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Gold is not the best inflation hedge

  • By Jeffrey A. Hirsch,
  • Wiley Global Finance WILEY GLOBAL FINANCE
  • Technical Analysis
  • Commodities
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Gold has been used as a store of value for millennia. In the modern era, investors buy gold as a flight to safety away from other liquid assets like cash, stocks and bonds during turbulent economic times and volatile geopolitical periods. It is also commonly believed to be an excellent hedge against inflation as it holds its value while currencies devalue. However, according to my research stocks have proved to be better than gold in hedging against inflation over the long haul.

Gold has been in been in a long-term bull market since the year 2000, but has not gained any ground since hitting all-time highs in 2011. Stocks have been in a long-term bear market since 2000, but the indices have rallied off the March 2009 bear market bottom and are currently encroaching on all-time highs. The term bull market refers to a rising trend in any financial market or group of securities: stocks, bonds, currencies, commodities, real estate, etc. The term bear market is a declining trend in any of these markets.

The relationship between gold and crisis: A look back

Active trading in Gold began in 1975 after it became legal to own it in the U.S. on December 31, 1974. Only the gold bull in 1979-80 was of a similar shape and magnitude to the rally gold enjoyed from 2000 to 2011. However, back then things were quite a bit different. Inflation had run rampant, with the year-over-year Consumer Price Index (CPI) peaking at 14.7% in March 1980. In mid-2008 inflation went into virtual free fall, from about 5.5% down to –2.0%. It is now returned to a tame level of about 1-2%.

Crisis played a different role in 1979-80 than it did in the 2007-09 financial crisis. OPEC’s oil-price hike in the summer of 1979 fanned the already raging inflation flames and then the Iran hostage crisis caused global panic and a flight to gold. The Hunt Brothers’ attempt to corner the silver market in early 1980 drove gold prices to a peak that held for 27 years.

A global expansion and commodity boom pushed gold to new heights in late 2007, but as the recession took hold in 2008, inflation evaporated and gold prices retreated with every other asset class on the planet. Then in 2010-2011, the Arab Spring, European sovereign debt woes and U.S. federal budget and deficit problems drove investors back into the gold safe haven and gold to new highs. Governments around the world have been printing money as fast as they can and pumping dollars into their economies, effectively supporting the economy until the private sector can do so itself. Anxiety that inflation will soon rear its ugly head has begun to build.

As we wind down our major military presence in Iraq and Afghanistan the war bill will come due, generating even more inflation. The most important question with respect to inflation is not if or when inflation will heat up, or by how much, but what will be the best hedges against it.

What may happen next

As the economic recovery gains traction over the next several years, it will be the stock market that moves to new heights; not gold or other safe havens. Figure 1 graphically shows the returns of $1000 annual investment in Dow Jones Industrial Average vs. Gold compared to inflation since 1975.

Since 1975, stocks have been a clear winner. Gold’s performance only worsens when the cost of storage and/or trading fees are taken into consideration. The performance of stocks only improves with the inclusion of dividends (left out of this calculation). Most striking is the advantage stocks displayed from 1980 to 1999. During this 20-year time frame, when the CPI more than doubled, the Dow was up 444% versus a 22% loss for gold.

Gold has handily outperformed stocks since 2000, but now that economic growth prospects are brightening gold has stalled out well below its record high. Meanwhile, stocks are gaining momentum and charging toward new all-time highs. Reducing exposure to gold and increasing your stock holdings may prove profitable once again.

I have known financial advisor Bill Staton for more than 20 years and he has been in the business for over 40 years. Perhaps Bill said it best in a client letter:

“Ever since the Federal Reserve Board was founded in 1913, the growth in the money supply has outstripped the growth of the economy…. So long as money continues to grow faster than the economy (recently it’s grown at an unprecedented rate), our currency will continue to weaken. And as it does, inflation will remain a threat to everyone’s financial well-being. “Whatever you do with your investments put much higher inflation at the top of your list of obstacles to overcome.”

JEFFREY A. HIRSCH is editor-in-chief of the StockTradersAlmanac.com and the author of The Little Book of Stock Market Cycles (Wiley, 2012). He is Chief Market Strategist of the Magnet AE Fund.

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Article copyright ©2012 by Jeffrey A. Hirsch. Adapted from the Stock Trader’s Almanac with permission from John Wiley & Sons, Inc. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Fidelity is not adopting, making a recommendation for or endorsing any trading or investment strategy or particular security. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before trading. Consider that the provider may modify the methods it uses to evaluate investment opportunities from time to time, that model results may not impute or show the compounded adverse effect of transaction costs or management fees or reflect actual investment results, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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