]

Andrew Ang - 'Real' Assets, September 29, 2012,
Columbia Business School Research Paper

Gold, surprisingly, has been a poor inflation hedge.

The studies I have seen concluded gold performs well when real yields are negative.

[Browser]

Andrew Ang - 'Real' Assets, September 29, 2012,
Columbia Business School Research Paper

Gold, surprisingly, has been a poor inflation hedge.

The studies I have seen concluded gold performs well when real yields are negative.

Thanks for the link. Quite interesting and in agreement with the backtesting data I looked at.

[EDN]

If we look at quarterly data since 1997 through 12/31, we don't find that Gold is all that highly correlated with inflation:

Gold = +0.07
Global Equity Asset Class Mix = +0.09
Treasury Bonds = -0.38
TIPS = +0.21
Commodities = +0.52

In-line with stocks and below TIPS, and well below a broad-based Commodities basket.

I think I'll just stick with stocks and bonds (real and nominal).

Eric

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I looked at correlations of the montly returns of TSM, REIT, TIPs, Commodities, and Gold with changes in the 10-year interest rate over the past 8 years. Here are the data:

TSM = 0.32
REIT = 0.14
Comm = 0.11
TIPs = -0.55
Gold = -0.13

We see that equities, commodities, and REITs correlated positively with interest rates, while TIPs and Gold correlate negatively. While there is an imperfect relationship between interest rates and the inflation rate, they are positively correlated. At least over the past 8 years, the returns of TIPs and Gold have benefited from the general decline in interest rates, but might be adversely affected if rates begin to increase. On the other hand, Stocks, REITs, and Commodities might help to hedge interest rate increases to some degree.

[athrone]

Why would central banks hold 30,000 tonnes of Gold as an "inflation-fighting asset" when they "control" inflation? Why is there $10,000,000,000,000 in worldwide wealth allocated to Gold? Why is the U.S. gold guarded 24/7 and stored behind a 21" thick vault door weighing 25 tonnes and embedded in solid granite. What do all these people know that you don't?

You can never understand something if you are operating on faulty assumptions. I suggest you tear down your preconceived notions and if you want to talk about Gold, go spend 500 hours of research on it and come back with what you find.

Time proves all things.

[craigr]

Andrew Ang - 'Real' Assets, September 29, 2012,
Columbia Business School Research Paper

Gold, surprisingly, has been a poor inflation hedge.

That paper has some problems in his assumptions and data. For example:

Erb and Harvey (2012), however, document that over the extremely long run, gold may be an effective inflation hedge in terms of gold returns matching inflation... Erb and Harvey compare the pay of a U.S. Army private today with that of a legionary during the reign of Augustus (27 B.C. to 14 A.D.), the first emperor of the Roman Empire. Erb and Harvey find the pay of U.S. army privates and Roman legionnaires very similar when stated in ounces of gold. They also find the pay of a U.S. army captain approximately the same as that of a Roman centurion, when expressed in gold. So over centuries, gold is an inflation hedge, at least in preserving the long-run level of military pay. If only we could live so long.

Sadly, these extremely long horizons are not relevant for most investors.

Actually they are relevant because paper currencies have, on average, very short lives in terms of human history and often do very unpredictable things quickly. Over an investor's time horizon, it is in fact *very likely* they are going to experience a serious currency problem eventually. Yes, it may not be Zimbabwe, but it could be 1970s U.S. Or it could be 2008 Iceland. Or it could be 2001 Argentina (or now 2013 Argentina). Etc. Just for reference, of the last century I think there are perhaps only six or so countries that still have the same government (not to mention the same currency). Paper currencies are extremely unstable when you take the long-view.

We should be realistic about these things. The longer a fiat currency exists without a big problem is just one day closer to it eventually having a big problem.

The point really is that gold as an asset is not just for long term of centuries or more. It is very much a short-term emergency currency hedge where you can bank profits from your stocks and bonds. Then you can draw on it when the stocks and bonds are being hurt by very bad market conditions.

[Browser]

Appreciate the posts addressing the Eternal Truths about gold. However, I had the more modest objective in this thread of looking at data pertaining how various assets that are commonly thought to hedge inflation actually did hedge inflation over a good part of my lifetime - the last four decades. That might be too tiny a slice of eternal time to be worthy of mention. And there might be superseding reasons for buying gold and holding it in foreign vaults; I don't dispute it.

