Gold can no longer be seen as a hedge against inflation and the recent spurt in its prices means that it should be looked at as a `crisis hedge' and any talk of recession rather than the fear of inflation pushes up the price of gold . The article explores the various reasons behind the current spurt in the gold prices.

During the era when `gold standard' was in vogue - i.e., until 1971, through a complicated mechanism the exchange rate was manipulated in order to prevent occurrence of inflation by transfering gold from one country to another. With the end of gold standard, gold was allowed to discover its own price through market forces. Yet, as it has been closely associated with money supply, it was felt that any fear of inflation would push up the price of gold. However, the inflation and gold price figures during the last three decades belie this.

In the last three decades, though inflation has occurred at regular intervals the price of gold has not shown huge spikes as the fear of recession has been limited. So the gold prices today have become more of an index of the health of the world economy and as such gold prices are affected by many more factors than mere inflation. The demand for gold comes from two different sources. The first is the `use demand' where it is used directly in the production of jewelry, medals, coins, electrical components, etc. The second is the `asset demand' for gold, where the demand comes from governments, fund managers and individuals as an investment. The asset demand for gold is traditionally associated with the view that gold provides an effective hedge against inflation and other forms of uncertainty.

Many empirical studies have attempted to model the price of gold and these studies can be categorized into three main groups. The first approach models variation in the price of gold as a result of changes in the macroeconomic variables, such as exchange rates, interest rates, world income and political shocks. The second approach focuses on speculative-versus-rationality factors behind the gold price movements. The third approach examines gold as a hedge against inflation with particular emphasis on short-run and long-run relationships between gold and the general price level. A brief review of these approaches will help us to understand the reasons behind the current spurt in gold prices and their likely movement in future.

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