11
June
Gold as an Inflation Hedge
It has been shown in numerous academic studies including by the highly respected portfolio and asset allocation experts, Ibbotson and Associates, in a June 2005 study, ‘Portfolio Diversification with Gold, Silver and Platinum’, how gold, and indeed precious metals, are the only one of the seven asset classes with a negative average correlation to the other asset classes. It is also worth noting that the authors showed that, excluding cash, precious metals are the only asset class with a positive correlation coefficient with inflation, which is further evidence that precious metals act as a hedge not just against macroeconomic and systemic risk but also against the long term threat of inflation.
The Ibbotson study wrote that “The three metals were chosen because gold and silver are often viewed as a safe harbor in times of crisis. Conversely, during economic expansion demand for silver and platinum is thought to increase.”
According to Ibbotson Associates, precious metals are the most positively correlated asset class to inflation. From a strategic point of view, Ibbotson determined that portfolios could reduce risks and improve returns with a 7-15% allocation to precious metals bullion.
In another important study, Wainwright Economics, the respected independent research firm, said that gold is the most effective indicator of rising inflation. Their research proves gold’s role as effective protection against inflation shocks and shows gold as the most accurate indicator of future inflation and, when used alongside other inflation shields, is an effective inflationary hedge.
Wainwright Economics research shows that gold is a superior predictor of inflation when compared with other measures such as the Consumer Price Index (CPI) and oil. The research provides strong support for gold’s long assumed role as a hedge against extreme events and economic shocks, including inflationary shocks. Wainwright Economics determined that, in the current rising inflationary environment, bond portfolios need an 18% allocation to precious metals bullion and equity portfolios need 47% just to immunize them against inflation. Because gold is an asset that goes up with inflation and actually increases at several times the rate of inflation, it is an excellent choice to be used alongside inflation indexed bonds.
Most investment portfolios have no allocation to precious metals whatsoever. As a result, they are not protected from inflation or other systemic vulnerabilities, and are neither balanced nor diversified.
Indeed Ibbotson and Associates determined that holding between 7.1 percent and 15.7 percent in precious metals bullion hedges against inflation and reduces portfolio volatility and improves returns over the long term.
Real diversification means diversifying and remaining diversified with gold, silver and some platinum bullion.
Gold as a Deflation Hedge
Gold and precious metals in general are effective hedges against inflation. They also massively outperform other asset classes in hyperinflationary periods as seen in Weimar Germany and other countries that have suffered hyperinflation.
As importantly is the fact that gold’s monetary qualities and currency characteristics make it an effective hedge against deflation. Cash is king in deflation and gold is a superior form of cash. This was shown in 2008 when in a period of sharp deflation, gold rose by 5% in USD terms, (one of the strongest currencies in the world in 2008) and by far more in most other currencies.
This was even more clearly shown in the last period of severe deflation - the deflationary Great Depression in the 1930’s. Roosevelt revalued gold by some 70% and devalued the dollar by some 70%, from $20/oz to $35/oz.
It is worth remembering that the Dow Jones fell by 90% from peak to trough and property prices fell by more than 50% in the early years of the Great Depression.
