The Shiny metal that dreams are made of proved on Tuesday that it might be pretty to look at and lovely to own, but it’s too volatile to play a reliable role as a hedge against inflation, a study of financial assets over the past 100 years showed.
While inflation does not lessen gold’s real value, it has no yield or income stream and the precious metal has given a far lower long-term return than equities.
In the time since 1900, gold gave a real return of 1.1% and its value fluctuated widely, the study was conducted by Credit Suisse and London Business School.
Gold is the only asset that does not have its real value reduced by inflation. It has a potential role in the portfolio of a risk-averse investor concerned about inflation. However, this asset does not provide an income flow and has generated low real returns over the long term. Gold can fail to provide a positive real return over extended periods, as stated in the report.
The investigation showed that global equities, the best performers among various assets since the start of the 20th century with a 5.4 percent
Gold A Great Hedge Just to Volatile
annual return, beat inflation in the long run. However, their returns may be more the result of equity risk premium, the reward for holding risky assets instead of risk-free government securities, than rising inflation.
Looking at the relationship between real return and inflation, the research found that equities were not that sensitive to inflation, compared with inflation linked bonds. For example, a rate of inflation that is 10 percent higher is associated with a real equity return that is lower by 5.2 percent.
When the inflation rate was at least 18 percent, equities suffered a loss of 12 percent on a real basis. Bonds were worse, suffering a loss of over 23 percent.
“Although equities are thought to provide a hedge against inflation, their capacity to do so is limited. While inflation clearly harms the real value of bonds and cash, equities are not immune.”
Equities by far provided the best real return in the 1900-2011 period. Bonds returned 1.7%, while bills gave 0.9 percent on an annualized basis. The study also found that investors earned gains in equities in markets where currencies have weakened, lending support to a “buy on weakness” strategy. For bonds, the picture was less clear.
The report by Credit Suisse, was detailed and informative. It provided good insight to the view that gold was a great hedge against inflation while overlooking the volatility issue.
Originally posted here
