How stocks, gold, bitcoin and TIPS can hedge rising inflation
London (Jan 18) How can you best hedge your investment portfolio against the possibility of much higher inflation? It’s an important question to ask because inflation expectations are heating up and the trend may continue,
Earlier this month, St. Louis Federal Reserve President James Bullard told reporters that “the quiescence of inflation that has characterized the last decade may not be a good guide for what’s going to happen in 2021, where I would expect more volatile pricing, possibly higher inflation than we’re used to.”
Consider the 10-year breakeven inflation rate, which is what the bond market currently is betting inflation will average over the next decade. It recently rose above 2.0%, for the first time in more than two years. As recently as March 2020, the bond market was betting that inflation over the subsequent 10 years would average just 0.50%.
In the discussion below I review how various asset classes have performed historically on an inflation-adjusted basis.
Gold
I start by focusing on gold, since in the popular imagination it is the go-to asset for investors wanting to hedge against inflation risk. I’m not so sure they’re right.
Consider the chart below, which plots gold’s GC00, 0.14% trailing five-year inflation-adjusted return (in U.S. dollars relative to the U.S. Consumer Price Index). Notice the lack of any consistency: Since the 1970s, when gold began to freely trade in the U.S., its five-year real return has fluctuated from a high of 27.5% annualized (in September 1980) to a low of minus 20.6% (in January 1985).
This record should give you pause if you’re looking to gold to provide an inflation-hedge in coming years.
Gold does have a better inflation-hedging record when measured over periods much longer than five years. Much, much longer, in fact. Research by Duke University professor Campbell Harvey and Claude Erb, a former commodities and fixed income manager at TCW Group, found that gold does a relatively decent job of keeping pace with inflation only when measured over periods close to a century or longer.
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