Today, when India’s unofficial gold reserves are surpassing 20,000 tonnes, as per World Gold Council and the demand for it always on a roll in our country, are you also the one who believes that gold had been a mighty metal ever since the beginning of mankind?
It’s hard to believe today but during the 19th century, aluminum was considered more precious than gold and silver, because it was tougher to obtain.
Since our childhood times, we have been taught about noble metals, the metals which resist oxidation and corrosion and Gold is one of them. It’s not noble only chemically, but also it has been noble enough for humans to have safeguarded them against its financial adversaries like the crises and the inflation.
Most people are hurt by inflation, especially those who hoard cash, be it in lockers under their bed or in savings accounts. In an inflationary macro-environment the buying power of cash diminishes. Even the return from financial assets suffer during the price rise if the nominal return does not keep up with the rate of inflation. For example, if you have money parked in a bank account that pays 3% interest, but inflation is 8%, your real rate of return stands at (negative) 5%.
Periods associated with high inflation are more likely to witness frail macroeconomic performance. Significantly high inflation is in particular, a dampener for growth. A study executed on eighteen countries that witnessed very high inflation witnessed real GDP per capita drop on average by 1.6 percent per annum compared to positive growth of 1.4 percent in low inflation years.
Why buy gold during inflation?
Gold is not only a vital part of our jewelry, it is also used for symbolic and decorative purposes. Gold is money itself.
Yes, these are important applications of gold but the most important ones are its uses wherein it shields its buyers against financial turmoil and inflationary economic environment.
If Britain votes to leave EU- gold surges, if 2008 crisis hits- the yellow metal skyrockets.
Similarly, when economies suffer inflation, gold is the first choice for investors. A study of the last 50 years advocates gold performs in favor of acting as a hedge against inflation shocks. The spike caused by surging oil prices in the late 1970s and early 1980s, gold safeguarded investors by providing returns higher than inflation. During inflation, investors fear equity and debt securities could be expensive and are likely to under-perform.
In India, people have traditionally flocked to gold as an inflation hedge to shield their savings from runaway price rise. A study by World Gold Council notes that for every one percent rise in inflation, Indian gold demand spikes by 2.6%.
In India, historically, gold has fared well and beaten inflation over the long-term.
Impact of Inflation on various asset classes is negative i.e., the prices of most of the asset classes fall as inflation surges.
Equity: High inflation leads to increase in interest rates by central bank (to tame inflation) which in turn leads to increase in borrowing cost. Most of the firms operating in the economy as many firms may not be able to pass on high borrowing cost on to consumers. This generally reduces their profitability and hence stock prices of the company.
Currency: Low interest rates deter foreign investment while underpinning inflation at the same time. High inflation causes local currency to depreciate as it fails to maintain its purchasing power.
Bonds/Fixed Deposits: Bond yields and bond prices bear a negative relation. As discussed above, high inflation leads to high interest rates/yields, thereby decreasing their prices. Hence a negative correlation between inflation and Bond prices.
Commodity: It is the price rise in commodities which causes inflation. Gold is an ideal asset if you are looking forward to make inflation surrender. As inflation raises its head, your currency’s value faces the heat and is only able to buy lesser quantity.
Gold, however has maintained its purchasing power over a period of centuries and will likely continue doing so. In today’s times of Fiat Currency, not backed by any solid asset, gold has an edge as with inflation, as time passes, more currency is required to buy a unit of gold, thereby pushing yellow metal’s prices northwards.
Intrinsic value of some financial assets is measurable while for some it cannot be quantified. Precious metals are one such asset class the exact worth of which hinges more on global macroeconomic developments than just the marginal cost of production.
And, if history is to be believed, Gold has always delighted its enthusiasts by holding itself up to the expectations as global macroeconomic stability is nothing but a dream!