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Although trading involves high risk, it is a popular activity among people from all walks of life. For the uninitiated, trading is the process of buying and selling goods. The stock market is a safe environment where trading happens. Various factors can affect the stock market, including politics, changes in economic policy, inflation, and others.
Inflation is a term used to describe the upward movement of prices. Supply and demand are the main factors that determine the prices. During inflationary times, investors use hedging strategies to protect themselves from losses.
How Inflation Affects Money?
In October 2021, it was reported that the United States is among the countries with the highest inflation rates. But it is not only America that struggles with the inflation crisis. Many other countries around the globe are in the same situation.
Inflation reduces the purchasing power of money and increases the cost of living. So, if your income does not rise, you have to tighten your belt. Inflation also affects the companies listed on the stock exchange.
Central banks tend to increase interest rates to fight back against inflation. Thus, if a company has a loan of $1 billion and the bank increases the interest rate by just 0.1%, the company will have to pay $1 million extra at the end of the year.
Inflation also puts cash savers in a disadvantageous position. Let us assume that you want to buy a car for $5,000. After 5 years, you already have the money in your bank account, but the car prices have surged. Now, you can purchase the car for $6,000, meaning that you have to add extra money to buy it. The example shows how money loses purchasing power when prices go up.
During inflationary times, the best thing people can do is invest their savings in commodities expected to retain their purchasing power in the long run.
Gold as Inflation Hedge
Whether gold is the best inflation hedge is a matter of debate. Gold is a durable store of value. The primary reason why the yellow metal is hailed as a good hedge against inflation is because of its price that is inversely related to the US dollar. This means that when the value of the US dollar falls, the gold price increases, and vice versa.
Supply and demand determine the price of gold. Nowadays, the yellow metal finds application in different spheres, including medicine, technology, jewelry, and others. This increases its demand and keeps its price stable.
But investors have to keep in mind that gold ownership has peculiarities and costs for storage and transportation. Furthermore, experts claim that gold is an effective long-term hedge against inflation. But in the short term, investing in gold is not the best hedging strategy as the price of the metal can be volatile. However, gold can be a successful investment, and we encourage our readers to check this comprehensive guide about gold trading.
Treasury Bills vs Gold
In the short term, investors prefer to buy Treasury bills (T-bills) to hedge against inflation. Experts state that investing in Treasury bills is a safe move as T-bills are endorsed by the US Government. If you buy Treasury bills, you are lending money to the US Government. The government uses the money to fund its debts and pays it back to the investor.
Investors buy T-bills at a price lower than their par value, while the US Department of Treasury pays the actual value of the T-bills to the investor. That is how investors profit from buying T-bills. Several factors affect Treasury bills prices, including maturity period, monetary policy, and risk tolerance. Interestingly, the maximum maturity period of T-bills is one year.
Determining whether to invest in T-bills or gold depends on the current situation and your goals as an investor. Gold is an effective hedge against inflation in the long term, but T-bills are the better option over shorter periods.
