Is gold the ideal inflation hedge? As central banks fight to devalue their currencies and raise inflation, can gold protect investors against inflation?
LONDON, Jan. 31, 2013 /PRNewswire-iReach/ -- The Inflation Hub (http://www.inflationhub.com) is an educational website that aims to help people learn about inflation and how best to protect their savings in an inflationary environment.
The Central banks of the world's biggest economies are all in a 'battle' to devalue their currencies. By 'printing' enormous quantities of money through quantitative easing, central banks are aiming to debase the value of their currency and therefore increase the competitiveness of their industry overseas. This should drive (a little – they hope) inflation which should motivate consumers to spend and invest. That is the theory.
In practice, however, this is a very risky attempt to manipulate the value of fiat currencies, which could lead to a severe currency and inflationary crisis and consumers lose faith in the value of paper money. In this environment gold could prove to be the ultimate hedge.
A popular topic and a good place to start is to look at gold and whether it can provide a useful hedge against inflation. Let's take a look at some positives and negatives on gold.
1). Gold has been a safe store of value in periods of high inflation
There is no denying that gold has fulfilled its role as a store of wealth for the last 2500 years. The gold in an aureus coin of the B.C. Roman Empire would purchase approximately the same quantum of commodities, labour, or fixed property today as it could then. No fiat currency ever introduced, even if all interest paid on it had been re-invested without taxation, has come close to passing that test over any extended period.
2). It has been used as a form of exchange and currency for millennia
The history of Gold as money in modern coin form spans 2630 years. The earliest known use was in 643 B.C in Lydia (present-day Turkey). Gold was part of a naturally occurring compound known as electrum, which the Lydians used to make coins. By 560 B.C., the Lydians had figured out how to separate the gold from the silver, and so created the first truly gold coin.
3). Gold is easily transported
Property and land are real assets that should theoretically retain their purchasing power relatively well over economic cycles. However, one would struggle to carry their property across borders. Due to the heavy nuclei in its atoms which are closely packed, gold is a heavy precious metal and therefore one doesn't need a huge amount of it to be carrying a very valuable cargo.
The traditional gold bar stored by central banks, weighs 400 troy ounces (438.9 ounces of 12.4kg) and can therefore easily be carried, is worth about $660,000 at today's gold price.
4). Gold cannot be printed
The price of gold is determined by supply and demand. While demand for gold is impossible to predict, one should assume that in times distress, demand for quality assets should rise. Supply of gold, on the other hand, is a little easier to predict given there is a limited quantity of it on our planet and we are restricted by how much we can extract from the earth. It's supply therefore should remain reasonably constant.
1). Gold does not provide a yield
While property, stocks and inflation linked bonds can provide a yield through rental income, dividends or interest payments, gold provides no yield.
This is true in most environments, but with today's ZIRP (zero interest rate policy) world, even yielding assets produce very little income. Some, such as inflation linked bonds, even give a negative yield!
2). The gold price is volatile and in periods of low or negative inflation it can be subject to severe draw-downs
Gold's 30-day standard deviation over the last 10 years has averaged 10% vs. 12% for global equities. The peak for gold volatility was in October 2008 when it peaked at 56%, although during that period equity volatility peaked at 82%.
The issue with volatile assets is that they can be subject to severe draw-downs and gold is no exception. The worst draw-down ever in gold was between September 1980 and August 1999 when it lost 62%. Had someone bought at the top in 1980 it would have taken them 21 and a half years to recoup their initial nominal investment.
Most commentators take very extreme views on one specific asset for an all in or out approach. That is definitely the best way to make (or lose!) a lot of money in short periods of time, but for sensible investors the key is to diversify into a number of asset classes and adapt the weighting to these as the economic cycle develops. Gold is not a guarantee for success and will be subject to severe draw-downs again in the future. However, at this juncture in the economic cycle, with uncertainty at every corner and central banks fighting to debase their own currencies, the asymmetry seems to point very much in favour of owning a portion of one's assets in gold.
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SOURCE Inflation Hub