Is Gold Really A Good Hedge Against Inflation?

I mostly agree with you and Jim on your anti-dollar tirades, although I think you both overstate the case.Inflation tends to take much, much longer to play out than people realize. Whether and when recent increases in money supply in the U.S. translate into serious inflation remains an open question. I suspect it will, eventually … but there are so many factors involved, it’s frightening to contemplate. Right now, the short-term trend seems to be toward deflation, although I’m sure we all agree that will reverse itself eventually. Unless, of course, the world falls into a global depression …

I want to take issue with your last comment about Precious Metals, Paul, and their role as a hedge against inflation. This is a hot topic in the industry right now.

There’s a great research piece on talking about gold and inflation. It includes two competing arguments.

One, from the World Gold Council, notes that gold cost $20.67/ounce in 1900—a figure which, when adjusted for inflation through 2006, translates into $503/ounce. Amazingly, for the two years ending December 2006, gold averaged $524/ounce. By that measure, gold is a great store of value.

But the other argument comes from Larry Swedroe, who takes up the case starting in December 1980, when gold was trading at $641/ounce. Swedroe writes:

“Over the next 27 years (1981-07), inflation rose at an annualized rate of 3.4%. If gold were an effective hedge against inflation, its value at the end of 2007 should have been at least $1,528. Yet, it was worth just $833/ounce.”

Rather than holding its value, gold lost 55% of its purchasing power over that 27-year time frame. When you consider that an investor who bought gold in 1980 forfeited, at the very least, the collateral return on ultra-safe Treasuries, it is clear that gold was a both a terrible investment and a terrible store of value.

What conclusion can we draw except that gold … Old Faithful in many peoples’ eyes … is actually unreliable as a hedge against inflation? It’s subject to booms and busts just like everything else.

Can we really trust gold to be a good hedge for inflation over the next 10 years?

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