Investments in real estate and gold have traditionally been seen as good ways to offset the impact of inflation, but the reliance on gold’s performance in high inflation markets is 40 years old and no longer relevant, according to a boutique Australian investment manager.
Quay Global Investors (QGI) said real estate was often considered as a place to seek better performance than equities during periods of high inflation, and gold also carried that reputation, however, this was based on inflationary periods from the late 1970s and early 1980s.
“Digging into the data, we found real estate outperforms equities during periods of moderate inflation (3 to 6 per cent) as well as high inflation (+6 per cent), all the while delivering positive real total returns (inflation up to 6 per cent) or preserving real purchasing power (inflation above 6 per cent),” the firm said in a recent briefing paper.
“It was clear from the data that real estate is a reliable hedge against inflation – but of course it’s not an investor’s only option. Gold is often cited as a natural hedge against inflation, but is it better than real estate?”
QGI said the reason real estate acted as an inflation hedge was that over time real estate values returned to an average based around replacement cost and in periods of high inflation replacement costs increased at a faster rate.
The firm added that as inflation and the cost to build increased, there was fewer new developments, which restricted supply relative to demand, and new developments only appeared when property prices matched building costs.
Conversely, the relationship of gold to inflation is tied back to when the price of gold was pegged to the US dollar after World War Two and when the US held two-thirds of gold reserves and had large trade surpluses with Europe and South-East Asia, which were recovering from the war.
“Inevitably the war-affected regions regained their competitiveness. US trade surpluses turned into deficits and US gold reserves dwindled,” QGI stated, adding that by mid-1971 the US dollar had been floated, leading to the relationship between gold and inflation becomes more tenuous.
Comparing returns and inflation data from that year forwards, QGI found gold performed well in a low inflation environment and delivered positive nominal and real returns, but underperformed real estate when inflation was up to 6 per cent, and only above that level did gold perform better than real estate.
“The more detailed analysis highlights that gold’s outperformance occurs when inflation exceeds 8 per cent per annum. Up until this point, real estate tends to deliver better returns,” it said.
“Digging into the data a little further, the period of +8 per cent inflation reflects the periods from Oct 1973 to Aug 1975, and Sep 1978 through to Jan 1982.
“In short, gold’s outperformance is based on +40-year-old data, a time when investor behaviour was potentially influenced by a recently abandoned monetary system.
“Today, the linkage between gold and inflation is not as concrete as under previous systems and therefore caution should be exercised in assuming gold will perform as it did in the past.”''