Does Gold Really Protect Against Inflation? What the Data Shows

One of the most common sayings when it comes to investing is 'gold is a hedge against inflation'. It is additionally one of the least clearly comprehended. There are times when gold increases rapidly when prices increase, and there are times when it does nothing or it even drops over the years as inflation keeps on increasing. Admittedly, over extended periods of time, gold has preserved purchasing power; however, in the short-term, it is not a reliable inflation hedge.

This article examines the data at hand, and asks why the relationship is not consistent; and how you can validate it for yourself using public data.

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What 'hedge' means

A hedge is an asset that gains value when a concern that you have occurs. An ideal inflation hedge would go up by at least the inflation rate, year by year, without exception. Gold hasn't. A more reasonable test is whether or not gold has maintained its value over extended periods of time, and whether or not it performs well in times of particularly high inflation.

To know what the problem of inflation is for people with money saved is to know why inflation hurts savers. If the prices go up 3 percent per year for 20 years, $100 today becomes approximately $180.6 (1.03 to the 20th power). The same product will cost approximately $265.3 at a 5% rate of inflation over 20 years. If your money does not grow by at least that amount, its worth is less. The expense of keeping cash at no return is a substantial proportion of its real value over that period.

Evidence from the 1970s

The best years for gold as an inflation hedge have been the 1970s. In 1971 the convertibility of the dollar into gold was discontinued and the Bretton Woods system of fixed exchange rates collapsed. During the decade, prices increased and by the end of 1979 to 1980, U.S. consumer price inflation was in the low double digits, in part caused by oil price shocks. At the end of 1974, the prohibition on the personal ownership of gold was removed in the USA. Before 1971, the official price of gold was around $35 an ounce, but in January 1980 it reached a record high of nearly $850. During this time frame, inflation was definitely outpaced by gold.

The long drought (1980 to early 2000s)

The story never developed. Following 1980, the Federal Reserve under Paul Volcker initiated a dramatic increase in interest rates as a means to quell inflation in the economy, and the federal funds rate increased to approximately 20 percent in 1981. Inflation came down but remained positive. Gold also experienced a decline, settling around $250 to $300 per ounce in the late 1990s and early 2000s. During those 20 years the economy's prices have increased by about a factor of 2, while the nominal value of gold has dropped substantially. Those who purchased at the 1980 peak have suffered a wait of many decades for any nominal return and much longer in terms of present purchasing power.

This episode demonstrates that the inflation rate does not have a direct effect on the price of gold. It reacts to the difference between the rate of inflation and the interest that you can get on safe assets.

Real yields: the key missing link

The best explanation for the behavior of gold is real interest rates, or the interest rate less the expected rate of inflation. A simple example to illustrate the reason. If the return on a government bond is 5 percent and the rate of inflation is 3 percent, then the real return on the bond is approximately 2 percent, and the real return on gold is 0 percent. However, if the bond earns 2 percent and the inflation rate is 3 percent, the real rate earned by holding the bond is negative 1 percent, so holding gold costs nothing in real terms by comparison. Negative real yields drive gold to be more appealing. That's why gold did well in the '70s when real rates were negative and badly in the early '80s when they were strongly positive.

The yield on 10-year Treasury inflation-protected securities (TIPS) is a commonly followed measure of real yields, and can be found on the Federal Reserve Bank of St. Louis's FRED data service in the series DFII10.

The 2000s and 2010s

During the 11-year time span from 2001 to 2011 gold performed well amid lower real yields, a weaker dollar and the international financial crisis, climbing to over $1,900 an ounce in 2011. However, the rate of inflation was relatively mild for much of this time. Gold's reaction was to monetary easing, financial stress, and not to soaring consumer prices. Since 2011, the price of gold has dropped about a third, as the U.S. economy improved and the Fed left emergency policy.

The 2020s: a modern test of the hedge concept

The pandemic was another challenge. The correlation of gold with real yields was strong enough to drive gold above $2,000 in 2020, a record price. Consumer price inflation reached record levels in the U.S. in 2021 and 2022 and hit its highest level in 40 years by mid-2022 around 9 percent year on year. But gold had come in close to even at the end of 2022, as the Fed was hiking rates fast and real yields were rising. In 2023 and 2024, gold rallied despite the persistently high real yields with record central bank purchases. The take-home message of the lesson is that inflation has more of an impact on gold through interest rates, policy and confidence than it does on its own.

You can do a simple test on your own

You can explore the relationship using free data:

1. Get the Consumer Price Index (CPI) for the United States (U.S. CPI) or your own country's CPI from your country's statistics office (FRED series CPIAUCSL).
2. Get the history of gold prices from a licensed source like LBMA or Goldhub by the World Gold Council.
3. Find the percentage increase and decrease over a long time period, such as 10 or 20 years.
4. Examine the rate of change of gold as compared to the rate of change of the CPI. Repeat for shorter periods (1 to 3 years).

It is likely that over long windows of time, gold will have kept pace with or outperformed inflation and, over short windows, the connection will be loose, if not negative. Be careful about the start and end dates: a time window that begins at a high or low point could change the results.

Please note: The information contained in this article is for educational purposes only and should not be relied upon as financial, investment, tax or legal advice. History is no guarantee of future performance.