Gold As Inflation Hedge, Or Something Else?

In his latest "Wealthy Boomer" column, Jonathan Chevreau makes the case for holding some of one's wealth in gold to hedge against the beast. In a talk with Nick Barisheff, he learned about the term "hyperstagflation" (which is, by the way, a real term.)

Consumers and investors well know garden-variety inflation and continual rises in the cost of living. Governments tolerate (and arguably create) modest annual inflation rates of 2% to 3%. This seems innocuous, but purchasing power of dollars will steadily erode unless you can generate real returns beyond inflation. With interest rates near historic lows, short-term savings vehicles have negative real returns.

The fear is governments and central banks will fail to maintain a balancing act between mild inflation and economic growth, with runaway inflation morphing into the kind of hyperinflation Weimar Germany experienced in the 1920s or currently afflicts Zimbabwe.

Gold enthusiasts like Mr. Barisheff believe the best protection against debauched paper currencies and inflation is physical precious metals....

It's a settled argument in the goldbug world that the gold bull market is forecasting or calling attention to high inflation in the developed world. A Bloomberg editorial begs to differ, though.

Buried amid the standard reportese is a statistical review of worldwide gold demand in 2011’s first quarter. The data show that gold’s ascent is being driven by extraordinary demand from India and China, where rising prosperity is making it easier for millions of people to buy gold in all its forms, particularly jewelry.

The WGC estimates that Indian households own more than 18,000 metric tons of gold, the largest holding on the planet. (By contrast, U.S. official gold reserves total about 8,100 metric tons.) Indian consumers aren’t done buying. In this year’s first quarter, they purchased an additional 206 tons of gold jewelry and 85 tons of gold bars and coins. China’s appetite is growing rapidly and could soon overtake India’s.

Or come at it another way: Strip out Chinese and Indian purchases, and the rest of the world isn’t nearly so vibrant. Some new buyers have shown up; some prior speculators are cashing out....

This take on gold's rise - that it's due to Asian demand - is likely the reasoning used at the Federal Reserve to dismiss gold's rise an an indicator of inflationary trouble down the road.