Gold is touted as a hedge against inflation, but UK inflation would need to average over five times its current level for gold’s buying power relative to wholesale prices to revert over the coming decade to the kind of levels it spent most of the 300 years to 1930.
While Schroders Private Banking’s head of asset allocation Robert Farago says this required rise from 3.4% now, to average 17.5% through to 2022 “seems unlikely”.
Though the private bank “expects a pick-up in inflation over the decade ahead, our assessment is that global inflation will decline this year and next.” He points to respected studies by Carmen Reinhart and Kenneth Rogoff that inflation remains subdued in the decade following financial crises.
Farago adds: “The combination of high unemployment levels and a cautious attitude to lending by the banking sector means that a further period of up to five to seven years of subdued price pressure seems quite likely.”
The private bank has reduced its gold positions, partly because of this relative pricing power measure recently hitting the record high of above 500, where the level in 1930 was taken as 100.
Farago says the new high suggests either gold is expensive “and is therefore likely to fall in price”; or the rise in gold’s price is a portent of inflation to come.
Ruling out extreme inflation in the near-term, Schroders Private Banking concludes gold’s price could be set to fall.
Farago notes gold also looks expensive against stocks, though not versus silver and copper and the number of barrels of oil an ounce of gold will buy is near its 29-year average – “supporting the theory that hard assets are rising in price relative to paper assets, due to fears of currency debasement”.
The main three reasons the private bank has trimmed gold are the following.
Strong performance over the last 11 years means “price of protection against an extreme outcome is high”, Farago notes.
Additionally, the last six months has seen an increase in correlation between gold and other risk assets, “reducing the metal’s attraction as a portfolio diversifier”.
And finally, a deflationary environment could produce a liquidity squeeze – with gold an easy place to take profits and raise funds.
But Farago notes the private bank will keep some allocation to bullion.
He rejects an argument gold at $1,671 per troy ounce is in bubble territory: “The rise in price has been orderly, with no replay of the surge seen at the end of the previous bull run”.
Price support remains from ETF holdings, while anecdotal support comes from financial institutions such as Barclays, JP Morgan (in both New York and Singapore), the Perth mint and Brink’s, all expanding storage vaults.