Oxford Economics Looks At The Role Of Gold Under Inflation And Deflation, Finds Average Gold Holdings Should Be At Least 5% Of AUM

Tyler Durden's picture

Predicting the future in general is a fool's game, while anticipating inflection points, we have often said, is for market oracles and dummies. That said, one can easily anticipate general themes. The inevitable implosion of an unsustainable economic model is one of them. The only question is how does one hedge best for an event like this. In the past 3 years, precious metals, primarily gold, have served as arguably the best hedge to the absolute loss of purchasing power of the global fiat system. And with increasing global instability, the prominence of gold will only rise. A just released must read analysis by Oxford Economics titled "The impact of inflation and deflation on the case for gold" finds just that, and culminates with the dramatic conclusion that "gold's optimum share of a portfolio to be around 5% in a base long-term
case for the UK featuring 2.25% growth and 2% annual inflation. This is
higher than levels found in typical mainstream investment portfolios,
although this may be in part because the analysis does not include other
assets such as index-linked bonds, foreign securities and other
commodities." Based on anectodal analyses, gold holdings on average at the institutional level are about 1% or less. Which means that a qunitupling in buying interest will have dramatic implications on the future price of gold (it is no secret that we have been and continue to be very bullish on gold). And just like "nobody could have predicted" the implosion of Italy, so soon nobody will have been able to predict gold rising to $2,000, $3,000 and other multiples of $1,000. Which is precisely what will happen as the next and possibly final lap in the global currency devaluation game is nearly upon us. The only beneficiary will be the one instrument that retains its absolute value as fiat around the world is relatively devalued against one another. Regardless, while the attached study does not break any undiscovered secrets, it is a must read for everyone who is still on the fence, or is considering taking profits with gold once again just shy of its all time nominal price.

From the report:

Executive Summary

  • Since 2007 the world has seen a period of considerable economic and financial volatility, during which gold has performed strongly with its price more than doubling. This performance has prompted some reappraisal of gold's properties as an investment vehicle.
  • Over the very long-term gold tends to hold its value in real terms, but short-run factors can move gold away from its long run equilibrium for extended periods. These factors include financial stress, political turmoil, real interest rates, inflation, central bank activity and the US dollar exchange rate.
  • To begin our investigation into gold, we estimate an equation to explain gold price movements over the 1976-2010 period. The modelling approach suggests that all of the factors outlined above are significant short-run influences on the gold price and that shocks to the gold price tend to wear off relatively slowly. The equation also highlights the fact that whilst the current price of gold is comparatively high, the adjustment back to equilibrium could take place via a rise in the general price level, rather than a fall in the nominal value of gold.
  • Using the estimated equation and Oxford Economics? Global Model, we examine the performance of gold relative to other assets from 2011-2015 over a number of variant economic scenarios. We find that while other assets outperform gold in the baseline scenario, gold performs relatively strongly in a high inflation scenario and also does comparatively well in a deflation scenario derived from a wave of defaults in the "peripheral" eurozone countries. This is because such a deflation scenario includes a sharp rise in financial stress.
  • The scenario analysis confirms gold's properties as a hedge against extreme events; properties that may be especially valuable given the considerable uncertainties still facing the world economy.
  • The study then goes on to examine gold's place in an efficient investment portfolio using optimisation techniques and different assumed long-run returns for gold, equities, bonds, cash and property. We find that because of its lack of correlation with other financial assets, gold has a useful role to play in stabilising the value of a portfolio even if the conservative assumption of a modest negative real annual return is made.
  • We find gold's optimum share of a portfolio to be around 5% in a base long-term case for the UK featuring 2.25% growth and 2% annual inflation. This is higher than levels found in typical mainstream investment portfolios, although this may be in part because the analysis does not include other assets such as index-linked bonds, foreign securities and other commodities.
  • Varying the economic assumptions can imply higher allocations for gold. Gold's optimal share rises in a more inflationary scenario, as well as for more risk-averse investors in a limited growth and lower inflation scenario, thanks to its low correlation with other assets.

Full report (pdf)

 

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GetZeeGold's picture

 

Get gold.....check.

 

LongBalls's picture

Question - Of ones gold holdings how should they be invested as a percentage. Physical, ETF's, Mining Stocks? I own physical as of now but struggle with the balance of type to own.

Janice's picture

A goldbug would tell you that if you can't physically hold it, you don't own it.

