Why Metals act as a good hedge against inflation?
April 27, 2023
The global economy has been through significant upheavals in the past year. The COVID-19 pandemic has created a massive disruption in the supply chain, leading to shortages of goods and services, and increased prices. The combination of these factors led to a surge in inflation expectations and increased volatility in the financial markets. Investors are now looking for ways to hedge against this inflation risk, and one popular strategy is to invest in precious metals such as gold and silver.
Impact on Precious Metals: Gold and Silver
Gold and silver have long been viewed as a safe haven for investors during times of economic uncertainty. The recent market events have increased the demand for precious metals, leading to a surge in their prices. Inflation expectations have further bolstered the demand for gold and silver as investors seek to protect their portfolios against the erosion of their purchasing power.
Gold, in particular, has traditionally been viewed as a hedge against inflation. This is because gold has a limited supply, and its value is not tied to any particular currency or government. During times of inflation, central banks tend to increase the money supply, which can lead to a devaluation of the currency. Gold, being a physical asset, is not affected by these actions and can maintain its value.
Silver is also viewed as a hedge against inflation, but it is more closely tied to industrial demand. Silver is used in a variety of industries, including electronics, solar panels, and medical devices. As the global economy recovers from the pandemic, demand for silver is likely to increase, leading to higher prices.
According to a report by Heraeus Annual Precious metals forecast for 20231, the prices of gold and other precious metals is likely to rise in a scenario marked by high inflation, global conflicts such as the Russo-Ukraine imbroglio and strong recession-like economic outlook. Gold, in particular, will also be seen as a ‘safe haven’ investment, given that its price is predicated by currency movements rather than by movements in supply and demand. Silver prices similarly2 are in line to touch record highs in 2023 spurred by high economic activity in handset manufacture and its massive presence in the energy efficiency sector. Analysts are expecting Silver to touch a high of $ 30 per Ounce, a record not seen since 2013.
Impact on Other Metals: Copper, Aluminium, etc.
While gold and silver are viewed as safe havens, other metals such as copper and aluminium are more closely tied to the global economy. These metals are used extensively in construction, manufacturing, and other industries, making them sensitive to changes in economic growth and demand.
As demand for copper increases, it is seen as a sign of growing economic activity. In contrast, a decline in copper prices can signal a slowdown in economic growth. The recent increase in inflation expectations has led to higher copper prices as investors anticipate increased demand for the metal. Copper is often viewed as a bellwether for the global economy and its wide use in the industrial activity will dictate the price movements in the metal. A report published by Investingnews.com3 reveals that perhaps due to Copper’s intrinsic relationship with the global economy, it is probably an excellent hedge against inflation and can be used as a lever to book profits during economic cycles. Since copper prices rise before the rise in prices of consumer goods due to the former being the production resource, investors can use it proactively as a hedge. Also the ubiquitous nature of its use also means that rise in prices of copper will be felt across every single sector of the economy. Many analysts even feel that copper is a much better hedge than Gold. A Bloomberg report4 of 2017 reveals that from 1992 on an average, copper has risen 18X as compared to the Consumer Price Index outperforming Gold and all other major asset classes.
Aluminium is also sensitive to changes in economic growth and demand. As demand for aluminium increases, prices tend to rise. However, unlike copper, aluminium is also influenced by supply-side factors such as production capacity and energy costs. The recent surge in energy prices has led to higher aluminium prices as producers pass on these costs to consumers.
The recent market events have led to increased volatility and inflation expectations. Precious metals such as gold and silver are viewed as safe havens for investors seeking to hedge against inflation risk. Other metals such as copper and aluminium are more closely tied to the global economy and are sensitive to changes in economic growth and demand. As the global economy recovers from the pandemic, the demand for these metals is likely to increase, leading to higher prices.