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The US economy is currently experiencing extreme inflation, with annual inflation reaching 7.9 percent, the highest on record in 40 years.
With a rich history dating back to Ancient Egypt, gold has always been the most prized metal of mankind for its artistic and cultural value. Demand for gold-backed investment products increased as well, with gold ETFs seeing net inflows of 187.3 tonnes (US$11.8 billion) in March, bringing total holdings just below the August 2020 record of US$240.3 billion.
It is a symbol of wealth and the focal point of almost every special social gathering in many parts of the world. More than 1,400 metric tonnes of the metal are consumed each year for jewellery and other decorations.
But the reason to buy gold goes beyond the customary yearly celebrations or the need to display affluence; people can also view the metal as a form of investment and growing their wealth. This is especially true during times of high inflation, where the cost of living rises and the value of currency depreciates.
Inflation fears have sparked a new wave of gold buying since the beginning of 2022, nearly pushing the precious metal past its all-time high of $2,070/oz set in August 2020.
1. Golds as a Store of Value
Even in ancient times, the notion that gold has monetary value was widely accepted, and for the most part, this principle has worked in practise. During the Roman era, one ounce of gold was enough to purchase a toga and accessories. The same amount of gold can now buy a tailored suit or a wedding gown.
The prospect value of gold is what attracts investors to the metal. People have historically hoarded gold when their traditional “money,” or currencies, have lost value, realising that metal is much more durable and can be exchanged for more value later on.
2. Gold as Inflation Hedge
As previously stated, gold is regarded as the ideal inflation hedge because its value rises in tandem with the price of goods. This is because our fiat currency (e.g., a $100 bill) loses purchasing power as prices rise, and gold is typically priced in those currency units.
Indeed, over the last 50 years, gold prices have kept pace with inflation, increasing the metal’s purchasing power while the US dollar has lost value and purchasing power.
In 1930, for example, one hundredth of an ounce of gold could buy 2.3 loaves of bread, while one dollar could buy 11 loaves of bread.
In 2021, 1/100 oz of gold will buy 8.6 loaves of bread, but $1 will only buy half a loaf of bread. This means that gold has roughly kept pace with the price of bread during that time, while the US dollar has weakened.
3. Gold for Diversification
Many of today’s major asset classes, such as stocks, real estate, and commodities, are highly correlated and tend to move in the same direction at the same time. Gold, on the other hand, is influenced by a completely different set of factors and has a low correlation with the other assets.
In other words, gold’s performance moves independently and can act as a return diversifier within a larger multi-asset portfolio. It perfectly aligns with the investment adage of “not putting all your eggs in one basket,” providing a safety net against events that could cause the value of popular investments like stocks to plummet.
More importantly, over the last 22 years, gold has outperformed the major asset classes, historically improving returns and increasing diversification.
It is also significantly undervalued in comparison to equities, with the gold-stock price ratio currently sitting at only 38%.
4. Economic & Political Instability
Gold also serves as a safe haven for investors during times of economic and political unrest. During the peak of the Covid pandemic in 2020, gold outperformed both stocks and bonds, setting a new high. According to the World Gold Council, gold’s performance during times of crisis has risen to the top of the list of reasons for central banks to hold gold.
Following Russia’s invasion of Ukraine, gold has regained investor interest this year. Sanctions against Russia have already sent the commodities market into a tailspin, fueling fears of stagflation — a combination of slow economic growth and high inflation, both of which are bullish for gold.
6. Rising Government Debts
The massive public spending spree, particularly during disruptive periods such as the Covid crisis, is providing additional support for gold. This has resulted in excessive government debt.
While increased spending may aid economic recovery in the short term, major economies such as the United States are actually accruing debt at a faster rate than their economic growth.
The crushing global debt burden is likely to weaken major fiat currencies (such as the US dollar), and gold can help investors protect their wealth. Gold has historically increased in value as the level of US federal debt has increased.