Inflation can sometimes be a good problem to have — at least in the short term.
It can happen when an economy is expanding at a good clip and growth stocks are doing really well. But over time, inflation eats into the buying power of a currency such as the U.S. dollar and makes dollar-denominated assets worth less.
Gold offers a different narrative, as it tends to hold its value over time when compared with currencies backed by governments, also known as fiat currencies.
“Gold bugs often say an ounce of gold should always be able to get you a new suit,” Brett Elliott, director of marketing with American Precious Metals Exchange. “In 1950, an ounce of gold was worth $40, which was about the price of a new suit. Today, an ounce of gold is over $2,600, which can buy a very nice suit and more. But you cannot buy a new suit with $40.”
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In November, the U.S. inflation rate stood at 2.7% on an annual basis — not far above the Federal Reserve’s 2% goal but still high enough for the central bank to adopt a more cautious stance on further rate cuts.
Even though inflation has moderated, it can move higher, and over the long run even modest inflation takes a toll on spending power.
Investors looking for an inflation hedge have long turned to gold. At the end of the day, the precious metal should be viewed as a store of value rather than as a growth asset.
Here are some factors to consider when looking to invest in gold as an inflation hedge:
— Why does the price of gold rise?
— Demand for gold.
— Gold price history.
— How to invest in gold.
— Gold stocks and mining ETFs.
— Is investing in gold a good idea?
Why Does the Price of Gold Rise?
Like other commodities, gold’s price is volatile, and it can rise and fall for multiple reasons.
Because gold is a store of value, it competes against other relatively safe investments such as the U.S. dollar and Treasurys. When interest rates are declining, gold can become more attractive compared with bonds because the opportunity cost of holding the non-interest-bearing metal is reduced.
Gold also becomes more attractive during times of economic uncertainty. When investors look for safe havens and flee to quality investments, the dollar and gold might actually rise together.
Gold can also rise when central banks, which have massive purchasing power, buy the metal to diversify their holdings — something China has been doing lately.
Because the supply of gold increases at a limited pace each year as miners get it out of the ground, its supply isn’t increasing anywhere near as fast as the supply of fiat currencies.
“Gold’s limited supply is a key tenet to its role as a time-tested inflation hedge,” says Han Tan, chief market analyst at Exinity.
Gold is often compared to fiat currencies such as the U.S. dollar, which is being devalued by money printing, says Michael Martin, vice president of market strategy with TradingBlock.
“The more dollars that flood the system, the less each one is worth,” he says. “Gold, on the other hand, is much harder to mine than dollars are to print, making it a far more stable and dependable store of value.”
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 they tend 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 $335 in today’s dollars. On Jan. 10, the spot price for gold was about $2,690 per ounce, 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 and geopolitical fears pushed the metal to a record of $850. When adjusted for inflation, that record still stands, as that price in today’s dollars would be about $3,400 an ounce.
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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.
How to Invest in Gold
If you want to hedge against inflation with gold, there are multiple ways to do it. But it’s important to consider the trade-offs to determine which type of gold investment suits your needs.
Owning physical gold in the form of bars, coins or jewelry is one of the most popular investments. 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.
Security, transportation and insurance are also factors you’ll need to consider. And keep in mind when buying coins that you may also be paying for numismatic value and not just the raw value of the gold in the coins.
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.
Investors can also consider gold futures and options, but these investments are often best left to the pros. To do so means learning about margin, contract rollovers and other considerations.
“I would not recommend futures/options to most clients, as the short-term swings are not for everyone,” says Vince Stanzione, CEO at First Information, a publisher of educational materials related to financial spread betting and derivatives trading.
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.
In their favor, mining companies may pay dividends, which gold itself does not. But they are also subject to company-specific risks, such as cost overruns when developing mines, political turmoil in the far-flung places they operate and bad management decisions.
“Miners have been known to make financially risky investments during boom years, which later impacted their stock valuations, driving negative returns for investors,” says Elliott.
To help cushion the risk of investing in single mining companies, investors can consider ETFs that group mining companies together based on certain criteria. But ETFs have costs that 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 industry also has so-called junior miners that are primarily involved in exploring for gold, developing mines or producing much smaller amounts than larger companies.
Investors can also consider gold royalty and streaming stocks, which can be less risky because these companies 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.
“The primary benefit of investing in gold through securities — paper gold — is liquidity,” Martin says. “For example, when you buy a gold ETF, you can sell it immediately, typically losing only a penny on the spread. However, in an economic catastrophe, accessing funds from your account may become impossible.”
Owning physical gold yourself and storing it in your home deals with the access issue in some sort of economic calamity or apocalyptic situation. That’s why this method is favored by preppers, or folks who prepare for disasters by stockpiling food, seeds, weapons and other items. There are even thin gold bars that are easily divisible into smaller bars to facilitate using the metal as a currency.
Still, in everyday situations, liquidity with physical gold can be a challenge.
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.
Experts often say that a portfolio should only contain about 5% commodities, which would include gold along with other assets.
Investors who hold the metal as a small, defensive portion of their portfolio may find that over long periods, it holds its worth better than currencies managed by central banks.
“I expect gold to have another good year; regardless of what politicians tell you about being fiscally responsible, they will all print money and debase their currencies, which helps gold,” Stanzione says. “It’s not the fact that gold is just going up, it’s the currency that is going down.”
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How to Invest in Gold as an Inflation Hedge originally appeared on usnews.com
Update 01/10/25: This story was previously published at an earlier date and has been updated with new information.
