Gold is widely regarded as the oldest, and safest inflation hedge, with its value dating back to as far as 3,000 BC. It’s been a store of value for thousands of years, with real-world uses primarily in jewelry, and recently within electronics as well. With tangible value and limited supply, it’s no surprise why it has held value for so long.

Although gold has an impenetrable track record, in recent times, the correlation between the value of gold and consumer prices hasn’t been as firm as one would expect. Today we’re going to be looking into gold’s legitimacy as a store of value in the modern world.

In modern times, people are increasingly seeking more aggressive returns, looking more toward assets such as properties or equities. Considering the performance of these asset classes over the past few decades, it’s not a surprise gold is being left behind. Additionally, gold as an asset is unable to create cash flows for its holder, while properties can be rented and equities can return value to shareholders through dividends or share buybacks.

An investment that hedges against inflation would generally rise along with the rapid growth in consumer prices. However, gold yielded a negative return for investors during some of the highest recent inflationary periods. Between 1980 and 2000, the price of gold lost over 40% of its value while the CPI rose nearly 120%.

Gold price (1980 – 2023 YTD, USD/oz)

Source: Bloomberg, InterCapital Research

Gold’s correlation to inflation (US) has been relatively low — 0.16 — over the past half-century. (This metric shows how closely gold and inflation track together. A correlation of 0 means there’s no relationship, while a correlation of 1 means they move in unison). This does not necessarily mean that gold makes a bad investment, it simply means that gold does not correlate with inflation and therefore does not provide protection against it. Rather, like many other investments, the price of gold moves based on investor sentiment.

In the COVID era, between January 2020 and mid-February 2022, there was a significant 21.4% increase in the price of gold, indicating a commendable return on investment. However, to evaluate gold’s potential as an inflation hedge, it has to be looked at as compared to the CPI during this period. During this same period, the CPI grew by 13.9%, which in the shorter term, meant that it was more attractive to investors. However, one also has to consider one other important factor: the fact that when gold starts being advertised as an effective “hedge” against inflation, the inflation rate is already high.

US CPI (YoY growth, 1980 – June 2023)

Source: Bloomberg, InterCapital Research

What we can take away from this, is that the price of gold is influenced by many other variables, then just inflation or gold’s correlation to it. Think of a scenario like this: in times when inflation is low, there are investments into gold for sure, but this is more determined by demand from investors/companies who actually need gold to do their business, such as jewelry or the industrial sector. During those periods, as we’ve seen in the last 10-15 years, investing in equity would have turned out to be a far better idea, as even though gold yielded some returns, it yielded far less. On the other hand, in periods of high inflation, when gold is promoted as a “hedge” against inflation, it’s already too late. Think of 2022, when inflation rates were above 10% (and still are in some places in 2023). For gold to be an effective inflation hedge, you’d have to buy it earlier, say at the beginning of 2021 before inflation started spiraling. And then you’d have to expect that other people will buy it too, to drive the price up, and act as the hedge against inflation. If you’ve been following the equity markets in 2021, then you’d know that for some of them, this was the best year on record. As such, in that period, it seemed like a more prudent idea to invest in equity. Of course, gold did not experience the decline that equities did due to the war in Ukraine and high-interest rates, but it also did not experience the same increase in the period before this.

What can be taken away from this? Holding gold for a longer period of time can be seen as a form of savings. Indeed, it does grow in price over time. At the same time, so do other asset classes. As such, maybe the best answer that can be given about gold, and its role as an inflation hedge is – it’s situational.