New Study: Gold Really Is An Inflation Hedge
August 14, 06
In 1833, the price of gold was $20.65 per ounce, or about $415 in 2005 dollars, based on the rate of inflation in the
Is this a fluke, or is there some relationship between
Key Finding: Own Gold to Hedge Inflation
The primary finding of the research: gold is an excellent inflation hedge. The caveat: the transactions should be denominated in U.S. dollars, since the research found that gold prices are tied only to the
Using heavy-duty mathematically based research, the authors of the study, academicians Eric J. Levin (
In an effort to reconcile gold prices with inflation over both the short and longer term, Levin and Wright developed an analytical framework based on simple economics of “supply and demand” that was consistent with the view that gold is an inflation hedge in the long run, but taking into account the fact that gold prices can fluctuate considerably in the short run. They analyzed factors such as the supply of gold, the gold lease rate, the convenience yield, and the default risk premium. In addition, they looked at the U.S. dollar exchange rate with major world currencies, especially those in gold-consuming countries such as
The study yielded three main findings, as follows:
- There is a long term relationship between the price of gold and the
- The
- In the wake of a shock that causes a deviation from this long term relationship, there is a slow reversion back to the norm.
In addition, the study found that there were some “negative” relationships between gold prices and some other factors. For example, there is a negative relationship between gold prices and changes in the U.S. dollar trade-weighted exchange rate and the gold lease rate.
The study also found that there is no relationship between certain factors and gold prices. For example, gold prices do not reflect changes in global inflation, global inflation volatility, world income, and gold’s beta (price volatility).
Short Term Gold Price Aberrations Obscure Long Term Trends
The authors of this gold price study note that despite the apparent high degree of consistency between gold prices and U.S. inflation rates over the long term, there have been significant gold price fluctuations that have lasted for years at a time, as the graph below illustrates. However, their research proved that the price of gold always reverts to the norm, given enough time.
Questions Raised
As with most research studies, the authors acknowledge that, in the process of completing their research, they found new questions that must be answered at some point in the future.
For example, they found that a major unresolved issue concerns gold as a long run inflation hedge for countries other than the U.S. Levin and Wright suggest that if the price of gold is quoted in U.S. dollars and gold is an inflation hedge for the
Policy Implications for Gold Investors
The authors looked at investment implications for gold investors. They note that the current consensus calls for the U.S. dollar to depreciate against other global currencies. The only questions are when it will occur and whether the depreciation adjustment path will be smooth or disorderly.
Levin and Wright conclude that “if it is true that real dollar depreciation against other currencies is inevitable, U.S. wealth holders should profit from holding gold during this period” for two reasons:
- The dollar depreciation will reduce the price of gold to investors outside of the
- The dollar depreciation will likely raise
This study is available as a free download from the World Gold Council’s website: www.gold.org. The study provides contact information for the authors, Eric J. Levin and Robert E. Wright. Potential readers should note that this is scholarly research; a background in math (and a very quiet room) will be especially helpful in understanding and assimilating the report.