Gold and Silver Are Not Proven Inflation Hedges

Over the past several weeks, there have been posts and articles stating that there is an inflationary period coming, so now is the time to buy gold. I do not know if an inflationary period is coming, and if I had an opinion it would be in another article. But the point here is that I can find no evidence that gold prices, or silver for that matter, correlate to inflation.

It is obvious that over time gold, silver and inflation rise. In that way they do correlate. Below is a graph showing the percentage change year-over-year of gold, silver and inflation (measured as CPI) from 1914 to 2007.

click to enlarge images

This graph should tell you that the major changes in the prices of gold and silver were caused by factors not associated with inflation. The big jump in 1979 was caused by the Hunt brothers' attempt to corner the silver market, while 1973 was the oil crisis. Pretty much, all the major price movements in the past are associated with events – not inflation.

There has been only one period of high inflation in recent history between 1973 to 1981. The problem with drawing any conclusions is that the inflation was triggered by the 1973 Oil Crisis (an economic shock), and included the Hunt Brothers effort to corner the silver market. The other period was 1916 through 1920. In this period gold prices were fixed, and silver underperformed the rate of inflation.

There is only one deflationary period – 1927 to 1933. Remember, gold prices are fixed. Unfortunately, any conclusions that you could have drawn were impacted by President Franklin D. Roosevelt’s order in 1933 outlawing private gold ownership causing a price bubble. Silver again underperformed.

Since 1990, inflation has been pretty much under control. Yet gold and silver’s price has fluctuated independently of inflation.

It is obvious there is no evidence to support a conclusion that gold or silver prices will react to inflation or deflation. Not only do we not have enough economic cycles for a statistical analysis, but the little data we have is contrary to the conclusion that gold or silver is a hedge for inflation. Gold does react to economic events and the price of oil.

But investing for profit is not the only reason to own gold. Gold is gold. For those of us who have a little in our safe do so as a hedge against a really bad day.

Disclosure: Author is a physical gold owner

Comments

[User 30121:]

Interesting article, Steve! Thank you for writing it! Do you consider silver to be more ADVANTAGEOUS to own vice gold, given its uses, scarcity, etc?

2008 Nov 13 09:16 AM

[QuasiYoda:]

Over 5000 years of history show that gold and Silver retain value when Fiat currency devalue.

And Please don't present Graphs of CPI as being some kind of stable state baseline when the methods by which it is calculated have changed with the designs of the Fiat printers. A commonplace disinformation tactic these days. Recently the CPI was showing a 3.5% inflation yet when calculated by the methods as in 1978 it would have shown over 12% . . . Most Gold Enthusiasts are aware of this so please don't insult our intelligence.

Also Gold and Silver respond to the Real Saving Rates . . . Interest Rates minus the Real Inflation Rate . . . if this is negative then you ar3e losing buying by holding cash. The Smart Money Moves into Gold and The Smartest money moves into Silver as Gold Silver ratio is 77.5 Silver oz to 1 Gold oz

2008 Nov 13 09:26 AM

[Greg Pinelli:]

The notion that there is "no evidence" to support the idea that gold (and silver) don't respond (I assume the author means respond "significantly")
to inflation and deflation reduces a very long chain of historical experiences to trivialities.
If by inflation we mean a general devaluing of the currency then gold obviously..and always..has responded as a safer preference. During times of inflation, the Civil War being the most obvious, people have ALWAYS exchanged paper for gold. Why does the author think Nixon closed the gold window?? Nations were taking cheap dollars and exchanging them for precious gold...
Gold is a current and anticipatory standard..its price both weighs current paper money and credit value AND what might be in several months.
Inflation is ALWAYS a lagging indicator..statistics for it's weighing are always after the fact! The litmus test for all this is..If investors knew inflation was going to be double in 6 months..would they not buy Gold? This is precisely what happened in the late 1970s...investors had NO assurances inflation in the US was being effectively controlled and gold..in anticipation of it getting worse...bid up gold.
If inflation hits us square in the eyes next year from extensive credit creation apparently this ignorant author will be pumping out analyses about golds rising price being due to astronomical considerations! Brilliant.

