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gold as an inflation hedge?

Updated on May 11, 2011

could gold crash?

Investors generally buy gold as a hedge against economic, political, or currency crises (including investment market declines, surging national debt, currency failure, inflation, war and social unrest. The gold market is subject to speculation as are other markets by the use of futures contracts and derivatives. The history of the gold standard and the role of gold reserves in central banking suggest that gold behaves more like a currency than a commodity.It has been in a uptrend the last decade and experienced double digits gains annually. Could it be that the cost of inflation protection is too high? It appears to be the consensus that prices can only go up. However the recent flash crash in silver illustrates the problem with bubbles and manias. In the end the silver price was supported by the theory of greater fool, i.e. somebody who would be willing to buy at higher prices and therefore it traded highly speculative. Silver has historically been more volatile than gold and it has industrial uses. Gold has historically been used as a source for payment and also backed reserve currencies. Gold is not an investment in itself as it does not provide any cash flows or dividends. A rally in the US dollar has historically been bearish for gold as it is denominated in this currency. It is difficult to predict the future but global tightening and interest hikes could create headwinds for commodities including gold. Likewise crowded trades and algorithmic trading could create crashes in more asset classes.


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