At first glance, gold might not seem to be that great of an inflation hedge these days. After moving above $2,000 an ounce in March, the precious metal has lost ground even as consumer prices have risen at their highest pace since the 1980s.
Despite its short-term weakness, digging a little deeper shows why gold, an element that has transfixed humankind for thousands of years, can serve as a strong store of value over the long run.
“Gold has proved, over hundreds and even thousands of years, to be a reliable store of value,” says Fergus Hodgson, director of Econ Americas, a financial consulting firm. “In other words, whatever events happen, gold has a robust value that stays relatively consistent over time in terms of its purchasing power.”
Here are some factors to consider when looking to invest in gold as an inflation hedge:
— Why has the price of gold fallen recently?
— Demand for gold.
— Gold price history.
— How to invest in gold.
— Gold stocks and mining ETFs.
— Bitcoin vs. gold.
— Is gold a good inflation hedge?
— Is investing in gold a good idea?
Why Has the Price of Gold Fallen Recently?
Because gold is a store of value, it competes against other relatively safe investments such as the U.S. dollar and Treasurys. As the Federal Reserve has been boosting interest rates to combat inflation, interest-bearing Treasurys have begun to look relatively more attractive than gold, which doesn’t pay any interest.
Those rising interest rates attract investment into the U.S. and push up the value of the U.S. dollar. A stronger greenback dampens demand for dollar-denominated gold by making it more expensive for those holding other currencies. This extra pressure makes gold less appealing as a safe harbor compared with the dollar and Treasurys.
But even though gold priced in U.S. dollars is down over the past year, the metal’s price in yen, euros and pounds is up. Also, gold prices in U.S. dollars are doing well by historical standards.
Demand for Gold
The single-biggest source of demand for gold is for jewelry, with the biggest markets being India and China, according to the World Gold Council.
Investment in physical gold in the form of bars, coins, medals and physically backed exchange-traded funds, or ETFs, is also an important driver of demand, as are central banks, which use gold to diversify their reserves.
Gold also has some industrial uses. While dentistry might be the first use that comes to mind, more gold is actually used in electronics.
Gold Price History
Like other commodities, gold prices can be quite volatile. But gold tends to move for different reasons than primarily industrial commodities, such as copper.
When the U.S. abandoned the gold standard in August 1971, an ounce cost about $43. That’s about $312 in today’s dollars. On Sept. 1, gold for sale immediately was trading around $1,700, demonstrating that the metal’s price has more than held up compared with the value of the U.S. dollar.
In 1980, inflation led by oil prices combined with geopolitical fears to push the metal to a then record of $850. When adjusted for inflation, that record still stands, as that price in today’s dollars would be above $3,000 an ounce.
Prices slumped in the late 1990s as central banks and mining companies sold the metal, but sentiment turned a corner after European central banks agreed to limit sales.
In 2008, the U.S. benchmark gold futures contract rose above $1,000 for the first time, as the dollar weakened amid worries over the U.S. economy.
Worries about the global economy during the pandemic, ultralow interest rates and anticipation of inflation amid government stimulus helped the metal breach $2,000 for the first time in 2020.
Geopolitical worries surrounding Russia’s invasion of Ukraine helped push the metal above that mark again in March, before the current slide kicked in.
How to Invest in Gold
If you want to hedge against inflation with gold, there are multiple ways to do it.
One popular way is by owning physical gold in the form of bars, coins or jewelry. A downside is that physical gold is often sold at a premium to the spot price, and dealers tend to only buy it at steep discounts.
“This can work for a buy-and-hold strategy with a long investment horizon but does not work well for those who are more trading-oriented or want liquidity,” says Steve Land, portfolio manager with Franklin Templeton. “Investors in many parts of the world often choose to hold gold in jewelry form so that it can be enjoyed for special events.”
Security, transportation and insurance are also factors you’ll need to consider. And keep in mind when buying coins that you’re also paying for numismatic value and not just the value of the gold the coins contain.
Investors who want exposure to physical gold without the hassle of storing and insuring it can consider physically backed gold ETFs, which have shares tied to gold stored in bank vaults.
“Futures, options and derivatives are not for the faint of heart because while there is potential for high reward, there is high risk,” says George Bee, CEO at U.S. Gold Corp. (ticker: USAU). “One must really know what they’re doing to play in that space.”
Gold Stocks and Mining ETFs
While physical gold and physically backed gold funds are investments closely linked to the spot price of the metal, buying stocks of mining companies introduces other factors.
“The bet on a mining company is a bet on management and properties as much or more than a bet on the gold price moving up,” says John Ryan, CEO of Gold Express Mines.
To help cushion the risk of investing in single mining companies, investors can consider exchange-traded funds that group mining companies together based on certain criteria. But ETFs have costs that owning individual stocks don’t, and because of the diversification, the ETF may not perform as well as a single gold miner that strikes it rich.
In addition to large mining companies with producing operations, the gold mining sector also has so-called junior miners that are primarily involved in exploring for gold, developing mines or producing much smaller amounts than their larger brethren.
Investors can also consider gold royalty and streaming stocks, which can be less risky because they don’t operate mines themselves. In a royalty deal, a company pays a miner upfront and later receives a percentage of the revenue that a mine generates. In a streaming deal, a company pays a miner an upfront price for a percentage of the metal produced by the mine.
Bitcoin vs. Gold
Both assets aren’t tied to any single nation or financial system, and both are scarce. The maximum number of Bitcoin in circulation is capped at 21 million by its code, and the amount of new gold is limited to what miners can dig up.
“This provable rarity is what makes Bitcoin a potentially stronger inflation hedge than gold,” says Dion Guillaume, global head of PR and communication at Gate.io, a trading platform for digital assets.
But for now it looks like that potential may be a long way off.
“Bitcoin shouldn’t be thought of as a hedge, like gold or real estate,” says Collin Plume, CEO at Noble Gold Investments. “A hedge is a secure, safe bet that steadily grows over time, whereas Bitcoin and other cryptocurrencies have more of an explosive growth potential.”
The newness of Bitcoin means that there is regulatory risk that gold doesn’t have. The metal is widely held by investors and nations, and there are established rules for its sale, purchase and taxation.
“Even though I would love to see private currencies thrive and dethrone fiat currencies, Bitcoin has thus far proved a poor alternative to gold,” Hodgson says. “It has had extreme volatility, and its practicality for transactions has been found wanting.”
Is Gold a Good Inflation Hedge?
While Bitcoin is the new kid on the block(chain), gold has proven itself as a store of value over many years.
Because the supply of gold increases at a fairly regular pace each year as miners get it out of the ground, its supply isn’t increasing anywhere near as fast as the supply of national currencies can.
“You cannot conjure it up with printing presses,” Bee says. “It must be hard-won from the earth’s natural resources. It’s held its value and allure for thousands of years.”
Is Investing in Gold a Good Idea?
Adding gold to your portfolio is a good idea, up to a point.
It would be a bad idea to treat gold like stocks or bonds and have a major part of your portfolio tied up in a precious metal that pays no dividends, earns no interest and is subject to bouts of volatility.
But investors who hold the metal as a small, defensive portion of their portfolio may find that over long periods of time it holds its worth better than currencies managed by central banks.
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