Report Says Optimum Gold Allocation to Achieve Inflation Protection Totals 5%

(July 11, 2011) — Research by Oxford Economics shows that investors should allocate 5% to gold in their portfolios in order to overcome the effects of inflation and deflation.

“This research comes at a time when high inflation is an ongoing reality for many developing economies, while Western economies face the threat of protracted low growth, low inflation or even deflation,” Marcus Grubb, Managing Director of Investment, the World Gold Council, said. “In this context, we wanted to understand why gold is being reconsidered as a risk management asset, particularly if one of the many divergent inflation scenarios came to pass.”

The World Gold Council commissioned the study, entitled ‘The Impact of Inflation and Deflation on the Case for Gold’.

Highlights of the report include:

• Gold performs relatively well compared to other assets in a high inflation scenario as well as in a deflationary period. Due to its lack of correlation with other assets, gold has a useful part to play in stabilizing the value of a long-run portfolio even if a modest negative real annual return is assumed.

• Gold’s optimum share of an investor’s portfolio is around 5% in a base long-term case for the UK featuring 2.25% growth and 2% annual inflation. This is a higher allocation than seen in typical mainstream portfolios, although the analysis does not include other assets such as index-linked bonds, foreign securities and other commodities.

• Gold’s optimal share in an efficient portfolio rises in a more inflationary long-run scenario and also does so for more risk-averse investors in a scenario featuring weaker growth and low inflation.

Jens Tholstrup, Managing Director, UK of Oxford Economics, added: “Because of its lack of correlation with other financial assets, the report shows that gold has an important role to play in stabilizing the value of a portfolio, even where the conservative assumption of a modest negative real annual return is made.”

However, even though gold is often viewed as a safe-haven during periods of crisis, it is being increasingly scrutinized as an investment for pension funds. While many investors view gold as a good way to invest in expectations of higher inflation, via a modest allocation, Dean Baker, co-director of the Center for Economic and Policy Research in Washington, told aiCIO in March that funds are not wise to invest in the volatile asset class. “A basket of commodities would be a much better hedge against inflation compared to purely investing in gold, which doesn’t give much of a return,” he said.

In February, a Netherlands-based $404 million (€300 million) pension fund for workers at several Dutch glassmaking plants owned by O-I International was ordered to rid itself of its gold holdings. The De Nederlandsche Bank (DNB), the Dutch pensions regulator, ruled the scheme’s exposure to the precious metal was too risky. The Stichting Pensioenfonds Vereenigde Glasfabrieken pension fund had wanted to maintain its gold allocation. Yet a Rotterdam court sided with the Dutch central bank — forcing the fund to sell its gold holdings, generally viewed as a safe harbor investment, to a percentage of 3% at most, compared with the current holding: 13% of assets. The regulator asserted that the average fund has just 2.7% in commodities, including gold.