Further to my last post Bullish signs for the inflation trade, I would also like to point out that Warren Buffett, in the latest Berkshire Hathaway letter to shareholders, also indicated that inflation is likely the effect of the macro policy response to the financial crisis (emphasis mine):

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.

Why are gold stocks underperforming?
The most obvious way to hedge against inflation and rising inflationary expectations is with gold and gold equities. However, gold stocks are not performing up to their potential in light of the relatively buoyant market for bullion.

The chart below shows the monthly ratio of the PHLX Gold & Silver Index (XAU) to the London PM gold fix. I also linked the Amex Gold Bugs Index (HUI) to the XAU price series to show the difference between HUI and XAU. While HUI has outperformed XAU, both gold stock indices have been lagging the price of bullion in the past few years. More importantly, gold stocks have not shown the same upside potential as they have in the past relative to gold.

Analysts have advanced several interpretations of the relationship as shown by gold stock to gold ratio.