It is far from a perfect hedge and may need to be held for longer periods to be effective as inflation hedge

The recent rally in gold prices is believed to have a linkage with the rising sovereign risks and defaults across the global financial markets. The yellow metal is often cited as a safe haven for investors thanks to the fact that unlike financial assets, gold is not other's liability. Historically, gold prices have reacted to demand arising from economic scenario and the current rally amidst global slowdown supports this notion. However, one section also raise questions over gold's perceived characteristics.

Apart from inflation hedge, the yellow metal is also considered as hedging against depreciation in dollar, recession and slump in equity markets. During March 2008, when gold prices breached $1000 per ounce level for the first time, factors such as falling dollar, impending slowdown, rising inflation and meltdown in the equity markets meltdown were responsible for the trend. But this time around, the major driving force behind rallying prices is worsening global outlook as all other factors have seen reversal. However, historically speaking, not all hedges mentioned above have aligned.

Suki Cooper, a precious metals analyst at Barclays Capital establishes a valid counter argument for gold as inflation and recession hedge in February, 2009 issue of Alchemist published by the London Bullion Market Association. According to her, the impact of recessions on gold demand has varied significantly. She explains that there is no strong consistent pattern of gold price during recessionary period. "Gold is sometimes bought as a hedge against inflation, but it is far from a perfect or dynamic hedge and may need to be held for longer periods to be effective," she says.

Bhargav Vaidya, a Mumbai-based gold analyst, while agreeing with Cooper says that gold should be considered more as store-of-value asset, rather than inflation hedge. "If one takes 100 year data, gold does emerge as inflation hedge, but this period is too long for proving it to be inflation hedge and there are going to be exceptions," he explains.

According to the latest report on global gold hedge book by Gold Fields Mineral Services (GFMS), the global producer hedge book at the end of September 2008 stood at 526 tonnes indicating a fall of 11% as compared to same quarter last year. The global hedge book peaked at 3,000 tonnes at the start of the decade.

As far as dollar hedge is concerned, the movement of gold prices this time is contrary to the popular notion of inverse relationship between the yellow metal and the greenback. Though recent appreciation in US dollar against major currencies is more about declining confidence in other currencies rather than increasing confidence in US dollar, it does not necessarily prevent gold prices from appreciating.

Moot point

Apart from inflation hedge, the yellow metal is also considered as hedging against depreciation in dollar, recession and slump in the equity markets

Current movement in gold prices does not support the popular notion of inverse relationship between the yellow metal and the greenback

Darshan Mankad/ DNA-Daily News & Analysis Source: 3D Syndication