Deflation Can Be a Good Environment for Gold

By Neils Christensen of Kitco News; [email protected]

Wednesday February 4, 2015 2:12 PM

(Kitco News) - Central Banks around the globe are doing whatever they can to fight the problem of weaker growth and lower price pressures, which could be a positive for the gold market, according to the latest report from Capital Economics.

Wednesday, Julian Jessop, head of commodity research at the UK-based research firm, released a report looking gold in a deflationary environment, which contrary to popular belief could be good for the yellow metal.

“Overall, our view is that the wider implications of a lengthy period of deflation, even one triggered by a favorable shock such as cheaper oil, should strengthen rather than undermine the price of gold,” he said. “Indeed, it is not difficult to think of circumstances in which deflation could be positive for gold, many of which apply now. For a start, interest rates are more likely to be held close to zero or even cut into negative territory, minimizing the opportunity cost of holding gold,” he said.

A good example of central bank loosening was seen Tuesday, as the Reserve Bank of Australia (RBA) became the latest entrant into what is becoming a full-blown global currency war.

The RBA surprised markets by cutting interest rates by 25 basis points to 2.25%. In the central bank’s monetary policy statement RBA Governor Glenn Stevens highlighted the risk of lower commodity prices and the economy likely to see “a degree of spare capacity for some time yet.”

“A lower exchange rate is likely to be needed to achieve balanced growth in the economy,” he said.

Jessop added that he sees gold as a long-term hedge against currency debasement, and future inflationary shocks.

In his last point, Jessop said deflation can also create economic and financial strain, which could boost gold as a safe-haven asset. He added that deflation could raise debt-servicing costs, which could be a problem for some struggling nations, especially periphery countries in the eurozone.

Most people would, of course, regard falling prices as good news. The problems come when deflation in consumer prices is reflected in falling nominal incomes and in asset prices, or when expectations of falling prices become ingrained.”

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