In focus

Tug of war: how multi-asset investors think about gold

Gold is often thought of as a hedge against everything. For thousands of years, it has been seen as a safe haven, and since the dawn of paper money, it has been seen as the ultimate currency.

In an extreme doomsday scenario, gold may well be an effective store of value, but the nagging reminder that our money is really just paper is closely linked to the fear of inflation. Hence the popular notion that gold is an inflation hedge.

Gold is in the middle of a tug of war

But it’s not as simple as that. We view gold as being subject to a tug of war between two key variables. Since gold doesn’t pay any income, the income available on other ‘safe havens’ is effectively foregone by owners of gold. The prevailing nominal interest rate available in the market, then, is a measure of the opportunity cost of holding gold.

If nominal interest rates go up, gold is less attractive and its price goes down, all else equal. So nominal interest rates are on one side of the tug of war. On the other side of the tug of war is inflation.

We don’t disagree with the notion that paper money is subject to erosion of value over time. So we too expect that as inflation goes up, demand for gold and its price should go up, all else being equal. So the price of gold is subject to a tug of war between nominal interest rates and inflation (Figure 1).


We can see this tug of war in the data. Figure 2 has two panels: one showing the relationship between gold and nominal interest rates, and the other showing the relationship between gold and inflation. We use 5-year interest rates and inflation rates to smooth out any short term fluctuations. 

A relationship is evident in both charts, but neither one is a strong fit.



Clearly it is not just one of the above variables driving the gold price, but a combination of the two. Combining nominal interest rates with inflation gives us the real interest rate. Looking at the relationship between real interest rates and gold gives a much better fit (Figure 3).


All in all, gold is an effective hedge against inflation when inflation is rising more rapidly than nominal interest rates are rising. If interest rates are rising more sharply, the impact of the increasingly negative opportunity cost of holding gold overwhelms the inflation hedging benefit – hence the tug of war.

Gold is unreliable as a hedge against equity risk

Neither is gold a particularly reliable hedge against equity risk. In some environments, gold actually moves in the same direction as other risky assets such as equities. The environment that prevailed in 2020 is a good example.

The relationship between real interest rates and equities is what drives gold’s relationship with the latter, given gold’s strong link to the former. Since gold is strongly linked to real interest rates, the link between gold and equities will be driven by the relationship between equities and real interest rates.

Since equity markets reacted favourably to central bank stimulus, which drove interest rates lower and inflation expectations higher, equities have been negatively correlated with real interest rates. This is why gold has been positively correlated with equities.

This is not always the case, as Figure 4 shows. But such behaviour does warn us against relying on gold to hedge us against the next equity market drawdown. The next market fall may well be driven by a rise in real interest rates (either because of a collapse in inflation expectations or a rise in nominal interest rates).


It is tempting to try and explain the behaviour of gold using the economic cycle, but we find a loose relationship at best. Every economic cycle is different; inflation and interest rates at a given stage in one cycle behave differently to the same stage in another cycle. What holds true across cycles, however, is the relationship between gold and real interest rates.

Framing this another way, we look back at history and measure gold returns in the worst months on record for equity markets. Figure 5 shows that gold was not always a reliable hedge, and sometimes a terrible one.


Equities are not the only ‘risky’ asset, but when a substantial fall in equity markets occurs, it usually sends shockwaves across financial markets. Many readers will recognise the dates in Figure 5 and remember seeking the supposed safety of assets such as gold. Hindsight allows us to see that gold was not so safe after all.

In summary:

It is important to avoid complacency when making assumptions about the behaviour of gold. Gold is not a hedge against everything. It is subject to a tug of war between two variables which in combination give us a simple relationship: gold is negatively correlated with real interest rates.

Given the difficulty in valuing gold due its lack of cash flows, it can be helpful to keep an eye on the yield of inflation-linked bonds to form a view about the estimated value of gold.

After considering market pricing, sentiment, flows and relative value opportunities, multi-asset investors should choose whether to buy gold, gain direct exposure to real yields through inflation-linked bonds, or make room for both in their portfolios.

To find out more about how we use gold in our multi-asset portfolios at Schroders, please see our PDF below.