What is Inflation?
Inflation is a systematic increase of the cost of goods or services over the course of a year. There are many products that have prices that not fixed and, as a result, the cost may vary on an hourly or even daily basis.
This is not inflation. Inflation looks at the average cost of a product or service and compares it to the previous years average cost. The other side of inflation is the buying power of currency. Some items go up in cost because of supply and demand, but if the value of the currency being used drops as the cost of goods goes up then you have inflation.
Gold as A Hedge Against Inflation:
The cost to purchase gold is always listed in US dollars. Since inflation is linked to the value of currency, when inflation rises so does the price of gold. The value of the US dollar is directly linked to inflation.
This means that if last week it took 20 US dollars to buy 1 oz of gold and this week the value of the dollar was cut into half then today it would take 40 US dollars to buy 1 oz of gold. Devaluation of the US Dollar is directly related to the world cost of gold.
A weaker US dollar means that it takes more US dollars to buy the same amount of gold. The price of gold has gone up not because gold has become scarcer but because the value of the dollar has dropped. This is one example of why gold can be used as a hedge against inflation.
The key concept in considering gold as an investment is that if inflation rises so does the price of gold. One important aspect to consider is that the value of money is not always backed by gold.
Gold, however, is recognized around the world as a form of currency. This is also another reason why when the value of printed money falls the price of gold goes up. Outside factors can affect the value of money.
Dropping interest rates is one of the key indicators of money valuation. This is true of the Central Bank (UK, Aust, etc.) and the Federal Reserve (USA) all issue an interest rate that denotes the value of money.
Higher interest means money is more valuable while lower interest rates means money costs less or has less value. This again is part of the reason why the value of the US dollar affects the price of gold.
Notice that it affects the price but not the value. There is a difference. The more something costs the great the value that is placed on it. If the value of money is an indicator of inflation, then the less value the money has the higher the inflation. Gold works the same way. If it takes more money to buy the same amount of gold, then the value of gold has increased because the value of the money is weaker.
Buying gold as an investment is fairly straight forward process. The value of gold as an investment is that it weathers tougher economic times by rising in value than do other investments. Unlike other investments the worse the situation becomes the higher the price of gold will usually rise. You may also want to buy silver, as this precious metal is also
a good hedge against inflation, although the prices swings are more volatile.
This translates into a form of investment security since as inflation rises so does the price of gold. Investing in gold is not without risks. People who are interested should investigate the process of investing in precious metals. A good place to begin is to look at the price of gold historically and compare it to the value of the US dollar.