Gold Has Competition for the Inflation Trade

We opened the charts this morning to find gold and silver falling again.

The explanation: higher oil prices, inflation concerns and fears of tighter monetary policy.

So, essentially, the same problems that brought many investors to precious metals in the first place. Apparently, inflation protection comes with a few terms and conditions.

Reuters linked today’s decline to rising energy prices and expectations that interest rates could stay elevated for longer.

One reason that explanation feels contradictory is that we often describe the choice too narrowly: hold gold, or leave money exposed to inflation.

Investors have another option.

Inflation protection can also pay interest.

U.S. Treasury Inflation-Protected Securities, or TIPS, adjust their principal with U.S. consumer prices and pay a fixed coupon on that adjusted amount. The inflation adjustment is built into the security; investors do not need its market price to rally for that adjustment to happen. TreasuryDirect explains the mechanics here.

That creates competition for gold. When real yields rise, investors can obtain a higher quoted inflation-adjusted yield from government debt. Gold offers no corresponding income. This helps explain why inflation anxiety can coexist with selling in the metal.

TIPS still carry price risk before maturity, and U.S. CPI will not match every investor’s living costs. Physical gold serves a different purpose too: directly held bullion does not require a government to make future payments.

Protecting against rising consumer prices and reducing dependence on an issuer are different objectives.

Our reading is that the distinction gets lost whenever “inflation hedge” becomes a promise that gold should rise with every uncomfortable headline.

Today’s selling does not establish that investors have stopped worrying about inflation. It is consistent with investors demanding more compensation for holding an asset that pays nothing while competing inflation protection offers a yield.

An expensive tank of petrol, unfortunately, does not automatically come with a higher gold price.