Rationale of buying gold as a hedge instrument

POSTED BY Sambaran Mitra ON August 5, 2012 4:37 pm COMMENTS (9)

It is said that wanton money printing by governments is leading to devaluing of paper currency. To counter this effect many experts recommend to buy gold.
I agree that paper currency is under pressure. However, to counter it, getting into any non-paper-currency should help. Gold is definitely one such avenue. Other avenues can be buying rice, dal, silver, platinum, fish, meat, fruits, vegetables, shares/mutual-funds etc. All will achieve the same purpose of hedging paper currency risk.
Now buying and holding fish/meat/fruits/vegetables for hedging purpose is cumbersome. Holding mutual funds is easy. So why holding mutual funds is not considered a hedge against paper currency devaluation?
To summarize, I agree with the paper currency devaluation problem. However I believe holding mutual funds of companies is as good a hedge against the problem as gold is. This view is not shared by many experts.
Can you share your thoughts on the issue?

9 replies on this article “Rationale of buying gold as a hedge instrument”

  1. TheZionView says:

    @ramesh

    Nope when the Fiat money loose value the MF will loose value but at the same time the gold will appreciate enough to give protection that is the general wisdom for the doomsday. I might be wrong but from wht i learnt that is what i understand

    1. Ramesh says:

      Explain in detail. Not in abstract terms. Preferably with some long term data.

      If doomsday really occurs, gold will also be useless. Then the real useable things will be the important things.

    2. @TheZionView,

      My question was not regarding doomsday scenario. I have some arguments against gold in doomsday scenario but that is not the point of this post. My question is regarding value of gold vs other-assets(like mutual funds) w.r.t. fiat money.
      You said: “Nope when the Fiat money loose value the MF will loose value ”
      I do not think fiat-money will suddenly lose all the value one fine day. In fact such drastic outcome may not happen. However, Fiat-money is indeed losing value (a.k.a inflation) due to government printing presses. As a result, any non-fiat-money-asset should ‘increase’ in value (be it gold, rice, shares-of-good-companies, good-mutual-funds). So why only gold is considered as a hedge?

  2. Ramesh says:

    Devaluing of paper money is just another name for inflation.

    “Proven above-inflation” assets have been equities and real-estate (Proven by reasonable analyse) over a long period of time.

    Debt instruments, gold, art for short periods of time have been able to give good returns, but on a longer term basis, they fall way short of inflation.

    When gold falls (from peak of $1900 to presently $1600), then it is not mentioned much. In terms of rupees, it will be interesting when the indian rupee will become stronger. The recent 20% decline has clouded the fall of gold prices.

    I have never understood the rationale of all gold-buffs. If they are so sure, that gold is really the saver in midst of the gloom and doom of world currencies and economies, then why they (the holders of gold) want to sell gold to prospective buyers in return of the futile fiat currency. Why are they interested in giving you the real currency of gold, and take fiat currency instead?
    Are they so naive as to think only and only for the good of others and not of themselves.

    Any exchange is a give and take of nearly equal valued things.

  3. TheZionView says:

    Mutual Funds as hedge? What will mutual fund give you when you redeem? the same paper money against which you are hedging.

    That is the difference. I believe gold hedge is useful for high net worth people or for doomsday.

    1. Ramesh says:

      And what will gold selling give you? The same paper money, isn’t it. 😉

    2. Hi ZionView,

      Thanks for your reply.
      However, as pointed out by Ramesh, ‘what does MF give you on redemption’ is not a convincing line of reasoning.
      Further, in this question I am not asking about doomsday situation. Gold may have value there.
      My question is only specific to currency-devaluation risk and how Mutual-fund may be as good an instrument as gold towards that respect.

  4. BanyanFA says:

    Hi Sambaran,
    The reason why Gold is considered the best hedge lies in its scarce availability. Not sure if it would surprise you, the total quantity of Gold mined till date is just around 165,000 tonnes. To give it some perspective, yearly production of Iron is around 2 billion tonnes !

    I have detailed the entire rationale in Gold as a hedge in my article http://insight.banyanfa.com/golden-path-of-gold/ . Hopefully it may answer your query.

    Regards
    BanyanFA

    1. @Banyanfa,

      I am unable to visit your link since yesterday, it is hanging.
      Your rationale about gold being rare explains why gold may be better than N other commodities.
      My question is only specific to currency-devaluation risk. I still do not understand why mutual-funds are not as good an instrument as gold to counter the currency-devaluation risk.

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