No man is an island, nor it seems is a country. One of the lessons learnt from the global financial crisis was that all economies and their stock markets are highly interconnected. By donning our macroeconomics hats and examining world growth, we may surmise that two potential flash points may lead to another bout of market turbulence.
Too much growth will lead to inflation and rising interest rates. Too little and a Japanese style period of deflation may beckon. In my opinion, deflation is more likely. US Federal Reserve Chairman Ben Bernanke has admitted that the rationale behind all the quantitative easing to date is to counter deflation.
Apart from providing cheap money, quantitative easing has not yet achieved its purpose. Many countries are having similar problems and only yesterday the Chinese September PPI confirmed the 18th consecutive month of wholesale deflation. The cycle may be perpetuated by other countries importing deflation via traded goods.
The good news is that gold thrives under both scenarios of inflation and deflation. Further, if deflation is more likely, it would be detrimental for all but the precious commodities, which would inevitably result in a falling Australian dollar. Thus, the right Australian gold shares would receive a boost from both the rising gold price and falling dollar.
While holding gold shares is a long-term protection strategy for a portfolio of shares, it also allows the shareholder to sell and take advantage of beaten down industrial and mining shares. During deflationary times cash is king, as the majority of asset classes become cheaper to buy.
Which gold shares to buy?
My preference is to seek out companies that may gain additional impetus from having internally generated tailwinds. I have written a prior article highlighting a turning point for Fortescue Metals Group (ASX: FMG) based on company specific factors. An almost identical situation arises with the gold stock Beadell Resources (ASX: BDR). It too has travelled over the hump of capital expenditure and may now look forward to strong cash flows, repayment of debt and as a result rising dividends.
Regis Resources (ASX: RRL) is one of the lowest cost producers and recently had a significant resource increase at its Moolart Well operations, better than expected production from the Edikan resource and delivered lower than expected capital expenditure at its Rosemount mine.
Finally, Newcrest Mining (ASX: NCM) is currently trading down to $10.20, having been as high as $13 in September. In addition to a recent gold price decline, Newcrest has had an uncommon run of bad news, including a mediocre FY13 financial result and some disruptive boardroom departures. Such times of turmoil are often the best time to pick up quality stocks and hold for the long term.
Foolish takeaway
Gold may well afford some protection during a period of either inflation or deflation. In particular, holdings of Australian gold stocks may offset some losses during a wider market decline.
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Motley Fool contributor Mark Woodruff owns shares in Beadell Resources.
