The experts who previously warned against gold as an inflation hedge now argue there's room to grow

By Jules Rimmer

Gold experts acknowledge boom periods for gold like this latest are often followed by years of underperformance, but this time may be different.

44% of gold production goes into jewelry, 26% into investments, central banks buy 23% and the tech industry takes the other 7%.

Even after setting all-time highs, gold could defy historical precedent and keep rallying, according to a research paper from two experts in finance.

The lead gold futures contract (GC00) fell over 2% on Monday and now sits 6% below its record high of $4,398 an ounce.

Claude Erb, a former fund manager, and the Duke University finance professor Campbell Harvey have again teamed up to address gold, more than a decade after the pair wrote "The Golden Dilemma," which posited that the yellow metal was unreliable inflation hedge.

They repeat their warnings that after setting a record in 2011, the price of gold fell by 39%, and that following other boom periods, gold has fallen into extended spells of underperformance and low to negative returns. Nor does it always guarantee a hedge against inflation; in the two decades from 1985, it lagged inflation, in the two decades since it has outstripped it comfortably.

Now in a new research paper published this month, they see two factors that could lead to more gains.

Already, they say, gold ETFs have shifted the landscape, by accelerating financialization of gold. Gold is heavy, difficult and costly to transport and the physical market is illiquid and expensive to trade. The proliferation of exchange-traded funds removes many of the constraints imposed on investors previously.

They identify two other potential big changes on the horizon.

Currently, gold does not qualify as a so-called Tier 1 high quality liquid asset. That means gold does not qualify an asset to meet liquidity standards, in the way for example that Treasury bonds do. The pair say that gold meets all the characteristics and that it doesn't make sense that central banks can hold gold as a reserve asset but commercial banks cannot.

If only 5% of the $4 trillion of high-quality liquid assets converted to gold, that would be 1,885 tons of new gold demand, some 57% of the annual mining production, they say.

The second potential demand shock could come if the de-dollarization trend continues, driven by fears the U.S. is weaponizing the dollar's global reserve status.

China adding safe assets, like gold, to its official reserves, can help increase confidence in the yuan, the academics say, and to reach parity with the U.S. on a per-capita basis, China will still need to accumulate over one billion ounces of gold, or more than 31,000 tons, well above the 1,240 tons it's accumulated over the last decade.

Erb and Harvey emphasize that gold can be a volatile asset. Since 1985, its volatility is comparable to that of the S&P 500 SPX and while inflation annualized volatility is 2%, gold's is closer to 15%. That said, the authors note gold works as a diversifier and crucially "its volatility is not the same as risk." Adding gold to an equity portfolio reduces portfolio volatility.

While its record against inflation is patchy, though, it has proved a very reliable hedge against equity drawdowns. The paper, "Understanding Gold" examines eleven crises going back to Black Monday in 1987, The Gulf War in 1991, the global financial crisis and so on, and finds that gold had positive returns in eight of these and only minor negative returns in three. In four recessions since 1975 when the S&P 500 index declined, gold eked out positive returns.

Gold has been extremely useful protection in most major drawdowns of the last half-century.

The paper concludes that even if expected returns may diminish given the record-setting run, it's "reasonable to add assets to a portfolio.... if they provide protection in tough times.

In this era, gold ETF flows are positively associated with gold price increases because investors buy more as the price goes up. There is pent-up demand from consumers who wanted to hold gold but found physical possession awkward and dangerous.

Gold ETFs facilitate exposure to gold for investors who were previously deterred by many constraints.

Erb and Harvey cite Warren Buffett's maxim: "What motivates gold purchasers is their belief that the ranks of the fearful will grow." They also note that "As bandwagon investors join any party, they create their own truth - for a while."

-Jules Rimmer

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10-27-25 0739ET