Grubb: Gold A Double-Edged Sword Against Inflation AND Deflation

July 24, 2011

World Gold Council director talks about precious metal’s duality in seemingly conflicting environments.

The World Gold Council this month released a study it commissioned from Oxford Economics, “The Impact of Inflation and Deflation on the Case for Gold.” The independent research found gold performs relatively well compared to other assets in a high-inflation scenario as well as in a deflationary period, among other findings. World Gold Council Managing Director of Investment Marcus Grubb talked from the council’s London offices with Hard Assets Investor Managing Editor Drew Voros about the study and its meaning for investors.


Hard Assets Investor: Why don’t we start off by having you briefly just tell us about the Oxford Economics report.

Marcus Grubb: Absolutely. With the current backdrop of financial crises in a number of places around the world, we started to see there are a lot of investors looking at different scenarios of strong recovery, weak recovery, inflation, disinflation, stagnation or even deflation. We felt that there was a real opportunity to commission research that would deliver powerful insights into what kinds of scenarios investors might be facing this year, going into 2012 and beyond, and then adding gold into that mix.

HAI: What key fact should we take away?

Grubb: Let’s assume a benign scenario, something akin to 2 percent GDP growth with 2-2.25 percent inflation, which investors would regard as a fairly favorable one that would be a return to a more normal world of lower unemployment, less output gaps, sustainable but moderate economic growth as well as sustainable inflation. That’s a scenario that many in the market might argue is not so positive to gold. The result [of the Oxford study] showed an optimal allocation to gold, even in that scenario, is 5 percent of a portfolio. While we have research that demonstrates that, this demonstrates it from an independent perspective.

There’s a second conclusion, which is perhaps again surprising. When you look at the deflation scenario — which would involve some shocks to the world’s economy — the study suggests that the allocation to gold in that scenario would actually be higher than 5 percent. It could be as high as 9 percent in an optimal portfolio, which would probably have a lot of fixed income, a lot of Treasurys, a lot of bonds, a lot of cash, but it would also have gold in it.

Analysts have always struggled to understand what deflation would mean in terms of asset-allocation strategy — in particular where gold is concerned, because the only real instance you have of that is in the 1930s when gold, of course, was not a freely traded asset and you had the gold standard. So you can’t really look back in the past and try and find out what happens to gold in deflation.

This econometric model, with a backtested equation on gold as well as the other asset classes, suggests that you would actually have a higher weighting in deflation to gold than even in the benign scenario.

HAI: If gold is such a useful weapon in both inflationary and deflationary models, why wouldn’t the allocation recommendation be a little higher than even 9 percent, especially in the times that we’re at right now?

Grubb: The scenarios [regarding assets allocation] that we asked Oxford Economics to look at were quite clearly delineated. They looked at the base case, a sort of benign return to normalcy and that, as you heard, was 5 percent. They then looked at a high-inflation case. It suggests an even higher weighting to gold. In that case, the gold weighting goes as high as potentially 17 percent in an optimal portfolio. They then looked at stagflation, which is less positive for gold, but it’s more aligned with the base case. And then they looked at deflation.

So it means, as you rightly point out, the spread of potential gold weightings in an optimal portfolio is anything from 5-9 percent to up to 17 percent. And yet you could create scenarios where gold might be even more favored than that. But those scenarios probably would look pretty ugly.

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