Gold’s popularity over the centuries has endured wars, plagues, civil unrest and all sorts of other perils. But would gold prices hold up well in a prolonged deflationary spell?
For the first time in several decades, we’re starting to find out.
With the economy shrinking sharply over the past two quarters, inflation pressures have faded. The U.S. Consumer Price Index has dropped in four of the past six months, and the inflation rate for 2008, at 0.1 percent, was the lowest reading since 1954.
Gold prices also have retreated, slumping from a 2008 peak of $1,011 an ounce to a current price of about $915.
“Gold is unusual in that it’s an asset that likes inflation,” Natalie Dempster, head of North American investments for the World Gold Council, an industry group, said during a recent stop in Phoenix.
Even so, gold has bounced back from a low near $700 an ounce in November. The metal has held up better than many other commodities amid the deflation headwinds.
Demand for gold isn’t just a function of inflation and deflation, of course.
More than anything, gold is used in jewelry, with 68 percent of the metal destined for this use, Dempster said.
Industrial uses such as electronics take an additional 19 percent, leaving a fairly small remaining slice for coins, bars and the like.
Much of the demand, especially from places such as India and China, isn’t directly tied to U.S. consumer-price levels.
The supply side of the equation, meanwhile, is affected by mining activity and new discoveries, of which there haven’t been many lately.
“Mine production has been in a downtrend since 2001,” Dempster said.
Supplies also are influenced by the amount of gold recycled as people sell jewelry to raise cash.
“A fair amount of scrap has been coming back onto the market,” she said.
With the economy showing signs of life, some observers think we may be near a crossroads where inflation picks up.
Russell Biehl, a chartered financial analyst at Classic Investment Management in Scottsdale, sees higher inflation ahead as the economy works through its rough patch and government spending kicks in.
He suggests investors diversify a slice of their holdings into inflation-sensitive assets, including gold.
“Eventually, the Federal Reserve will gain traction (in inflating the economy) with all the money they’re printing,” he said.
Jay R. Penney, a chartered financial analyst in Scottsdale, also sees an investment role for gold.
‘A compelling story’
“As a dollar hedge, it is a compelling story for a portion of a portfolio,” he said. “I do expect inflation to rise, and dramatically so in the future, if things continue in Washington as they are headed.”
A case could be made that investors generally are underexposed to gold.
Dempster estimated in 2007 that, on average, individuals and institutions held only about 0.5 percent of their portfolios in gold.
Long-term demand for the metal would increase to the extent that investors add to their allocation.
Volatility in the financial markets and extreme uncertainty over the economy have raised awareness of gold as something worth holding to supplement positions in stocks, bonds and the like.
Because gold doesn’t move in sync with the financial markets, the metal provides a hedge in times of instability and unease.
So, how much gold should you hold?
“If you’re concerned about future inflation, you might want 8 to 10 percent of your portfolio in gold,” Dempster said.
“But even 2 to 4 percent can have a diversification impact.”