A Case for Hedging with Gold Against Inflation or Deflation 10 comments
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An interesting analysis of the prospects for gold from Ambrose Evans-Pritchard this week. Along the way to his conclusion he does a nice job of stating the cases for inflation and deflation.
He starts out by noting that the Chinese have substituted gold for some of the paper they could be buying from the West and also touches on John Paulson’s big move into gold and his new real estate-oriented fund. Evans-Pritchard sees Paulson’s moves as a reflation play. Others have made the same observation and it probably is an accurate depiction.
He points out that Paulson and others of his age — early 50’s into their 60’s — may well be drawing on the experience of the 1970’s. That may be relying a bit too much on psychology but it is true that our views are shaped by prior experience and that often is the prism that we fall back on in times of stress. It's probably a good reason why so many of us fail to predict the outcome that ensues.
On the other side of the argument are those who either had experience with or are students of the Japanese experience. This group sees deflation as the primary risk and is concerned that it might well become a chronic condition. Essentially all of the stimulus that the West is pouring into its economies is just being used to offset tremendous deflationary pressures.
Evans-Pritchard is in the deflationary camp. He feels that the likelihood of a Japanese outcome is the most obvious, yet he’s also a gold bug. Here’s how he rationalizes the dichotomy:
Personally, I remain a gold bug out of fear that the most corrosive phase of this crisis lies ahead. There are two more boils to lance: Europe and China. As the IMF keeps telling us, Europe’s banks are still covering up their vast toxic debts. Nor has the G20 begun to address the root cause of the global crisis, which lies in excess exports from East (aided by currency manipulation) to an over-spending West. China is putting off the day of reckoning with its crisis response, which is to build yet more plants to flood the world with yet more over-capacity.
For “political bears” the risk is that the EU polity fragments under strain, and that governments restrict basic markets to defend themselves – whether by imposing exchange controls to stop bond flight, or shutting derivatives markets used as hedges, or putting up trade barriers. We will find out if and when unemployment hits 10pc in America, 12pc in Germany, and 20pc in Spain, or if migrant workers rampage in Shenzhen.
Some call this the “Armageddon case” for gold. That is going too far. However, gold has outperformed Wall Street’s S&P 500 index by 500pc so far this century, as if able sniff out trouble in advance. Such runs tend to finish with a “parabolic” blow-off before they die. Mr Paulson may yet make another fortune, whatever his reason.
He may not think that it’s an “Armageddon case” but it sure looks like one to me. While the events he postulates may ensue, I think the probability of that happening is low. In this case, Evans-Pritchard ignores, I think, the very real progress that has been made since last fall. That’s not to say that land mines aren’t out there, I just think that if one or two do blow up, things are under sufficient control so that the damage will be controllable.
Having said all of that, I think that any prudent person would have at least some gold in their portfolio just in case. Look at it as a hedge against either Evans-Pritchard’s scenario or an explosion of inflation but for my money the best play is one that anticipates the Japanese outcome.
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Probably for the next three years.
The Chinese are going to sell two billion electric motor scooters around the world, each requiring some twenty pounds of lead. There are some 350 reactors being proposed world-wide but best to own shares rather than lugging around yellowcake.
Deflation? With monstrous pensions promised, healthcare benefits unfunded, vast sums printed electronically and so on? Not likely. Deflationists argue that even larger sums have been lost, which is true, but neglect to point out they're pulling every string they can reach to get it all back.
We will see continued deflation in asset classes which are grossly over-supplied (i.e. U.S. dollars, U.S. financial products - including bonds, and U.S. real estate).
On the other side of the fence, there are the asset classes in short supply: commodities - and especially gold and silver.
Precious metals should be the CORE of any/every portfolio, not merely some ancillary hedge for people who really have no clue about what is going on.
> The Chinese are going to sell two billion electric motor scooters
> around the world, each requiring some twenty pounds of lead.
Wait, what?
Math check!
There are 6.5 billion people in the world. Surely 31% of the earth's entire population isn't going to buy a Chinese motor scooter with twenty pounds of lead in it.
The Chinese may be HOPING that occurs, but forgive me if I am skeptical.
We are going to be like the japanese but with tremendous inflation. No job growth, falling house prices, rising commodity prices, food costs rising, TAXES UP,UP AND AWAY, but no economic improvements to speak of since what ever we do have will be saved and/or taxed.
Every breath you take,
Every fart you make,
they will be taxing you.
I think we will all know the song.