[Kulak]

Craig, obviously you've never heard of TIPSs. The government has promised us a positive real return, so we have nothing to worry about. That's the U.S. government, the full faith and credit. Besides, I heard that exchange rates mean-revert over time. Ignore the noise, stay the course, etc. What we should really be agonizing about is whether a 60-40 split of S&P500 and long Treasuries is only "95% safe" and whether a 50-50 could up that to "98% safe."

[hazlitt777]

Appreciate the posts addressing the Eternal Truths about gold. However, I had the more modest objective in this thread of looking at data pertaining how various assets that are commonly thought to hedge inflation actually did hedge inflation over a good part of my lifetime - the last four decades. That might be too tiny a slice of eternal time to be worthy of mention. And there might be superseding reasons for buying gold and holding it in foreign vaults; I don't dispute it.

Well, let's throw this in the mix. Gold in 1971 was around $35. Today it is around $1675.

Using this calculator, http://www.dinkytown.net/java/AnnualReturn.html

one sees that gold gave an average annual return of 9.65% Now if it was matched up with stocks and bonds in our personal portfolios over those years, that gave ones portfolio some stability over those years. It doesn't matter whether it acted like an inflation hedge or not when it was "suppose to." The crowd catches on but never at the most logical times, otherwise gold would be the "perfect inflation hedge" whatever that is. My take on it.

There are unique properties that the element of gold has such that the market goes to it over and over as money/store of wealth/diversifier. I just hope that more of us little guys and gals make a gold allocation instead of it all being concentrated in the hands of the big players. Just as I wouldn't like all homes to be owned by a few players, renting them out to the rest of us, so too I don't want to see gold owned by a few big players, empowering them to have a disporportionate ability to use it and manipulate it to their advantage.

Last I read, about half of all investable gold is in the central banks, and the rest in our hands. I would like to see that around 75% ours, and 25% theirs. Diversify diversify.

[craigr]

Craig, obviously you've never heard of TIPSs. The government has promised us a positive real return, so we have nothing to worry about.

Everyone's views on this particular subject are heavily influenced by their own life's experiences. In the U.S. we have not had seriously bad inflation for at least a generation now, and we have not had a hyper-inflation since the Confederate currency went away (however before that we had the Continental currency which went belly up). So there is this memory gap in place in the U.S. because it just hasn't been a problem here in a while.

But I just got back from traveling in Argentina where they officially have something like 10% inflation, but unofficially it was more like 20-30%. Flights in country were easily 2-3X what they were in neighboring Chile as companies try to outrun the inflation and still stay in business. They also had riots in grocery stores in Buenos Aires where two people were killed. At some places they are now using dogs trained to sniff out US Dollars (http://www.businessweek.com/magazine/ar ... 22012.html). When you leave the country, no currency exchanger will take Argentine Pesos (I managed to spend mine down to 100 pesos before I crossed the border for about a $20 USD loss - not too shabby). The President just announced food price freezes to attempt to control the situation, but it will fail. I bet most Argentinians, if asked, would rather be holding gold right now than their pesos.

Now I'm not saying the U.S. will go Argentina, it's just a current example. But I don't know that it couldn't in the future and it's the future I need to insure against, not what a backtest said worked in the past. The history of currencies is full of Argentinas. So for me to discount the possibility of it happening anywhere I invest/live is not a prudent move.

In the event of very bad inflation, investors aren't going to want TIPS. They will want gold. That's what has been established time and time again. The history on it is about as strong as you're going to find. Maybe it will change in the future, but so far I've not seen anyone make an effective argument why this is not true.

Gold is not an investment in the strictest sense, but it is a very powerful way to diversify against currency risks that could hammer stocks and bonds. Would I like to own a portfolio that didn't have gold in it? Sure, that means I could put the money to use in more productive ways. But sadly, financial history just shows that is a really bad idea. I think anyone that doesn't hold a hard asset like gold in a diversified portfolio is making a serious error. You know it may drag down returns when the stock market is humming and the currency is all unicorns and rainbows. But if that isn't the future an investor ends up with then the gold could be the only asset they have that is performing.

[RenoJay]

Why would central banks hold 30,000 tonnes of Gold as an "inflation-fighting asset" when they "control" inflation? Why is there $10,000,000,000,000 in worldwide wealth allocated to Gold? Why is the U.S. gold guarded 24/7 and stored behind a 21" thick vault door weighing 25 tonnes and embedded in solid granite. What do all these people know that you don't?

