Gold, Silver and Deflation 24 comments
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The question has been pouring in: “What happens to gold during a deflation? Of course, many of my readers are equally if not more interested in what happens to silver in a deflation as well.
The views on this topic vary. Some insist that both metals will do well under almost any economic conditions; some, like Bob Prechter, think neither gold nor silver will do well; and others, like Jim Sinclair and Bob Hoye, believe gold and gold alone will be the only thing left standing.
In all matters such as these, studying the past can be beneficial, but—as you have read so many times before—knowing the past is not a guarantee of future results. Personally, I like to let the market speak, and for many years I have forecast that a day would come when the price of the physical silver market would separate from the price “set” in New York or London. Alas, this is the case when looking at the retail market versus the commercial market.
In all fairness, the COMEX price is being used as predicted to capture profits by purchasing COMEX bars and selling 100-oz. silver bars. Jason Hommel of Silver Stock Report has stated:
I own over 200,000 oz. of silver. I’m not selling out. I’m only selling 12,500 ounces, and I plan to buy more silver, cheaper, but in a different form, such as 1000 oz. bars.
The price manipulation at the COMEX is so severe, that it has now created the profit incentive to create a free market in silver, through this auction, in order to arbitrage between the two markets, by buying in one, and selling to the other.
Readers might recall I wrote an article titled Silver Arbitrage, back in August.
Looking at the Opinions
Dr. Marc Faber: “Therefore, under both scenarios—stagflation or deflationary recession—gold, gold equities, and other precious metals should continue to perform better than financial assets.” See article here.
Castrese Tipaldi wrote on Financial Sense University,
I don’t know if in the last week we saw the last gasp of those usual subjects trying to cap gold, and I don’t know if we now have the very last possibility to get silver at a price so cheap.
What makes this quote so interesting to me is he wrote this on April 20, 2004. See article here.
Steve Saville of the Speculative Investor writes,
The most important difference between then (the 1930s) and now is that gold and cash US Dollars were interchangeable during the early 1930s (the deflationary period) by virtue of the fact that the Dollar was defined as a fixed weight of gold. A typical effect of deflation is an increase in the purchasing power of cash. The fact that gold and cash were officially linked during the 1930s meant the deflation caused the purchasing power of gold to increase along with the purchasing power of cash. In other words, under the monetary system that was in effect during the 1930s gold was a hedge against deflation. Furthermore, under such a system the purchasing power of gold would decrease during periods of inflation; that is, when the dollar was defined in terms of gold, it would have made sense to shift investment away from gold during periods of inflation.
See entire article here.
Adam Hamilton of Zeal LLC wrote,
Anything typically financed by debt is likely to see its prices plunge dramatically, like houses and cars, as the ongoing Great Bear bust continues to destroy the gross excesses of debt via higher long rates. Conversely, anything not typically ‘paid for’ with debt, including groceries and general living expenses, is almost certain to rise in the coming years. We are staring down a brutal environment of widespread inflation marked by various sectors witnessing falling prices as debt leverage implodes.
See entire article here.
One of my favorites is from Dan Ascani, who wrote essentially about Professor Jastram’s very long-term study on gold, and he essentially states that Jastram studied four pronounced price deflations taking place. In all four deflations, operational wealth in the form of gold appreciated handsomely. When one sees that just by holding gold for 13 years, from 1920 to 1933 operational wealth would have increased 2½ times, one realizes that gold can be a valuable hedge in deflation—however, a poor one in inflation. See full article here.
Gary North states,
There are a few contrarians who think that deflation is coming: both monetary deflation and price deflation. As far as I know, there are only about a dozen of them who write newsletters or run websites. For some reason, most of the deflationists seem to think that gold’s price will rise in a mass deflation. They do not warn their subscribers, ‘Don’t buy gold or silver!’ If they did, they would have fewer subscribers.
See entire article here.
Bob Prechter has written much on the topic; his overview of defining Inflation and Deflation can be found here. Further, Bob goes on and states that neither gold nor silver will do well in the deflation he had predicted for so long. Specifically,
I’ll cut right to the chase: Unless you’re about 80 years old, the United States economy is undergoing the worst downturn in living memory. Every measure of growth is grim. The world’s most recognized stock index—the Dow Jones Industrial Average—is down 30% from its October 2007 all-time high.
