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Alan Schram

Alan Schram

Posted: February 1, 2010 12:37 AM

Is Gold a Good Inflation Hedge?

What's Your Reaction:

In light of the large amount of fiscal stimulus, monetary easing, and credit creation in the form of new dollars that have all taken place recently in the United States, many are concerned about the dollar, its buying power and the inevitable higher interest rates that will be necessary to entice people to buy Treasury securities.

Their concern is not unreasonable. Traditionally, indebted countries have debased their currency to ease the burden of debt. With current federal government total tax receipts adding up to $2.2 trillion vs. expenditures of $3.5 trillion, the expected deficit of $1.3 trillion is an alarming 9% of GDP (state, local and federal government spending in the U.S. now consume about 38% of GDP). We may have no other way out but inflation.

Some investors are trying to hedge such risks by buying gold. Gold is supposed to be an insurance policy against economic chaos and a hedge against inflation.

But gold bugs have not done well over time. In the last 30 years gold has not been a good investment, and substantially lagged both the S&P 500 and Bonds (as measured by the Merrill Lynch Bond index).

While gold may reduce your anxieties, it is an unassailable fact that gold (and oil) are not actually effective hedges against loss of purchasing power, and could lag inflation for decades. And gold is not a good insurance policy either. When the world's financial system was on the precipice in 2008, gold did not prove to be a particularly good hiding place.

Incidentally, this also reinforces the folly of trying to time the stock market based on macroeconomic predictions, and not just when it comes to gold. For example, emerging markets such as China, India, Brazil and Russia are often touted as great investment opportunities due to expected rapid GDP growth. But the data shows that there is little correlation between GDP growth and stock market returns. So even if you somehow manage to make accurate macro predictions (by itself no small feat), your predictions would not be helpful in telling you what the stock market will actually do.

Gold does not generate cash flow (indeed it has a carrying cost for storage, insurance etc.) and does not have any intrinsic value, and therefore it is of dubious value as a long term investment. I believe currency and interest rate risks are best hedged by owning high quality businesses that have a durable competitive advantage and pricing power. Such solid businesses grow, raise prices and outperform in the long run.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.