Investing in gold is a topic that’s been on a lot of people’s minds over the last several years, and there are very good reasons for that. The economy has been in the doldrums, the stock market continues to show significant volatility, and Congress has been unable to rein in government spending as of yet. With all this commotion, it’s no wonder that Americans are very confused about what role gold can play in their retirement plans. Hey, let’s be honest, you probably ended up on this page because you heard that investing in gold could help you achieve more security and long term growth as compared to other types of investments. Now, there is a ton of information to know about gold investing, and it’s impossible to cover everything in just one article, but let’s take a look at one important factor: gold prices and inflation.

There are many reasons why people choose to include gold in their portfolios, one of the biggest ones being the perception that investing in gold is a good way to hedge against inflation. Here’s the hard truth: gold and inflation are not perfectly correlated. What this means is that the changes in the price of gold are not always the same as the changes in the Consumer Price Index (CPI), which is the official measure for inflation in the United States. In fact, there are periods of time in history when gold couldn’t keep up with inflation, and you lost purchasing power holding this asset, just like there are periods in time when the increases in gold prices significantly outpaced growth in the CPI. For example, between January 2001 and January 2013, gold prices shot up by around 350%, while the Consumer Price Index went up only by about 31%.

But let’s take a look at a longer time period to really understand the relationship between the two. Take a look at the chart below, where the yellow line shows changes in average gold prices, and the red line shows changes in the average CPI. If the two were perfectly correlated, they would move in exactly the same direction 100% of the time, but as you can see, they do not! The most recent example is the period beginning around 2001, when gold and inflation begin to move almost in opposite directions.

Why does this happen? Well, there are several reasons. First of all, the official CPI calculations have a tendency to change over time. The federal government routinely changes these calculations, because even small adjustments in the formula can make a big difference for increases in Social Security benefits, and other government programs. Secondly, investing in gold means that you’re buying a commodity, and like any other asset, gold prices are affected by investor psychology. For centuries, all over the world, when economies faltered, gold became an asset of choice for those looking to preserve their wealth. During these times of uncertainty, the surge in gold investing can sometimes drive the price up more quickly than inflation, as investors anticipate the looming crisis – exactly what happened over the last decade, and the smart ones got on the gold band wagon early.

But just because investing in gold isn’t the perfect inflation solution, that doesn’t mean that it shouldn’t be part of your portfolio strategy. Think about it? What are your other options to investing in gold? Buying up canned food and storing it in your garage, so that you can sell it 10 years later? Buying up toilet paper, and holding on to it until prices rise? Or better yet, buying inflation-indexed treasury bonds… Bonds issued by the same government that’s been on a spending spree over the last 5 years, and printing money with seemingly little regard for what it will do for the value of the dollar?

When you look at your options for preserving your wealth, especially in the face of looming economic uncertainty, besides investing in gold and other precious metals, your options are fairly limited. You are forced to choose between either direct investment into physical goods, or buying securities that are based on the financial system – the same financial system that brought the U.S. economy to the brink just a few years ago, and caused hundreds of banks to fail.

So if you’re considering investing in gold to protect the purchasing power of your nest egg, it’s important to have a long term mindset. Short term investors who think that investing in gold will make them gazillionaires are in for a big surprise. The shrewd ones, those that do their research, are realistic about their expectations and understand how investing in gold can preserve and build their retirement assets, will have an upper hand in building wealth for their families. If you want to know more, stay tuned for our upcoming articles, where we’ll talk about investing in gold in more detail, and will provide you with useful information that will help you make better-educated decisions.