You can never understand something if you are operating on faulty assumptions. I suggest you tear down your preconceived notions and if you want to talk about Gold, go spend 500 hours of research on it and come back with what you find.

Time proves all things.

The reason for the thick walls is because you'd guard anything worth $10 TT. It doesn't, however, answer whether gold is an inflation hedge. It just answers that gold does in fact have value.

[brianbooth]

Guys,

I think there's a disconnect here between what some people consider "inflation" and the currency risk that Craig is referring too. If the price of milk goes up because demand is up or supply is down, that's inflation. If the price of imported milk goes up because dollars are worth less relative to other currencies, that's currency risk.

As for TIPS vs. Gold, it's important to think about the macro factors involved in the recent financial crisis and the inflation of the 70's. In the recent crisis, the economy suffered a demand shock so prices fell and inflation/interest rates collapsed: TIPS, like all bonds, won on interest rates even as their inflation adjustments dropped off. On the other hand, with a supply shock, as was the case in the 70's, prices went crazy and inflation/interest rates spiked. TIPS should have done well in the 70's with the high inflation but at the same time, rising base interest rates would have worked against that. Gold, on the other hand, should respond to currency risk more than regular inflation in the price of milk, which is why it performed spectacularly during both inflationary and deflationary recessions: When the economy goes in the tank, people run to safe havens and gold, as a currency that isn't dependent on any government, is about as safe as it gets. It happened during the Great Depression, it happened in the 70's, it happened in the Great Recession, and it will happen again. Anyway, it seems like gold is a better bet since it protects during recessions resulting from both demand and supply shocks but I'm certainly not going to tell people that TIPS are a bad idea. You know, unless we get stuck in a Japan-style deflationary liquidity trap.

[Kulak]

IMHO, gold has a negative expected real return but should save your bacon in hyperinflation. That's not an investment; it's insurance.

[wesleymouch]

Craig, obviously you've never heard of TIPSs. The government has promised us a positive real return, so we have nothing to worry about. That's the U.S. government, the full faith and credit. Besides, I heard that exchange rates mean-revert over time. Ignore the noise, stay the course, etc. What we should really be agonizing about is whether a 60-40 split of S&P500 and long Treasuries is only "95% safe" and whether a 50-50 could up that to "98% safe."

The problem is that the government decides what is CPI. Kind of like the fox guarding the henhouse. Argentina has 25% annulal inflation but per govt stats it is only 10%.

[athrone]

The reason for the thick walls is because you'd guard anything worth $10 TT. It doesn't, however, answer whether gold is an inflation hedge. It just answers that gold does in fact have value.

The USG only has 8,000 tonnes out of the 170,000 in existence. It's only "worth" about $500 billion, just a drop in a bucket compared to what the Fed prints in a single round of QE or even one year of the $3700 billion Federal Budget.

So to ask the question again, why have we been guarding a puny $500B "inflation hedge" behind 21" bomb-proof doors 24/7 for the last half century if the Fed can control inflation and the USG can just issue TIPs?

What do they know that [most] Bogleheads refuse to even consider?

[stevewolfe]

The problem is that the government decides what is CPI. Kind of like the fox guarding the henhouse. Argentina has 25% annulal inflation but per govt stats it is only 10%.

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[stevewolfe]

The USG only has 8,000 tonnes out of the 170,000 in existence. It's only "worth" about $500 billion, just a drop in a bucket compared to what the Fed prints in a single round of QE or even one year of the $3700 billion Federal Budget.

So to ask the question again, why have we been guarding a puny $500B "inflation hedge" behind 21" bomb-proof doors 24/7 for the last half century if the Fed can control inflation and the USG can just issue TIPs?

What do they know that [most] Bogleheads refuse to even consider?

The sole on this argument is worn pretty thin frankly. You could've said the same thing about the US when there was 130,000 tons of gold extracted. You're a student of gold history - when was the last time the US government bought gold if it's so valuable to them? Gold is a show for governments - it's a prestige thing for the US government to have the largest gold reserve.

If I have $50,000 in a jar on my coffee table and I tell all my neighbors about it, do I leave the door unlocked? Of course not. Maybe your implication will come true in the future - it didn't the last time gold exploded in value and it likely won't this time either. When we get real yields back above 2% let's see what happens to gold. I'd say that most folks know that if real rates are materially positive, we'll see gold fall. Time will tell.

