Website owner:  James Miller

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Gold as a hedge against inflation

   Many view gold as a hedge against inflation.  Is this a valid 
   assumption?  No.  If one looks at a chart of the price of gold 
   from 1974 to present one can clearly see that in the period 
   from 1980 to 2002 gold would have been a very bad investment.  
   In 1981 gold was at $600 and going into 2000 it was at $300. If 
   a retiree had invested his money in gold in 1981 it would have
   been a terrible decision. We need to ask what the mechanism is 
   that causes gold to go up in price - and to drop in price.  What 
   causes gold to increase in price?  Increase in demand.  A 
   situation where suddenly a whole lot of people become 
   interested in gold and start buying it.  Heavy buying of gold.  
   What causes it to drop in price?  A decrease in demand.  A 
   situation where people lose interest in gold and stop buying 
   it.  Gold goes up or down in price according to human behavior 
   in regard to it.  What kind of situation may cause people to 
   suddenly become interested in buying gold?  An example would be 
   governmental conduct that creates fears of possible 
   hyperinflation, of monetary collapse, of national economic 
   upheaval, as occurred in Germany in the 1920's when the mark 
   became worthless i.e. the kind of thing that can happen when a 
   government spends far more than it ought to, goes way into 
   debt, and then just starts printing money in large amounts.  
   Thus investment in gold may protect one against calamity of 
   that kind since in such a situation everyone with wealth to 
   lose thinks of gold and silver and starts buying them, pushing 
   their prices up.

   We note that one can have bubbles in gold as in anything else.  
   If the price of gold starts going up people may all flock into 
   gold just because it is going up (just to make quick and easy 
   money) thus causing it to rise ever faster.  We know about 
   bubbles in stocks, bubbles in housing.  Some financial asset 
   starts increasing in value, everyone becomes aware that one can 
   just buy it and sit around and watch himself become rich. 
   Everyone and his brother, from construction worker to lawyer, 
   starts buying it, all the ever increasing demand makes it go 
   higher and higher faster and faster and people are sitting 
   around becoming fabulously rich -- and then there is the crash 
   and people start jumping out of windows. 

   Suppose the government is behaving in a way that you think 
   will bring heavy future inflation.  What can you do to protect 
   your wealth? Where is the best place to put your money?  I 
   think land. 

   Apr 2011

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