Spot Commodities as Inflation Protection

Abstract

Inflation degrades the function of the U.S. dollar as a storehouse of value. The goods and services that constitute the cost of living become more expensive in dollar terms. Physical commodities, and gold in particular, are often recommended to hedge that risk. The authors cast that popular advice into doubt, showing that inflation hedging with physical commodities is difficult, risky, and ultimately unreliable. Buy-and-hold strategies are impractical for many, and inflation hedging with commodities requires bold and successful management, together perhaps with good luck. After examining 53 years of spot prices for 45 commodities and 14 commodity aggregate indices, they find that owning certain things—specific commodities—rather than dollars would have been a better storehouse of value in the inflationary 1970s and in the brief period of high inflation from 1989 to 1990. Various commodities performed very differently in different periods, however, and some of the best in one period proved to be the worst in another. A basket of commodities to protect against inflation would be difficult to construct and uncertain as a result. Furthermore, precious metals, often cited as inflation hedges, carry significant timing risks. Finally, even though a diversified basket of energy commodities has performed well under historical inflation, it carries its own risks.