2008 Nov 13 09:43 AM

[paxjds:]

In 1935 $35 got you 35 $1 BILLS, or one oZ of gold. Today those $35 one dollar bills are still worth $35. Savings accounts at banks are always way below the CPI index, and in the past 15 years, the CPI has become a joke as our good Uncle tells us it is 3%, but a big Mac has been going up 2-3 times faster than that.
One once of gold is now only worth $700+ today. A one OZ St Gaudens MS62-66 coin is easily worth $1350 to $35000 each today. With the high and prolonged inflation sure to follow the worldwide inflation to follow, I'll stick with 15% alllocation to St. Gaudens vrs. our Good old Uncle. The remaining 85% sitting on the sidelines since July of 07 in a money market, and ill wait for the real bottom. Hope your portfolio is doing as well.

2008 Nov 13 10:02 AM

[jetsby10:]

So let me get this straight, you post a graph of gold and silver over 100 years hovering around the rate of inflation and it's not a hedge how? Seems to me that gold/silver have performed well over the past 100 years protecting you from inflation.

2008 Nov 13 12:56 PM

[marxbites:]

I guess Jim Rogers is an idiot then?

2008 Nov 13 01:25 PM

[Did U Think...:]

"Gold is money, and nothing else is."
- J. Pierpont Morgan

2008 Nov 13 02:58 PM

[Steven Hansen:]

thank you all for commenting.

first, i offer no defense that the cpi portrays inflation correctly. if you review my past comments, you will see that i believe cpi is so manipulated it has lost its value. cpi is the basis for inflation baselines whether i like it or not. but the cpi used in the above graphs was as follows in the high inflation period.
1974 11.04%
1975 9.13%
1976 5.76%
1977 6.50%
1978 7.59%
1979 11.35%
1980 13.50%
1981 10.32%

second, jim rogers is not an idiot. i am not claiming gold will go up or down. i am presenting evidence that gold historically has not reacted to inflation by itself - it reacts in bursts to other stimulus.

although debasement of currency is not inflation, inflation is one of the signs of debasement.

this article was not meant to cover the issue of debasement.

the rate of return of gold between 1914 and 2007 was 4.01%. using the cpi as an inflation index shows an annual inflation rate of 2.05%. so as pointed out gold outperformed inflation. long term gold appears to stay ahead of inflation. but it does not outperform inflation in the short bursts, and this is the point of this article. if you believe we are destined for a period of accelerated inflation, there is no evidence that gold reacts to this.

gold reacts in bursts to events - there is no evidence gold reacts in short term changes in the rate of inflation.

steven hansen

2008 Nov 13 06:25 PM

[norespect:]

i suggest you read the attached article from hard assetshttp://hardassetsinvestor.com...

2008 Nov 13 08:09 PM

[GMiki1:]

The bottom line is that the author holds gold as a hedge.

2008 Nov 14 12:26 PM

[Mweezy:]

Interesting, However Looking at our History i do not find it a viable comparison on what is occuring present day. We have never seen Inflation like we are about to see in the US. I think it would be better to look at Weinmar Republic Germany. The Germans resorted to a printing press to finance the war and as confidance was low the people horded their cash. GOLD at that point was around 100 marks/ounce. After the war consumer confidence returned and the excess of Marks ran through the system creating Hyperinflation. Gold then Fluctuated between 1000 and 2000 Marks/oz. That is 1000% to %2000 increase. The comparison comes now with Our War, which has put us beyond our manageable debt and will make borrowing more money to finance our Economic catastrophe very difficult. So, Good ol Ben is doing exactly what he said he was going to do, resorting to a printing press. Consumer confidence at the moment is at record lows and people as well as banks are hording cash. When that newly created cash hits our streets and goes through the fractional reserve banking system, hello hyperinflation! I expect Gold to adjust in price accordingly.
While i see your point that gold doesn't adjust for small inflationary trends, your correct in saying that this short span of American History is not enough data. Do not see gold as an investment but a preservation of wealth.

2008 Dec 10 01:54 PM