[patrick]

What do they know that [most] Bogleheads refuse to even consider?

The Fed knows that it is a central bank. I refuse to even consider that I could also be a central bank, and therefore feel no need to imitate a central bank's investment policy.

[athrone]

You're a student of gold history - when was the last time the US government bought gold if it's so valuable to them?

With what funds do you purchase Gold when you run a perpetual trade deficit as a result of being the world's reserve currency?

Can you name a super-producing country that is currently not importing Gold or trying to increase/secure it's Gold reserves?

[athrone]

The Fed knows that it is a central bank. I refuse to even consider that I could also be a central bank, and therefore feel no need to imitate a central bank's investment policy.

Are you suggesting that what Gold is to Central Banks is different from what it is to private investors? Or are you not following the thrust of my argument (to be fair I didn't state it directly)?

[athrone]

Ok, I will be more direct.

The title of this thread is a strange question. Strange enough IMHO and as respectively as possible, it indicates a fundamental misunderstanding of Gold by the OP. To use an example, it would be like asking "Are Equities the best inflation-fighting asset?" and then trying to correlate inflation to the price of equities.

Can equities be used as an "inflation fighting asset." Yeah I guess. So can Gold or 3 month Tbills. But what is the point of that statement? Do people invest in Equities because of inflation? Well no, not really, hopefully they invest in equities because they believe the underlying businesses/economy is sound and will experience growth.

So I guess a question to the OP would be: why are you trying to prove/disprove whether Gold is an inflation-fighting asset?

[stevewolfe]

Can you name a super-producing country that is currently not importing Gold or trying to increase/secure it's Gold reserves?

Japan is the 3rd largest economy in the world in 2012 and they were a net seller of gold. Germany is the 5th largest economy in the world and, despite moving some gold back home from the US and France over the next 6 years of so, was a net seller of gold last year. We've already established that the US as the largest economy in the world did not buy gold in 2012. That's 3 of the top 5 economies in the world. Of course China and India were net buyers. Surely you aren't going to suggest that the US, Japan and Germany are not super producing countries?

[patrick]

The Fed knows that it is a central bank. I refuse to even consider that I could also be a central bank, and therefore feel no need to imitate a central bank's investment policy.

Are you suggesting that what Gold is to Central Banks is different from what it is to private investors? Or are you not following the thrust of my argument (to be fair I didn't state it directly)?

It's possible that I didn't follow your argument. In any case, I was not suggesting that gold is different for central banks versus private investor. Rather, I was saying that central banks themselves are different from private investors. Central banks have different goals and follow different rules than private investors. For instance, central banks aim to influence inflation rates, interest rates, unemployment rates, and/or currency exchange rates, and central banks have the authority to issue legal tender fiat money. The typical private investor, on the other hand, is interested in getting the best risk adjusted returns, is not allowed to issue legal tender fiat money, and has negligible ability to impact the rates I mentioned even if the private investor did seek to control them. With these huge differences, we shouldn't assume that the right choices for central banks are the same as the right choices for private investors.

[patrick]

Actually they are relevant because paper currencies have, on average, very short lives in terms of human history and often do very unpredictable things quickly. Over an investor's time horizon, it is in fact *very likely* they are going to experience a serious currency problem eventually. Yes, it may not be Zimbabwe, but it could be 1970s U.S. Or it could be 2008 Iceland. Or it could be 2001 Argentina (or now 2013 Argentina). Etc. Just for reference, of the last century I think there are perhaps only six or so countries that still have the same government (not to mention the same currency). Paper currencies are extremely unstable when you take the long-view.

We should be realistic about these things. The longer a fiat currency exists without a big problem is just one day closer to it eventually having a big problem.

The point really is that gold as an asset is not just for long term of centuries or more. It is very much a short-term emergency currency hedge where you can bank profits from your stocks and bonds. Then you can draw on it when the stocks and bonds are being hurt by very bad market conditions.

You might be right about few governments/currencies surviving the whole century, but far more financial markets have survived. For instance, the stock markets of Japan, Germany, and Italy all survived the last century in spite of problems with their governments and currencies.

