Does gold protect against inflation? On average, the reply is empirical. However, the connection between gold and inflation is complicated, so blanket statements about its role in portfolio construction are unwise.
In this blog post, I provide evidence against the claim that gold is a reliable hedge against inflation. However, I don’t conduct any tests and subsequently don’t dismiss the potential value of gold as a diversifier on another grounds.
Gold Rush
Gold’s recent increase has pushed its real price (deflated by the Consumer Price Index) to its highest level since July 2020 – nearly $740 an oz. in April 2024 – but continues to be below its peak of about $840 in early 1980 (Figure 1).
Exhibition 1.
This recent peak has increased interest in gold as a portfolio diversifier normally and presumably as an inflation hedge specifically. This blog examines gold’s inflation-hedging properties visually and empirically. The full results and R code may be present in the Online R Supplement.
What inflation protection should do and what gold doesn’t do
An inflation hedge should move with inflation. If inflation rises, the protection also needs to rise. The claim that gold hedges inflation is subsequently testable.
First, the scatter plot in Figure 2 shows the monthly change in the non-public consumption expenditures (PCE) inflation deflator relative to the spot price of gold from 1979 to 2024. This is the longest publicly available data series for gold prices.
Annex 2.
As the random scattering of the points in Figure 2 shows, on average, changes in PCE inflation don’t correlate meaningfully with changes within the spot price of gold (confidence interval of the correlation coefficient = -0.004 to 0.162). And the best-fitting line (blue) is statistically flat. The results are robust when the buyer price index is used for inflation, although on this case the lower end of the boldness interval is just positive—as within the Online R Supplement.
However, the connection between gold and inflation shouldn’t be stable. There are times when the connection between gold and inflation is positive and times when it’s negative.
Figure 3 shows the 36-month rolling inflation beta estimated by regressing the monthly change within the spot price of gold on the monthly change in headline inflation over a rolling 36-month period.
Annex 3.
Changes in sign—where the series crosses the dotted horizontal line within the graph above—and enormous errors indicated by the prolonged confidence interval band (two standard errors) that comprises zero at almost every point make general statements in regards to the relationship unimaginable.
At least the evidence doesn’t support the belief that spot gold prices change reliably with inflation. But there are periods, a few of them long-lasting, when that is the case.
A cursory glance suggests that the “gold-inflation relationship,” if you happen to can call it that, is stronger during expansionary periods – the periods between the grey recession bars – apart from the Great Recession of 2007-2009. Perhaps it’s because the inflationary impulse plays a job within the gold-inflation relationship. I’ll take a look at that possibility next.
Decomposing inflation using economic theory
Inflation may be decomposed into temporary and protracted components, as reflected within the Phillips curve models of the inflation process utilized by economists (Romer 2019). The persistent component is the underlying or trend inflation. The temporary component is because of temporary shocks (consider oil price spikes) whose effects fade away.
What may be really interesting for practitioners is how gold reacts to an increase in underlying inflation resulting, for instance, from an excessive amount of demand or rising inflation expectations. This sort of inflation may be stubborn and (economically) costly to contain. We can test this response.
To do that, we’d like a measure of underlying inflation. There is a robust theoretical and empirical basis for using an outlier-removing statistic comparable to the median as a proxy for underlying inflation (see, for instance, Ball et al. 2022). The Federal Reserve Bank of Cleveland calculates mean PCE and CPI inflation every month, and I exploit the previous measure here, although the outcomes are robust to using the latter measure, as shown within the Online R Supplement.
A regression of the monthly change in gold price on the change in mean PCE results in rejection of any association at the same old significance levels (t-value = 1.61). This is recommended by the shapeless scatter plot with the best-fit line (blue) in Figure 4.
Annex 4.
Rolling 36-month regressions of gold on mean inflation produce similar results to those for headline inflation. The relationship is unstable and variable (Figure 5).
Annex 5.
Interestingly, gold’s median inflation beta is way more volatile – the usual deviation is about thrice as large – and fewer consistent (as measured by autocorrelation) than headline inflation. That is, gold’s relationship to underlying inflation appears to be weaker than to headline inflation (regressions also confirm this – see Online R Supplement.)
One possible explanation is that gold can hedge the difference between headline inflation and mean inflation – sometimes known as “shocks” – more reliably than underlying inflation. I is not going to go into this point intimately on this blog post, although I briefly touched on the thought in Online R Supplement and located no evidence for it.
If underlying inflation reflects the economic forces of excess demand and rising inflation expectations, as reflected in Phillips Curve-style models, gold doesn’t appear to hedge the worth pressures these aspects may cause.
To test the connection between gold and an overheated economy, I test one other, easy model. Using quarterly real gross domestic product (GDP) and potential GDP estimated by the Congressional Budget Office, I regress the spot price change of gold on the difference between actual and potential GDP as a measure of economic slack or lack thereof. That is, I regress gold on the GDP “gap.”
If gold were a hedge against the “demand inflation” that may result from an acceleration or too rapid growth of the economy, it should a priori be positively correlated with the change within the gap. But I find no evidence that this Online R Supplement.
Gold and inflation: an unstable relationship
An inflation hedge should react positively to inflation. On average, gold doesn’t. I cannot deny that its “inflation beta” is zero, whether inflation is measured by overall inflation (excluding food and energy) or by outlier median inflation without taking averages into consideration. Moreover, I see no connection between gold and economic overheating. But gold’s relationship to those economic forces is unstable. There have been times when gold has hedged inflation quite well.
I subsequently don’t interpret these results as meaning that gold cannot protect against inflation in certain circumstances or that it shouldn’t be a diversifier more generally. Rather, I interpret these findings as a warning against blanket statements.
Just as bonds don’t all the time function a hedge against stocks, gold has not yet provided a reliable hedge against inflation – and that is unlikely to be the case.
References
Ball, L., Leigh, D., & Mishra, P. (2022). Understanding US inflation through the COVID era. Brookings Papers on Economic Activity, BPEA Conference Proceedings, September 8–9.
Romer, D. (2019). Advanced Macroeconomics. McGraw-Hill Education.