If ever there was a time for the ‘Safe-Haven’ lure of precious metals to surface—now, yesterday, even seven months ago when the Bear Stearns’ bailout launched the historic reshaping of Wall Street—would have been it. Yet, from its March 17 record peak, GOLD prices have plummeted more than 20%.
The entire article can be found here.
So we can read many varying views on what will happen to gold and/or silver under a deflation. Right now the financial marketplace is so unstable that it is difficult to put too much faith in anyone’s opinion based upon such a short snapshot. Doug Casey has repeated often that the metals, and particularly gold, are a CRISIS HEDGE. I think this is the way to look at the situation. As I stated so many years ago in my Ten Rules of Silver Investing…
Rule # 1. When ALL else fails, there is silver.
No one likes to be a prophet of doom, but the simple truth is that silver is the world’s money of last resort. Should a severe economic collapse occur, leaving paper assets worthless, silver will be primary currency for purchase of goods and services. (Gold will be a store of major wealth, but will be priced too high for day-to-day use.) Thus, every investor should own some physical silver-and store a portion of it where it’s accessible in an emergency.
When the editor of the book who published all ten rules called me back, he was “all over” this first rule and stated he had never really thought of silver’s role before. Of course, he was quick to scoff at the idea of an economic collapse. I wonder what his thoughts on the subject are, currently.
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This article has 24 comments:
As Gold is an unproductive asset, almost exactly like houses, except that you can't (easily) make more of it (have to dig hard).
The trick to owning any non-productive asset is to forecast future demand for such asset, as that is the sole source of any "growth" in value.
In other words, if less people want it next month, then it's price *will* go down, since on it's own, it doesn't produce any money. If for whatever reason (Think rallies times), there are alternative investments that is growing fast and catching the popular attention, then gold will lag and even go down.
Right now, the main drive for gold going forward is fear. Fear of currency collapse, fear of stock market, fear of govt intervention/hyperinfl...
And yet, in the real economy, money base is quickly shrinking. We're staring into deflation, which is due to de leveraging and declining total debt/credit. Essentially, there is simply less money to go around.
This creates a "wedge" situation. If fear is constant, then the fact that money is in decline asserts that Gold *must* drop in price simply because there's less money to buy it. For gold to go up, the rate of increase in fear must exceed the rate of decline in money-availability.
In a sense, we're in a "bubble" of gold, but like any bubble: the Market can remain irrational much longer than you can remain solvent.
It is also true that bubble is in the eye of the beholder: (1) Are we building a gold bubble that will eventually burst (when fear subsides or currency-deflation becomes too extreme to support the gold prices), or (2) Are we actually unwinding from the great fiat currency bubble built over 60+ years and Gold is the actual indicator of true "value"?
Economics aside, there's also true issues with owning gold physically that anyone should deal with:
1. Theft is a non-trivial problem. My family have actually lost physical gold because we've been burglarized. The total loss ratio is 100%, which is much worse than simply owning, say, GE stocks. Crime is going to get worse if economy really worsens to a point that gold is useful.
2. Govt confiscation is outlawing is non-trivial too. Just look at governments in history during troubled times. Look at what happened during the Chinese Communist Cultural Revolution, where owning gold is illegal and it's confiscated. Part of current gold's value is it's liquidity because there's a market, if the market disappears as it becomes illegal to trade gold, then by virtue of being forced into black market, gold *will* lose it's liquidity and have to pay a premium to trade.
3. When gold is one day finally more useful than all the other fiat out there, we may very well be facing global world wars and social collapse. Which countries whose govt cannot pay it's police and military is able to maintain peace for long? In that scenario, owning gold may very well be like having a red target painted on you. You may need to swallow it or bury it to keep it.
Notice #1 - #3 fulfills the irony that "when you truly need something, you can't/don't/are unable to have/keep it anymore".
So, these are issues to contend with when you want to own gold.
My advice is own some/enough gold to buy a ticket out of where-ever you are, but don't bet your whole worth on it, because it will not save you during extended unrests.
Good points but no one said to put all your money into gold,but it still can't hurt to have some.As far as your 1-2-3
1-You don't have to leave your gold sitting out on the coffee table,hide it.You could put 50 oz in your atic rafters under the insulation,in your basement were a burgler won't find it.there are a lot of place's to stash it.A burgler is a burgler he will take what ever he can get money for.That does not mean you should have a empty house because someone mite take it.
