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Is Gold a Good Hedge?

CAMBRIDGE – As I walked through the airport in Dubai recently, I was struck by the large number of travelers who were buying gold coins. They were not reacting to Dubai’s financial trouble, but rather were joining the eager rush to own gold before its price rises even further. Such behavior has pushed the price of gold from $400 an ounce in 2005 to more than $1100 an ounce in December 2009.

Individual buying of gold goes far beyond the airport shops and other places where gold coins are sold. In addition to buying coins minted by several governments, individuals are buying kilogram gold bars, exchange-traded funds that represent claims on physical gold, gold futures, and shares in gold-mining companies that provide a leveraged position on the future price of gold.

And gold buyers include not just individuals, but also sophisticated institutions and sovereign wealth funds. Recently, the government of India purchased 200 tons of gold from the International Monetary Fund.

Many gold buyers want a hedge against the risk of inflation or possible declines in the value of the dollar or other currencies. Both are serious potential risks that are worthy of precautionary hedges. Although inflation is now low in the United States, Europe, and Japan, households and institutional investors have reason to worry that the low interest rates and the extensive creation of bank reserves could lead to inflation when economic recovery takes hold. And the declining value of the dollar – down more than 10% against the euro in the past 12 months – is a legitimate cause of concern for non-US investors who now hold dollars.