Wednesday, 23 October 2019

Gold Has Dual Purpose: Portfolio Insurance for Inflation or Deflation

Like other forms of faith, those who believe in gold will not apostatize, and most who do not believe cannot be convinced. That is the generational fallout from some 50 years throughout which the majority of the global population believed that fiat currency was the only legitimate store of value. 

On that score, I would hope that gold will eventually be judged on the quality of its track record — its massive liquidity, strong price performance versus fiat currencies, and eventual use as a digital savings asset and payments medium (see The Rebirth of Gold as Money).

My career has involved interacting with many of the most notable investors in the gold sector. Although these gold aficionados all share a similar long-term belief in the advantages of gold, it has never ceased to amaze me how different their macro-economic outlooks are, especially as it relates to the potential for harmful inflation or deflation. Few strategists or economists go into depth about what extreme scenarios could play out for either of these possibilities. Let’s consider both in the context of gold’s utility as an asset.

Gold has successfully been used by savers as a store of value during periods of high inflation and corresponding currency devaluation. Deflation, on the other hand, triggers debilitating solvency and liquidity issues which usually lead to severe market corrections, again leaving gold as a better asset to own outside of those correlated with credit and equity markets. The reason why gold supporters do not debate their differentiated macro forecasts is that gold is a chameleon that can benefit from both outcomes, and thereby provides insurance from negative market developments stemming from polarized monetary outcomes, as shown in Figure 1.

Figure 1. Gold Provides Proven Portfolio Protection1

This chart measures the performance of Spot Gold versus the S&P 500 Index versus during 11 crisis periods since 1985. Gold returned an average +6.4% compared to -21.7% for the S&P 500 for these 11 crisis periods. Click here to view a larger version of this chart.

- Source, Sprott