Inflation has finally reared its ugly head and investors are growing concerned. It’s not a little inflation, it’s not transitory, it’s real, it’s big, and it’s a problem.
The inflation is so bad that not only is no one denying it is a problem, even the Federal Reserve is saying it’s a problem. Because of this, it is only natural for investors to buy protection and they are looking at gold.
Now, gold does not negatively correlate to the dollar perfectly, markets tend not to work like that. But when an investor “zooms out” and looks at decades-long charts of gold versus the dollar, you can see better how the amount of dollars being printed keeps going up, and the price of gold keeps going up.
Why We Finally Have To Deal with Inflation
Investors have been hearing the warning bells about inflation for many years, but until now have been able to ignore the warnings. But as the global economy tries to get back on its feet after the pandemic investors are having to face the music.
And dealing with inflation is something that most investors have never had to tackle because the markets in the United States have been in a goldilocks zone for nearly thirty years with little to no inflation.
Well, when you printed trillions and trillions of dollars, to deal with a health issue, then print trillions and trillions again the next year, you end up with some serious inflation. There are consequences for actions.
Because the US dollar and US interest rates are highly manipulated, they do not directly correlate with the price of gold, which fluctuates freely.
The economists at the US Money Reserve point out that since the early 1970’s only 16% of the difference in the price of gold can be attributed to the fluctuations in the consumer price index.
That may not sound like an impressive performance either, but you have to consider what makes up the CPI’s numbers. The CPI number is made up by the government. It is a bad look for the government’s public relations when the price of everything the average American has to pay for keeps going up. So the government keeps taking important stuff like rent and gas out of the consumer price index. It gets to the point where they take out the American consumer and it is just a random assortment of goods that the government chooses.
But I digress.
Another reason that gold does not correlate directly with numbers like the CPI is that gold is not the only game in town to protect against inflation. There are financial assets that can also give a portfolio relief from inflation like a super high-quality capital-efficient business like Hershey’s. Owning a stock like Hershey’s is always going to be a great idea and if they have to battle inflation, they simply raise prices. The world will always buy chocolate bars and Hershey’s Kisses.
Real Estate is also another excellent hedge. The value of all the real estate in this country far exceeds the value of all the gold, and that just makes sense. Gold is a store of value, but you can’t do anything with it. Real estate is a store of value, but it is also home or a place where you can conduct business, and there will always be demand for homes to live in.
The price of homes tends to follow the price of inflation pretty closely. Just look at the great financial mess of 2020 and 2021. Home prices skyrocketed more than 30 percent each year. And that’s just on average. In some places like Florida, some areas saw their home prices double in a year or two. Truly amazing stuff, if that is not inflation, then I don’t know what is.
So gold has some competition for being an inflation hedge, it’s not the only tool in the toolbox to combat rising consumer prices.
There is a better way to think of gold as portfolio insurance. When you have a balanced portfolio and you add some gold and other precious metals, then you build a stronger, more durable portfolio. Investors like Ray Dalio have called this more well-rounded approach the “All Weather Portfolio”. You can learn more about that here: The All Weather Portfolio explained | The Evidence-Based Investor (evidenceinvestor.com)
To better judge an inflation hedge you need to consider several different factors like liquidity, diversification, reliability, cost, and sensitivity. Gold may not have high marks on the sensitivity and reliability factors. There are sure bets that outperform inflation-protected security notes from the Treasury and commodities like oil.
Gold tends to act like a portfolios anchor, not as if it is dragging the portfolio down, but keeping the portfolio on track when it gets hit by a sudden storm. The price of gold is non-correlated to more modern financial instruments. And never in the 5,000-year history of gold has the asset gone to zero, gold will always have about the same value. The same cannot be said for stocks, bonds, and even real estate.
You want to construct your portfolio in such a way that a small portion of it is “boring”. Gold is boring, and boring is safe. At least most of the time. There are times when the price of gold wakes from its slumber and decides to go on a tear. These tears are impressive. The average gold bull market runs for about a decade. It is impressive when the insurance you bought ends up outperforming your entire portfolio.
Now, this is not how you want to think about gold, but sometimes this does happen.
How Does The Price of Gold Compare to the Money Supply?
The price of gold versus the United States money supply has been inconsistent at best. Despite what most pundits and gold promoters, and even Mom and Pop investors think, the data shows a weak link.
Now, it appears that the relationship was much close in the 1980s and decades earlier. One possible explanation for the break-in this correlation may be the mid 90’s when the Fed created Treasury Inflation Protection Securities (TIPS) that were auctioned off for the first time in history. This combined with the Fed’s stated goal of a 2% annual inflation target, and gold broke its correlation with the money supply.
You could think of the decade of the ’90s as a time when the price of gold went into a deep sleep. Now, if you were astute enough to notice this hibernation, and were smart enough to start buying, then you would have been able to get a fantastic cost basis on your stockpile of gold.
And you would have been richly rewarded in a few short years as the first decade of the 2000s saw the price of gold enter one of its famous bull markets and the price ran up and up for the next 10 years.
At the end of the day, almost no one can time the perfect time to buy gold. Markets don’t work like that. In general, the best time to buy gold for your portfolio is when no one wants it. When everyone thinks gold is boring, like in the ’90s when the internet was new and the tech boom was in full swing, that was a phenomenal time to buy. In the next decade, when tech stocks bust, then gold went on its tear.
Gold has been around for 5,000 years, it is stable and it’s not going anywhere. It will never go to zero. There is nothing else in your portfolio that can say the same. Do yourself a favor and add a little protection to your account today.