What Are Inflation-Hedge Assets?

An inflation-hedge asset is one that preserves its real value, or even rises in value, during periods of rising prices.

Conditions for a good hedge asset: 1. Positive correlation with prices: its price should rise when inflation is high 2. Preservation of intrinsic value: value independent of currency depreciation 3. Liquidity: it can be sold when needed

Commonly cited inflation-hedge assets: gold, real estate/REITs, inflation-linked bonds (TIPS), commodities, and stocks (long-term).

Gold has been used as a store of value for thousands of years. In the high-inflation 1970s, the gold price rose more than 30% per year on average.

However, gold's inflation-hedge effect is stable only over the long run. In the short run, the correlation between the gold price and inflation is low. For 20 years from 1980 to 2000, the gold price actually fell despite inflation.

Gold also generates no dividends or interest, so there is a holding cost. Over the long run, the real return of stocks tends to greatly exceed that of gold.

Counterintuitively, historically stocks are the most powerful long-term inflation hedge.

The reason: companies can pass rising prices on to their prices. When inflation rises, nominal revenue and profit increase. Historically, the U.S. S&P 500's long-term real return (net of inflation) was about 6-7% per year.

Note that in the short run, at the onset of an inflation surge, stocks often fall along with it (rate hikes -> falling stock prices). Stocks' inflation hedge works over a long horizon of 5 years or more.