Is gold a good inflation hedge?

The selling point of gold is that is a hedge against inflation as it maintains its value unlike fiat currency. The global inflation has soared this year but why isn’t gold rising after it peaked last March? What could that possibly mean?

The price of gold is expressed in dollars. While it is true that inflation has occurred in many other currencies except for yen, the dollar has grown stronger. Maybe because inflation is much higher in other currencies.

For instance, EUR/USD is trading below the parity its lowest level after 20 years. Compared to the dollar, the euro has declined by nearly 13% which is far more than the previous record of 8.9% annual inflation. It has lost its value on a yearly basis by roughly 17%. Even with the worst inflation in the common currency, that represents a net benefit of roughly 8% for everyone who maintained dollars during the past year. 

What does this mean? It means that there is no need to buy gold to protect themselves from inflation. Buying a dollar and holding it is a better alternative than putting your money in the bank that loses its value. This goes to show that the price of dollar has great influence in the price of gold.

Looking back, gold rallied early this year due to the geopolitical tensions between Russia and Ukraine. The Fed already started raising rates that time and since monetary policy takes time to see its effect, the inflation was expected to increase for the time being.

However, at some point, Fed will be able to keep inflation under control which means inflation will eventually go down. More importantly, interest rates are anticipated to continue to rise which means that even if inflation is high, dollar holders may expect to see their returns rise as well. In contrast, neither dividends nor interest are paid on gold. As a result, the price of gold will continue to go down.

Gold acts as a hedge to inflation when investors have given up on the central bank’s ability to fight inflation. Unlike the 1970s, when we saw gold rise with inflation in the US, this is now a global problem. Therefore USD strengthening from the Fed’s being the most responsive will make it difficult for gold prices to rise.

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