Is gold losing its lustre as a hedge asset?

The aim of a hedge asset is to protect your finances from risky situations. The higher the risk of loss, the greater the importance of protection against it. However, rarely does a hedge investment completely eliminate your potential loss.

Gold still holds the value of a hedging instrument simply because of the fact that it lacks credit or default risks. Gold prices go up when interest rate goes down; which is directly proportional to the strength of the economy. So, in a broad sense, gold is a hedge against a falling economy.

Gold is also extensively used as a hedge against inflation. Hard assets, such as natural resources including gold, silver and real estate hold intrinsic value because of their limited supply. It is interesting to note that when a crisis spooks financial markets, gold becomes a good asset for hedging to absorb the shocks in equity, bond and oil markets.

People see gold as a way to pass on and preserve their wealth from one generation to the next. When official currency loses its purchasing power to inflation, gold tends to be priced in the base currency (mostly US dollar) and, thus, has a tendency to rise in local currency terms. Moreover, gold is seen to store a good value than local currency.

Although the price of gold can be volatile in the short term, it has always maintained its value in the longer run.

However lately, critics are developing adverse feeling for bullion, and its capability to hedge against moves in other assets, such as stocks, as well as inflation. While it is a reasonable store of value over the long-term (decades) – it is less reliable across most smaller investment horizons. Bullion has lost ground in 2021 as the recovery from the pandemic gains more traction and Treasury yields surged. However, it was still demonstrating a strong inverse relationship with the US currency. In the current scenario, gold should be thought of as a dollar hedge.

Economists feel stocks or Bitcoin are now better positioned to hedge against long-term inflation for investors. Carefully selected stocks can definitely help protect you against long-term inflation. Stocks have produced the highest inflation-adjusted return of any major asset class over the long term.

However, Bitcoin’s history is short to make any robust conclusions about its inflation-hedging capabilities.

Bitcoin has risen as an alternative anti-fiat asset. It has been popular because of the libertarian anti-government ideas that have accompanied the digital currency since its inception. Bitcoin can facilitate instant cross-border payments and remittances without restriction from central authorities.

There is circumstantial evidence that some money has flowed directly from gold into Bitcoin. Institutions appear to be making a decision to allocate some money to Bitcoin as a hedge against a fiat collapse.

Bitcoin’s performance over the last year is directly aligned to the movement in bond yields. When yields rise, so does Bitcoin. This implies that the digital currency benefits directly from the ‘reflation trade’ — or the belief that inflation is coming.

Bitcoin and gold are both inflation-sensitive, but gold is happiest when the world faces a downward spiral. In contrast, Bitcoin prefers a stronger economy, when the yield is rising.

Gold is good for slightly higher inflation, but not necessarily much higher real interest rates. Gold, which is a hedge against uncertain economic conditions, is now less in favour owing to an increased risk appetite fuelled by fiscal stimulus programmes of central banks worldwide. Though the precious yellow metal can also have big drawdowns, but nothing like the epic losses that bitcoin periodically inflicts on its holders before rallying again.

As Bitcoin’s declines tend to be three-times bigger, risk can be equalised by holding three times as much gold as Bitcoin.

Demographic trends confirm that the tide is turning, with many younger investors preferring digital assets over metals. For example, only 7.5% of millennials aged 25-34 own gold and silver, while among affluent millennials, 25% own cryptocurrency (and 31% are interested in acquiring it). Bitcoin has many of the symptoms of a speculative mania; like gold, its value is in the eye of the beholder.

It has no intrinsic value. Bitcoin has nothing straightforward to fall back on. Official action might easily limit use of the digital asset if it grew big enough to challenge the government’s monopoly of currency issuance. An estimated 20% of all Bitcoins are stuck in wallets to which people have lost the keys. Most places won’t accept Bitcoin, and transactions are often slow and expensive, occasionally taking days or costing more than $25 each when the network is congested.

The computations required to maintain the Bitcoin blockchain alone consume as much electricity as a mid-sized country, making a significant impact on climate.

The supply of gold isn’t completely static, it rises at about 1.25% a year as more is mined. It can be expensive to store and tricky to transfer around the place in its physical form. It is easily confiscated and cannot be divided and distributed in a hurry. Bitcoin has none of these drawbacks.

The supply is inelastic and capped (only 21 million digital coins will ever exist out of which 18.638 million Bitcoins have been mined till February). You can send it around the place as easily as you would an email (as long as you don’t lose the codes that allow you to access it). It’s fungible, resilient, verifiable, independent of any government and crucially, easily divisible.

Analysts and crypto currency investors expect higher targets for Bitcoin over the long term if Bitcoin becomes a “gold disrupter”, and no upper limit at all if it ends up being commonly used as a payments network rather than just another asset to hold and pray over.

Demand for gold is driven by its perception as a superior ‘anti-fiat’ asset. If people are worried about the long-term buying power of government-issued currencies, they will be prepared to pay more for gold, with its perceived role as a store of value.

Large debt borrowed by the governments across the globe and by corporates also raises the spectre of stress on repayments, when again gold may come back in favour.

There are numerous advantages that, at this point, gold poses over cryptocurrencies as a store of value and medium of exchange. These benefits make it hard to believe that gold will ever lose its luster as a store of value and an inflation/currency hedge

  • Long-term price stability.
  • Secure storage in vaults.
  • Custodian oversight of gold or silver individual retirement accounts.
  • Real-world industrial utility.
  • Proven longevity over millennia.

Mature investors want a portfolio protector that has a multi-millennium record in the safe haven top spot.

Here is where gold scores well. With gold, volatility can be managed because production can accelerate or decelerate in response to demand, but you don’t have that for bitcoin. Relative to other assets, it might continue to be slightly more volatile, even after market structure has matured completely.

Going by the rising popularity of bitcoins, investors could keep buying them (like stocks) in good times and rising yield scenarios, while gold could continue to be the ultimate hedge against bad times, inflation and currency debasement.

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