I’m trying to understand how Gold is a good inflation hedge. Here’s why.
If Gold is priced in USD and inflation in the US erodes the purchasing power of the USD, then surely if Gold is priced in USD, then wouldn’t gold be cheaper to buy?
For example, if the Gold Price is $100 and inflation increases in the US, $100 is still $100 if the price of Gold remains the same. So purchasing Gold at the price that it was ($100 US) would still cost the same.
I’m just not sure I understand the argument that because real purchasing power of the USD is eroded during periods of inflation then it takes more USD to buy gold. It would be the same amount of USD if the Gold price remained the same at $100 wouldn’t it?
I’m clearly missing a fundamental point there. Can someone explain it to me?
Thanks
Not sure I understand your question but let’s just look at it this way.
In order to purchase an ounce of gold, it costs $1,900 per ounce. As inflation rises, the price of gold now costs $2,000 per ounce. That means you need $100 more dollar to buy the same quantity of gold. This means the dollar loses its value (inflation). Therefore, the owner of gold is hedged against the dollar depreciation.
Ok, I think there’s the fundamental question. Why or how does increasing inflation increase the price of gold?
I’m assuming it’s this. If you take the view that inflation is an increase in the money supply and thus raising prices, then commodity prices tend to rise due to increased demand. If this is so, they why buy gold (which would in turn push up the price and create an inflation hedge) when there are probably higher returns elsewhere?
Hence my confusion, how does inflation increase the price of gold, and more importantly why?
Thanks
Going back to econ 101. Inflation can occurs from increasing in cost of productions leading to increasing in prices. Also, increasing in prices can occur from demand as people are willing to pay more for products and services.
Therefore, for the price of gold to increase, there’re so many factors involving such as:
Strong economy can indicates an expectation of inflation. This is caused by aggregate demand expanding faster than aggregate supply. Therefore, this will push up the prices. (Consumption demand)
When inflation rises, currency loses its value. So, people will hold their money in the form of gold.
And many more factors…etc.
You see? Once when people demand more and more, it pushes the price of gold.
An increase in the money supply means people will have more money to spend. When you have more money, you’re likely to pay more. This will bid up the prices.
Why buying gold instead of other asset classes? Let’s look at this way, if you’ve expected the inflation will rise in the near future. Would you hold cash or buy gold to hedge out your hard earn Benjamin? Of course you would buy gold. But it’s not just you, there are more people that think like you too. Consequently, the price of gold is pushed up.
Yes, but this still doesn’t address the question. Obviously supply and demand and the availability of money affect the price, but why gold over other asset types?
I assume that it has appeal as a precious metal, no doubt, but it does not require more USD to buy it because inflation had increased and it takes more USD to buy it. It’s priced in USD, and this means it does not matter how much inflation there is, it’s priced in USD.
The only reason I can see why it might make a good hedge is because as inflation climbs too high, possibly late in the business cycle, then investors may sell the USD making it weaker against other currencies. This then makes shiny gold a bargain. So the only way I can see gold as an inflation hedge is if it’s pricing has more to do with relative exchange rates.
Typically speaking gold tends to follow inflation rate. Let’s say you hold stocks and bonds during inflation period. What would you get in form of return? Dividends and interests? And what form are they? Cash?. And in general when inflation rises, what happens to stocks and bonds prices? Just consider gold as an alternative currency separating from USD or whatever currency. If there’s a zombie apocalypse today and currency becomes just a plain paper, would you rather hold gold or just a piece of paper? Once inflation erodes your dollar’s value then you want to opt for gold instead. Because inflation destroys value. But in the real world, it’s more complicated than that. What I’ve tried to explain is just the general sense to look at it.
(P.S. try to connect the dots and make some simple sense of it first, then think step by step and you will be illuminated)
