Are Commodities an Effective Inflation Hedge?

People seem to think commodities (especially gold) are suitable guards against inflation. They are often touted as an effective tool for protecting wealth from rising prices. However, history has shown that using gold and other commodities to offset inflation poses significant challenges.

Commodities differ from a lot of other strategies you hear about in one important way: they are, as their name indicates, commodities, which means they are standardized, interchangeable goods. Commodities are just things that don’t produce any value in and of themselves. They’re like a ceramic cat sitting on the shelf. Yes, they’re valuable, but they don’t create new economic activity. If the market is a pie, commodities are already baked in there, and they are not going to make the pie any bigger.

This is fundamentally different than investing in a company. Companies are going concerns, meaning they create economic value (or at least try to). They have the capacity to increase the size of our market pie through expanding business, a good year, or other value-adding factors.

In practical terms, because commodities are merely physical goods, this means that the long-term expected return of commodities is inflation. But what gets people excited about commodities is their massive volatility. That may seem counterintuitive since generally, you don’t want to add any more volatility into your portfolio than you need to. That volatility means that commodities will occasionally experience huge returns, and those returns will sometimes align with poor returns in other asset classes. But they also have some truly abysmal years to bring the long-term returns back down to Earth. This isn’t a very good recipe to offset something that moves as slowly and steadily as inflation.

 

Inflation and Commodity Data from 2/1991 - 3/2025

Data provided by Dimensional Fund Advisors. Indices are not available for direct investment. Past performance is not indicative of future returns.

Over a long-term period (roughly thirty-four years), Inflation and Commodities have roughly the same return, but materially different levels of volatility. When looking at the standard deviations, commodities are bouncing around like the S&P 500 Index without providing additional return in exchange for that volatility. Ultimately, investing in commodities adds a massive chunk of risk to your portfolio, but none of the payoff offered by the equity markets.

Commodities are even worse inflation hedges for retirees. At any given time, you could be on the wrong end of inflation. If you’re spending from your portfolio (as retirees often are), you are locking in potential losses when you sell assets to create income.

What Better Tools Are Available?

You don’t want to let inflation steal your portfolio’s purchasing power, but commodities clearly aren’t the answer. So, what should you try instead?

There are two main options:

1. You can either directly hedge some of your inflation risk with TIPS, which are US Treasury securities that adjust based on what inflation has been doing, or
2. You can go the indirect route by investing in securities that have higher expected returns than inflation.

Both options can be effective, depending on your specific situation. Your advisor can help you figure out which option makes the most sense for you. As always, the most important thing is to stay disciplined and stick to your financial plan.