For a long time I have heard how the mint prints currency 24 hours a day, how government finances are in ruins, how inflation is inevitable, and how precious metals are the best form of protection from the coming chaos. I recently noted that some say precious metals are a good hedge in times of hyper deflation as well as hyper inflation. That hedge against deflation puzzled me, so I did some digging. Guess what. It is probably a good hedge, but it has little to do with either inflation or deflation as such.
I have often said correlation is not proof of causation, but I need to use correlation here to give you insight into the question.
First a little tech. Correlation is measured by an indicator called R-Squared. R² 1 means the two series are perfectly correlated. One goes up exactly as the other or behaves exactly opposite. Sometimes there is mutual causation but not always. You have to be careful. R² zero means the relationship is random.. Most times the numbers are in between. Anything much over .50 is strongly correlated.
Credit Suisse did some work and found that the R² for the gold price to inflation is .0111. Random. So we can likely dismiss inflation as a meaningful factor in gold pricing. By extension likely deflation is out too. They did find one strong correlation though.
R² for gold price to TIPS (Treasury Inflation Protected Securities) is .749 Not perfect but strongly indicative.
TIPS provide yield from a safe security after inflation. The real yield.
It makes some sense that people are looking for real yield. Gold is not often player in that game because it costs to own it. Storage and insurance being most common. No income. Negative cash yield on annual basis.
All investment decisions are comparative. Rental income at 5% of cost is the same as a purchase at 20 times earnings. There are many other factors of course, but the idea is there. If bonds pay 1% and inflation is 2%, the the real yield is -1%. If I could hold gold for half of one percent then gold is comparatively attractive. I am better off holding gold with no income and some cost than owning a bond, assuming gold prices don’t fall for some other reason.
Which brings us to negative interest rates. If the rate offered is -1% and inflation is 2% a real yield of -3%, then comparatively gold is a great investment. And it will get better if interest rates rise again because of monetary inflation and continuing negative yield.
I think we can expect to see governments print money to avoid deflation and if they do and inflation is say 4% and the bond yield is 5%, real yield +1, gold may still be attractive. The stock market, the real estate market and many commodities will have fallen in price. Gold will look good because it will be comparatively better than the alternatives.
So. Owning at least some precious metal component in a portfolio seems indicated. Base the share on the TIPS pricing and its change. The gold advantage will not last forever, because real yield cannot stay negative forever. People would stop investing if it did.
Eventually gold will become just another commodity and the hucksters who are selling it in TV commercials will disappear. But for now, maybe own some.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772