Why hedging with Gold is Popular

Discussion in 'Forex' started by FP Markets, Nov 19, 2019.

  1. Of all the precious metals, gold has maintained its popularity as an investment. Perhaps this is due to its long history as the first form of money. Societies and economies have placed value on gold throughout the centuries, therefore preserving its worth.

    Gold was used as the base for the gold standard which set the value for all money. It’s regarded as a source of money that will always have value.

    Also, gold is different because its value has little to no correlation with other assets. For instance, stocks have an inverse relationship with bonds but gold prices don’t rise or fall when most asset classes do.

    Investors use gold to diversify their portfolios and hedge risk, but what is it about gold that makes it a popular choice for hedging?

    Gold is a good hedge against the decline of a currency, typically the US dollar. Although the US dollar is one of the most important reserve currencies in the world, its value sometimes falls as it did between 1998 and 2008.

    Typically, when the value of the dollar declines or there is a financial crisis, the value of gold rises. For instance, the value of gold nearly tripled between 1998 and 2008. Gold is therefore used as a hedging tool when the economy negatively affects major currencies.

    The stock market tends to plunge as the cost of living rises and inflation increases. You need an asset to help you balance this out and this is where gold comes in.

    The price of gold tends to increase as the cost of living increases. This is because when a currency loses its purchasing power to inflation, people tend to hold money in the form of gold and this increases its value. As such, gold has always been an excellent hedge against inflation.

    Gold has also been used as a hedge against deflation – the flip side of inflation. Deflation occurs when the economy is in a downturn, business activity slows, excessive debt looms and prices drop.

    When this happens, people hoard cash and the safest way to hold cash is in gold. As more people compete for gold, its supply decreases and this increases its purchasing power.

    Gold not only retains its value during times of financial uncertainty but in times of geopolitical uncertainty as well. Gold has often been called the “crisis commodity” – people rush to it when world tensions rise. For example, its price tends to increase when confidence in governments is low as highlighted by the recent increase in gold price amidst Brexit uncertainty.

    This is because people trust in the safety of gold. Crises such as wars, which have a negative impact on the prices of most asset classes, tend to impact gold positively as increased demand for the metal pushes up its value. This means gains in gold can help you offset the losses in the other asset classes.

    Although gold goes through times of volatility, it has always maintained its value over the long-term. Gold is great for hedging because its value increases in response to events that cause the decline of paper investments like bonds and stocks. Including gold in a diversified investment portfolio helps maintain the value of the portfolio.

    Do you use gold to hedge your portfolio? Have you managed to maintain the value of your investment using gold? Join the conversation and share any experience you have hedging with gold.
    MrKJoe likes this.
  2. dozu888


    because it's a comfort trade for the dumb money.
    MrMuppet likes this.
  3. gaussian


    My first experience learning about money was in a personal finance class I took at the community college a long time ago. The guy bought gold at like $50 in 1970. He's absurdly wealthy now.
  4. MrMuppet


    This is like the story of the guy who bought bank stocks in 2009 or Bitcoin at 300$
    In trading and investing timing is everything.
    The performance of one lucky guy does not justify an entire asset class.

    Gold still is a dumb money hedge and it works because "it's always been that way"
  5. gaussian


    This is disparaging to the large swathes of people who have been buying gold and getting rich. It's only recently that it no longer makes sense.

    Gold is an extremely important component for engineering, electronics, medicine, jewelry, glassmaking, and more. It's "always been that way" because it's one of the single most important elements we have and it's a finite, consumable resource.
  6. dozu888


    long term gold just tracks inflation while producing no yield.... one of the worst investments out there.

    currently there are 2 problems -

    - the dumb money is very crowded there, you can search youtube for those gold pumping vids and you get like 100:1 like dislike ratio... that is BAD news for long term.

    - also if you look at gold silver ratio and platinum/gold premium, both indicating gold over valued compared to other precious.

    long term sure you bot gold in 1970 that guy get wealthy? how wealthy can you get with 3% annual.... what if he bot technology stocks in 1970... nasdaq 100 12.5% annual return.. leaves everything in the dust.

    gold serves no purpose - for hedging inflation there are yield producing assets that work far better... for hedging crisis you need dollars and guns.... check what happened in the 2008 crisis. gold went DOWN, dollar went UP.
  7. MrMuppet


    So you are saying that buying gold is the way to get rich? Very nice, dude, very nice. Inflation adjusted you would be way richer by dollar cost averaging into MSFT or BRK-A every month, just saying.

    And by the way: Only about 16% of gold produced is used for industrial production. 50% is for jewelry (aka. bling bling without any other value than showing off) and the rest goes to HODL'ers.

    Gold is a hedge for people who don't know better and don't have the time to do research for a proper hedge. It feels good to them, because they have it at home and they can touch it.

    It generates a mediocre performance, it has no real life use for the investor (at least you can live in the house you bought 20% over value) and it even costs money to store it.

    The only way to really make money with gold is by generating investment advice that caters to fear (everything is going to shit, buy gold and store it in your own bunker).
    And even for them gold is a bad bet. Anti Money Laundering laws already prohibit anonymous gold purchases in the EU above a certain limit. Meaning if you want to buy gold worth north of 1000€ in France, 2500€ in Spain or 3000€ for Italy, your purchase will be registered.
    Good luck with your gold when the shit hits the fan. Authorities might just prohibit personal gold ownership and take it away from you in exchange for fiat that is worth 10% less next month.

    But on the other hand I might just have stepped on a gold bug :D
    Last edited: Nov 19, 2019
  8. gaussian


    The actual inflation adjusted return over the last 50 years is closer to 5%, with a total annualized return of 553%.

    I'd say a sizeable investment in the 70s would've produced consistent, safe, profits. Especially if, like my professor, you have a distrust of both governments and stocks.

    I will agree with you today gold pumping is very, very active. If you listen to conservative talk radio gold is on every single commercial. Don't mistake me for saying buying gold today is a good idea. The idea is antiquated. After the removal of the gold standard completely in 1971, it wouldn't surprise me gold and dollars diverged. In fact, it would be expected. Gold was borrowed and sold into the market to create dollar liquidity during one of the largest crises in history.

    I'm not saying that at all, just sharing a story.

    I don't own an ounce of precious metal.

    There's a reasonable argument that gold would be worthless in a crisis anyway. It lacks any value, cannot be traded for anything of value, and the only people you could sell it to are refineries.

    I'm not advocating buying gold today. I was just sharing an interesting counterpoint.
    Last edited: Nov 19, 2019
  9. MrMuppet


    no hard feelings :)
  10. bd10


    In my eyes, gold is a funny one. It can serve as hedge when equities crash/get sold off for a few months. I looked at the past 8 downturns and gold did well during these episodes, equally if not better than bonds. But this is not to suggest to hold gold over the long term. That's a different animal.

    A funny story a decade back. So, I was on the way to Kansas City for a seminar in grains. Flew via Toronto. Anyways, I was sitting next to this German guy and his business friends who were heavy in gold. For 8 hours straight I had to listen to his doomsday story that the financial system will implode yada yada yada. He was not referring to the credit market at the time but fiat money and all that. Anyways, he was travelling with a bullion of solid gold. 250g at least. Puzzles me to this day how airport security did not pick that one up. What these guys did, they had a little physical gold bullion buying scheme going in Germany. Client money with gold certificates and all, quite a sizable stock they held. Similar schemes blew up a little while back. The old spiel: more certificates than actual gold, lol. Wasn't these guys but, there is a huge psychological element in play that makes people feel safe with gold.
    #10     Nov 19, 2019