Gold is not an Inflation Hedge: It is a Credit Default Swap on Hyper-Inflation (GLD)

July 9, 2012 9:51 AM EDT Send to a Friend
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If gold were truly an inflation hedge, it would be trading at around $780 per ounce based on the current inflation rate measured by CPI. The analysis is based on a research paper titled The Golden Dilemma, by Claude B. Erb and Campbell R. Harvey.

In the paper, they argue that gold is not an effective hedge against unexpected inflation whether measured in the short term or the long term. Additionally, the gold as a currency hedge argument does not seem to be supported by the data, since fluctuations in the real price of gold are much greater than FX changes.

So, if gold isn't an inflation hedge, and it isn't a currency, what is it? More importantly, what is driving the prices higher?

"There is some other economic force, perhaps a fear of inflation, driving variation in both TIPS and the real price of gold," stated the researchers. "Our analysis shows that the price of gold is very sensitive to even a remote possibility of another Weimar Republic-like inflation episode."

In other words, gold is not an inflation hedge. But you might say it is a kind of credit default swap on a specific event - hyper-inflation in the U.S.

The research paper notes an important, and growing, secondary characteristic of gold that investors should be aware of - the gold as an asset class story. A single exchange traded fund, SPDR Gold Trust ETF (NYSE: GLD), holds more gold than the official reserves of China. Gold is about 9% of today's capitalization of world stock and bond markets, notes the report.

"A widespread move to increase gold in diversified portfolios would lead to upward pressure on the real and nominal price of gold," noted the researchers.

SPDR Gold Trust ETF (NYSE: GLD) has fallen 1.42 percent year-to-date, and is trading flat on Monday.


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