Gold vs. the S&P 500: With Inflation at a 3-Year High, Which Does History Say Wins?

Rising energy costs and the Middle East conflict drove U.S. inflation to a three-year high in May. According to the Bureau of Labor Statistics, prices rose 4.2% over the previous 12 months, accelerating from its 3.8% increase in April. That pressure could force the Federal Reserve to raise its benchmark interest rates to throttle economic growth and tame inflation.

However, the S&P 500 is still trading near its all-time highs and looks historically expensive at 32 times earnings. Meanwhile, gold -- the conventional hedge against inflation -- has retreated about 24% from its record high of $5,589 per troy ounce in January.

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So is it smarter to invest in the SPDR Gold Trust (NYSEMKT: GLD), the world's largest gold ETF, instead of the Vanguard S&P 500 ETF (NYSEMKT: VOO), the top S&P 500 ETF? Let's compare their historical performance and see if gold can bounce back and outperform the S&P 500 over the long run.

Why are GLD and VOO reliable long-term investments?

Most major currencies, including the U.S. dollar, were once backed by gold. But today, they're all fiat currencies that are backed by public trust in the issuing government. Over time, fiat currencies lose their value because central banks increase the money supply and lower borrowing costs to stimulate economic growth.

Since gold is valued in U.S. dollars, those expansionary monetary policies make gold more valuable as the dollar weakens. That's why gold's spot price rose 655% over the past 20 years. Meanwhile, the same item that cost $1.00 in 2006 would cost $1.66 today.

The S&P 500, which includes the 500 most prominent companies in America, has risen 504% over the past 20 years. With reinvested dividends, it delivered a total return of 785%.

The S&P 500 is rebalanced every quarter, which ensures that only the strongest companies in America remain in the market-cap-weighted index. That's why most hedge funds still can't beat the S&P 500 over the long term. So if you expect the largest companies in America to continue growing, even as macro headwinds rattle the economy and the dollar loses its value, the S&P 500 is a good place to park your cash.

Should investors buy GLD or VOO today?

I consider GLD to be a more pessimistic investment, since it's a bet against the U.S. dollar, while VOO is a more optimistic play on the future growth of the U.S. economy. Both ETFs will be volatile, but I believe the S&P 500 (with reinvested dividends) will continue to outperform gold over the next few decades as the largest companies in America grow even larger.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.