HomeGold As a Hedge Against Inflation – Does It Work?

Gold As a Hedge Against Inflation – Does It Work?

Gold outpaces the rise in consumer prices in the long run. What makes it a store of value?

Gold is the only form of money that has survived for millennia. While not money per se in the 21st century, it is the store of value with the longest history. In fact, it is the longest store of value in humankind’s history.

In the 1970s, the United States dropped the gold standard. Effectively, the US dollars in circulation were no longer backed by gold held by the Fed. From that moment on, the gold standard was dropped by other countries too, and so the free-floating currencies were born. Ever since, gold has acted as a hedge against inflation.

On A Long-Enough Timeline,  the Price of Gold Outpaces Inflation

Portfolio management in modern times emphasises the role of alternative investments. That is, all investments other than long-only strategies.

Alternative investments are not only commodities but also real estate investments, collectibles, infrastructure investments, as well as hedge funds and private equity strategies. They are characterised by two main properties – they act as a hedge against inflation and are less liquid than traditional investments.

Only that the gold market changed since the 1970s drop of the gold standard. Nowadays, the paper gold market, or the gold used as an investment, is a big share of the overall financial system.

Moreover, it is more liquid than, say, real estate. Yet, it serves the same traditional function of offering protection against inflation. Therefore, the poor liquidity problem is solved by paper gold instruments, and thus investment managers typically allocate a small proportion of their long-term portfolios to gold.

In recent years, the “digital gold”, as Bitcoin is also called, has emerged. Have you ever wondered why Bitcoin is pictured in gold’s colour? Indeed, the adoption among institutional managers has increased, but the volatility in the Bitcoin market makes it unattractive to the long-term investors that typically focus on alternative investments.

Take this month, for instance. Gold has advanced to above $1,850 and trades with a bid tone on a declining US dollar. Yet, Bitcoin dropped 25% in less than two days at the start of this trading week.

Since 1975, gold has advanced 829%, while the Consumer Price Index, or the CPI, by only 410%. Hence, in the long run, gold does serve as a hedge against inflation.

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