Gold as an Inflation Hedge?*

This paper attempts to reconcile an apparent contradiction between short-run and long-run movements in the price of gold. A theoretical model is developed that suggests a set of the conditions that would have to be satisfied for the price of gold to rise over time at the general rate of inflation and hence be an effective long-run hedge against inflation. The model also demonstrates that short-run changes in such factors as the gold lease rate, the real interest rate, convenience yield, default risk, the covariance of gold returns with other assets and the dollar/world currencies exchange rate can seriously disturb this equilibrium relationship and generate significant short-run price volatility. Using monthly gold price data (1976-1999) and cointegration regression techniques, an empirical analysis confirms the central hypotheses of the theoretical model. JEL Classification: D4