Hedging is a risk management strategy that is aimed at protecting investments. The technique is used to mitigate various risks and to avoid the potential negative impacts. The practice doesn’t prevent the investments from suffering losses.
It only offsets the risk of losses from other assets. The rise in the cost of goods and services over a period of time defines inflation, which is the expansion in the money supply in an economy. As a result of inflation, a higher amount of money competes for the same amount of goods and services, thus cranking up the prices.
Gold is widely used as a hedge against inflation. During economic crises, gold acts as a hedging asset capable of absorbing shocks in the bond, oil, and equity markets. The yellow metal is considered as a safe haven investment for preserving wealth over generations.
Investment in gold in the form of exchange-traded funds (ETFs), which hold the metal and issue shares that speculators can trade, is another factor driving gold prices. Some ETFs hold the ownership of actual metal while others may hold the shares in mining companies. With strong investment in ETFs, the prices may rise.
The inflation hedge characteristic of gold is its unique and traditional selling point. As a tangible asset, gold holds its value, unlike dollar and paper currencies which lose their purchasing power with an increase in inflation. With rising inflation, the value of gold appreciates, thus it is a perfect inflation hedge asset.