Is Gold a Hedge Against Inflation?

Gold’s price behavior is a reflection of a built-in perception of uncertainty and nervousness regarding all currencies and the current global socio-economic state. From a low of $250 in 1999 to the current price of about $1400 per troy ounce, gold is the only perceived store of value that investors have come to accept. The inverse correlation to the dollar that has somewhat held true for quite a while — gold and dollar values move opposite of each other — has been lost as of late, and the metal has risen on days when the greenback lost against all other currencies.

From a supply and demand perspective, consumption by the precious metal major market – retail jewelry — has declined, according to the World Gold Council, an organization funded by the world’s leading gold mining companies. Total gold demand in the second quarter of 2010 rose by 36%, largely reflecting strong gold investment demand compared to the second quarter of 2009. In Dollar terms, demand increased 77% to $40.4 billion. However, global jewelry demand declined 5% from one year ago despite China’s increase of 5%. In India, the largest retail market in the world, had a decline of 2%. The key driver behind the spike in price is due to investment demand with an astonishing 118% increase from last year, with the largest growth coming from the Exchange Traded Funds segment, which registered 414% growth. It is starting to look like oil between 2007 and 2008, but when many thought that oil was high at $100, it proceed to shoot up to $150, before it fell.

Why gold and not something else? Rarity, acceptability, usability, portability, and liquidity. But isn’t gold a hedge against inflation? Never was and will never be. It’s a hedge against instability, and a consensus exists that gold, for lack of a different asset, is the asset to hold due to the uncertainty that surrounds the markets, which are affected by the constant flux of less than clear economic policies at home and abroad. Positive consumer sentiment in conjunction with easy credit, cause inflation, and if inflation was the issue, the value of hard assets, such as land and housing, would be rising – and that is not the case.

I know about the guy that goes on TV and shows a shrinking dollar and then adds the dramatic clink-clink sound of security to the message. Oh, and he has been in gold for 10 years, except that ten years ago he forgot to mention it, when prices were a lot more accessible. But doesn’t your dollar buy you more house than it did in 2007? And by the way, the unscientific milk index has dropped from around 4$ a gallon in 2008 to the latest special of 99 cents for the same jug. Meanwhile, the price of gold is still rising, completely oblivious that inflation is not around – but global instability is.

Unfortunately, the rapid rise in the value of the commodity has attracted less than scrupulous operators, that rely on misinformation to trick the public into buying their inventory of extremely over priced gold coins, and many unsuspecting individuals are being taken to the cleaners. Whether the value of gold will rise to the stratosphere is an unknown, and I wouldn’t bet on a price level of any kind. Thus far, the price appears poised for further gains, but once the economic future of the major global players is well-defined – whether it is a positive or negative outcome – gold prices will subside because certainty will clear the air, even if sovereign default is the end result. Ultimately it’s only a commodity.

Lastly, gold cannot be money because the supply cannot grow at will to keep up with population and productivity. Only its value can change — up and down — relative to currencies, and the mining market supply coupled with demand from investment, industrial, and retail markets will determine the valuation. Shouldn’t platinum be money? The higher value of about $350 over gold, would translate into lower storage costs for Central Banks and everyone else. How about rhodium at $2,300 per ounce, a member of the platinum family?

The first gold coin used as money was the ‘florin’, minted by the Republic of Florence in the 13th Century, now modern Tuscany in Italy. Yet gold had been around for a little while longer. Gold was also used as money in Rome way before then, but since the mines were in North Africa, the metal lost its appeal as currency due to supply issues, and silver was used instead. In addition, gold is impractical to use as money because an extremely small one gram coin, if in existence, would be something less than 1/16 inch in diameter, and would be worth over $40 at today’s price. Do I have to buy 20 loaves of bread at a time? Let me pay you with this tiny golden speck.

Gold offers opportunities as an investment, much like other commodities, just not for the reasons that are commonly given. And silver has outperformed gold over the last 10 years.

Author: Carlos X. Alexandre
http://seekingalpha.com/article/236312-is-gold-a-hedge-against-inflation-not-really?source=feed