Is Gold Still a Hedge Against Inflation?

What is the first thing that comes to mind when you think of protecting your money from inflation? For most people, gold is the first thought that comes to mind. Gold has been used as a form of currency and as a hedge against inflation for centuries. But is gold still a good investment in today's economy?

In this article, we will explore the pros and cons of investing in gold and answer the question: is gold still a hedge against inflation?

First, let us look at the factors that drive the price of gold. In broad terms, the price of gold is determined by the function of supply and demand.

Supply of gold:

The first and foremost factor is the supply of gold and the bottom line here is that gold has limited supply, which is why it is so valuable. Gold is a rare metal and it is estimated that all the gold ever mined would fit into a cube that is just 23 meters from every side.

About 4580 tons of gold are expected to be mined in 2022 with this number expected to go down to 4533 tons in 2023. This makes it difficult to increase the supply of gold in the market, which in turn keeps prices high.

Demand of Gold:

The second factor is the demand for gold. Unlike other commodities, gold isn't just used in industries but is also bought by central banks and investors as a way to store wealth. In addition to this, gold is also heavily used in jewelry and plays a vital function in generational wealth. These diverse uses create a continuous demand that ensures that the prices of gold don't fall sharply.

Q1 demand for gold in 2022 was 34% higher than the Q1 demand in 2021. This is the highest rise in year on year demand growth for gold since 2018. The driving factor behind this sharp rise in demand is the inflation. With supply expected to go down in 2023, we can expect gold prices to hit their historical highs once again.

Let us now try to break down the determinants of gold demand, to understand how the price mechanism for gold works, in a better manner.

Investor demand:

Investors play an important role in driving up gold prices. Gold is seen as a safe haven asset and investors tend to flock to it during times of economic uncertainty. At present, many countries are experiencing record high levels of inflation, which is why we can see that investors are flocking to hedge their savings in gold. In 2022, Gold ETFs had the strongest quarterly inflows since 2020.

Central banks:

Central banks around the world are another big factor that drives the price of gold. Central banks use gold as a reserve asset and they have been buying gold at a steady pace in recent years. This demand from central banks has helped push prices higher.

It was in 2010, in the wake of the Global Financial Crisis that the Central Banks shifted from being net sellers to net buyers of gold. At present, global Central Banks hold over 35,000 metric tonnes of gold in reserves. This is the highest level of Central Bank gold reserves since 1990.

According to World Gold Council, Central Banks have been in a buying spree for gold to shore up their reserves. This year in June, Central Banks added almost 59 tonnes of gold to their reserves, without any sales. June marked the third consecutive month of Central Bank gold purchases.

Central bank net purchasers rise for third consecutive month in June

One look at the graph above shows that the gold buying trend is in line with the global rise in inflation. According to the World Gold Council.

"It shows that gold's performance during a time of crisis and its role as a long-term store of value/inflation hedge are key determinants of central banks' decision to hold gold.

Inflation: Is Gold Still a Hedge Against Inflation?

One of the main reasons why gold is seen as a hedge against inflation is because it tends to move in the opposite direction of other assets, such as stocks and bonds. When inflationary pressures start to build up in an economy, stocks and bonds tend to fall in value, while gold prices tend to rise.

In 2014, a study was carried out to find systematic risk in gold investment. The study used GARCH dynamic conditional correlation analysis to find out that gold serves as an effective hedge against systematic risk. In times of extreme market volatility, gold provides much needed stability, which is why in the age when we are transitioning from fiat to digital and crypto assets, Central Banks across the world still prefer to hold their reserves in gold.

The Pros of Investing in Gold

1. Gold is a valuable commodity.
2. Gold is a safe investment.
3. Gold can be liquidated easily.
4. You can invest in gold without having a lot of money through Gold ETFs.
5. Investing in gold can help you diversify and stabilize your portfolio.

The Cons of Investing in Gold

1. Unlike stocks and bonds, gold is not a productive asset. It does not generate interest or profit unless you actively trade it.
2. It is difficult to store and transport.
3. If you invest in a lot of gold, you will incur storage costs.
4. Low return in the short term.

Investor Takeaway:

In the current inflationary environment, with dark clouds of a global recession looming on the horizon, the stocks and bond market is bound to lose its value. When investors lose their trust in the market and governments, gold becomes the last safe haven that provides stability.

The value of gold has seen a steady rise in recent years as investors add more gold to stabilize their portfolios. Central banks have also been buying gold at a steady pace, which has helped push prices higher. While there are some risks associated with investing in gold, its long-term store of value makes it a wise investment for those looking to hedge against inflation.

So, if you are looking to protect your wealth from inflation or a market crash, gold is still the best investment you can make.