What Gold Really Is a Hedge Against: Instability
But it turns out that gold isn't really much of an inflation hedge at all, which explains how a big-time deflationist like David Rosenberg, Gluskin Sheff's bearish chief economist and strategist, can be so bullish on the yellow metal.
"The widespread consensus that gold is an effective inflation hedge is not on the mark," Rosie told clients Thursday. "Our statistical analysis shows there to be a fairly loose link even if gold is a store of value. We also know that in the deflationary 1930s, the Sterling price of gold doubled."
In Rosenberg's view, gold is about as easy a call as it gets. The ductile metal has been in a secular bull market for more than a decade (see chart). "And if inflation is really the be all that ends all for the gold price, then keep in mind that gold has rallied five-fold since 1999, and yet inflation is the same today as it was then, and the core rate has been cut in half," Rosie says. "Go figure."
So forget about inflation. Rosie says gold could easily double from its current price of about $1,200 an ounce because it's really a hedge against financial instability. The world is awash with more than $200 trillion in household, corporate and government IOUs. Deflation makes debt more expensive to service -- and harder to refinance. No wonder gold fever is heating up. Rosie says: The integrity of the global financial system is in question.
"This is why gold has so much allure today," he writes. "It is a reflection of investor concern over the monetary stability, and [Federal Reserve Chairman] Ben Bernanke and other central bankers only have to step on the printing presses whereas gold miners have to drill over two miles into the ground."
But Rosie's bottom line on gold comes down to this: The yellow metal makes up a mere 0.05% share of global household net worth, he notes, and so even small incremental allocations into bullion or gold-type investments can exert a dramatic impact on price.
"What makes gold different is that, unlike paper money backed by the good word of the government, it has withstood the test of time for thousands of years," Rosenberg told clients recently (but it's worth quoting again). "It is not the liability of any government. It has an inelastic supply curve. How many times is gold mentioned in the Old Testament? Try 391 times. How many times is paper currency mentioned from Noah, to Abraham, to Moses? None. Nada. Efes. Gornisht. Nihil. Rien. Nichts. Niente."