How does Gold hedge against Inflation - Satori Traders

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Gold is often called a hedge against Inflation but this is really only true over long periods of time.

When we look at shorter time frames Gold’s hedging abilities are questionable.

For example, gasoline prices have more than doubled since 2020 but Gold is only up 25%.

The good news is that Gold responds to Inflation after some time delay so we are likely to see Gold stage a significant rally in the near future.

Analysts at Goldman Sachs are predicted that Gold will reach $2500 before the end of 2022.

Gold and Inflation relationship

According to Milton Friedman (American economist, 1912 – 2006) the only cause of Inflation is an overproduction of the money supply.

If central banks create money faster than the economy is growing, each new monetary unit reduces the value (Purchasing power) of all the existing monetary units.

As the value of the monetary units decline, it takes more of them to purchase the same amount of goods and services.

Gold, for example, has a constant value. One ounce of Gold is always worth exactly one ounce Gold.

Gold’s price, however, rises during Inflationary periods because investors have to fork over more of their watered-down monetary units to obtain the same quantity of Gold.

What is a common hedge against Inflation?

Common hedges against Inflation include Silver, Gold, and Real Estate. TIPS bonds and Commodities are less common Inflation hedges.

Best hedge against Inflation

The best hedges against Inflation preserve Purchasing power while also reducing Portfolio risk.

Counter-party risk is the probability that a company will default on their contractual obligations causing the value of their Stocks and Bonds drop, potentially to zero.

Enron is a good example of counter-party risk and how it can affect a company’s stock price. In 2001 it became widely known that Enron was riddled with fraud and the stock dropped from $90 to well under $1 in less than a year.

Physical Precious metals have zero counter-party risk so they provide an Inflation hedge for our Portfolios while also reducing our exposure to risk.

This double layer of protection is why physical Precious metals are the absolute best hedge against Inflation.

Hedge against Inflation example

The performance of Silver and Gold during the 1970s provides an example of hedging against Inflation.

During this decade Gold rose from $35 to $850 per ounce and Silver increased from under $2 to almost $50.

Bond investors took significant losses during this era as interest rates climbed relentlessly (Bond prices move inversely to interest rates).

Stock investors did better than Bond investors, but there were numerous companies that failed outright due to Inflation.

Gold as a hedge against Stock market

Gold serves as a hedge against Stock market risk because it has zero counter-party risk.

Inflation is currently hurting corporate profit margins as input costs rise and consumers reduce their spending on discretionary items.

Some companies will not survive this high Inflation economy and investors holding the Stocks and Bonds of these companies are likely to lose 100% of their Investment.

Investors holding physical Precious metals, on the other hand, will be completely unaffected by the ravages of the Stock market.

Gold vs Inflation chart 2021

When we chart Gold vs the Inflation rate we find that Gold responds to Inflation after a time delay of months or years.

For example, Inflation started climbing sharply in late-1967 but it was 1971 before the price of Gold started to rise in response.

This time-delayed effect suggests that the price of Gold is currently poised for a significant rally in order to counter the massive Inflation that has occurred in the last two years.

Goldman Sachs analysts are predicting that Gold will reach $2500 an ounce before the end of this year.

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FTC Disclosure: Satori Traders is a fee-only California-registered Investment Advisor. We provide Precious metals information for free to help consumers educate themselves. The contents of this video do not constitute financial advice. Satori Traders provides financial advice exclusively to clients with assets under management as detailed in our Investment Management Agreement. Always perform your own analysis and due diligence when putting your hard-earned money at risk. Before making any Investment decision consult your own Investment, Financial, Tax, and Legal advisors. We receive compensation from external companies when you do business with them.