Gold is an alternative investment. Just like collectables (e.g., art, wine) or real estate, gold’s main feature is that it protects against inflation.
Inflation refers to the rise in the price of a basket of goods and services over a predetermined period. Different ways to measure inflation exist in the world, but central banks typically use the Consumer Price Index (CPI) and some other variations of it (e.g., Personal Consumption Expenditure – PCE).
Rampant inflation leads to hyperinflation. When it happens, money loses value, leading to fortunes being wiped out virtually overnight (e.g., Argentina, Turkey, Venezuela). Gold, therefore, protects against rampant inflation or against currency debasement. As such, investors typically allocate 5% or so to a portfolio, in the idea that gold will protect it should inflation be a problem.
Judging by the way central banks and governments reacted to the COVID-19 health crisis (i.e., printing money), inflation may be just around the corner. Is it safe to believe that gold will still do its job and protect an investor’s portfolio?
Gold – The Ultimate Hedge Against Inflation
The chart above is clear enough to scare even the biggest fans of fiat currencies. It literally says that the U.S. dollar lost 98% of its value against an ounce of gold since the Federal Reserve of the United States was created in 1913.
Other currencies suffered a similar fate, with the degree of currency debasing differing. However, in the end, gold stood the test of time for centuries, if not even more. Why would this time be different? From this point of view, investors would be better off to consider gold a currency, not a commodity.
The key to using gold as a hedge against inflation comes from understanding inflation. If one looks at the definition of inflation as measured by the CPI baskets, it appears that inflation was nowhere to be found. Not even in 2020, when central banks and governments flooded the financial system with newly created money, inflation does not appear as troublesome.
The problem comes from what is included in the basket of goods and services. For instance, energy prices are considered too volatile and thus excluded. Think here of everything influenced by the price of oil – transportation, etc. In other words, any change in the price of goods and services due to a change in the price of oil will not be counted as inflation. Medical services or education are other examples of services that increased in value but are not included in the official inflation numbers.
By keeping its value against all fiat currencies throughout time, gold is the ultimate hedge against inflation – regardless of how one defines inflation.