A commentary by James McDonald, Daniel Phillips, Michael De Juan of Northern Trust today (2020 0729) on Advisor Perspectives argues that gold is a “less than perfect” inflation hedge:

The Role of Gold; A Less Than Perfect Inflation Hedge

The writers leave it unclear just how they would define a perfect inflation hedge, and certainly don’t cite an example of one. Just one of several counts on which this essay is found wanting.

For starters, they use the Consumer Price Index as their measure of inflation. This makes for incomplete logic at best since they make no case that the CPI is a perfect measure of inflation. In short, they use an imperfect measure of inflation as a measuring rod against which to evaluate the perfectness of another.

TIPS are cited as putative inflation hedge with a better correlation with inflation.  Of course, since they’re indexed to the writers’ chosen measure of inflation.  This is plainly circular reasoning.  The perfect hedge against inflation would be the CPI … by the CPI standard.

“We do not have a strategic allocation to gold as, over the long term, gold doesn’t generate returns sufficient enough to justify its risk levels.”

Yet gold’s returns so far this century have been much higher than stocks, to which presumably they do have a strategic allocation. Over twenty years is a pretty big chunk of any investor’s career to be solely in underperforming assets. The fact that they don’t acknowledge this significant stretch of history suggests either they are not aware of it or that they they’re only choosing facts to support a position already taken, rather than choosing a position based on the facts. Neither inspires confidence in their conclusions.

The caveat “to justify risk levels” lacks foundation as well. What risk is to be defended against? If the question is hedging “inflation”, presumably that would be the standard of risk, but there’s no indication that’s the basis they use. Instead, it appears to be volatility. In which case wouldn’t one expect the conclusion to be that gold is a less than perfect volatility hedge?

Not to mention that volatility is tacitly assumed to be measured in dollars.  Do dollars have no volatility of their own?  Only if the answer is in the affirmative can they be uncritically used as a standard against which to measure the volatility of something else, especially when that something else is specifically being evaluated for its utility in hedging against negative returns in the dollar.  Sort of a bootstrap variation on circular logic.  

We also have the problem that the argument is founded on historical statistics, devoid of precedent for the scope and degree of present and foreseeable threats to the value of the dollar.  How much of this historical data is from periods in which the US government was running multi-trillion-dollar deficits?  Which were being monetized by multi-trillion-dollar Fed printing?  Is there no room for considering current fundamentals?  

The slippery wording “over the long term, gold doesn’t generate returns sufficient…” conflates past, present and future, indicating a lack of care in distinguishing among them.  In fact the only factual statements that can be made about long term returns is what they have been, not what they are.  The implication that past performance indicates future returns is among the most discredited in finance.  We can only say ‘gold hasn’t generated returns sufficient…’ … and even if that could be extrapolated to the present (doesn’t), or future (won’t), the case isn’t made, as we’ve already pointed out.

The authors conclude “The benefits of gold can be fleeting”.  Again, gold has outperformed stocks for the entire century to date – over two decades – not exactly a flash in the pan.  And no investment is without its drawdowns.

Yet we agree that gold falls short of the artificially high bar of the perfect inflation hedge.  It’s a little like Winston Churchill’s characterization of democracy; it’s perhaps the worst hedge against inflation … except for all the others.  Can we improve on it?  Sure.  But instead of posing artificial dichotomies that assume we invest in either gold or something else, why not gold and something else?  A mix of asset classes, say stocks and gold, perhaps including other inflation hedges such as real estate and other elementary commodities, has been superior to any one.  But that’s just what the authors reject.  To imply that gold deserves no place in such a strategic mix is misleading and can only be based on questionable assumptions and less than perfect logic.