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Gold

Is gold a good hedge against inflation?

Katya Stead
Financial Writer
Jun 12, 2023
When inflation and interest rates rise, gold is arguably the most famous safe-haven asset that traders and investors turn to. In this article, we’ll look at reasons why gold has this reputation, the pros and cons of using gold as a hedge against inflation and other markets used for hedging when inflation spikes.

Why is gold considered a hedge against inflation?

Gold is always popular with traders, but it really shines when markets are volatile and uncertain. It tends to hold its value during times of economic hardship because it is considered a safe-haven asset that investors can turn to for shelter from the storm. But why?

Unlike other assets, gold is not tied to the performance of a particular company, government, or currency. Instead, it is valued for its intrinsic properties, such as its scarcity, durability, and non-corrosive nature. During times of economic uncertainty, investors often flock to gold as a store of value because it is seen as a hedge against inflation and a way to preserve wealth in the face of market volatility. As a result, gold prices tend to rise when other asset classes, such as stocks and bonds, are falling. They’re also loved by traders, due to plenty of opportunities to go long and short on the versatile precious metal.

Historical performance of gold versus inflation

Gold has a long and storied past of doing well when inflation is high. The last hundred years have had several examples of this:

  • Germany experienced hyperinflation in the 1920s after the Treaty of Versailles, when gold was sought-after for wealth preservation and outperformed other asset classes.
  • The U.S. experienced high inflation due to the oil crisis in the 1970s. Gold did significantly better than stocks and bonds during this time.
  • During the 1980s, many Latin American countries experienced high inflation due to external debt problems. Gold outperformed other asset classes such as stocks and bonds in this period too.
  • During the Covid-19 pandemic, gold mining and production in countries such as South Africa halted or was reduced greatly. This, combined with general uncertainty, drove the gold price up.

Factors affecting gold’s performance as a hedge against inflation

There are several factors that can affect the performance of gold as a commodity when inflation is high. But generally, the overall level of economic uncertainty and market volatility can drive investors towards safe-haven assets like gold, which can increase its demand and price.

  • High inflation leads to decreased purchasing power of currency, which may increase the demand for gold as more look for useful hedges against inflation – including gold. So, the level of inflation itself can have a direct impact on the demand and price of gold.
  • Changes in supply and demand, such as increased mining production or decreased consumer demand for jewellery, can also impact gold’s performance and popularity as a hedge.
  • Central bank monetary policies, such as quantitative easing or tightening, can also influence the gold price, which can affect its popularity as a hedge against inflation.
  • When geopolitical events, especially unexpected ones, create a feeling of uncertainty and volatility in the markets, investors and traders tend to look for assets which are traditionally considered.
  • The strength of the U.S. dollar can also impact the performance of gold as an asset class when inflation is high, as gold is often priced in dollars and a weaker dollar can lead to a higher gold price and increase demand for gold.
  • The other key factor that affects gold’s performance as an inflation hedge is the availability of alternatives. While gold has traditionally been viewed as a safe haven asset, other assets such as certain types of bonds, real estate and precious metals such as silver, palladium, and platinum may also provide protection from inflation.

Pros of trading in gold to hedge against inflation

There are certainly reasons for gold’s long standing reputation as an inflation hedge. Here are just some of the advantages of investing or trading on gold during times of tight monetary policy:

  • Because gold tends to be associated with good returns during uncertainty, the gold price tends to perform well simply due to market sentiment in these periods, often becoming a self-fulfilling prophecy.
  • As a precious metal and commodity, gold’s price responds well to any market conditions that cause scarcity (for example, delays to production in a large gold mining company) due to the laws of supply and demand. This means that many economic conditions that can cause inflation can also cause surges in the gold price.
  • Also, gold is useful as a diversification for any investor or trader in order to better manage and spread their risk.

Cons of trading on gold to hedge against inflation

  • Gold can be a volatile market to trade, meaning that there is always a risk of loss.
  • Some asset classes can be a source of income, for instance rental-producing real estate for property owners or dividend-paying shares for investors. Gold, on the other hand, doesn’t offer any income generation.
  • In addition to this, purchasing gold can be a complicated and costly process in terms of storage and security for your shiny new asset.
  • That being said, trading on gold rather than investing in it removes the downsides of storage and security for the gold, as you won’t be purchasing any gold outright but instead be speculating on the gold price itself. With Pepperstone, you can trade on the spot gold price, as well as several other gold markets and more than 1100 other instruments, with CFDs.

