Must-know: Understanding gold price drivers (Part 3 of 12)
What is an inflation hedge?
Inflation is generally measured by changes in the Consumer Price Index (or CPI). It measures the general increase in price levels. It measures the fall in money’s purchasing power. An inflation hedge is basically an investment that’s expected to increase its value over a specific period of time.
Gold’s unique position compared to other commodities
Inflation usually impacts commodities that are tied to economic cycles. However, gold is placed uniquely compared other commodities that have a strong link to the economic cycles. Only ~10% of gold’s demand comes from industrial uses—the rest being jewelry and investment demand.
Gold as an inflation hedge
Recent research from the World Gold Council (or WGC) shows that gold and oil held their value over the long term—compared to other commodities. Their relative prices have remained constant over the last 50 years. Gold tends to go up in an inflationary environment. It doesn’t do well during periods with low inflation. It’s effective in countries where inflation rates are high and the real interest rates are negative. This makes savings unattractive. An example of such a country is India.
Gold needs a long-term horizon to match the inflation pace. In the short-term, there are other variables like the real interest rate and people’s confidence in the economic outlook. These variables could cause inflation to run ahead of gold prices or vice versa.
The above chart shows that the period from the 1980s to 2000 was characterized by declining gold prices. It’s also visible in the falling inflation levels. After this period, the inflation levels were volatile. However, gold continued to move forward. This was due to factors other than inflation—like the falling real interest rate environment.
So, gold might not have a linear relationship with inflation. However, it’s probably better than most of the investment alternatives available. It protects the portfolio against inflation. This also helps gold stocks like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), Agnico-Eagle Mines (or AEM), Yamana Gold (or AUY), and exchange-traded funds (or ETFs) like the SPDR Gold Trust (GLD) and the Gold Miners Index (GDX) in an inflationary price environment.
Visit the Market Realist Gold ETFs page to learn more about investing in gold.
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