SPDR Gold Trust (ETF) (GLD), iShares Silver Trust (ETF) (SLV): Do Gold and Silver Protect You From Inflation?

In a recent, interesting article on the Fool’s blog network the author tries to settle which precious metal, gold or silver, is a better investment and serves as a better hedge against inflation. But do these metals serve as a good inflation hedge to begin with? I would like to tackle this issue and examine how well precious metals have protected your portfolio against inflation in recent years; let’s also compare them to other inflation hedges.

It is not new that both gold and silver haven’t done well in the past couple of years. Moreover, gold and silver prices might further fall in the coming months, especially if in the near future the Fed decides to taper its current asset purchase program, which is likely to lessen future inflationary pressures.

Gold and silver ETFs such as SPDR Gold Trust (ETF) (NYSEMKT:GLD) and iShares Silver Trust (ETF) (NYSEMKT:SLV) also showed a sharp drop in prices: Since the beginning of the year GLD has plummeted by more than 18.5% (year-to-date); shares of SLV dropped by 28.9%. The sharp drop in gold prices also led to a decline in GLD’s gold holdings by more than 25% since the beginning of 2013. Conversely, SLV’s silver holdings only slightly fell since the beginning of the year, by less than one percent.

In any case, both precious metals ETFs and prices haven’t performed well in 2013. On the other hand, U.S inflation rose by 1.1% in the past twelve months. Thus, in the past year, investors haven’t protected their portfolio from inflation by holding gold, silver or a precious metal ETFs. But perhaps gold and silver are more of a “doomsday hedge” in case of a sudden spike in inflation.

Why gold and silver?

The sharp rise in demand for gold and silver started soon after the financial collapse in 2008, which was followed by the Federal Reserve augmenting its balance sheet by buying long term securities. This led to a sharp rise in the U.S money base. The price of gold soon followed and rallied alongside the money base as seen in the chart below.

Many investors fell back on precious metals as a safe haven against a potential sharp rise in inflation. The Fed kept its asset purchase program and people kept waiting for the program to translate into a rise in inflation. Alas, inflation remained stable, below 2% in most years since 2008.

Gold price is beating inflation

Many gold and silver enthusiasts look at the sharp rally precious metals had in the past decade as a selling point for the benefits of holding gold or silver, especially as a hedge against inflation. But do gold and silver hedge against inflation? The chart below shows the developments of gold and U.S CPI in which both series are normalized to 100 as of January 2004.