Gold’s stomach churning volatility – up some 30% in less than a month since the start of the year, only to subsequently lose 20% in a matter of days – has, unsurprisingly, left some investors doubting its role as a hedging asset. But they’d be wrong to dismiss its value as a vehicle for offsetting risk – it does very well under some circumstances and less well in others. Investors just need to identify which they’re facing.
There are broadly three sources of risk facing portfolios: economic growth; inflation; and government policy. Gold isn’t a suitable hedge for the first, but it has proved its mettle for the other two. The balance of how these risks are expected to play out should then determine one’s approach to gold.
From our perspective, growth is less of a concern right now than inflation and, particularly, policy risk. Which is why we remain positive on the precious metal.
Understanding the fundamentals
Recessions, slumps in demand, drops in corporate earnings are all best hedged with bonds. Gold can even struggle in a difficult economic environment if it causes investors to liquidate defensive holdings to meet margin calls on their leveraged positions in risk assets.
On the other hand, gold has historically been a hedge against rising inflation. For instance, during the inflationary crisis of the 1970s, gold represented a strong store of value. It started the decade at USD35 an ounce and peaked at just under USD800 at the start of the following decade. Over the same period, the US consumer price index only slightly more than doubled.
However, over the following decades, gold softened or trended sideways as central bankers took control of inflationary pressures. That negative environment for the precious metal was reinforced by a ‘rules’ based world order and a widespread acceptance of the Washington Consensus – economically liberal policy prescriptions. By the time the then Bank of England Governor Meryn King identified “the NICE decade” of non-inflationary constant expansion, which ran between 1992 and 2007, few investors were interested in the metal. British Prime Minister Gordon Brown went so far as to divest the country of its gold reserves.
The Covid pandemic and post-Covid inflationary period were, however, a sharp reminder of gold’s usefulness. And even as inflation has once again started to moderate, gold is holding its own as a hedge against policy volatility. In fact, gold’s legacy as a safe haven against politically-driven uncertainty stretches into the farthest reaches of history. Over the past year, investors have had to deal with concerns about fiscal dominance – where central banks’ policy choices are shaped by governments’ financing requirements – and crumbling institutional credibility. Repolarisation of geopolitics, trade wars, the breaking up of some old alliances and growing uncertainty of others makes it plain why, despite recent gyration, the price of gold is still up 80% since the start of 2025 in US dollar terms.
Not risk-free
We have never argued that gold is a risk-free asset. Even relative to risky assets, gold is volatile. For instance, gold’s long term realised volatility runs at an annualised 16%. By contrast, the S&P 500’s is 14%.
It is not immune to generalised selloffs of assets. For instance, it also suffered an initial drawdown following the post-Covid inflation shock. But gold recovered quickly, while US Treasury inflation protected bonds are still 8% under water – albeit having started from stretched valuations.
Much of gold’s volatility is related to a relatively small proportion of very large moves in its price – fat tails in statistical parlance. These big moves don’t mean that gold isn’t driven by fundamentals, just that the metal is more prone to exaggerated moves given that it has no stablising cash flow and is prone to leveraged trading amplifying shot-term moves.
As for now, gold still cleves to its fundamentals. There is even stronger investment demand – the marginal buyer as opposed to jewellery or technological demand – for the metal which is reflected in its price. Some of that is central banks’ response to the freezing of Russian central bank assets, which means that since 2022 it would take an even bigger swing in US rates to hit gold price than was the case over the previous decade.
But this volatility hides what is a clear and compelling case for gold in circumstances such as those that face investors now.
It's easy to overemphasise the attractions of other asset classes relatively to gold – to investors’ detriment.
For instance, inflation-linked bonds – a staple of many portfolios – are in fact an imperfect inflation hedge. Especially when issuing governments retain inflation-fighting credibility, inflation-linked bonds suffer capital losses, like other bonds, when central banks raise rates. These losses are frequently not fully offset by the inflation-linked rise in their coupons. Meanwhile, all financial assets – sovereign bonds, corporate credit, equities – see constant increases in supply, with consequent dilutive effects. By contrast, it’s much harder to increase the number and output of gold mines – the supply of newly extracted gold is relatively modest.
A pragmatic hedge, not a panacea
Gold is not a low risk asset. It is, however, a high volatility store of value. And it is particularly effective as a hedge against two of the major exogenous factors confronting investment portfolios: inflation and policy risk. Gold isn’t there to replace bonds, which are good at protecting investors against the impact of economic downturns.
Throughout history, the metal has helped to mitigate the effects of inflation and political uncertainty in ways that equities and other assets can’t. The challenge for investors is to understand and interpret the wider economic and geopolitical environment to know whether and when it’s time to hold gold. All that said, as with any other investment, we don’t expect gold to work in all circumstances. We’d be inclined to reduce our gold position if the Fed under the new chairman were to turn increasingly hawkish or materially reduce its balance sheet, or indeed if there was a significant shift in global geopolitics from confrontation to cooperation. Until then, gold continues to glisten for us.
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