Why Gold Is Still A Poor Inflation Hedge
- Gold has an extremely low correlation to inflation.
- During the pandemic, the price of gold spiked initially when the first big batch of government spending was announced but underperformed when inflation actually arrived.
- There are far better inflation hedges to be found in the realm of real estate.
- Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Learn More »
Co-produced by Austin Rogers
Our May 2021 article "Why Gold Is A Poor Inflation Hedge" stirred up quite a controversy. But we do not believe our argument was as controversial as many readers seemed to think.
Our argument was not that gold makes a bad investment. Nor was it that no one should own gold. Rather, it was exactly what the title implies: Gold does not work well as inflation protection.
We cited data from Investors Chronicle showing a correlation between gold and inflation of 0.28 from 1971 to 2020. And according to Nancy Tengler of Laffer Tengler Investments (via CNBC), the correlation between gold and inflation over the last 50 years has been 0.16.
We also showed how, between 1980 and 2000, the price of gold lost over 40% of its value while the CPI rose nearly 120%.
What about during particular periods of higher inflation? Gold sometimes underperformed, sometimes outperformed, but there's no real correlation to speak of.
Again, this does not necessarily mean that gold makes a bad investment or that no investor should hold it in their portfolio. It simply means that gold does not correlate with inflation and therefore does not provide protection from it.
Rather, like a great many investments that are not intrinsically tied to inflation in any way, the price of gold moves based on investor sentiment.
But what about the COVID-19 pandemic period of 2020 and 2021? How did gold perform during the spike in inflation that began in 2021? As we will see below, though gold has given investors a decent return in the two-plus years since the beginning of 2020, it still does not make a good inflation hedge.
Gold In The COVID Era
From January 2020 to mid February 2022, the price of gold has risen 21.4% - certainly a respectable return! But remember that our goal is to determine whether gold makes a good inflation hedge. Let's look at the price movements of gold compared to the CPI rate over that time period:
There's virtually no correlation! Notice that in late spring 2021, the price of gold followed the CPI higher, but then it collapsed from its price of $1,900 back to around $1,800. Prices of consumer goods went higher and stayed higher. But the price of gold went higher for a short period, then fell about 5%. Is that how a good inflation hedge should behave?
Then, in the fall of 2021, when the CPI rate went even higher to the 6%-7.5% range, gold remained in the same trading range it had been in during the summer months. Shouldn't it have gone up along with inflation?
Now, proponents of gold might point to the huge rise in the price of gold at the beginning of the pandemic. But as we explained in our first article on gold, bullish sentiment correlated with a sudden spike in (announced) government spending.
And yet, during 2020, inflation remained muted all year.
It wasn't until 2021 that inflation began to rise, but during the 12 months of 2021 the price of gold actually dropped in value.
Why didn't the price of gold follow the CPI higher? Our argument would be that investor sentiment surrounding gold does not really follow inflation. It follows sudden changes in government spending.
As we can see below, the price of gold soared at the beginning of the pandemic when Congress passed a major stimulus bill that massively increased the growth in the money supply.
Thereafter, however, the money supply grew at a fairly steady pace, and thus gold did not capture another bout of bullish investor sentiment for the rest of the pandemic.
Better Inflation Hedges Exist
As we pointed out in our last article on gold, there's nothing intrinsic to gold that ties price movements to inflation. The vast majority of the gold price is determined by investors, rather than the jewelry or industrial end-users or gold mining output. If investors are bullish, then the price of gold will rise. If investors are bearish or see better opportunities elsewhere, the price of gold will fall.
So, if gold doesn't make a good inflation hedge, what does?
At this point, readers may predict what we're going to say. We believe certain types of commercial real estate make much better hedges against inflation than gold. Yes, we know we are talking our book. But the truth is that one of the primary reasons we at High Yield Landlord have always been attracted to real estate (especially highly liquid, publicly-traded REITs (VNQ)) is its inherent inflation protection characteristics.
Consider apartments, perhaps the most inflation-protected form of real estate. Over the course of 2021, average rents and net operating income at the apartment REITs in our portfolio rose exactly in tandem with the CPI. In the fourth quarter, when the CPI was highest, apartment rent growth was likewise the highest. That's what an inflation hedge looks like. It's highly correlated with the rate of inflation, unlike gold.
To give you an example, BSR REIT (OTCPK:BSRTF) is hiking rents by 20%-plus and its NAV per share rose by 40%+ in 2021. Camden (CPT), Mid-America (MAA), and Independence Realty (IRT) are also posting similar results:
Other forms of real estate like industrial have also proven themselves excellent inflation hedges during the recent spike in prices. This is a big reason why we love real estate as an asset class. STAG Industrial (STAG) is currently hiking its rents by 10% as leases expire. It leases space to companies like Amazon (AMZN) that are growing rapidly and need more warehouse space:
Even better, farmland is by nature probably the best inflation hedge there is because its supply is limited and declining, but its demand is rising with population growth and the expansion of the middle class. We need food to survive, and therefore, we also need farmland.
In 2021, farmland values rose by ~20% and the share price of REITs like Gladstone Land (LAND) more than doubled:
To reiterate, though, we are not saying that gold is necessarily bad investment or that no investors should hold it. Instead, we're simply stating what the facts make clear: Gold is not a good inflation hedge. There are much better options available for inflation protection.
We're heavily invested in such real assets that actually benefit from surging inflation and our Portfolio returned 40% in 2021, which is more than 10x the return of gold.
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This article was written by
Jussi Askola is a former private equity real estate investor with experience working for a +$250 million investment firm in Dallas, Texas; and performing property acquisition in Germany. Today, he is the author of "High Yield Landlord” - the #1 ranked real estate service on Seeking Alpha. Join us for a 2-week free trial and get access to all my highest conviction investment ideas. Click here to learn more!
Jussi is also the President of Leonberg Capital - a value-oriented investment boutique specializing in mispriced real estate securities often trading at high discounts to NAV and excessive yields. In addition to having passed all CFA exams, Jussi holds a BSc in Real Estate Finance from University Nürtingen-Geislingen (Germany) and a BSc in Property Management from University of South Wales (UK). He has authored award-winning academic papers on REIT investing, been featured on numerous financial media outlets, has over 50,000 followers on SeekingAlpha, and built relationships with many top REIT executives.
DISCLAIMER: Jussi Askola is not a Registered Investment Advisor or Financial Planner. The information in his articles and his comments on SeekingAlpha.com or elsewhere is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions. High Yield Landlord is managed by Leonberg Capital.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BSR; CPT; STAG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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