Wednesday, October 1, 2008

Should Investors Use Gold as Hedge During Times of Financial Uncertainty?

“It is well that the people of the Nation do not understand our banking and monetary system, for it they did, I believe there would be a revolution before tomorrow morning.” –Henry Ford

Yesterday when the House of Representatives voted down the financial bailout package,
the Dow Industrial experienced its biggest one-day drop in the Index's 102-year history falling 777.68 points.

And there still is no financial plan in place to help revive the economy.

Historically during times of financial uncertainty, investors have turned to Gold as a hedge. This is because gold is the type of investment that is always an asset. (not simultaneously someone else’s liability).

"Investors are leaning toward it as a hedge against what could happen next,” says Carlos Sanchez, a precious-metals analyst with CPM Group.

But, according to the author of an article I found at , Gold is actually a “crisis hedge’ not an “inflation hedge.”

During times of crisis, governments tend to lose control over the price of Gold. However, during more peaceful times, governments are able to keep a ceiling on the price of Gold. This causes Gold to move up in a “stair step” manner.

The author of this article at also says that gold as an inflation hedge has “a very spotty record.”

But is Gold is a bad investment now? Of course not. However, I do tend to agree with the author’s notion about why the price of gold has not done well over the last twenty years. (See image: price of gold over last 20 years).

The author infers that Governments have historically been known to buy and sell Gold on a whim to create an a sort of “illusion of stability.” The low volume of the gold market compared with say the stock market also lends to it being seemingly easily manipulated by governments.

Most investors in my circle don’t know that, up until about five years ago, it was illegal to invest in gold in China. When that market opened up, obviously there was an increase in worldwide demand for gold when China was free to buy Gold. (See image: price of gold over last 8 years) By 2006, the Shanghai Gold Exchange had become the world’s largest trading exchange for gold bullion with its trading volume well ahead of London, New York, and Hong Kong! Now that’s an incredible fact to ponder on when looking at the price of gold.

But if not Gold as an effective inflation hedge then what are some other inflation hedges?

Commodities ?

Price Inflation is defined as the increase in the costs of various commodities. (Although it is also caused by an increase in the money supply). The idea is that, by investing in various commodities, you should be able to at least break even. What commodities have historically done well in times of inflation? Oil. And oil is also a primary component of the increase in the consumer price index. Also, think about the fact that China is also increasing the global demand for oil along with gold. China will also increase demand for other precious metals. And what about world demand for food and what that will do to its prices? Yippee.

 *Inflation indexed bonds ?

Yes, there is such a thing .These bonds have an inflation adjustment characteristic. But they are not adjusted according to the “actual” inflation rate of course.

Any other suggestions for inflation hedges besides the ones I’ve mentioned in this post? Or any thoughts on utilizing gold as an inflation hedge?

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