Why is Gold an Inflation Hedge
Gold is considered a smart investment option to add stability to a diversified portfolio, especially as a hedge against inflation because its price tends to rise when the value of a paper currency falls. This is because when inflation rises, the cost of goods and services increases, reducing the purchasing power of paper money. As people seek to protect their wealth from the eroding effects of inflation, they often turn to assets like Gold, which has a history of retaining its value over time. Additionally, central banks and governments tend to increase their gold holdings during times of economic uncertainty or high inflation, further supporting the metal's value. Gold's scarcity, simplicity to purchase and hold, historical use as a store of value, and perceived immunity to government manipulation ultimately make it a popular hedge against inflation.
Gold prices have lately been on a steady uptrend and managed to surpass $1900 for the first time since May 2020 after an inflation report released mid-last month showing that inflation in the US decreased last month for the first time since May 2020. The overall consumer price index fell 0.1% from the previous month, in line with economists' predictions. When removing food and energy from the calculation, the core CPI rose 0.3% last month and was 5.7% higher than a year earlier, the slowest pace since December 2021. This decrease in inflation may allow the Federal Reserve to reduce the pace of monetary tightening. Following this news release, gold prices rose by 1.4% to above $1,900 before dropping slightly. Gold prices have been trading above the $1,900 mark, supported by a weak US dollar.
Let's now dive deeper to understand how gold acts as a hedge against inflation, what makes gold prices climb, and whether it's the right time to consider adding Gold to your portfolio.
What makes Gold Prices climb up?
Several factors can cause the price of Gold to increase, including:
- Economic instability or uncertainty: Gold is often seen as a haven investment during economic turmoil, so its price may rise when there are concerns about inflation, currency devaluation, or political instability.
- Interest rates: Lower interest rates can make Gold more attractive to investors because it does not pay interest or dividends.
- Supply and demand: The price of Gold can also be affected by supply and demand. The price will likely increase if demand for Gold is high and supply is limited.
- Inflation: Gold has traditionally been a hedge against inflation, so when the inflation rate is high, the price of Gold tends to rise
- Currency fluctuations: The price of Gold can also be affected by fluctuations in currency exchange rates. If the value of a currency falls relative to other currencies, the price of Gold may rise.
Why Gold is a Hedge against inflation
Gold is considered a valuable asset that tends to retain its worth for longer than other types of assets. This makes it an excellent option to protect against inflation, which is a decrease in the purchasing power of money. In 2022, inflation reached a 40-year high, and consumer prices increased by 9.1% year-over-year. The Federal Reserve's interest rate hikes have not kept up with the inflation rate, making Gold and other commodities a more attractive option for investors looking for a safe and stable place to put their money. Historically, Gold had performed well during inflationary periods, such as in the 1970s when its value increased significantly. However, it is essential to note that past performance is not indicative of future trends, and the price of Gold can fluctuate.
Is it the right time to consider adding Gold to your portfolio?
People tend to rush to buy Gold when its value seems to increase, hoping it will keep rising. However, before making a hasty decision to buy Gold, it's advisable to take a step back. Gold is just like any other asset; its value can fluctuate based on market sentiment.
To ascertain the investment merits of Gold, let's check its performance against that of the S&P 500 for the past year (as of March 2022). Gold has outperformed compared to the S&P 500 over this period, with the S&P index generating about 10.4% in total returns compared to Gold, which returned 18.9% over the same period.
That said, the period that we look at is incredibly important. Looking at longer or shorter timeframes will see Gold or the broader market outperform, sometimes by a wide margin.
Investing in Gold may not always be a wise decision. It's usually better to invest in Gold more, so adding it to your portfolio when it's cheap, and people don't have positive opinions about it opens up the possibility of significant gains if Gold regains popularity. With the stock market downturn and inflation on the rise in most economies worldwide and the possibility of a recession, Gold has been performing relatively well, making it an attractive asset to consider adding to one's portfolio.
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