This year, both gold and Bitcoin have hit record highs, but their sharp rise did not start until long after inflation peaked in June 2022.
Concerns about inflation have suddenly flared up again, which is a bullish sign for inflation hedges like gold and Bitcoin. However, anxious investors should not overlook a simpler solution: stocks.
The Federal Reserve on Wednesday took its third rate cut action of the year, but lowered its rate cut expectations for 2025, sparking concerns on Wall Street, with the Dow Jones Industrial Average falling more than 1,000 points. The U.S. economy is still growing strongly, and inflation remains high, so while the Fed cut rates as expected, concerns about inflation are a key reason for the sharp rise in 10-year Treasury yields.
The prospect of persistent inflation can provide a "tailwind" for gold and Bitcoin, but the reality is much more complex than what the proponents of these assets would have you believe. Bitcoin and gold are considered inflation hedges due to their limited supply, which is not directly controlled by any government decision-makers: gold must be mined from the ground, and Bitcoin is "mined", with a fixed total supply.
In October, legendary investor Paul Tudor Jones told CNBC, "All roads lead to inflation... I'm long gold, I'm long Bitcoin." This video clip is still frequently shared by Bitcoin enthusiasts.
The argument for hedging inflation is very straightforward, but reality does not always match the theory. On Wednesday, concerns about inflation pushed up long-term interest rates, causing both Bitcoin and gold to fall.
Before the Fed's rate decision announcement on Wednesday, Bitcoin was trading near $105,000, but then fell sharply. According to CoinDesk data, Bitcoin fell to $98,000, and according to Dow Jones Market Data, gold fell 0.3% on Wednesday and another 1.5% on Thursday.
The long-term performance of these two assets has also been mixed. While both gold and Bitcoin saw gains and hit record highs this year, their sharp rise did not start until long after inflation peaked in June 2022, with gold returning -0.4% in 2022 and Bitcoin plunging 64%.
Why is this the case? Investors buy gold to protect their portfolios from inflation, but gold prices also reflect another counterbalancing force: interest rates. Since gold does not generate cash flow, its attractiveness relative to bonds declines when interest rates are high. To combat high inflation, the Fed has been steadily raising rates in 2022, so despite high inflation, short-term Treasuries are more attractive to investors than gold in the near term.
These dynamics may also be affecting Bitcoin's price, but it is almost certain that the biggest driver of Bitcoin's price is speculation. Bitcoin's brief history makes it more difficult to assess long-term price dynamics, but its price has largely followed the meme stock frenzy that emerged during the COVID-19 pandemic. The launch of Bitcoin ETFs this year, as well as the rising odds of a Trump victory in the presidential election supporting cryptocurrencies, have provided new "tailwinds" for Bitcoin.
Of course, even if Bitcoin and gold cannot serve as short-term or medium-term inflation hedges, they can still serve investors as long-term stores of value. The World Gold Council industry organization often says, "Gold has maintained its value for thousands of years."
However, if the investment horizon is that long, investors should consider investing in stocks, as simply keeping up with the rise in stock prices would suffice. In the short term, inflation may have a negative impact on stock market returns, as companies struggle to raise prices fast enough to keep up with rising costs, and the S&P 500 has not performed well this year, down more than 18% for the full year.
But over time, corporate profits will gradually adapt to inflation, and stock prices will rebound, just as they have over the past two years. From a long-term perspective, stock investors can also benefit from the profit growth that Bitcoin and gold cannot provide.
