A significant argument for investing in gold has always been that it's a hedge against inflation. Gold enthusiats argue that you are not going to lose your purchasing power if you hold your savings in gold instead of fiat currency. Yet although inflation escalated beyond expectations in 2022, gold prices didn't increase as expected. Why is that?
Price Relativity and the US Dollar
First, it is important to remember that the gold price is set in US Dollars. Despite worldwide inflation, the Dollar has grown relatively stronger. This also means that many other currencies worldwide have faced worse inflation than the US Dollar.
For instance, EUR/USD experienced its lowest rate in over 20 years in 2022, falling to a rate of 0.9900. Against the Dollar, the Euro has dropped in value by over 13% since the beginning of 2022. This is way more than the previous year’s annual inflation of 8.9%.
As a matter of fact, the Euro’s has depreciated by nearly 17% year-on-year, which, regardless of the inflation, also indicates a nearly 8% increase for the Dollar against the Euro last year.
What does this mean for the gold price?
This relativity of price means that in order to hedge against inflation, buying and holding dollars has been a more effective hedge than buying gold. This is especially true for those living in countries where the main currency has depreciated further against the dollar.
The price of gold depends heavily on the value of the dollar. Despite losing 8.5% of its value since 2021, the dollar is still considered by many to be the best investment.
The increase in the gold price in March 2022 was caused by Russo-Ukrainian geopolitical tensions, and the Fed and other central banks increasing their gold reserves. With a tightened monetary policy, the demand for dollars increases. So when the demand for dollars is high, the demand for all other assets decreases, including gold.
On the other hand, since Covid lockdowns there are now shortages caused by underinvestment in skilled labor, energy production, and housing, and over-investment in SaaS, blockchain and food delivery sectors. These imbalances have caused an increase to the price of many products now in shorter supply (including food), relative to all currencies. This also includes gold and other commodities.
Gold can act as a hedge against inflation, but this hedge factor will depend on a number of other factors, including stagflation, the rates of Fed or central bank interest rate increases, and many other factors. As a result, if the dollar gains in value, then the price of gold goes down comparatively. However, there is on significant factor here that needs to be taken into account - US debt levels continue to grow at alarming rates. Standing at over 31 trillion dollars today, this debt has reached levels where paying the interest on the debt will quickly be problematic if the government continues to hike the interest rates. Despite dollar growth, systemic problems in the dollar system still indicate that gold over time may be a safer and more secure option.