Gold Is Not An Inflation Hedge, But It Is Going Up

by: D. H. Taylor


Gold is correlated to inflation but outperforms.

Inflation will move higher from the Fed's balance sheet.

Gold will outperform upcoming inflation moves.

The Federal Reserve pushed their balances sheet up from $800 billion to $4.5 trillion in a very short period of time. Now that the economy is expanding progressively, the ability for that balance sheet to create inflation is here and now. Gold, as a physical asset will appreciate in value. And, I believe the move upward will be sharp and continuous.

Gold as an inflationary hedge

"Gold is an inflation hedge". I have heard that statement 1,000 times. I could not disagree with it more. Gold is a physical asset. Just like any physical asset it will appreciate in nominal terms simply because inflation erodes the purchasing value of all assets. This happens to a lot of assets such as stocks, commodities and other tangibles. These all move upward in nominal levels simply because of the erosion process of inflation in the dollar's ability to purchase things.

Therefore, I do not look at gold as a hedge against inflation. I look at gold as something that moves along with inflation, but it does just a little bit more. Here is an interesting look at a chart to show what I am talking about:

Looking at this chart, the CPI index itself moved upward during the 1990 - present period from 120 - 240. Since 1990, the CPI doubled. Gold, during the same period of time did the same moving from just under $400.00 to its current level of about $1,250.00 right now. That is a lot more than just double. That is more like triple and, if you look at the chart a few years back it did more than just triple hitting about the $1,750.00 level, gold's most recent high.

Gold is precious. It is in demand for that reason alone. Its moves are greater than inflation and so to call it an inflation hedge would be to discount its many uses in industry as well as an adornment for jewelry. Gold has supply limitations. Gold requires a great deal of effort to obtain.

Given that, though, the move upward around 2009 was more than just a buying binge. That move was a safe-haven move as holding on to gold makes people feel safe. And, during the financial crisis people wanted to feel safe any way they could.

To be sure, however, all commodities have supply limitations. Gold, you have to stand in some frigid river and pan for, or get some very big machines to remove a mountaintop and sift through the dirt. Other commodities have some kind of supply concerns as well, and so they will appreciate In value according to their limitations.

As I have mentioned I believe the balance sheet the Federal Reserve is sitting on has the potential to balloon inflation and asset prices significantly. We have never been in an economic landscape similar to where we are now. So, we have no comparison of how the economy will look after its next cycle completes.

The Fed had $800 billion prior to the Great Recession. With Quantitative Easing (QE), the Fed pushed interest rates down to the floor. But, when you and I buy bonds, while although we may affect price things are different with the Fed. You and I are subject to the laws of microeconomics. The Fed is subject to the laws of inflation.

If we all collectively bought bonds the price would go upward pushing down interest rates. Once we stopped buying bonds, however, the bond price is very likely to move upward because of the lack of buying. With the Fed the difference is that they create new money, something you and I cannot legally do. Just because the Fed stopped buying bonds does not mean that interest rates are now going higher.

Instead, prince pressures are what we will see from the Fed's buying binge. They created an astronomical amount of money at that time.

There was a time when the rate of growth in prices was much slower than our current rate of growth. It is my belief that this rate of growth in the money supply is going to wreak havoc on the inflation pressures in the United States.

Given this, I am very interested in long gold. I have been accumulating gold over the past several months with synthetic options, selling puts and buying calls. I have about a 90-day outlook on this position.

The market saw the Fed sound slightly dovish on their speech from the last rate increase. Gold shot up. I do not believe that any further interest rate increases are a factor in the price of gold. I see it otherwise; gold is going higher because of economic factors, interest rates are going higher because of economic factors. I do not see interest rate increases as the cause but the effect. Slightly different approach.

With future gold prices I am very interested in the money supply and bank assets as well as loans. If these numbers start to push higher in a hurry, gold will do the same.

I reiterate my long gold position. I hold for long term.

Disclosure: I am/we are long GOLD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.