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Is Gold an Inflation Hedge?
W W W. G O L D R AT E F O R T O D AY. O R G
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1. Gold is often regarded as a perfect inflation hedge
2. Let’s discuss this issue by answering the following four
questions: 3. First, what is inflation
4. Second, what are the reasons for inflation?
5. Third, is gold an effective hedge against inflation?
GOLD AS INFLATION HEDGE
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Definition and Measurement of Inflation
1. Inflation is an increase in prices for goods and services of an
economy over a certain period
2. In the United States inflation is mostly measured as an annual
percentage increase of the Consumer Price Index (CPI)
GOLD AS INFLATION HEDGE
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1. This index is reported monthly by the US Bureau of Labour
Statistics and takes into account the price for a basket
of goods
2. If the money required purchasing these good
increases from $100 to $125 within one year, then the annual
inflation rate is 25%
GOLD AS INFLATION HEDGE
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1. Of course, the CPI basket of goods does not correspond with the goods and services acquired
by each individual
2. Therefore, the ‘personal inflation rate’ is lower or higher
than the official one
GOLD AS INFLATION HEDGE
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Reasons for Inflation
1. There are four major theories trying to explain inflation, all
with its advantages and downsides
GOLD AS INFLATION HEDGE
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Quantity theory1. This theory was refined by Friedman and other University of Chicago economists (Chicago
School)2. It states that the price levels
are controlled by the money supply
3. Therefore, if the money available in an economy goes
up, prices for goods and services will also rise
GOLD AS INFLATION HEDGE
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Keynesian theory1. Keynes tried to explain inflation
with the theory of income determination
2. Inflation does not directly influence prices
3. It arises because consumers attempt to buy more goods and
services than that can be supplied at full employment
levels
GOLD AS INFLATION HEDGE
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Cost-push theory1. This third approach assumes
that products and services are basically defined by their costs2. The price-wage spiral is responsible for this increase
3. Here employers demand higher wages, which will then lead to higher production costs and
eventually pushes again wage increase demands
GOLD AS INFLATION HEDGE
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Structural theory1. One version of this theory proposes focuses on developing
countries2. Here, inflation is caused by the
gap between imports and exports
3. Imports happen fast than the country’s citizens are able to
pay for them4. Also, imports outcompete local
goods5. This leads to an increased pressure on the local currency
and an upward pressure on prices, which is inflation.
GOLD AS INFLATION HEDGE
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Gold as an inflation hedge1. First, gold supply has been
quite stable over time2. In average, mined gold
increased by 1.5% over the last 100 years (including several
times during which gold output increased due to wars and a
reduction of demand for gold)3. The finite amount of gold helps
to keep the annual addition of gold at low levels
GOLD AS INFLATION HEDGE
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1. Second, during the gold standard, when the currencies where pegged to gold and their
value was determined by the amount of gold the countries had in their vaults, national
inflation increased usually by not more than an annual two
per cent2. (However, a comparison of the
gold standard time with the post gold standard period is invalid if only the different
monetary system is considered.)
GOLD AS INFLATION HEDGE
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1. Third, due to inflation, all currencies lose their value over
time2. This becomes evident when
comparing the purchasing power of $100 dollar today, with ten, 50 and hundred years ago.
3. However, gold retains its value, or even increases it.
GOLD AS INFLATION HEDGE
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1. The value of gold has remained remarkably stable for centuries
2. In 1900 the gold price stood at $20.67 per fine ounce
3. End of December, the price was above $700 per ounce
4. And in the first quarter of 2011 gold has reached a record of
$1500
GOLD AS INFLATION HEDGE
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1. Another illustrative example is to see what one can buy for one
ounce of gold2. During Roman times it was
possible to buy a suit of expensive clothes for one ounce
3. During the great depression the same was true. How is it now?
4. It is still possible to buy a fine, tailor-made suite for one ounce
of gold!
GOLD AS INFLATION HEDGE
W W W. G O L D R AT E F O R TO D AY. O R G
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Relative to gold, all currencies have lost their purchasing
power, whereas this precious metal has not only kept, but
even gained value
GOLD AS INFLATION HEDGE
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1. What is the downside of gold? Of course, gold neither pays
dividends nor interests and the might be better inflation hedges (depending on the criteria taken
into account)2. Also, a look at the gold chart shows that gold does not always
increase in price3. There are some bearish periods
as well
GOLD AS INFLATION HEDGE
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1. Gold plays with fear2. Pessimistic people buy gold3. The more pessimistic people get, the higher the value of gold
will rise
GOLD IS INFLATION HEDGE
W W W. G O L D R AT E F O R TO D AY. O R G
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Or as Warren Buffett put it aptly
“Gold is a way of going long on fear, and it has been a pretty good
way of going long on fear from time to time. But you really have
to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t
produce anything.”
GOLD AS INFLATION HEDGE
W W W. G O L D R AT E F O R TO D AY. O R G
2020
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