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Is gold a good hedge against inflation, or not? Can it provide positive real returns? 2 decades of data analyzed for definitive answers.
Keywords: In-depth analysis of gold as an inflation hedge, gold to protect portfolio, gold better than us dollar, gold returns compared to stocks, benefits of adding gold to portfolio.
Summary:
1. Data reveals that gold has been an effective inflation hedge.
2. Data reveals that it has yielded a positive real return.
3. 2 decades of data reveals that average annual price appreciation of gold has been 9.02%, Inflation rate for the same period has been 2.12% p.a.
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Gold (XAU), often touted as 'the flesh of the gods,' is argued to be the best inflation (INFL) hedge. INFL concerns lately have increased substantially. With over 40% of US dollars printed recently, it is very logical to be concerned about INFL and the USD's devaluation. Others may be more interested in this analysis for commodities speculation and may want data to provide unequivocal clarity.
So, is gold a good inflation hedge? Will it protect you against inflation?
To answer this question, two decades of data have been analyzed in this report. Hypothesis testing has also been conducted to ensure the statistical significance of the results.
For XAU to be a good INFL hedge, its monthly return, theoretically, should, at the very least, equal the monthly rate of INFL. The INFL rate can be assessed through the GDP deflator and the consumer price index (CPI). This report uses the CPI.
Logically, the premise can be expressed as = XAUUSD monthly returns – increase in CPI = 0. If the result is greater than 0, we would be able to say that XAUUSD yields a positive real return
If the data verifies this condition, we can state that gold is an effective hedge against inflation.
So, what does the data tell us?
The mean monthly return of gold for the last two decades stands at 0.84%; the mean monthly inflation rate in the US stands at 0.17%.
Does this mean that gold yields a positive real return, i.e., XAUUSD monthly mean return > monthly rate of inflation?
To answer this question with statistical significance, hypothesis testing must be employed. The hypothesis, hence, has been constructed as:
H0: μd - μ0 = 0 versus Ha: μd - μ0 ≠ 0.
, where
μd – the mean difference between the monthly returns of XAUUSD and the rate of INFL.
μ0 – 0
Paired sample T-test, using T distribution (df=243) (two-tailed) (validation)
1. H0 hypothesis Since p-value < α, H0 is rejected. The average test population is considered to be not equal to the μ0. In other words, the difference between the average of test value and the μ0 (0) is big enough to be statistically significant. 2. P-value The p-value equals 0.004469, ( p(x≤T) = 0.9978 ). It means that the chance of type I error (rejecting a correct H0) is small: 0.004469 (0.45%). The smaller the p-value the more it supports H1. 3. The statistics The test statistic T equals 2.8698, which is not in the 98% acceptance region: [-2.3418 : 2.3418]. x=0.0067, is not in the 98% region of acceptance: [-0.00549 : 0.00549]. The standard deviation of the difference, S' equals 0.00234, is used to calculate the statistic.
The null is rejected, thus.
So, what does this mean?
We can say, with statistical significance, that the mean difference between gold monthly returns, and the rate of inflation is not 0. XAUUSD yields a positive real return.
XAU thus is a good hedge against INFL, but that's not all; historically, XAUUSD demonstrates positive real returns.
We should expect XAU to yield a positive real return, and as the data clarifies, it should be used as an inflation hedge in a portfolio; however, expecting a real return from XAU is also not unrealistic.
Furthermore, the average increase (growth rate) of XAUUSD (geometric mean) for the last two decades stands at 9.02% p.a. INFL rate for the same period has been 2.12% p.a.
Source: https://fred.stlouisfed.org/series/CPIAUCSL#0
However, to use XAU for a positive real return generating investment, it would have to be examined against other more diversified investment options, such as S&P500, Nasdaq, etcetera. Arguably, to generate a return equivalent to the aforementioned, leverage would have to be used, which, of course, increases risk. There is no arbitrage in financial markets, and if by leverage an investor generates a higher return through XAU, compared to the most popular indices, for example, the risk profile of her position should be on par with other investments with similar returns.
So, what's the final verdict?
An investor who primarily has a risk concern can invest in gold to remain protected from inflation; the data clearly backs this expectation. But it does not end there, i.e., there is statistically significant evidence that XAUUSD can yield a positive real return, over a long-term horizon.
In the current situation, as INFL expectations and concerns are genuine, holding XAU should provide protection against INFL, or even a substantial increase in the rate of INFL. This, however, would be limited to the amount held in XAU; for example, if an investor holds a liquid amount of $100 today, and she invests $50 in XAU to protect against inflation, and also to earn some real returns, XAU would only protect 50% of her present liquid amount from future inflation. This is a question of the individual exposure investors want, weighing risk and returns. Intelligent portfolio design that integrates a XAU position strategically will yield better results.
See also:
How Much Can Metals, Energy, & Grains Fall In a Market Crash? | Which Is the Best Commodity to Hold?