2-Goverment confiscation That might have worked back in the 30s.Do you think people would line up to turn it in today?The goverment can"t even stop the drug trade,billions of dollars traded in untaxed dollars every year.
3-If things are that bad that red target on your back will be for anything you have,a can of soup or beans.Maybe even that warm coat with that target painted on it.
All in all it is just a commitity that will go up and down with time.
Does nobody recognize that if gold goes down in a "deflation" when priced in dollars that those dollars will buy you more stuff? Yet if we see inflation and you're in gold it will probably also go up and mirror that? I didn't get the impression from the comments that this was understood. Gotta stop thinking just in terms of dollars.
How much house or car or clothing or food will an oz of gold buy you? That is the important question. That is the beauty of it in a crisis. If things turn out to be good, you keep most of your investment and your job. But if things hit the fan, you are protected.
2. Your scenario: Gold becomes like Drugs/Contraband, that owning it can get you into trouble at airport security, metal detectors, random stops by cops. I'm not sure it's as easy to do that as you think, the risk is too great. It's like running through airports with an underwear full of cash -- if it's so risky to do that with cash, imagine doing that with METAL gold!
In any case, the debate with deflation or inflation ultimately depends on which of the two powerful forces wins in the end:
1. (Deflation) The 600 trillion CDS actually cases cascading-cross-defaul... Building default pressure on debts and demand slacking feeding into lower employment and deflationary spiral down.
2. (Hyperinflation) The Governments successfully inflate away debt, pumped up *main-street's* money supply or legislate inflation into economy.
(This is non-trivial and much harder than goldbugs realize. Japan had a housing bubble, and they weren't able to inflate their way out of it no matter how they tried. (A)Zero Inflation Rare Policy ends up pushing on a string as nobody is willing to borrow [ so the interest-policy never becomes currency ]. (B)Massive printing with an existing debt-base is also deflationary because we still have mortgages/debt that haven't fallen into trouble yet -- the moment you print too much money, interest rate will skyrocket, and now you have a new round of debt default/deflation even on people that were relative strong before -- resulting in even more powerful deflation force than before! )
These two are ultra-powerful forces colliding into each other right now. think Superman vs XMen. Which one wins will decide our fate. Our relative calm right now (compared to what will be coming) is a quirky byproduct of the fact that there's no winner yet.
Instead of foolishly guessing wildly about the next stamping herd and rushing after it to the same collosal losses as the last five such herd stampeded caused, how about instead noticing that they never, ever work?
Gold is a bubble and it goes smash. Look at the 5 years chart and compare to every other commodity on the planet. We go to $650 and then we work sideways while the true believers hope against hope that the next move after that is up. Instead it is dead money for several years at that lower price.
Meanwhile, investment grade spreads of 7-8% go begging. Why? Because very silly people are more interested in guessing where the whole dumb herd might run next.
" And yet, in the real economy, money base is quickly shrinking. We're staring into deflation, which is due to de leveraging and declining total debt/credit. Essentially, there is simply less money to go around. "
I don't know where you get your information. From where do you think the $700 B (really $1T or more) bailout is coming? Treasury is printing 24/7 along with the other central banks. Sure, the banks are not lending because they want to improve their balance sheets. Eventually, all this currency will find its way into the world market with nothing more than government promises backing it. I'll take my chances with owning, and more importantly, possessing gold and silver.
Who cares if gold falls to $600? Reasonable minds understand that gold and silver are not an investment; they are a safety hedge. In this day and age of crooked banks with politicians in their pockets, one needs to hedge. If one wants to make profits in the metals then one should trade them albeit trading is extremely risky. The risks and rewards can be extreme.
As I've said before, if you own it, keep it. If you don't, get some. I would strongly discourage ownership (unless trading) in ETF's and shared pools where all you get is a piece of paper.
