Hedging Against Inflation: Gold vs Crypto



In the ancient times of Mesopotamia, gold found its initial role in the city of Babylon, serving as a currency to be used for trade and barter. In the modern global economy, gold is mostly held by the central banks, which do so in order to diversify their reserves. Since gold is a finite commodity, it is considered a natural hedge against inflation. Inflation has become a hot topic as of December 2021 in America, as the annual rate of inflation just hit 6.2%, which is the highest rate since November 1990. However, as opposed to pouring money into gold, many investors are turning to cryptocurrency, especially Bitcoin (BTC), in reacting to rapid inflation. Today, we will compare investing in gold to Bitcoin within the context of rising inflationary rates.


Gold is a precious metal that has been seen as a store of value for centuries with also providing a natural hedge against inflation. Since gold is finite due to the restriction of natural resources, it acts in an opposing way to the dollar, since the supply of the dollar is not finite because the Treasury can always print and create more money. I will reference an NYU thesis project, "Gold and Equities as a Hedge Against Inflation" by Krish Metha, in order to use CPI (Consumer Price Index) and gold futures data from 1978-2018 to track the volatility of gold futures.* The use of a variety of summary statistics and a GJR-DCC model yielded the following correlation summaries between inflation and gold futures (as opposed to equities) pictured below.


As we can see, the correlation table reflects the idea that gold futures have a robust, positive correlation with inflation, strengthening the case for gold as a hedge against inflation. Equities fail to exhibit a similarly strong connection over the same time spans.

*The thesis project will be linked and cited properly at the bottom of this page.

Bitcoin, as opposed to gold, has only been around for just over a decade. BTC's price has soared to new heights during 2021, reaching a cost of more than $68,000 per token, yet has seen large price swings and overall volatility throughout its emergence this year. Similar to gold, there is a limited supply of Bitcoins, with about 21 million tokens that are in circulation currently, which represents about 90% of all potential BTC. According to current estimates, the last Bitcoins will be completely mined by the year 2140. Whereas gold has been an accepted financial instrument for inflation hedging, many investors still are very skeptical about Bitcoin and consider cryptocurrencies to be too volatile.

However, many institutional investors have started to accept cryptocurrencies as a viable tool for decentralized finance but also as an inflation hedger. JPMorgan stated in an October report that Bitcoin is "looking more and more like the new gold," among other funds that claim to own some coins.

As inflation surges to 30-year highs, deciding between BTC and gold as which to invest in purely comes down to your investment philosophy and values. If you believe that cryptocurrency is merely a fad and that gold, which has stood the test of time, will continue to work as a hedge against inflation, then prefer to invest in gold. If you believe that cryptos such as Bitcoin are the future to further freedoms and that volatility is just a small bump on a long road to riches, then invest in BTC. Yet, if everyone adopted the idea that gold was to be held forever in regards to hedging against inflation, we most likely would be unable to see the technological innovations in the current world with regards to currency, macroeconomics, and banking. The failure of the gold standard after centuries of "golden" success earlier in American history should stand to uphold the following idea: history teaches us that the future is truly unpredictable.




Sources:

1. Mehta, Krish. “Gold and Equities as a Hedge Against Inflation.” NYU, 2019,https://www.stern.nyu.edu/sites/default/files/assets/documents/Alec%20Winshel_Thesis_NYUNY_%20Honors%202020_1.pdf.

2. Quiroz-Gutierrez, Marco. “Bitcoin-Not Gold-Is the New Inflation Hedge, Says JPMorgan.” Fortune, Fortune, 11 Oct. 2021, https://fortune.com/2021/10/08/bitcoin-not-gold-is-the-new-inflation-hedge-says-jp-morgan/.



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