Working Paper: NBER ID: w18706
Authors: Claude B. Erb; Campbell R. Harvey
Abstract: While gold objects have existed for thousands of years, gold's role in diversified portfolios is not well understood. We critically examine popular stories such as 'gold is an inflation hedge'. We show that gold may be an effective hedge if the investment horizon is measured in centuries. Over practical investment horizons, gold is an unreliable inflation hedge. We also explore valuation. The real price of gold is currently high compared to history. In the past, when the real price of gold was above average, subsequent real gold returns have been below average consistent with mean reversion. On the demand side, we focus on the official gold holdings of many countries. If prominent emerging markets increase their gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold may rise even further from today's elevated levels. In the end, investors face a golden dilemma: 1) embrace a view that 'those who cannot remember the past are condemned to repeat it' and the purchasing power of gold is likely to revert to its mean or 2) embrace a view that the emergence of new markets represent a structural change and 'this time is different'.
Keywords: No keywords provided
JEL Codes: E58; G10; G11; G15; G28; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| gold (L72) | inflation hedge (E31) |
| gold (L72) | inflation hedge in the long run (E31) |
| real price of gold above average (E39) | subsequent real gold returns below average (G19) |
| increase in gold holdings by emerging markets (G15) | real price of gold rises (E39) |
| investor sentiment during economic stress (G41) | gold price (L72) |
| various factors (including legal ownership restrictions) (R21) | gold's effectiveness as a hedge (G13) |