Learn more about CFD trading Learn more about how to trade gold 

Comparison: gold versus other inflation hedges

Gold has been a go-to asset for hedging against inflation for centuries, but it is far from the only option. Other assets such as property, bonds, cryptos and certain commodities can all be used to protect portfolios from inflation-induced losses.

Let’s look at two examples to see how gold measures up compared to other hedges against inflation:

Property

During times of high inflation, real estate values tend to rise, and rental income increases, providing investors with a steady stream of income.

Real estate has unique advantages, such as tax benefits and diversification. Property also has the potential to generate income, while gold does not. However, property prices are also subject to market fluctuations and economic downturns, as seen during the 2008 financial crisis for example, when real estate prices plummeted.

In terms of returns, gold has outperformed real estate over the past 100 years as a hedge against inflation. According to data from the World Gold Council, gold has returned an average of 7.7% per year since 1971, while U.S. real estate has returned an average of 4.1% per year over the same period.

TIPS

Treasury Inflation-Protected Securities (TIPS) are a type of bond that is issued by the US Treasury to protect investors from inflation, which have been available to investors since 1997. TIPS work by adjusting their principal value to keep pace with inflation. This means that as the Consumer Price Index (CPI) rises, the principal value of TIPS increases. As the CPI falls, the principal value of TIPS decreases. In this way, TIPS provide protection against inflation.

The performance of TIPS can be measured by their real yield, which is the yield adjusted for inflation.

Between 2000 and 2011, the US experienced an average annual rate of inflation of 2.5%. During this period, TIPS provided investors with an average annual real return of 5.2%. Gold, on the other hand, provided an average annual return of 10.2% during this period.

However, there are some important differences between the two. Gold is a physical asset that can be held and stored, while TIPS are a financial instrument that can be bought and sold on the open market. Gold is also more volatile than TIPS, which means that it can experience larger price swings in the short term.

Cryptos*

In the past 15 years, cryptocurrencies have emerged as a new asset class that some view as a potential hedge against inflation. Bitcoin, for example, was created in 2009 and has experienced significant price fluctuations since then. In 2017, its price skyrocketed from around $1 000 to nearly $20 000, only to crash to around $3 000 in 2018. Since then, its price has risen again, reaching over $60 000 in 2021.

While some traders and investors see cryptocurrencies as a viable hedge against inflation, others remain sceptical due to their high volatility and lack of regulation. Cryptocurrencies are not tied to any government or central bank, nor are they regulated by them, which can make them more susceptible to market manipulation and unexpected price swings. Additionally, many cryptocurrencies have yet to gain widespread adoption, which can limit their usefulness as a hedge against inflation.

How to trade on gold as a hedge against inflation

  1. Study how inflation affects the markets and the gold price rigorously
  2. Choose a reputable broker like Pepperstone that offers the gold markets and trading instruments you want to use to hedge using gold trading
  3. Create an account and fund it to get started
  4. Open your first live trade on the platform
  5. Set up and take profit orders to maximise your risk management
  6. Observe your gold trade’s progress and close the position when you’re ready

Conclusion:

  • Gold is famous for being a safe-haven asset class, often used by traders and investors to hedge against inflation.
  • That’s because its value is less dependent on other markets as it’s prized for its intrinsic properties, such as its rarity, usefulness, durability, and more. It has several examples across hundreds of years of being a powerful hedge against hyperinflation and inflation.
  • However, other effective hedges against inflation do exist. Two examples of these are real estate and TIPS (United States bonds named Treasury Inflation-Protected Securities).
  • You can hedge your existing positions by trading on gold with Pepperstone on platforms like MT4, TradingView and cTrader.

Footnote: *Cryptocurrencies are not available for trading across all entities and/or classifications. Please check with our Client Services team via phone, email or live chat, whether or not they’re available for trading in your region.

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