Gold as a Hedge Against Inflation

March 22, 2008

Gold beckons to investors as a hedge against inflation ! Soaring prices and global financial upheaval give metal added shine

By Goh Eng Yeow

THERE is a lot going for gold at the moment but two factors are giving the precious metal an added lustre for now - inflation and global financial turmoil.

At a time of skyrocketing prices and weakening currencies, investors are rediscovering the allure of gold as an anti-inflation hedge. And holding something tangible like gold - or shares in gold funds - seems a sound move amid talk of bank failures, crashing share markets and financial Armageddon.

Gold's scarcity is at the root of its appeal - unlike paper money, which can be printed almost with impunity. Despite record-high prices, miners have not been able to increase the supply of the precious stuff. Mining output started tapering off some years ago.

Most of the world's gold has been held by the central banks of rich Western economies such as the United States, France and Switzerland, but in the past five years, fund managers have also become big hoarders of the precious metal.

This is after they persuaded retail investors to buy gold in the form of exchange-traded funds, which are rather like unit trusts. Instead of shares, the funds actually hold gold - billions of dollars of it in 400-ounce bars - which results in far lower overhead costs than investing in coins, kilobars or jewellery.

US-based street Tracks, for example, holds about 649 tonnes worth US$20 billion (S$27.8 billion), a hoard as big as if not bigger than those held by major central banks. Gold also has more intangible attractions - a beautiful lustre that does not fade with time and ready malleability - that few have been able to resist down the ages.

Yet just a decade ago, when American financial guru Peter Bernstein wrote a book about the obsession with gold, the metal seemed in danger of losing its investment allure.

After hitting a high of US$850 a troy ounce in 1980 in the wake of the Soviet invasion of Afghanistan, gold plunged by about two-thirds over the following two decades.

Gold bugs, as keen investors in the metal are known, had plenty of time to lick their wounds and even Mr Bernstein was not quite convinced of its attraction.

In his book, he dwelt at length on the curse that gold had inflicted upon those obsessed with it, such as Crassus, a Roman general who died when Parthians poured molten gold down his throat.

And while gold once protected people against the deprivation of war and tyrants, Mr Bernstein argued that it had become an anachronism in the past 50 years, as the greenback gained ground as the world's currency.

Gold bugs must have felt they were having the last laugh when the metal climbed above US$1,000 an ounce for the first time on March 14. It proves, they claim, that over time, gold provides the only real store of value as an investment compared with paper money like the US dollar.

And even the wild price swings it experienced this week, as it suddenly fell by up to 8.5 per cent, has done little to convince them that the golden era is over yet. Investors like gold more and more in these volatile times as it is not correlated with other investments such as equities and bonds.

Better still, gold has been closely tracking crude oil prices as they shot up sharply in the past five years with the upsurge in global demand for energy.

Like other commodities, gold is benefiting from the rise of the Chinese and Indian economies.
Chinese and Indians have traditionally been big hoarders of gold, given the political and financial turbulence their countries have encountered over the past 100 years.

So surely, it is a win-win to hold gold. Sniffing a good deal, hedge funds have been pouring billions into gold, and this has caused its price to escalate even more.

But many others fear that gold may lose its shine just as quickly as its allure was rediscovered.

Some observers argue that it is unusual for crude oil prices to keep rising while the US economy slows amid a financial crisis. And it is also worth noting that the bulk of the world's gold reserves is still held by the US - 147 million ounces or so - so it can always sell off some of its hoard to take the heat off the ailing greenback.

The world may suddenly find itself with a lot more gold than it has counted on. Some food for thought for gold bugs.