This post was written with contributions from George Milling-Stanley and Diego Andrade. George is the Chief Gold Strategist with State Street Global Advisors and Diego is a Senior Gold Strategist in the Global SPDR Business.
Investment discussions and portfolio allocations often generically bucket gold alongside other commodities and broad commodity indices that include oil, copper, wheat and several others. This may make sense on the surface, given the fact that gold is mined, produced, and used for various consumer and industrial applications in a manner similar to that of other raw materials and commodities. But digging deeper, this basic grouping - along with exclusive broad index exposures - may overlook several of gold’s unique and distinct investment characteristics relative to the broader commodity complex.
Weighing gold’s characteristics against the current market backdrop further highlights several important factors that investors may want to consider when evaluating their commodity and gold exposures.
Lower Trend Inflation Favors Gold Over Many Other Commodities
A commonly cited motivation to invest in broad commodities is to combat inflation. Intuitively, this dynamic appears sound since commodities are important components, directly or indirectly, to typical consumer baskets that make up general price indices. The extent of broad commodities’ ability to offset inflation is actually more nuanced and dependent on the inflation regime. Historically, commodities have provided average positive returns across various inflation environments. But not all commodities perform similarly across all business cycles.
As shown below, during periods of low inflation1 , gold’s average annual return outshined that of a basket of broad commodities. Furthermore, during periods of extreme inflation (6% or greater), gold was by far the preferred choice, outpacing commodities by more than double the average annual return. Although this level of US inflation was mostly contained to the 1970s - during a period of stagflation and revaluation of the US dollar following the end of Bretton Woods - it highlights that gold has historically aided against these limited, yet extreme, price levels. During periods of moderate to high inflation (3% to 6% 2), gold still provided an offset against high inflationary periods, but other commodities posted better returns.
Source: Bloomberg, State Street Global Advisors. Data from 1/1/1970 – 12/31/19. Inflation is represented by the US Consumer Price Index (CPI) Index. Gold Price = LBMA Gold Fix PM Index. Commodity prices are represented by an equal-weight average of monthly returns for the Bloomberg Commodity Price Index and S&P GSCI Price Index. Past performance is not a guarantee of future results.
The Here and Now on Inflation
Turning to today’s market, investors are contending with a subdued inflationary environment. Realized inflation - along with current inflation expectations - remains below 3% (see below). Deflationary headwinds emanating from technology, aging global demographics, and slowing global growth have made stoking price inflation back to trend level a challenge, much to the chagrin of policymakers’ efforts. With the risk of trend inflation rising still broadly contained, investors may consider evaluating their overall commodity exposure based on gold’s positive historical performance during periods of relatively low inflation.