The price of gold, which is close to $3,000 an ounce, is so high compared to inflation that it is unlikely to generate a positive real (inflation-adjusted) return in the years to come (GC00).
Research by Claude Erb, a former commodity-fund manager at TCW, and Campbell Harvey, a professor of finance at Duke University, suggests that. By the time they finished this study in 2012, the price of gold was about seven times lower than the U.S. consumer price index. They projected that gold’s following return would be below average because that ratio was roughly twice its historical norm.
The price of gold fell by half over the next three years. The gold-to-CPI ratio is currently about 9 to 1, which is much higher than it was in 2012. Therefore, it shouldn’t be shocking if gold performs worse than expected in the upcoming years.
“After past peaks (all-time highs, perhaps) in the real price of gold, subsequent realized real returns were negative over the next five to ten years,” Harvey noted in an email. Our current climate is one of “risk on,” which is advantageous for investors until it isn’t. “Risk off” always comes after “risk on.” Investors, take caution.
The fair value of gold
In “The Golden Dilemma,” published in 2012, Harvey and Erb presented a model for determining the fair value of gold. Their model’s central tenet is that the price of gold is mean-reverting in relation to the consumer price index. Therefore, gold is expected to beat inflation in the years that follow when the ratio is below average. In following years, gold is expected to lag inflation when the ratio is above normal, as it is at the moment.
The price of gold over the previous 50 years is plotted in the above chart, along with the model’s predicted fair value. According to Harvey, “gold has outperformed inflation for the past 20 years.” The gold return was unable to keep pace with inflation in the 20 years prior.
The graph also provides context for the claim made by many gold enthusiasts that gold is a useful inflation hedge. The two lines in the chart would closely follow one another if that claim were accurate. This is obviously untrue, indicating that gold prices fluctuate greatly in relation to inflation.
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A book that is well-liked by gold fans is cited by many people who think gold is a good inflation hedge. The 1977 book, titled “The Golden Constant,” was written by Roy Jastram, a now-deceased management professor at the University of California, Berkeley. The book concludes, among other things, that the inflation-adjusted price of gold stays largely stable over the very long run.
Although Harvey and Erb discovered some evidence that supported Jastram’s findings, they warn that it may take a century for gold to retain its purchase power. Gold prices in inflation-adjusted terms fluctuate significantly during shorter time periods, such as a few years or even decades.
The fact that gold is a strong hedge against geopolitical threats is another explanation given by gold aficionados for why the commodity is poised to rise above $3,000 an ounce. On the surface, this reasoning appears convincing because such risks appear to be particularly significant at the moment.
Harvey and Erb’s research shows that the reasoning is not practical. They utilized the months when the U.S. stock market lost the most since the 1970s to illustrate this. The researchers discovered that gold’s performance throughout these months was split reasonably evenly between gains and losses.
In previous years as well as in recent weeks, Gold has performed admirably. However, there is little chance that gold will continue to do well in the years to come.
