- Date : 31/01/2020
- Read: 5 mins
The characteristics of gold that make it a safe bet during inflation, along with other investments that too act as a hedge against price rise. Read on.
Inflationary hedge and gold
It has been observed that with a rise in the rate of inflation in a country the local currency falls in terms of value. An inflation hedge can be an investment that protects you from losing out wealth due to inflation. During inflation, you become less wealthy with the same amount of money because the money itself is losing its value. There are different investments which offer varying degrees of hedge or protection against inflation. One of them is gold. Take the instance of outstanding by gold during the 2006-2010 period, when the global economy was at its lowest ebb. As the inflation rate in India rose from 5.3% in 2006 to 11.7% in 2011, gold price tripled during the same period. With a fall in the purchasing power of the local currency, gold rides on public sentiment and its value appreciate. As a result, people look to invest in gold as it seems like a safe investment. Thus in a scenario where there is price rise and the inflation touches double-digit, gold is expected to retain its inherent wealth and act as a long-term hedge against inflation. 1
Traditional inflation hedges and their performance over three historic period
Some of the popular investments that are considered to be inflation hedge are:
1. Term insurance policies:
Term insurance policies offer considerable protection since the premiums remain the same in spite of inflation. This decreases the burden on the insured. Apart from regular plans, insurance companies offer plans where the cover continues to increase with every passing year since the inflation-adjusted term plans appreciate the sum assured. This is designed to address the issue of inflation. Combined plans of lump sum and monthly payments is another customisation done by insurance companies to cancel out the effects of inflation at the end of the term.
2. Real estate investment:
Real estate investment in itself can be susceptible to inflation as the purchasing power decreases and it generally needs a hefty cash outlay. However, real estate investment which has been let out continues to generate handsome rental income even during inflation. In fact, the price rise is cited as a common reason when landlords ask for a raise in rent.
Commodity prices are bound to increase during inflation. In fact, the rise in commodity price is one of the key indicators of inflation. As an investor, therefore, putting some money in commodities can protect you from inflation, as you will be able to earn more returns on your investments during inflation. Long-term investment in commodities also makes a lot of sense. Inflation can be considered to be an integral part of today’s economy. Since 2012, the rate of inflation has oscillated between 2-12%. In other words, price rise did slow down to a little less than 2% but it has never completely stopped.
History of gold as an inflation hedge
- The weakening of the Indian rupee against the US dollar triggered a record surge in the gold price in August 2013. As rupee fell, investors resorted to the safety of gold which, in turn, led to the rise in the gold price.
- Gold prices increased almost 3 times in the six-seven years leading up to the aftermath of the 2008 recession. During this period each year showed a steady rise in price as inflation rate hovered between 2-4%.
- Between 1880 and 1914, the price of gold in the USA was fixed. However, with massive inflation in the economy, the intrinsic value of gold had increased. This was evident when the government corrected the rate by increasing it by 69%.
Taking inflation as a backdrop, it is the fixed-income investments that take a hit because of inflation. Inflation-adjusted term insurance plans and price rise adjusted rental income can be a decent hedge against inflation. Commodities including gold and oil are investments which can become profitable during inflation, however, compared to most commodities, there are several ways of buying and selling gold – be it physical gold, gold units in ETFs, virtual gold, etc.
Gold is a very logical and obvious part of an investment portfolio as it balances the investment profile. As it shares an inverse relationship with most financial instruments and investments, it is seen rising when other assets fall. In fact, gold tends to register growth during economic downturns, as observed in 2008. Therefore, having some investment in gold keeps our investments safe as gold has often seen a rise during inflationary periods. Even when inflation went below zero or deflation prevailed, people still relied on gold. Unsurprisingly, the value of gold has increased in all three major deflationary situations in the last two centuries. During the periods 1814-30, 1864-97 and 1929-33, the American economy has documented records of deflation, the last period being the infamous Great Depression of 1929. The price of gold fell each time, but on all three occasions, the purchasing power of the precious metal rose drastically - making it the asset to have during deflation. Are you a smart shopper when it comes to buying gold? Take this quiz to find you out.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or insurance or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.