Is Gold Really An Inflation Hedge?

Inflation is back, and that’s usually depicted as good for gold. But is the yellow metal still a hedge against inflation, or has something changed?

Inflation has returned. This is partly understandable. After all, during the Covid recession, consumers and businesses accumulated a lot of cash as their spending was reduced, while revenues were sustained by money transfers from the government. These funds are now entering the economy, which makes demand grow much faster than supply, thus boosting prices. After some time, supply may catch up, curbing inflation. However, there is an important risk that inflation will turn out to be higher and/or more permanent than many analysts believe.

From the fundamental point of view, gold should benefit from higher inflation. But why? In theory, there are several channels by which inflation supports the yellow metal. First, the inflationary increase in the money supply makes all goods and services more expensive, including gold. Indeed, the scientific paper by Lucey and others finds a reliable long-run relationship between gold and the US money supply.

Second, gold is a real, tangible and rare good with limited supply that cannot be increased quickly or at will. These features make gold a key element during the so-called flight into real values or into hard assets, which happens when inflation gets out of control. In other words, gold is the ultimate store of value which proved to hold its worth over time, unlike paper currencies that are subject to inflation and lose their value systematically.

Third, inflation means the loss of purchasing power of the currency, so when the greenback depreciates quicker than its major peers, the dollar-denominated price of gold increases. Fourth, when inflation is unexpected or when the Fed remains behind the curve and doesn’t hike nominal interest ratesreal interest rates decline, supporting gold prices.

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does ...

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