DON'T TRUST ANYONE WITH YOUR GOLD!
i would like to add that re,
"...Bob Prechter has written much on the topic; his overview of defining Inflation and Deflation...'If ever there was a time for the ‘Safe-Haven’ lure of precious metals to surface—now...would have been it. Yet, from its March 17 record peak, GOLD prices have plummeted more than 20%....'" -
that much depends (from my admitted just-learning of elliott waves) on the time frames of the wave lengths being viewed
the short term forecast also offered by robert does still point to lower lows for gold and silver, but, also, a rebound (though i'm not sure of what degree it might be)
and the longer term newsletters from elliott wave also have mentioned that, after the deep deflation, the (to paraphrase) the momma of all inflations would follow
either way, it's all interesting
may it also be profitable for us and our families :-)
You are absolutely correct! To understand gold and silver, one has to look at the time frame. It seems that the natural human perspective is a short one; that is, we want instant gratification and if we don't get it, that in which we are looking can't be of value. Patience is a virtue and it can be profitable.
It is the most saleable commodit. When offered gold or paper in payment for a good or service, which would YOU prefer given the choice?
There is ZERO interest expense that we currently pay to the Fed for using our own money, when the people use a money they freely chose to use instead of legal tender at gunpoint of legal govt counterfeiting.
PM monies arose to eliminate the problematic double coincidence of wants that barter generally requires. They are the most trustworthy intermediate mediums of exchange. Harder for govts to debase than printing press inflation, which BOTH reduce buying power of existing money units.
America went to a paper money system only at banker behest precisely to enrich themselves with the gains from inflation they steal by way of the reduced buying power of last users, plus a big fat interest income on every dollar created from nothing. A $0.04 dollar and 100 yrs of 6% interest compounded robbed us all being millionaires ourselves.
THAT has been the opportunity cost of allowing private bankers to print unbacked money in America the same as they'd done to England pre-1700, and why fiat was forbidden in our Constitution. The founders were fully aware of Banker treacheries, they'd lived with the King's!
Some of you talk as if deflation is happening. My question to you would be...what deflation are you talking about.
Their are two major forms of deflation.
1. Monetary deflation
2. Asset deflation.
What we see in today's markets is asset deflation initially caused by the massive deleveraging effect instigated by the low interest loans and mortgages that fueled consumer spending and the inflation of housing prices. More on that in a second.
That said, we have a liquidity problem, a credit crisis. Banks have dealt with bad securities and derivatives based on inflated subprime mortgages bundled together in tranches. Banks don't trust eachother anymore, thereby stopping the interbanking supply of money. This slows the consumer and corporation spending overtime.
Now, the point is, that this is deflationary. But not monetary deflationary. Because for having monetary deflation, you have to see price levels decline. Actual products become cheaper. People postponing expenditures of consumergoods. That was not the case until (probably) now. There are signs of product pricings going down slowly. Inventories stockpiling, creating major discounts in shops. If this continuous, we will see producers try to compete eachother on the marketplace, fighting for customers, thereby lowering their prices, until a level where pricelevels meet costlevels. That is the ultimate situation of deflation. Spiralling down of an economy. Again, not widely happening yet.
To continue with asset deflation; which is happening widespread accross our markets. This phenomenom is caused by deleveraging as I said earlier. This results mainly from banks and hedgefunds, not being able to hold on to their customers, or reaching their given trailing-stops and investment criterias, thereby selling their stocks and investments. This affects all stocks and sectors momentarily, due to the grim outlook of the market sectors. All are based on the problems in the motor of our economies, that is the financial (banking) sector.
The FED is trying to spur this 'motor' with fiat dollar currency. Inflating its way out of an recession and possibly a depression, regardless of the cost of inflationary practices. Eventually debasing the dollars face value.
If the dollar remains the reserve currency of the world (questionable) countries like China and Japan will remain invested into Treasury bonds. Holding the dollar up eventually.
On the other side, if problems in their (China) own country become greater, there may even be a decoupling phenomenom happening soon, first shown into export decoupling and continued by a dollar decoupling, as they experience that their domestic growth will not flourish anymore by a constant decline in American consumer spending towards manufacturing sectors in (mainly) China.
To Finalize;
If monetary deflation shows not to be an issue in the future, inflation will rule the markets when it hits the ground in the real economy (banks will have to start lending out again first) then we will see inflation sky-rocket.
If that happens, the comment from (mrees999) is very appropriate;
[quote]
"We have a Tsunami of inflation building. Before a Tsunami hits, it's common for the tide to rush out to sea. This deflationary act - just adds fuel to the wave of inflation building to come wash over us. Our surfboard in this mess will be gold and silver. Rushes down in price now - stays on top of the wave bearing down on us." [end-quote]
Very nice analogy.