Of all the precious metals, gold has maintained its popularity as an investment. Perhaps this is due to its long history as the first form of money. Societies and economies have placed value on gold throughout the centuries, preserving its worth.
What makes Gold special?
Gold was used as the base for the gold standard which set the value for all money. It’s regarded as a source of money that will always have value.
Also, gold is different because its value has little to no correlation with other assets. For instance, stocks have an inverse relationship with bonds but gold prices don’t rise or fall when most asset classes do.
Investors use gold to diversify their portfolios and hedge risk, but what is it about gold that makes it a popular choice for hedging?
#1. It maintains value when major currencies erode
Gold is a good hedge against the decline of a currency, typically the US dollar. Although the US dollar is one of the most important reserve currencies in the world, its value sometimes falls as it did between 1998 and 2008.
Typically, when the value of the dollar declines or there is a financial crisis, the value of gold rises. For instance, the value of gold nearly tripled between 1998 and 2008. Gold is therefore used as a hedging tool when the economy negatively affects major currencies.
#2. It’s resilient in the face of inflation
The stock market tends to plunge as the cost of living rises and inflation increases. You need an asset to help you balance this out and this is where gold comes in.
The price of gold tends to increase as the cost of living increases. This is because when a currency loses its purchasing power to inflation, people tend to hold money in the form of gold and this increases its value. As such, gold has always been an excellent hedge against inflation.
#3. It’s a good defence against deflation
Gold has also been used as a hedge against deflation – the flip side of inflation. Deflation occurs when the economy is in a downturn, business activity slows, excessive debt looms and prices drop.
When this happens, people hoard cash and the safest way to hold cash is in gold. As more people compete for gold, its supply decreases and this increases its purchasing power.
#4. It’s good in times of geopolitical uncertainty
Gold not only retains its value during times of financial uncertainty but in times of geopolitical uncertainty as well. Gold has often been called the “crisis commodity” – people rush to it when world tensions rise. For example, its price tends to increase when confidence in governments is low as highlighted by the recent increase in gold price amidst Brexit uncertainty.
This is because people trust in the safety of gold. Crises such as wars, which have a negative impact on the prices of most asset classes, tend to impact gold positively as increased demand for the metal pushes up its value. This means gains in gold can help you offset the losses in the other asset classes.
Hedging with Gold
Although gold goes through times of volatility, it has always maintained its value over the long-term. Gold is great for hedging because its value increases in response to events that cause the decline of paper investments like bonds and stocks. Including gold in a diversified investment portfolio helps maintain the value of the portfolio.
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