Is Gold An Inflation Hedge? How Much Should Be In Your Portfolio?

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Our fascination with gold has been ubiquitous since the beginning of recorded history, and it has been a stalwart investment across cultures worldwide. The value of gold comes from its scarcity as a commodity, and its price tends to grow during times of economic uncertainty, particularly when inflation is high.

Gold is unique because, unlike other commodities, gold is not consumed or utilized to the extent of other commodities. The primary value of gold is intrinsic, although it is used in many electronics today. The United States monetary system was based on the gold standard until the 1970s, and advocates of this believe that a system based on gold, which has a finite and physical supply, is the best option.

Gold is no longer the standard, and it has been more lucrative at some times than at others. However, the precious metal has a long history of being a solid investment. It is worth considering how gold can fit in your portfolio.

A Storied History

Since the dawn of civilization, gold has been used as both a currency and a symbol of wealth. Governments hoarded wealth, and explorers scoured remote areas of the globe in search of the precious metal. Even in modern times, gold has remained a viable investment and a standard for many currencies. Historically, while gold has not outperformed stocks, it has continued to be a solid investment—even after President Nixon declared that dollars could no longer be redeemed for gold in 1971.

Gold has been a valuable commodity for investors for centuries, and it will continue to be because of its inherent nature. Historically, gold has surpassed all other commodities in value. Even through price fluctuations, the intrinsic value we place on it has never faded. Gold has always been an investment people run to in times of economic uncertainty, such as the bear market in which we currently find ourselves.

A Hedge Against Inflation

Gold is widely hailed as an inflationary hedge due to its relationship with U.S. currency; its price in U.S. dollars fluctuates. This means that if the dollar loses value because of inflation, gold tends to gain value. So although the dollar’s value may be eroded due to rising inflation, a gold investor is compensated for each ounce of gold they own.

It has not been a lucrative year for Wall Street, and with inflation hitting 9.1 percent at the end of June, many investors have renewed their interest in the precious metal. While gold is currently sitting a little over $1,700 an ounce, Goldman Sachs forecasted that it could hit $2,500 an ounce all the way back in January.

Precious metals, not just gold, have long been considered good hedges against inflation. Just like companies that have adopted business models to weather inflation and have been paying out dividends for decades, gold tends to maintain its purchasing power in times of rising inflation.

Gold has done well historically when compared to the U.S. dollar. Right after World War II, during the Bretton Woods era, the world had agreed upon a fixed price for gold, valuing 1 ounce at 35 U.S. dollars.

If you had put an ounce of gold in a safe alongside $35 in the mid-forties, today, adjusted for inflation, the $35 would be worth $518. However, the ounce of gold would be worth nearly $1,700. That is a sizeable difference.

Gold Has Not Outperformed Stocks

While gold certainly has a place in many portfolios, investors should not have unrealistic expectations about what the precious metal will do for them. Buying gold and banking on it to make you rich is not a sound strategy, as it has performed poorly when compared to stocks over the past several decades. One study found that from 1972–2013, stocks outperformed gold regardless of whether or not rates were rising or falling.

While gold prices certainly fluctuate, they simply are not valued the same way that stock prices are, and don’t have the same growth potential. A company’s value can be predicted and valued based on the forecast of its future earnings. Gold has no earnings, and its worth is valued at what people are willing to pay for it, which is determined by supply and demand. This can be tough to predict, although demand tends to rise due to fear of economic uncertainty rather than from any objective cause.

What Percentage of Your Portfolio Should be Gold?

When deciding how much gold you should have in your portfolio, it’s important to understand the purpose it serves.

While some of your portfolio may be dedicated to dividends paying a steady income, or to tech stocks you’re hoping to see rise exponentially, gold investments should serve a different purpose.

Most experts agree that from five to 10 percent of your portfolio should be allocated to gold. Since it will not be something that drastically grows your portfolio, many experts advise that you use your gold-related investments to prepare for the unknown.

Stocks and bonds are typically considered better tools for wealth building and retirement accounts, as they have historically outperformed the price of gold. However, during economic uncertainty and recessions, gold is great insurance.

How to Buy Gold

Owning physical gold is an option, although it is no longer necessary if you want to invest in gold. Physical gold as an asset is increasingly rare and incurs additional costs. Since physical gold is susceptible to theft, owners must also ensure that they have the proper security, such as safes, to protect their assets. Physical gold also poses a problem since it is harder to sell, making it less liquid.

Exchange-traded funds (ETFs) allow for investment in gold without the hassles of owning physical gold.  Some, like VanEck Vectors Gold Miners ETF (GDX), track gold mining companies’ overall performance. GDX is one of the more liquid options when investing in gold.

If you are new to investing in gold or seeking to add some more diversification to your portfolio, there are several gold-related ETFs with varying levels of risk.

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