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Gold as a Hedge Against Inflation

by Jeremy Holcombe

Inflation seems to sink in when goods are expensive and above reasonable prices. During these times, investments with debt and equity are not preferred, as there is fear among the investors. What they are afraid of is buying the asset at a higher price and circumstances lead it to underperform. Historically, during high inflationary periods, gold has performed well. It is during deflationary periods that it sinks lower.

In late 2000, a global boom in commodity and expansion pushed gold to new heights, but as the recession took hold in 2008, there was an evaporation of inflation and the price of gold retreated with every other type of asset on the planet. Then in 2010-2011, investors were driven back into the safe haven of gold and this took gold to all new highs.

Governments all over the world have been printing money as quickly as they can and filling their economies with dollars, providing effective support to the economy until the private sector can do so itself, but as long as socialized medicine is the norm, high taxes rule the day, and the private sector is going to be dormant.

Gold as an Inflation Hedge

Recent research from the World Gold Council (WGC) shows that compared to other commodities, oil and gold retained their value over the long term. Over the last five decades, their relative prices have remained constant. As mentioned earlier, gold tends to increase in an inflationary environment and does not do well during low inflation periods. It is highly effective in countries with high inflation rates and negative real interest rates. This causes savings to become unattractive. India is an example of such a country.

A long-term horizon is required with gold so that it can match the inflation pace. There are other important short term variables like the real interest rate and the confidence that people have in the economic outlook. Due to these variables, gold prices could run ahead of inflation or vice versa.

Gold and inflation may not have a linear relationship. However, gold is probably a better investment than most of the alternatives available. It provides portfolio protection against inflation. This also helps gold stocks like Goldcorp Inc. (GG), Newmont Mining Corporation (NEM), Barrick Gold Corp. (ABX), Yamana Gold (or AUY), AEM or Agnico-Eagle Mines and ETF i.e., exchange-traded funds like the Gold Miners Index (GDX)  and the SPDR Gold Trust (GLD) in an inflationary price environment.

Why Gold is the Best Option

The uncertainty in the current global economy has dampened investment returns from different asset classes. Moreover, with rising inflation levels across the globe and a fuel price surge, more investors are looking at gold as an investment that can provide value and safety to their investments.

Although there could be continuous debate about whether gold could be a hedge against inflation, with some arguing otherwise, because they feel an inflation rise would also result in a gold price spike, it is crucial to remember that the precious metal, unlike other commodities that are used for production and consumption purposes only, is money (wealth).

When it comes to the premier store of wealth, nothing can beat gold and even though it is no longer the official currency, this fact remains unchanged. And it is especially during economic crises and periods of high inflation that buying power or an effective preserver of wealth is required.

Inflation and Gold

As in the case in Zimbabwe which is under a period of hyperinflation, if inflation were to run its full course, the only asset that is bankable would be tangible assets. Paper currency could end up not having any worth as well as debt denominated in that currency. This means that prices in terms of paper currency would also be absolutely meaningless. The prices of all assets are then based in terms of other assets, in particular those with monetary properties.

Due to the fact that they have more use in asset exchange transactions, these assets will trade at a premium. In situations like these, the perfect hedge against inflation is gold. Even if an investor has just one quarter of investments in gold, they gain the ability to make up for their other investments that are unable to keep up with inflationary trends.

In their bid to spur growth in their economies, the world’s major economies are currently still competing in currency devaluations. This is still a majestic time to buy gold as a way to protect wealth. Since its steep increase of more than $1,900 in 2011, the price of precious metals have significantly come down. No matter what many say, gold has proven to be an effective hedge against inflation, thus making it one of the best investments you could make.



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