Is Gold a Hedge Against Excess Liquidity?

By Franklin in Economics, Thoughts on December 5th, 2007

No.

Short article today.

In the above chart, an ascending line shows gold acting as a hedge against the mad emission of currency by the fed. A descending line show gold losing value against the “currency inflation.” As you can see, gold is not a particularly apt instrument to hedge against liquidity injections by the Federal Reserve (which eventually produce inflation).

The flat line at the left of the chart is the period during which the US used the gold standard (the fed could not print more money than the gold it had in its reserves and the price of gold was regulated).

The periods of accelerated injection of currency are marked by steep down lines. If the current conditions persist, and history can provide any lessons, we shall be in a period of high inflation in the next 2 to 5 years.

The following chart shows the same data (adjusted for scale), where you can see how the price of gold does not correlate to the injection of money by the Fed

In fact, this data may suggest the fear of inflation due to the injection of money and the illusion that gold is a hedge against inflation, may act as catalyst for increases in the price of gold.

Even if we consider gold in a very limited fashion as a hedge against commodity inflation, the data is not compelling.

The above chart shows gold against several commodities, electricity, and Borodium (a commodity that had the same price as gold in 1946 and only adjusted for inflation).

As you can see, gold is not even a good hedge against rises in other precious metals. Any gold investor would have lost money historically against Platinum (which follows a similar pattern). As a hedge against increases in the price of oil, it is a mixed bag.

What I find interesting is that against electricity (which perhaps is the best indicator of real inflation) gold has been historically a poor hedge, surpassing the rate of increase of electricity only in 2005.

By the way, when researching for this article I found something interesting for which I don’t have an interpretation.

There seems to be an inverse correlation between small time savings (savings in accounts of $100,000 or less) and gold. It is hard to say whether this means that gold runs are correlated to small savers taking the money out of the banks and putting it on gold or that during gold runs small savers take the money out of the banks and buy gold. In either case, I thought it was an interesting correlation or coincidence and wanted to share it.