Gold as an Inflation Hedge: a Study on United States

Topics: Inflation, Gold as an investment, Regression analysis Pages: 7 (1631 words) Published: October 24, 2010

1. Introduction
Inflation hedge can be defined as an investment designed to protect against inflation risk where such an investment's value will typically increase with inflation. There are many ways of investment to hedge against inflation and one of them is by taking gold as an inflation hedge. Gold is a type of commodities that is used for investment. Commodities are said to be the best way to hedge against inflation which reduce the returns of purely financial assets like stocks and bonds because commodities are physical assets, but unlike most commodities, gold is durable, relatively transportable, universally acceptable and easily authenticated.( Worthington, A.C., and Pahlavani, M.,2006). However, gold is also a high-risk and highly volatile investment. Unlike common stock, bonds, and real estate, the value of gold does not reflect underlying earnings. Gold is a purely speculative investment. Over the next few years, it may fall to $500 an ounce or rise to $2,000 an ounce. There is no way to know which it will be. (Feldstein, M., 2009) Therefore, by using the yearly average inflation rate and the yearly average gold price in United States from 1968 to 2009, the purpose of this study is to find out gold act as an inflation hedge and how strong the inflation rate and the period of time influence the gold prices where we can know whether the gold is a short-run or a long-run inflation hedge.

2.0 Problem Statement
There is an argument that the price of gold has actually only exceeded the inflation hedge price on a small number of occasions - 1875-1879, 1884-1889,1892-1899,1974-1975,1977-1991 and 2006. (Worthington, A.C., and Pahlavani, M., 2006) Therefore, the problem is whether the gold can be used to hedge against inflation in the long-run or in the short-run.

3.0 Objectives
• To find how gold act as an inflation hedge.
• To predict the future value of the gold price from the historically measurement in its relation to the inflation rate and time.

4.0 Scope of the study

To study how strong the inflation rate and the period of time influence the gold prices.

5.0 Literature Review

The previous studies have used cointegration regression techniques as a measure of the relationship between price of gold and inflation rate. Ghosh, Levin,Macmillan and Wright(December 2000) have used this model and their paper attempts to reconcile an apparent contradiction between short-run and long-run movements in the price of gold. This theoretical model suggests a set of the conditions that would have to be satisfied for the price of gold to rise over time at the general rate of inflation and hence be an effective long-run hedge against inflation. The model also demonstrates that short-run changes in such factors as the gold lease rate, the real interest rate, convenience yield, default risk, the covariance of gold returns with other assets and the dollar/world currencies exchange rate can seriously disturb this equilibrium relationship and generate significant short-run price volatility. Using monthly gold price data (1976-1999) and the cointegration regression techniques, an empirical analysis confirms the central hypotheses of the theoretical model. Similarly, Worthingthon and Pahlavani (2006) apply the same method tests for the presence of a stable long-run relationship between the monthly price of gold and inflation in the United States from 1945 to 2006 and from 1973 to 2006. Since both the price of gold and the consumer price index have been subject to structural change over time, a novel unit root testing procedure is employed which allows for the timing of significant breaks to be estimated, rather than assumed exogenous. After taking these endogenously determined structural breaks into account, a modified cointegration approach provides strong evidence of a cointegrating relationship between gold and inflation in both the post-war...
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