Over the long term, gold has a proven track record of being a reliable hedge against inflation. However, gold’s track record over the short term isn’t as stable, but that does not mean it isn’t a valuable investment asset.

In Sept., Urban Jermann, who is an economics and Wharton finance professor released a paper outlining what the added value in gold is beyond what its intrinsic value as jewelry is.

“The model has implied that on average over half of the value of gold is because of its role as an investment asset,” Jermann stated. “What the model does is reveal a way to think about the metal as bonds where interest rates do matter. But it is not just a simple bond. It is a bond with an option to sell at the floor price.”

Jermann’s research in the investment value of gold comes at a time when the Federal Reserve is looking to raise interest rates to fight increasing inflation pressures. Markets have been pricing in the possibility that the United States central bank increases interest rates by about 50 basis points in the month of March. In total, markets are expecting around six rates hikes in 2022.

Markets are pricing the aggressive monetary policy as inflation see an unprecedented increases. This past week consumer prices increased 7.5% for the year.

Jermann’s modeling mentions that its gold’s connection to interest rates is the reason why it is not a great short-term hedge against rising inflation. He stated that gold’s relationship with interest rates has been strong for the past 15 years.

Jermann said that gold might struggle in the environment of today; however, there’s a natural floor in the price.

“Gold is attractive as a store of value in times of negative and low real interest rates,” Jermann stated in his report. “When interest rates increase again, the value of gold will decline again. However, this isn’t the whole story.”

“What my model does capture is that if interest rates were to increase, gold prices will fall, but they will stop falling at some point,” Jermann says. “At some point, the people that like jewelry will purchase the gold. They basically offer you as an investor a kind of insurance. As interest rates go up, gold prices respond to them less because gold becomes less of an asset of investment and more of a consumption good.”

As to how far gold prices might fall, Jermann says that the market may see a 20% correction as the Federal Reserve looks to increase the interest rates.

Helping to combat the effects of the coming rate hike cycle is a new safe-haven demand as tensions between the United States and Russia remain elevated.

Author: Steven Sinclaire

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