Skip to main content

Can Gold & Natural Resources Help Combat Sticky Inflation?

  • Inflation remains sticky and persistent and may remain elevated compared to the pre-pandemic market regime
  • A mix of gold and global natural resource equities may provide a better option than broad commodities for portfolios seeking to strike a balance between inflation protection and risk mitigation
Head of Gold Strategy

Inflation had been a factor largely dismissed by investment strategies for well over a decade following the 2008 financial crisis, which preceded an 11-year period of historically below-average inflation. This disregard, however, quickly shifted to fixation following the pandemic as US inflation hit a 40-year high in 2022. While prices have come off their peaks, pressures from higher commodity prices, a shift towards de-globalization, and upward wage pressures from tight labor markets may keep inflation sticky and persistent — closer to the historical average than the preceding decade.

To combat this new regime, investors have dusted off textbook strategies for how to navigate an elevated inflationary environment. Liquid real assets, particularly broad commodities, have seen renewed interest. But not all real asset exposures may serve portfolios in the same manner or with the same efficiency. Investors need to take into account the inflation sensitivity of real asset exposures alongside the portfolio impact from risk-adjusted performance and diversification benefits.

Higher Correlations to US CPI

When evaluating the correlation and beta of key real assets to inflation, both commodities and natural resources lead the way. Broad commodities historically exhibited the highest correlation and beta to US Consumer Price Index (CPI) over time which reflects the impact commodities have as economic inputs for business and consumption (energy and food prices).

Natural resource equities, however, also carry a much higher sensitivity compared to a global 60/40 stock and bond portfolio, as well as other commonly referenced liquid real assets such as infrastructure, real estate investment trusts (REITs), and gold. This makes intuitive sense since the highest contribution to revenue of these natural resource companies is commodity prices.

While gold may not carry a high sensitivity to broad price inflation, it may provide protection against another form of inflation — monetary inflation — by protecting against currency depreciation and loss of purchasing power over time. This is the dynamic historically at play when gold is referred to as an “inflation hedge.”

Examine Risk-Adjusted Performance

Inflation sensitivity shouldn’t be the sole determinant when constructing a real asset exposure. Taking into account the overall risk-adjusted performance over time is another key factor to consider.

Since November 2002, broad commodities posted a total return of 1.32% with a standard deviation of 16.40%. Comparatively, natural resources posted a total annualized return of 8.60% with an annualized volatility of 20.82%. Translating this to a risk/return layout, natural resources provided a better option than broad commodities with higher return per unit of risk, 0.41 for natural resources versus 0.08 for commodities.

Over this 20+ year period, gold provided an attractive risk/return trade off as well, with an annualized return of 9.01% and 16.90%, resulting in a 0.53 return per unit of risk.

Figure 3: Combining Gold With Natural Resources Historically Created a Better Risk/Return Profile Than Either Asset Individually

While these historical returns are representative of a set period from late 2002 through early 2023, what is most interesting is the dynamic yielded when combining these real assets. When natural resources are combined with gold on an equal-weighted basis, the historical annualized volatility is reduced (15.49%) while the annualized return increased (9.46%) compared to either of these assets’ performance statistics independently. Interestingly, the combination of gold and broad commodities does not result in a similar improvement from a risk/return standpoint.

One possible explanation for the improvement with both gold and natural resources? The low correlation between gold and equities may provide ballast against natural resource equities’ higher volatility over time. Meanwhile, natural resources’ equity risk premium provides comparative outperformance versus broad commodity indices that invest directly in underlying commodities through futures contracts and typically exhibit negative performance drag due to the rolling of futures contracts at maturity.

Gold Plus Natural Resources May Improve Sharpe Ratio

The combination of gold with natural resources is an attractive option for portfolios because it may also improve a diversified portfolio’s Sharpe ratio. Gold’s diversification and risk-management characteristics coupled with the inflation-sensitive characteristics of natural resources show improved Sharpe ratios, whether allocations to this mix are a percent or two, or perhaps more. While a standalone gold allocation historically exhibits a higher Sharpe ratio, the higher inflation beta from including natural resources may prove valuable against a backdrop of elevated inflation. Additionally, including gold provides a more efficient option than global natural resources or commodities alone, which historically exhibit a drag against a portfolio’s Sharpe ratio across various allocations.

Figure 4: Combining Gold With Natural Resources Provides an Improved Sharpe Ratio With Inflation Protection

As inflation and elevated prices are expected to persist in the near term, investors seeking to manage portfolios against this environment may be best served by seeking to combine gold with natural resource equities rather than broad commodity exposures. Gold’s diversification benefit coupled with the equity risk premium and high inflation sensitivity of natural resources may provide a complementary solution for real asset exposures in the future.

More on Gold