Top 5 reasons why gold failed as a hedge against inflation

Inflation is running hot around the world. Advanced, developing, emerging, and frontier markets, they all feel it.

Most recently, it was announced that inflation in Turkey reached 73.5% in May, the highest level in 24 years. In the Euro area, inflation sits at its record level – 8.1%.

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The United States also records levels of inflation not seen in the last four decades. And yet, gold, which traditionally acted as a hedge against inflation, failed at offering protection to investors.

Here are five reasons that might explain gold’s underperformance in a world of rising prices of goods and services:

• Strong prior performance
• Firm US dollar
• Soaring stock markets
• Increasing crypto adoption
• Trust in central banks

Strong prior performance

One of the reasons why gold failed to act as a hedge against inflation in the last couple of years is its strong past performance. For instance, gold delivered 18.3% in 2019 and 24.6% in 2020.

Even in 2022, as of June 1^st, gold delivered a positive return while stocks are well into the negative territory. Nevertheless, when compared to other commodities, gold didn’t return as much YTD.

Firm US dollar

The very strong US dollar made it difficult for the price of gold to rally. The greenback made impressive gains against its peers, rising across the board as investors looked for safety in the world’s reserve currency.

Soaring stock markets

At the same time with a strong dollar, stock markets climbed to all-time highs. As a result, investors were more willing to ride the stock market than invest in gold, as stock market gains attracted both speculators and long-term investors.

Increasing crypto adoption

The last few years saw growing adoption of crypto assets by institutional investors. Crypto became a huge market and divested away funds that were otherwise meant to be used in different asset classes.

Trust in central banks

Perhaps the biggest reason for gold failing to rally was the central banks’ narrative. All major central banks were certain that inflation would be transitory.

As such, the market participants did not fear that inflation would remain at such elevated levels in the long term. But central banks now have pivoted as interest rates rise across the world.

It is hard to believe that inflation, at least in the developed world, would rise further. Even if it doesn’t, one should not be surprised to see investors turning their attention to gold, especially if the US dollar’s strength eases.