Why investors use gold as shield against inflation

For centuries, whenever a crisis has struck, gold has proven to be a time-tested friend of investors. It has been a saviour to those who incurred heavy losses in other investments. One of the biggest challenges of investing is to beat inflation. So, if an investment is not able to deliver inflation-beating returns, there is a huge possibility of it being not enough to provide for an investor’s retirement years. On the other hand, gold has historically performed well during high inflationary periods.

According to an International Journal of Research in Management & Technology paper, in 1946, 1974, 1975, 1979, and 1980, when inflation was high in the US, the average real return on stocks, as measured by the Dow, was -12.33%, while that of gold was 130.4%. Furthermore, In the past few years, from the beginning of CY18 to the end of CY20 (three years), Nifty50 witnessed extremely high volatility and generated a CAGR of 10%, while gold generated a CAGR of 19% in the same period.

It is because of the gold’s limited supply and inherent value in many cultures, the performance of it goes high during an event of inflation. Moreover, at the time of inflation, the bonds and other fixed-income schemes fail to lure the investors.

An inflation hedge is an investment that protects from the reduced purchasing power of a currency due to a fall in its value because of rising prices. The hedge is something that holds a higher position in assets.

Let’s understand this with an example: Suppose you invest in a stock that gives you a 5% return, but inflation is 6%, so you end up losing that 1%. Hence, the assets, which are considered as an inflation hedge, have a high value that prevents them from losing out to inflation. Like when the dollar loses its value due to inflation, the gold prices go high because as inflation rises and it lowers the value of the dollar, leading to a rise in every ounce of gold in dollars.

For every 1% rise in inflation, the demand for gold in India soars by 2.6% , as per the India Gold Market report by World Gold Council. While gold is considered a protection against inflation by investors in developed nations, it also acts as a protection against currency depreciation for investors in developing nations like India. Apart from the rise in the value of gold in the international markets, a weak stock market due to a fall in the Indian rupee over 15 years (2001 – 2016) contributed to gold to match with Sensex returns.

Many experts opine that gold should be a part of an investor’s portfolio, irrespective of the fact whether it has been able to provide a hedge against inflation or not. Not to be ignored, besides inflation there are other peculiar risks also that can adversely affect investments in stocks. These risks include geopolitical tensions or a catastrophe like the Covid-19 pandemic. During such circumstances, gold has proven to be a safe haven for investors. Hence, it is advisable that each investor must allocate 10-20% of his/her portfolio to gold.