RockyRacoon's picture

An ETF is a type of paper, not a type of metal.

I guess that makes me a bug, per Janice.

DoChenRollingBearing's picture

Rocky and I are in the same club.  If you don´t have it in your warm little hands (paws), it ain´t yours!

I am in with 12% PMs (75% of that in gold).  But then again, I joined the Tinfoil Hat Brigade when I could not take the lies anymore...

JumpinJonnyK's picture

I think 5% may be a little low if you ask me.  I am trying to keep around the 15% mark.  Just an FYI for everyone www.goldshark.com is a cost comparison shopping site for gold and silver.  It has saved me money and it's free to use.  Thought I would share

Whalley World's picture

This morning I sold half of my paper physical in my retirment account (RRSP in Canada) and will get the money (less 20% tax) to put into more physical.  With the world financial markets in turmoil, I need to hold my gold and silver close to home.  All of my phys. was taken out of my bank safety deposit box years ago.

Take possession and sleep at night.

WilliamShatner's picture

Only 5%?

Get moar, bitchez!

mayhem_korner's picture

+1556.

Downside outlier of being "too long" gold = I can live with

Downside outlier of being "too short" gold = I can't live with 

Bay of Pigs's picture

Roger that.

The next leg up is going to be a big one. Probably 200 points or more.

Sudden Debt's picture

If every fund would go to 5%, gold will be priced at 3000/4000 dollar.

Without the national banks of course which make it go to 5000/6000 dollar.

 

But they do everyting to prevent a price like that.

mick_richfield's picture

It will be more than 5% after you lose the rest of your portfolio in the Panic.

Thorlyx's picture

good one ! I was also thinking along these lines. If one has 30 % today, it might become 100 % very quickly.  Alternately, 5 % of 1.000.000 invested 10 years ago is already 50 % of the same amount !

mayhem_korner's picture

I love it when these guys find the "optimum" in a stochastic analysis with an indeterminate underlying distribution.

Always a deterministic solution to a probabilistic problem.  I call that betting.

 

 

cpnscarlet's picture

Okay...I'll bet on 7.

A reasonable solution.

Oh yeah - I'll go long human nature...sure win.

Zero Govt's picture

Mayhem,

not quite sure what you said there but think i agree!!

Oxford Economics recommends 5% of your portfolio in Gold. What would they do with the other 95%?

Gold's gone from $250 to £1,500 in the past 10 years. Would any other part of their 95% out-perform that? So why the hell not go all-in if you're onto a winner!

This absolutely spastic belief in a "diversified portfolio ..spreading risk" suggest you're too timmid or clueless to know which asset class is going to be best performing (ie. 95% of their portfolio will be underperforming)

mayhem_korner's picture

Layman's terms: if the future is uncertain and thus subject to a whole host of possible outcomes, there can be no "optimum"; every strategy will have a maximum upside and a maximum downside.

The way to look at these probabilistic problems is to understand how well you can tolerate the extreme outcomes for a given strategy...that is risk analysis in a nutshell.

RockyRacoon's picture

Where's the "risk" in holding physical gold?   It is valued in fewer dollars (or the fiat du jour)?

So everything else costs less as well.   Not a risk in my book.

Shell Game's picture

It also lacks the counter-party risk paper assets are plagued with.

mayhem_korner's picture

Holding more gold means holding less of something else.  The risk is that the something else out-performs gold over your time horizon.  If the gold you now hold was instead invested in silver, and silver out-performs gold 3:2 over the next year, you would be better off with the silver, no?  That's the risk.

So if one believes that the best road is to be 100% invested in gold, the measure I look at is ... can you tolerate the worst-case (possible) outcome of gold under-performing its alternatives.  If you can, fine; if not, then you probably ought not be 100%.

 

Shell Game's picture

Is physical gold an investment or is it security?  I see it solely as a quiet and time-tested store of my wealth.  My trading account, on the other hand, has some diverse competing assets  like SCO, AGQ, DAG, several gold miners and on again/off again short hedges.  The latter is investment, the former is a different beast entirely.

RockyRacoon's picture

Moderation in all things, grasshopper.

Whalley World's picture

Go all in like you are sitting on a Royal Flush

Pladizow's picture

Those who predict the future, lie, even when they tell the truth!

