HEDGING

1/1/2016

What Does "...A Hedge Against Inflation" Really Mean?


  • HEDGE:  A financial tool to protect oneself from loss by trading a higher risk asset for one of lower risk. Loss, for the purpose of this discussion, is the erosion of your dollar's purchasing power due to inflation (Standard & Poor's Financial Dictionary)
  • INFLATION:  the loss of purchasing power as evidenced by higher prices for goods and services--one unit of currency buys less and less (Dictionary of Finance and Investment Terms).
Many will hear the two words hedge and invest used interchangeablely. However, their meaning, the respective strategy and related products to facilitate the strategy are quite different. This article is about Hedging, not investing. 

So, due to inflation (everything costs more) your your hard earned income buys less and less. The objective is to hedge some of your income to maintain its purchasing power. The purpose of hedging is to buy and sell disparaging asset classes to protect against loss. 

One way to do this is by purchasing precious metals.  During a period of economic uncertainty, currency (the more volitile asset) is traded in for precious metals (the more stable asset) in the form of low premium ( Spot + 15% or less) precious metal coins and/or bars. The following is a simplified example illustrating how precious metals can help maintain purchasing power. 

In the late 1950's through early 1970's, the average price of gasoline was $0.25 +/- per gallon. US quarters made prior to 1965 contain 0.18084 troy oz. of silver. While we no longer can purchase gasoline for $0.25 per gallon, had one held on to that same pre-1965 silver quarter and sold it today, its silver value is worth about $3 - $3.15 based on the price of silver - $17.50 per troy oz (June 2016). That's close to the price of a gallon of gasoline today! 

In a perfect world if there is a 6% rise in inflation, we would see an exact correlation of 6% rise in the precious metals market. As we know the world is not perfect and there are myriad indicators of inflation and economic health. One of these is the correlation between the value of the US dollar (NYE: DXY, ICE: USDX) and the price of precious metals. Theoretically, as the dollar goes down (inferring instability in the US) precious metals go up. Conversely, as the dollar goes up (inferring stability in the US) precious metals go down. The reader should note, there are many factors that drive the price of commodities, not just one thing. Furthermore, whether we are a period of economic stability or instability, there are different strategies for each situation.  

Typical Low Premium Precious Metal items for Hedging
  • 1.00 oz. Gold & Silver Modern Bullion Coins, Bars, and Rounds
  • 0.50 oz. Gold Bullion Coins - Government Mint Produced
  • 0.25 oz. Gold Bullion Coins - Government Mint Produced (marginally appropriate)
  • 0.10 oz. Gold Bullion Coins - Government Mint Produced (marginally appropriate)
  • US $10 Gold Liberty (1866-1907) Common Date, Low Grade (< VF)
  • US $  5 Gold Liberty (1866-1908) Common Date, Low Grade (< VF)
  • US 90% Silver 50 cents, 25 cents, 10 cents (1916-1964) Common Date
  • US 40% Silver 50 cents (1965-1970) Circulated
  • World Gold Circulated Early 2oth & Late 19th Century. Check the premium before buying. These are highly promoted and can carry unnecessarily high premiums.
Avoid Certified Graded Bullion, unless the price is the same or very close to the same as an uncertified coin. Remember the key to your hedge account is, the premium over  Spot should be low; not be more than 15% over the precious metal value.  

Caveat Emptor -- If you see it on a shopping channel or advertised in a magazine that is not a publication for the numismatic trade,  It Does Not Belong in Your Hedge Account! 

For more information on Investing Read Precious Metals 101 - Investing.