Gold has historically been viewed as an inflation hedge, but its long-term performance lags equities, making it better suited as a short-term hedge against currency debasement.

Gold vs. S&P 500: Who Shines Brighter Over Three Decades?

Source: Morningstar Direct | Click here for a larger image.

Market participants tend to view gold as a classic inflation hedge. This is likely the result of the strong relative performance gold provided in the last inflationary cycle during the 1970s, which was a very difficult decade in the stock market. But gold has dramatically underperformed equities over the last 30 years with a similar level of volatility. With this kind of long-term risk/return profile and no interim cash flow, it is difficult to argue that gold should be a long-term strategic holding in investor portfolios. We believe the real estate asset class to be a better strategic inflation hedge. Perhaps a better way to view gold is as a tactical hedge against the debasement of fiat (government controlled) currency, which has happened often throughout global economic history. 

It is impossible to value gold (or any other commodity) the same way investors value most other financial assets: by discounting the expected cash flows. Gold is valued by estimating the intersection of supply and demand, and as supply is rather fixed, the driver of demand will be the effective driver of price. Gold tends to perform well when real yields (nominal yields minus expected inflation) are falling, which usually happens in an inflationary environment. However, gold’s strong performance relative to stocks of the past few years occurred in an environment of rising real yields with inflation declining from the peak levels of 2022 closer to central bank targets.

The catalyst for this more recent performance appears to have been when the United States and its Western allies froze Russian assets after the invasion of Ukraine. The Russian central bank and central banks in other countries who are not as aligned with Western values took notice and began to aggressively diversify away from the U.S. dollar. With no apparent alternative currency developed enough to replace the dollar as a reserve currency, gold became the preferred alternative. The beginning of policy rate cuts by the U.S. Federal Reserve (Fed) and other developed market central banks in the second half of 2024 likely provided a further boost to prices as did a distinct allocation away from faltering real estate investments by Chinese investors.

It appears these asset reallocations by central banks are near completion, so any continued bullish case for gold will likely be dependent upon further loosening of monetary policy by developed market central bankers, led by the Fed. The recent stall in the progress of lowering inflation to the 2% target may be a near-term headwind for the yellow metal, although the near-term trend toward reducing policy rates as inflation has subsided and growth slows may allow for continued appreciation. There is a strong possibility that this future monetary ease is already reflected in the current elevated price.

Past performance does not guarantee future results.

Please read important disclosures here.