What is gold worth to you? The answer to this question will vary from person to person. However, investors often use gold as a hedge against inflation. But does gold really serve this purpose?
Let’s go back to look at the early uses of gold as currency and wealth possession. Using gold as currency is thousands of years old. The yellow metal has been used in different forms and shapes since then.
Today, gold is the most widely used precious metal, and it was only several decades ago that many currencies were pegged to gold.
When gold is used as a store of value, investors convert other assets and savings into gold to save their wealth from depreciation. The reason behind this confidence in gold is that the acceptance of gold as a means of payment has never disappeared. Furthermore, gold prices tend to increase during periods of uncertainty. For example, if we look at the historical market data, we see that whenever there is uncertainty in the market, the price of gold surges. It happens for two reasons.
The first reason is purely based on market principles; the demand for gold pushes the price of gold upward because everyone wishes to buy more gold during such time.
The second reason is that the gold traders also know that the demand for gold will increase, and people with money will buy gold whatever the price may be. So it has been proven by historical data that the correlation between gold prices and uncertain times exists.
However, the question that needs to be answered is whether gold is a hedge against inflation?
The correlation between the gold price and inflation does not imply that inflation causes an increase in gold price or not. The rise in gold prices is always mainly driven by the high demand. The demand for gold is only high during uncertain times, while inflation also normally occurs after such market periods. We can say that it may be a good move to buy some gold during periods of high inflation. However, just as gold prices rise during periods of inflation, prices also fall when market conditions stabilize.
In the short term, if you want to buy gold as a hedge against inflation, you must make sure that you are aware of the market.
When there is a sharp decline in the gold price, that indicates the stabilizing market. In the long term, on the other hand, investment in gold has proven to be a hedge against inflation.
Investing in gold, like any asset class, can be both volatile and risky. Therefore, it is advisable to only invest a portion of one's portfolio into precious metals.
Irrespective of inflation or deflation, the general rule of thumb is to keep10-20% of one's investment in gold or precious metals. This can hedge one's portfolio not only from inflation, but also from idiosyncratic risks, such as pandemics, natural disasters, market crashes etc. The safe-haven qualities of gold and precious metals are beneficial to any portfolio.