Why is Gold a Great Hedge Against Inflation ?
Broadly speaking, inflation is the rate at which prices of goods and services rise while the purchasing power of consumers falls. When inflation rises, consumers will have to part with more money to purchase the same goods and services. For instance, an inflation rate of two percent translates to $1.02 for a product that costs $1 earlier .
Although there are many precious metals that an investor could buy, 24 carat gold is by far the most popular. The reason this gold is so popular is because it is one of the most reliable hedges against inflation. According to figures published by the World Gold Council, the value of gold has appreciated from $20.67 in 1900 to the current price of $1,371. In comparison, major currencies such as the Japanese Yen, US dollar, and Sterling Pound have all lost value over the same period.
A study commissioned by the World Gold Council (WGC) and carried out by Oxford Economics found that gold is a great hedge against inflation because it has certain properties that set it apart from other precious metals .
Gold does not degrade regardless of the passage of time. Gold mined hundreds of years ago is the same as gold mined this year. Investors can use it as a store of wealth without worrying about its physical integrity.
The supply of gold is almost constant and annual production is unlikely to change by much in the coming years or decades. This means that the price of gold is largely immune from supply constraints experienced by other precious metals .
The amount of gold used in the manufacturing industry is relatively small compared to other precious metals such as platinum and silver. In fact, another report published by the WGC (Gold Demand Trends) shows that industrial use accounts for 10% of annual gold demand. The rest goes towards satisfying investment and jewelry demand. This unique characteristic unhinges the value of gold from inflationary forces associated with world economic cycles.
Other precious metals such as silver and palladium are not as lucky as gold. A study carried out by C. Lawrence and published by the WGC found that such precious metals tend to have a positive correlation to economic cycles of major industries or countries.
Gold does not deliver a yield such as government bonds or equities. As a result, investors are likely to buy gold because it has a low default risk. In addition, the opportunity cost of buying and holding gold rises as interest rates increase and vice versa. A clear example of this is the modest inflation and near zero interest rates experienced in 2012 that pushed the price of gold to new highs .
The price of gold tends to rise when inflation rises. According to figures published by Blanchard, gold averaged a return of more than 130.4% during years when inflation was high. This includes in 1946, 1974, 1975, 1979, and 1980. Investors who stuck with the stock market saw the value of their investments plummet by -12.33% over the same period. All these characteristics make gold a great inflation hedge .
Gold remains one of the best precious metals one can use to hedge an investment portfolio against inflation. Gold excels because it has a negative correlation to the world’s economic cycles, does not degrade over time, does not deliver a yield, and its value rises as inflation rises.