[athrone]

Japan is the 3rd largest economy in the world in 2012 and they were a net seller of gold. Germany is the 5th largest economy in the world and, despite moving some gold back home from the US and France over the next 6 years of so, was a net seller of gold last year. We've already established that the US as the largest economy in the world did not buy gold in 2012. That's 3 of the top 5 economies in the world. Of course China and India were net buyers. Surely you aren't going to suggest that the US, Japan and Germany are not super producing countries?

Japan - Ran almost $80 billion deficit in 2012 (1,400 tonnes of Gold at present prices)
US - Ran over $500 billion deficit in 2012 (8,500 tonnes of Gold at present prices)
Germany - Repatriating almost 700 tonnes. How about private investors?
China - Arguably imported up to 1,000 tonnes (data is very opaque)
India - Private investors hold over 20,000 tonnes and growing

It's not the size of the economy that matters, it's the balance of trade. And yes, super-producing means having a large surplus, not a deficit. You also failed to mention other key economies (ahem, Saudi Arabia)

[wesleymouch]

The USG only has 8,000 tonnes out of the 170,000 in existence. It's only "worth" about $500 billion, just a drop in a bucket compared to what the Fed prints in a single round of QE or even one year of the $3700 billion Federal Budget.

So to ask the question again, why have we been guarding a puny $500B "inflation hedge" behind 21" bomb-proof doors 24/7 for the last half century if the Fed can control inflation and the USG can just issue TIPs?

What do they know that [most] Bogleheads refuse to even consider?

The sole on this argument is worn pretty thin frankly. You could've said the same thing about the US when there was 130,000 tons of gold extracted. You're a student of gold history - when was the last time the US government bought gold if it's so valuable to them? Gold is a show for governments - it's a prestige thing for the US government to have the largest gold reserve.

If I have $50,000 in a jar on my coffee table and I tell all my neighbors about it, do I leave the door unlocked? Of course not. Maybe your implication will come true in the future - it didn't the last time gold exploded in value and it likely won't this time either. When we get real yields back above 2% let's see what happens to gold. I'd say that most folks know that if real rates are materially positive, we'll see gold fall. Time will tell.

Central banks hold gold because it can be ued to stabilize a currency if they cause high inflation and/or if there is loss of confidence in the currency. That is tail risk. Gold is not a prestige thing. I serves as the ultimate bailout if Central Banks fail in their job which they historically done many times in the past

[Browser]

Ok, I will be more direct.

The title of this thread is a strange question. Strange enough IMHO and as respectively as possible, it indicates a fundamental misunderstanding of Gold by the OP. To use an example, it would be like asking "Are Equities the best inflation-fighting asset?" and then trying to correlate inflation to the price of equities.

Can equities be used as an "inflation fighting asset." Yeah I guess. So can Gold or 3 month Tbills. But what is the point of that statement? Do people invest in Equities because of inflation? Well no, not really, hopefully they invest in equities because they believe the underlying businesses/economy is sound and will experience growth.

So I guess a question to the OP would be: why are you trying to prove/disprove whether Gold is an inflation-fighting asset?

I'm really interested in which assets have seemed to perform best in terms generating positive real returns, meaning that they seem to offer some benefit in inoculating portfolio returns from the effects of inflation. Gold, commodities, equities, REITs, and TIPs have all been highlighted as assets of this type. Harry Browne specifically recommends a large allocation to gold to protect against inflation. However, looking at the real returns from 1971-2012, I found that the total stock market, REITs, commodities, and TIPs have produced more consistent real returns over all 1, 3, 5, 10. and 15-year rolling return periods than Gold. In particular, gold was least effective in generating positive real returns over longer 10 and 15-year rolling time periods, while the other four asset types were most effective over longer rolling time periods. Since many investors are buy-and-hold investors over longer time periods, the behavior of gold is not what I want to see from an asset that I'm holding for inflation protection. These findings lead me to the conclusion that, defining risk in terms of the failure to meeting future real spending liabilities, gold seems to be the least desirable of these assets, at least based on the last four decades of data. Technically, the time period that should be examined is from 1975 - 2012, since gold was not an investible asset in the U.S. from 1933 to 1975 as it was illegal for citizens to own it. That would exclude 1972, 1973, and 1974 in which the price of gold increased by 49%, 71%, and 72% respectively following the severing of the link to the dollar in August, 1971.

[umfundi]

So, what did you expect? Or, more to the point, what will you expect in the future?

Gold has an expected return of zero.

Gold has been abandoned as having any connection to fiscal policy.

