Why is gold considered to be the best hedge against inflation

Gold is especially attractive in times of economic and political crisis. As the most widely accepted global currency, gold is viewed as a source of stability in times of currency inflation, stock market uncertainty and political conflict. When the US $ collapses we find gold value shooting up manifold. This is simply because crude oil is traded in $ per barrel and when dollar value falls, the price of crude oil shoots up as a concomitant effect. With crude oil prices rising and the OPEC group getting richer by the day, the automatic channelisation of the surplus profits finds its way to gold as a safe investment destination.

Gold prices have the advantage of independence from correlation with stock market prices and gold investments can help offset the risks of a portfolio heavy in stocks and bonds. Gold hedges against the possibility of interest rates moving against one’s bond investments and protects against the devaluation of one’s primary currency.

Gold is now at around USD 900 per ounce. It was trading at USD 37 in 1971. Gold then shot up to USD 850 in 1980, collapsed all the way to USD 260 in 1999, and has only now crossed the previous peak of USD 850 that it established 27 years ago.

Because many of the central banks of the world have lost sight of what they are supposed to do.
As a student of economics, we were taught that the role of a central bank was to ensure that it maintained the value of the paper currency issued. It did this by ensuring that every time it printed paper, it had a fixed ratio of gold lying in its vaults( Also known in economic parlance as gold standard). But, over the past few decades - and increasingly over the past few years - the central banks have shifted to a "fiat" currency system whereby they have been printing more paper and not worrying about the gold they have as a reserve for their paper currencies. And paper currencies are, in the end, paper. History has shown us that governments have fallen and paper currencies have died with them. Gold has been a currency - a medium of exchange - for centuries. No paper currency has existed for that long. Not the US Dollar. Not the Sterling Pound. Not the Indian Rupee. As governments have printed larger amounts of paper currencies, these currencies have lost value against real assets like property, or for that matter even a samosa. The danger with fiat currency is that nations may lose discretion and print too much currency or allow too much credit, devaluing the currency and causing inflation. Gold serves as a bulwark against a dropping dollar and other fiat currencies in part because it can’t be produced at will.

Even as global demand has increased, gold mining efforts have actually decreased production because of a decreasing supply of easily accessible reserves. Limitations in the global supply of gold ensure its precious nature.

In 1980, it probably cost you Rs 1 to buy one samosa. Today, it costs you Rs 10. Has the samosa become 10 times larger over the past 27 years? Not at all. The fact is that Indian rupee has lost value over the past 27 years, so the samosa wallah wants more of your rupee to sell you the same samosa. He wants 10 times the rupees for that same samosa. Or look at the price of your house. In 1980, it cost Rs 200 to buy one square foot of property in Cuffe Parade, Bombay. Today, it costs Rs. 40,000 per square foot. That is an increase of 200 times! Money, obviously, buys less these days. Paper money has lost value. This is what is called "inflation".

Now look at gold. It was USD 850 briefly in 1980 - when samosa was available at Rs. 1 and land in Bombay at Rs 200. Today it is at USD 900. Interesting, isn't it? The one currency that governments cannot print at will and which has, across civilisations, been a "store of value" - a hedge against inflation in the language of economics - has not really seen any increase in price over the past 27 years.

If the price of gold was to move in line with the price of samosas, gold should be trading at USD 9,000 per ounce or over Rs 1 lakh for every 10 grammes. But gold can be bought for around Rs. 11,000 for every 10 grammes today. If gold was to have moved along with the price of Bombay property, gold should be trading at Rs. 20 lakhs for every 10 grammes.

That may sound absurd. But sometimes the most attractive investment opportunities are those that sound absurd. Like Infosys at its IPO in 1992 or Zee at its IPO in 1993. You could have multiplied your money by over 1,000 times in each of them.

Don't get me wrong - not every absurd idea is a good investment.And not every investment will increase in value by 10 times let alone by 1,000 times. But, sometimes, simple logic and harsh facts should allow us to make simple investment decisions. Do I expect the price of a samosa to fall to Rs. 1 ? Do I expect the price of Bombay property to fall to Rs. 200 per square foot? Or do I expect gold to start climbing and get closer to the equivalent price of a samosa and the price of Bombay property?

Inflation and uncertainty require insurance. Gold is an insurance against absurd government policies - worldwide. I own gold. Do invest more in gold but mainly through ETF's (Exchange Traded Funds) as they dont have the drawbacks of investing in physical gold like making charges and impurity charges which reduces the quantum of gold u get to purchase with ur investible funds. Also if we compare the movement of gold prices over the last 27 years, one factor that clearly comes out is that gold prices are clearly bearish during the first half of the year and they pick up steam over the second half (from june onwards)..therefore the best phase to buy gold would be the current first half from Jan- June 2008. The crash in gold prices have already commenced. Place your bulk orders now on NSE through Benchmark Gold ETF that is traded on the NSE just like any other scrip. Buy on a staggered basis until june and hold ur investments for the long term.