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

July 24, 2011


HAI: What fundamentals for gold do you see as temporary right now, and which ones are the more long-lasting?

Grubb: This is where I would come back to a more fundamental view of the gold market, rather than discussing the findings of the report, because they aren’t fundamentally related.

It’s been clear for some time that gold is a traditional Western investment, and to some extent now there is an added element of fear in that trade, because of sovereign debt issues in Europe and because of the uncertainty of the economic growth in Western countries; in particular, the U.S., but also Europe.

But it’s always worth remembering that it is an Eastern or Asian super-cycle or growth trade, because those are cultures that invest in gold. They buy gold jewelry. They have a strong cultural affinity with gold. And now together, China and India account for more than 50 percent of the annual physical demand for gold. These are countries where the average household may well be 5-10 times richer in the next 10 years, where the urban population is going to increase by several hundred million just in China and another 100 million in India. The average age of the population in India is 25 and the savings rates are on the order of 25-40 percent of their income.

I think a lot of the time in Western countries, we’re looking at the macroeconomic scenario, treating gold as a sort of macro-asset class as a hedge against risks, and a currency. But Eastern investors are seeing it as a savings and a wealth-accumulation vehicle on the basis of economic prosperity.

HAI: What are some of the temporary conditions?

Grubb: If you look at the state of public finances in Europe, it’s now clear that a number of countries will be in crisis again in the future unless there’s a comprehensive solution and transfer of wealth from the wealthy large economies to the smaller peripheral economies. I see that is a key short-term driver, but it’s also a theme that is not likely to disappear in the next few years. I think it is a longer-term driver as well. And in the U.S., although the bonds market doesn’t seem particularly perturbed, the debt-ceiling debate and the austerity package are coloring the debate. Weakness of the U.S. economy, whether or not growth is sustainable and unemployment will fall, are issues, too, I believe are having an impact [on gold prices].

HAI: Speaking to that, there was an interesting piece in the Wall Street Journal, the gist of which was that a logical response to a U.S. default would seem to be a broad Treasurys sell-off. But some argue that buyers would resurface if the nation’s debt problems stoke enough of a broad base reduction and risk appetite. A sell-off would likely push interest rates up broadly, which could spark selling in alternative safe havens like gold. Do you agree with that hypothesis?

Grubb: No I don’t. I think the only thing that might mitigate the attractions of gold in that hypothesis is if there’s a clear resolution to the issues in the United States around the federal debt ceiling and a longer-term path towards a more manageable debt-to-GDP ratio in the United States.

A spike in rates would actually be bullish for gold, not bearish. The bigger concern for gold is a policy shift occasioned by a return to growth that reinstitutes a positive real interest rate. Then, of course, gold is more challenged because it has no yield. And it wouldn’t only be challenged in that scenario, but clearly it would be less attractive.

HAI: What can ETF investors take away from this study?

Grubb: I’ll confine my comments to the 100 percent, physically backed ETFs. I don’t see any dichotomy here, or splitting of the conclusions. The findings of this report really concern physical gold, and what this is saying is very much that it’s a physical gold investment that seems to be positive in a portfolio context in these different scenarios, not a synthetic one.


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