Gold During Deflation>Golden during deflation
By: David McKay
Posted: 2002/10/15 Tue 19:34 ZE2 | © Mineweb 1997-2002
JOHANNESBURG – A report by JP Morgan’s gold research team raises the spectre of deflation in the US economy, a development that would throttle consumer spending and pile the pressure on equities. But gold stocks and physical gold will probably survive the effects of deflation better than most asset classes, says JP Morgan’s John Bridges. The fear of a new world economic order, shaped by woes in the US economy, was recently mirrored by Merrill Lynch which advised that as much as five percent of general investments should be in gold.
JP Morgan’s Bridges and Merrill Lynch agree there’s nothing less porous than gold, the metal widely reviled during the tech boom and which suffered a highly public sell-down by the world’s central banks, most visibly the Bank of England. How eccentric it now seems for central banks to have disposed of gold – and the Swiss still selling theirs - when JP Morgan, among others, is recommending the metal for its ability to resist the vortex of deflation.
South African economists are certain the US economy is running the risk of deflation as producer prices are falling. Interest rates, at their lowest for 40 years, also attest to the fact the US Fed is battling hard to stimulate the economy through fiscal means. But there’s hope deflation will be avoided: unemployment is still under control and the property market remains buoyant. “Deflation should be avoidable but a recent paper from the Federal Reserve on the matter suggests they are thinking about the possibility,” says Dennis Dykes, economist for Nedcor.
The inference of JP Morgan’s recent gold market and gold equities research is that although gold is a hedge against inflation and a weak currency, it is also a reliable asset in the reverse. The underlying principle is of gold’s safe-haven status which equally applies in periods of war. “Cash is king during deflation but there’s generally a lack of confidence in other paper wealth which is where physical gold comes in,” another economist says.
Bridges draws from the world’s last major deflationary period, the 1930s depression, in which listed gold producers easily outpaced the Dow Jones Industrial Average notwithstanding the fact that the gold price was fixed. Bridges uses silver, which had a spot price and moved in greater volumes than it does today, as a proxy for monetary metal.
“In an environment with expectations for rising gold prices, owning the most leveraged gold stocks is, in our view, the most profitable strategy, as many investors have discovered over the past 18 months. We believe those investors that fear deflation should have a gold position. However, this should be at the more conservative end of the risk spectrum,” Bridges says.
He believes, however, this exposure should be at the more conservative end of the risk spectrum”. He argues for a position in the early stage of a deflation focusing on low-leverage gold stocks and some physical gold. Bridges also examines the role of gold during periods of war and finds that gold bullion does possess a safehaven identity.