There’s a saying that all that glitters is not gold, but that might not be the case if inflation continues to prove very stubborn. Gold could be the best asset to hedge this risk although there are other alternatives available.
Mr.Steve Barrow, Head of Standard Bank G10 Strategy, said he wouldn’t be sure that high inflation will prove persistent, but those that want to hedge against this risk have a number of assets they can choose. “On the list, we’d include inflation-protected securities, the USD, cryptocurrencies, and gold. Of course, others might champion different assets but we think these are the main ones. Index-linked bonds are something that we’ve been praising for some time. So far this year, US index-linked bonds have returned over 6% compared to the fall of 3% that we’ve seen in conventional treasury securities. But can we count on these returns continuing if US inflation proves stubborn?”, Mr. Steve Barrow stressed.
A difficulty in assuming such out-performance is that policymakers – notably the Fed – could slam on the monetary brakes and, in doing so push the economy back towards a recession. This would undoubtedly ease inflationary pressures leaving many to wonder whether future inflation will be higher than the breakeven levels. If, as seems likely, the market concludes that it will not be higher, index-linked bonds could rapidly lose their attraction. So, in short, index-linked bonds seem a decent way to hedge inflation risks, but only as long as central banks don’t panic and hike rapidly.
What about crypto assets? For while we might regard the 6% return this year on US TIPS to be quite good, it’s not a patch on the 220%-plus return from the major cryptocurrencies. And given that much of the attraction for these assets is said to result from the monetary irresponsibility of fiat currency issuers, who are now seeing the error of their ways in surging inflation; the future could be even brighter. Whether you agree with this or not, there’s little doubt that surging inflation will generate more crypto converts. But can crypto be considered a hedge against inflation?
For one thing, we might want a hedge to be reasonably stable in the event of a crisis-type situation. But our concern here is that if central banks have to act aggressively to stem inflation, they will likely provoke a significant risk-off episode in the financial markets and, as we have seen before, crypto-assets can be vulnerable when this happens. Yes, crypto might have returned over 200% this year but don’t forget that Bitcoin, for instance, lost half its value against the dollar at the height of the Covid crisis last spring. The same thing could happen again. So, while significant and stubborn inflation might well prove to be like manna from heaven for crypto assets over the long haul, there could be a lot of pain first. If crypto proves too volatile to be a good short-term inflation hedge, what about the dollar?
While we think that the dollar would provide a better short-term hedge, particularly if Fed policy provokes a risk-off crisis in other assets; we are not so sure about the longer term. For a start, surging inflation undermines the credibility of the Fed, perhaps especially in light of its decision to opt for more inflation in last year’s monetary policy review.
The US dollar could also have much to lose as the foremost fiat currency if an inflation episode pushes the case for crypto forward, and perhaps that for other currencies such as the renminbi. Hence, while we don’t doubt that the dollar will likely be the best short-term inflation hedge, should rising inflation morph into a market crisis, this won’t be the case over the long haul. This leaves gold which, in some senses, may lie between the dollar and crypto.
“What we mean by this is that if surging inflation produces a more determined Fed response which lifts the dollar, we are likely to see gold fall back temporarily. At the height of the Covid crisis last spring, it slipped by around 10%; far less than the halving of Bitcoin. But its longer-term upside would likely be far less than crypto in our view. This leaves it in a sort of halfway house position: not the best short-term inflation hedge and not the best long-term asset either. However, if we put the short and the long terms together, it might just come out on top and that includes against index-linked securities as well”, Mr.Steve Barrow said.