Economic Activity, Inflation, and Hedging

Abstract

Research in economics and finance documents a puzzling negative relationship between stock returns and inflation rates in most economies. The present study investigates this relationship for gold and silver in the context of the Fisherian hypothesis and the proxy hypothesis of Fama. We show an insignificant relationship between these precious metals' returns and unexpected inflation. However, gold prices are positively correlated with expected inflation. These findings indicate that investing in gold and silver may be a reliable hedge against inflation in the short- and long-run. We also find strong evidence to support the Fisherian hypothesis that real gold and silver returns are not adversely affected by inflation. The findings, however, are not unequivocally consistent with the proxy hypothesis. The Johansen and Juselius cointegration tests verify a long-run equilibrium between these metal prices, general price levels, and the real economic activity. Furthermore, both prices and general price levels also show a strong long-run equilibrium with the real economic activity and each other.