Wednesday, December 9, 2009

Gold isn't best hedge against inflation

Economic chaos? The dollar crumbling? Central banks printing money like crazy? Probably the only real surprise about the surge in gold prices over the past few months is that it took so long to arrive. Last week, gold touched an all-time high of $1,227.50. Back in September, it was still less than $1,000. Chalk that up as a victory for the gold bugs.

This week, the price is heading down, dropping below $1,200. Chalk that up as a victory for the gold sceptics, who regularly point out that the metal’s value is just a sentimental memory from a long-buried era.

In reality, while investors are right to be nervous about inflation, maybe they are catching on that it’s wrong to see gold as the best hedge against a general rise in prices. There are plenty of alternatives: equities, property, oil, luxuries or private equity funds should prove just as effective a way of shielding yourself.

It isn’t hard to figure out why investors had been getting interested in gold again. Central banks are pumping freshly minted money into the system. A few hundred years of economic history says that eventually this will lead to inflation. It might be next year, or the year after.

Alloyed Record

But gold? Whether it’s a hedge against inflation depends on where you want to start drawing the graph. Back in 2002, gold was less than $300. If you bought it then, you’d certainly have protected yourself against rising prices. The 1990s were a different story. Gold started that decade at around $400, and ended it below $300. Not so great. As for the 1980s, forget it: gold lost almost half its value during that decade.

There isn’t much chance, either, of the world’s central banks making their currencies convertible into gold once again. They would bankrupt their governments in the process. In truth, while gold may have a role in protecting against inflation, there are plenty of alternatives.

Rate Squeeze

The only real way to control inflation once it gets started is to raise interest rates high enough to create a deep recession, and so choke off rising prices. That’s what central bankers did in the late 1970s and early 1980s, and may do again sometime around 2015 or 2020. Once that happens, you’ll need to think again — you might not want to be in property or equities. That, however, is some way off. As we move into the early stages of an inflationary era, those five assets should do at least as well as gold, if not better.

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