Is Gold an Inflation Hedge?

In a word, no. Yet this is one of those inaccuracies that just won’t die. When anti-gold Wall Street pundits want to talk down gold, they say gold is an inflation hedge and since there is no inflation, sell gold.

Consumer price inflation can certainly drive the gold price higher. But you don’t have to see inflation to get a higher gold price. A good example is right now; gold is on the move but inflation at the consumer level is low and inflation expectations are lower still, using market-based measures like the 5 year/5 year Forward spread which is the yardstick preferred by the Fed.

What consistently drives the gold price? Loss of confidence in the financial system. By this I mean banking, securities markets, currencies, property rights, the fairness of the tax system and, especially, central banks. When investors have confidence in these institutions, they sell gold. When confidence declines, they buy. It is not any one thing. Inflation can cause confidence to decline if investors fear the loss of purchasing power. Deflation can be the cause if investors fear defaults.

Higher Gold Prices
You don’t have to see inflation to get a higher gold price.

That’s why investors need to keep an eye on confidence. When there is confidence, investors are willing to take risks and gold is left for dead. When investors become risk-averse, there is never enough gold to satisfy them.

What is currently undermining confidence? My guess is that investors are beginning to believe that central bank policies do not work to generate economic growth and that the global economy is therefore vulnerable. This is not a problem that is easy to fix because faith in central banking has been a pillar of market performance in recent years. The result is that investors are beginning to think that stocks may not be sure bets. At some point, the new sure bet will be gold.