Gold is not now (was it ever?) a proxy for constant real value.

"Inflation" is the increase in the price of goods and services. If you want inflation protection, invest in goods and services.

Keith

[Clive]

Gold has an expected return of zero

Gold is not now (was it ever?) a proxy for constant real value.

Spot on Keith. 100% loading into gold might broadly pace inflation over long periods of time, but it does so in a volatile manner and as such isn't the 'best inflation hedge'. Gold is a commodity and any real gains arise out of volatility, not income/earnings streams

Using silver since 1900 as a proxy for gold price changes (silver can be even more volatile than gold, so not an ideal proxy - but in the absence of anything better)

Arithmetic 6%, standard deviation 23.4%, Geometric 3.4%. Compared to CPI geometric 3.2%

So over that period silver more or less paced inflation (annualised 0.2% real - which might be assumed to have gone in costs).

A little silver, with an asset that tracks inflation closely, or a portfolio that maintains relatively stable value, periodically rebalanced will provide the equivalent proportioned gain from silver that's close to its arithmetic gain. i.e. as though the silver provided around a 2.5% real reward. i.e. I've assumed geometric = 95% of arithmetic here.

If gold is being held, it should be for its diversification and low correlation characteristics, and not heavily loaded into in the belief that it will provide an inflation hedge - other than perhaps over very long periods of time.

[athrone]

Harry Browne specifically recommends a large allocation to gold to protect against inflation.

I'm sure craigr can chime in here, but I'm almost positive this is false. Can you point to the quote or passage in his books/podcasts where he says this? Even if he did say that, why are you staking your financial future on one person's opinion?

However, looking at the real returns from 1971-2012

Looking at the returns over the last 40 years does not indicate what happened in those markets or why the prices moved the way they did, when they did, or for what reasons. If that is all you are basing your research on, you are very unlikely to arrive at the proper conclusion.

the behavior of gold is not what I want to see from an asset that I'm holding for inflation protection

See the posts above. Maybe I am investing with a different perspective, but I cannot understand the reason to be obsessed with the goings-about of a single currency when there are hundreds of countries, currencies, and equity markets worldwide.

Let's say you find a vehicle which exactly tracks inflation in the USD and nothing else. What then? You are guaranteed 0% real return. Is that really something you want to invest in? Why? Even if it tracks "Inflation" as defined by some nebulous Government metric, what if it doesn't track the things you personally buy?

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Inflation hedging is important for institutional investors, such as pension funds and insurance companies, that have the mission of meeting future real liabilities (claims, promises). It is also relevant to individual investors, particularly those at or near retirement, who have to meet real "liabilities" in terms of funding essential living expenses. So I think it's not a trivial concern in determining one's asset allocation and investment management strategy.

Investing in "real return" assets, such as commodities, real estate, TIPS, is one dimension of inflation hedging, but not the only dimension. There are also complex strategies employed by institutional investors, but unfortunately these are mostly out of the reach of individual investors. We are left with asset allocation strategies and reliance on the inflation-hedging benefits of certain assets; particularly real return assets. So it's essential for some investors (particularly those concerned with matching real liabilities) to have valid information about the inflation-hedging benefits and limitations of these asset types.

As I've said, one source of that information is to look at how they've performed against inflation. We have live data over the last four decades, which encompasses the period in which gold was an investable asset in the U.S., and when we look at it we see that gold didn't do particularly well compared to other types of real return assets such as commodities, TIPS, and real estate (REITS). Even stocks did better against inflation over longer time periods, but that's probably an artifact due to the tendency of stock prices to increase over time. IF we are relying on gold primarily to help protect the real value of our investment portfolio from the impact of inflation, that might not be the best idea we ever had. The data from this 40-year period is pretty consistent with other findings that gold is not an effective inflation hedging asset, and shouldn't be bought with that expectation. It might be desired for other reasons, such as protection from extreme left-tail events, but that's another topic.

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Great thread. Love the debate. I see both sides of the fence. I happen to believe that inflation is such a dynamic variable, within the context of the other factors that contribute to a global economy, that there simply is no one-sized-fits-all way to hedge inflation. Timing which inflation hedge is the best to hold during a given period will be next to impossible. I happen to like holding some gold for hyper-inflation and negative real rate environments (insurance policy), in addition to a mix of TIPs and REITs. I currently have no REITs but would love to buy more on the next 20-30% draw down.