Intelligent Design

John McMillen | Portfolio Manager

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Do Inflation Hedges Really Help?

August 2009

Ask economist and layman alike about the recent activities of the Fed and you’ll likely hear the foregone conclusion that inflation is right around the corner. As a result, many investors are questioning whether their current portfolio is properly structured for such an environment, and, if not, what changes should they make?

A common theme among investors who fear a rise in inflation is to invest heavily in “real” or tangible assets such as gold, commodities, or real estate. Looking at the historical relationship between inflation and the above-mentioned assets, however, there is little evidence that these asset classes reliably help buffer a period of high inflation.

The table below shows the correlation between the above mentioned assets’ yearly returns and inflation over the past thirty years. Correlation is measured between -1.0 and +1.0, and captures the strength and direction of a relationship. Investors who expect inflation to go up would prefer to hold assets that have a high positive correlation (> 0.70) and avoid assets with a high negative correlation (< -0.70). Correlations that are close to zero have little to no relationship; sometimes they move together, sometimes they don’t. As such, they don’t provide a reliable hedge – and that is what we find with commodities, gold and real estate: 



Correlation to Inflation, 1980-2009

Morningstar Commodities Index


S&P GSCI Gold Index


Wilshire US REIT Index


Clearly these asset classes don’t live up to their reputation as inflation hedgers. In fact, gold (the asset class everyone seem intent on piling into right now) has often done the opposite of what investors expect, going down during high inflationary periods and going up during low inflationary periods, as seen in the graph below:

Using the correlation data from the table above, investors should not be surprised to see the following returns in 1980 and 1981 when inflation was running in double digits:




Morningstar Commodities Index



S&P GSCI Gold Index



Wilshire US REIT Index



Nor should they be surprised to see the following returns 2002-2003 when inflation was running in low single digits:





Morningstar Commodities Index



S&P GSCI Gold Index



Wilshire US REIT Index



Just as we would expect from the lack of correlation, there is no clear behavior pattern with commodities and gold in relation to inflation. And while real estate would appear from these examples to be the best hedge, there are many examples (such as the early 1990s) when real estate suffered big losses during a period of high inflation.

In addition to the uncertain relationship with inflation, all of the above assets have historically yielded higher levels of volatility than the broad market:



Standard Deviation

Morningstar Commodities Index


S&P GSCI Gold Index


Wilshire US REIT Index


S&P 500 Index


As the table above shows, investors selling equities to fund purchases of real assets are likely to actually increase their risk. Combine this with the lack of a strong relationship between inflation and these asset classes and it becomes clear that making a major shift in one’s portfolio to offset this risk is likely to be a fruitless exercise.

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