By Nitesh Shah, Director of Research; Pierre Debru, research director; and Christopher Gannatti, Research Manager, Europe at WisdomTree.
Long time series, back to 1970
Commodities have always been an excellent hedge against inflation. Figure 1 below shows that commodities generally rose during times of higher inflation. Figure 2 also shows that gold has always been a strong hedge against inflation.
The relationship may not have been as close for gold as it was for the big basket in most time series, but in the 1970s when inflation got particularly high, gold did a job. exceptional to protect against increasing price pressure.
The link between inflation and returns: Beta (1988 to 2021)
If you look at the numbers, commodities have a higher inflation beta than any other asset class, including gold (graph 3). Gold, however, has a very high inflation beta, which is several times higher than that of stocks. This indicates that while commodities at large follow inflation upward but also downward, gold tends to only track upward, resulting in an overall smaller beta.
Several asset classes respond to âexpected inflation,â where expectations are often shaped by monetary conditions and judgments about the strength of demand in the economy. These expectations are often demand driven.
However, inflation can also be generated by supply side shocks. For example, the cyberattack on the Colonial Pipeline last month raised the price of gasoline for consumers. Or, there is the example of the ongoing drought in Brazil which is pushing up food prices. Most asset classes tend to react much less to this type of inflation, but commodity prices have a direct link with many supply-side shocks, which can make them a better hedge against inflation achieved. These examples of supply side shocks often tend to squeeze corporate margins and are therefore not positive for stocks or corporate bonds.
While Figure 3 shows the betas for the full time series, over 30 years, we recognize that these statistics would not stay at constant levels. Over the period 2010 to 2020, these figures were 6.2 for broad commodities, 1.1 for gold, 2.0 for US stocks, -1.2 for US government bonds and -0.6 for US corporate bonds.
The significantly lower beta of gold in the 2010s is another testament to the fact that gold is doing better in high inflation environments and that the period 2010-2020 was marked by the absence of a high inflation. Investors need to ask themselves if they think the 2020s are more like a continuation of the 2010s or something more similar to an earlier historical paradigm.
Gold has an asymmetric character
But that only says part of the picture. Gold behaves very asymmetrically. It tends to perform very well when the economy is doing badly (for example following an economic shock) and it also performs very well in strong economic times when inflation is high. Gold doesn’t fare as well when the economy is average (usually during times when inflation is just moderate). Figure 4 shows that gold is the best performing asset class during times of high inflation (above 2.5%) and has outperformed commodities during these times.
Inflation levels relative to the expected future path of inflation
High inflation scenarios are positive for the price of gold, whether the inflation rate rises or falls (Chart 5). Commodities, on the other hand, tend to benefit from rising inflation. When inflation is past its peak, it tends not to be as favorable to commodity prices.
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While we think inflation will ease a bit in the near term after the huge base effect of ultra-low energy prices wore off last year, we think inflation is nowhere near. ‘be transient. Looking at the details behind the CPI readings, inflation appears to be widespread. The magnitude of money growth, combined with pent-up demand for many goods and services, will be a recipe for continued price inflation even after the extraordinary base effects disappear. Inflation could very well rise again once the base effects are behind us. Broadly defined commodities and gold are likely to be essential assets in protecting your portfolio against inflation.
Conclusion: what are you hedging on?
Each investor’s portfolio will have its own character and tolerance for risk. Those worried about the dawn of a new era with the risks of increasing fiat currency would likely gain more from holding more gold or even bitcoin and moving away from fiat money systems. However, those who see shortages of key commodities at the heart of economic growth – those who can benefit from the pull of economic demand – may benefit from a larger basket of basic commodities that each responds to on their own. supply / demand considerations.
(The opinions expressed here are those of the authors and do not necessarily reflect those of ETF Strategy.)