Quintus's picture

2.25% Growth and 2% Inflation?  That would be the Bank of England's wet dream.  How about the much more likely scenario of 0.0% Growth (IF we're lucky) and 5.5% inflation?

I'll see your 5% Gold allocation and raise you 50%

grey7beard's picture

>> I'll see your 5% Gold allocation and raise you 50%

50%? Piker.

Quintus's picture

Well, I need the other 50% for silver.

Flore's picture

you should go the fulll 100 % in gold.. i did

problemfixr's picture

Gold and Silver Bitchez...

Transitory Disinflation's picture

Just when will house prices crash in the UK?

kengland's picture

5%? I'll take a zero hedge with 100% yellow metal coins

Shell Game's picture

That 5% number is something I would expect from a nadir of gold sentiment and zenith of $US sentiment, circa 80s-90s.  With world events as they are and writings on the wall as they are, these baffoons come up with 5%? Really?

Temporalist's picture

They are trying to be realistic I think.  Since you reference the `80 at that time gold investment was 4%.  Presently gold investment is under/around 1%.  If more people, let's say 2% or a doubling of the present investment interest, decide to get 5%, from the 1% now, it will have a major impact.  That doesn't seem so paltry when looked at from that perspective.

 

Shell Game's picture

I see your point and agree that having more of the public at 5% exposure would be a vast improvement, so perhaps 'buffoons' (thanks TM) was a bit harsh.  I remember 30 years ago hearing advisors suggest 5%-10% physical PMs, so this 5% in current times seem uninspiring to me.

Herd investment has never put much emphasis on capital preservation and fiat realism, and has preferred to emphasize playing The Game.  So, I don't have a lot of respect for most mainstream investment advice.

DoChenRollingBearing's picture

5% - 10% is OK what my banker / investment advisors say.  And they are very mainstream.

I am happy at 12%.  That will likely grow slowly as money comes in.  Buy a little here, buy a little there.  I have been doing that a long time...

Shell Game's picture

30 years ago 5% was a good number.  When the dotcom bubble burst signs formed that strongly suggested 10% was a better number.  The Fed's QE program, which got started summer of '09 I believe, was another strong signal to increase one's percentage of physical metals in portfolios to 15% or higher.  I'm at the point where all extra money is converted and a good portion of my IRAs have been converted.  Crazy times...

You have a good advisor, Bearing.  But the thing is, in this world of fiat, there has not been mainstream reality. All pro-gold talk has been quite alternative and contrarian.

tmosley's picture

Better than the 0% most buffoons in the profession come up with.

Urban Redneck's picture

Those same buffoons generally can't beat the S&P with a 100% fiat allocation and almost full deployment of capital to the endeavor.

akak's picture

That 5% number is something I would expect from a nadir of gold sentiment and zenith of $US sentiment, circa 80s-90s.

Are you sure you don't mean, from the Nadlir of gold sentiment?

;-)

Shell Game's picture

aah, my clever cross-boned provocateur... :)

PulauHantu29's picture

If Paulson had bought more gold instead fo bankrupt Chinese companies and BAC he would be up 40% now instead of losing his investors money. He need sto follow Kyle Bass and UT Retirement System .....buy more gold.

coppertop's picture

and he uses paper gold too.

Just Observing's picture

Yeah 5% if you want to lose your ass in the next few years.

50% is a lot closer, and only if another 30% or so is in silver.

Add in 10-20% energy stocks/trusts and you have the "well rounded portfolio" for the next decade.

Bastiat's picture

5% in gold and the other 95% in silver?

Transitory Disinflation's picture
A third of finance directors believes UK economy will double-dip Boardroom confidence in the economic recovery is collapsing at its fastest rate in three years as companies predict falling profit margins and fear the fallout from weak consumer spending in the UK.

http://www.telegraph.co.uk/finance/economics/8629184/A-third-of-finance-...

Temporalist's picture

Kingworld News interviews ex Goldman Sachs Silver Manipulation Whistleblower Andrew Maguire about the new Gold and Silver exchange in China

http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/7/11_A...

300 million customers.  If 1% bought a 10oz contract it would require new physical demand of 1000 tons of gold. (paraphrasing)

Similarly if the same 1% chooses to move into silver it will require 1.6 billion oz of physical to be found (I guess they can dig it out of the ground for $5).

 

Here is summary of interview:

http://tiny.cc/zmzez