Gold Doesn’t Care If It’s IN-flation or DE-flation 43 comments
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Gold doesn’t care if it’s inflation or deflation.
One of the central arguments for financial commentators right now is whether the US is currently facing inflation or deflation. Everyone (at least everyone with a functioning cortex) is aware that the US (and the rest of the world for that matter) will face more difficult times ahead. However, whether it will be an environment of increased inflation or increased deflation is up for debate.
Personally, I have been in the inflation camp for some time now. However, when it comes to investing, it never pays to grow complacent with one’s thinking. So I did some research into how gold performed during inflationary vs. deflationary periods. The results were rather shocking, to say the least.
According to Scott Reamer of Vicis Capital, gold and the dollar index has shown an inverse correlation of -.28 over the last 17 years. Now, a correlation of -1 would be a perfect inverse correlation, meaning that every move the dollar index made would be mirrored to the inverse by gold (the dollar falls 1, gold would rise 1).
As Reamer points out, a correlation of -.28 is not a strong correlation at all. So to claim that gold will spike if the dollar rolls over because the two are inversely related is overly simplistic. A far more reasonable assumption would be to say that should the dollar collapse, gold will rally due to safe haven seeking by investors.
Indeed, it is gold’s status as a safe haven of wealth (the ultimate currency if you will), NOT its inverse relationship to the dollar, that makes it so special. Gold has been the ultimate storehouse of wealth going back thousands of years. But what’s truly remarkable is that it has maintained this quality even during periods of DE-flation.
The ultimate text on this matter is Roy Jastram’s The Golden Constant. I don’t recommend looking for or reading this book because a) it’s out of print b) it’s a very dense read.
To summarize, Jastram performed a study of gold’s performance over a 416-year period in England’s history (from 1560 to 1976). He found that historically, gold has acted like a storehouse of value throughout wars, plagues, and the like. However, what’s most striking is that gold actually INCREASED its purchasing power during periods of DE-flation.
Deflationary Periods in England | Purchasing Power of Gold |
1658–1669 | +42% |
1813–1851 | +70% |
1873–1896 | +82% |
1920–1933 | +251% |
This last point is absolutely extraordinary when you consider that the thought pattern “gold rises in inflation and falls during deflation” is one of the most commonly believed investing mantras out there. Indeed, gold has undergone a seismic shift in the last year, largely due to inflationary concerns.
Consider the following: Global gold demand jumped 38% in the 1Q09. Three years ago, demand for gold as an investment only comprised 10% of global gold demand. Today it’s over 30%. That’s an unbelievable increase in investment demand.
From an anecdotal standpoint, I’ve begun hearing numerous “we’ll pay cash for gold” radio advertisements. And just yesterday at the gym I saw G. Gordon Liddy on TV touting gold as king and the dollar as garbage (he actually crumpled a dollar bill up on camera). When a guy like Liddy (central architect of the Watergate break-in) becomes a spokesperson for distrusting the government, then you know the general public is growing anxious about the currency.
But my main point is this: Gold will perform well in ANY investment environment going forward, whether it’s inflation OR deflation.
If the dollar rolls over and tanks, gold will benefit greatly from a flight to safety or a desire to seek a non-fiat currency.
And as Jastram’s book shows, if deflation takes hold (as credit and household wealth contracts further) gold will ALSO perform well just as it did during numerous deflationary periods between 1560 and 1976.
How’s that for a win-win?
Good Investing!
Disclosure: I am long gold
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This article has 43 comments:
Coin shows are the BEST place to purchase gold & silver. Most major shows have 30-60 major dealers COMPETING for business in the same convention room! Comparisons and sound decisions are made a lot easier when you confront many sources face to face in the same arena. Also most shows are on Saturdays when the markets are closed and prices are stable. Physical possession is mandatory...no paper investments are sound.
What might help people understand precious metals better is to simply point out that gold or silver can never "increase in value", since they are what they are. Rather, it is a matter of people losing confidence in paper money which causes the nominal price of gold and silver to rise.
Calling gold (or silver) the ultimate "store of value" is just another way of saying it is the ultimate "store of confidence".
P.S. Swashbuckler, as first predicted by John Williams, the U.S. is heading for a "hyperinflationary depression" (i.e. the worst of both worlds).
I agree with you except for your last assertion.
If the DOW crashes to 1000, a deflationary event, gold will not necessarily "move up".
It will likely hold steady and therefore be able to purchase more DOW shares, or whatever, than it does today.
But, I'll take that over any of the alternatives.
On Jun 24 08:56 AM Swashbuckler wrote:
> I've read many fine articles on SA that claim that INFLATION is imminent
> because of the asinine deficit spending and money printed by our
> elected representatives. I have read equally compelling articles
> on SA that flatly state that DEFLATION is here now and will accelerate
> because of the deleveraging necessary to purge the excesses of the
> past few decades. I do not pretend to know which school of thought
> is accurate. I do know that many in each camp are utterly convinced
> that they are right and the other side is horribly wrong. I am glad
> I read this article, as it makes a good case for what I have long
> suspected---that in ANY major monetary crisis gold is likely to make
> a big move up.
mechonomic.blogspot.co...
On Jun 24 10:07 AM yellowhoard wrote:
> Swashbuckler,
>
> I agree with you except for your last assertion.
>
> If the DOW crashes to 1000, a deflationary event, gold will not necessarily
> "move up".
>
> It will likely hold steady and therefore be able to purchase more
> DOW shares, or whatever, than it does today.
>
> But, I'll take that over any of the alternatives.
Now, that gargantuan paper behemoth is seeking ways to stay whole and is re-discovering gold, the storehouse of wealth for thousands of years.
Gold may go down or up tomorrow but be assured on each drop in price a little more of that paper moves into it and will continue to do so until faith in paper as a store of value returns. By all means, play the market, but book winnings in gold.
(I bought gold in november but hapily sold in march)
Good point Albert, but it ignores the fundamentals. How can you have price "stability" with soaring demands, runaway currency printing and unsustainable debts? Something has to happen over the next few years before we once again see stability.
On Jun 24 11:11 AM Albert Ling wrote:
> But what if what we have is neither inflation nor deflation, but
> price stability instead... should a coin of 1oz gold still be worth
> 10 iphones 3G? I think the latter has more "intrinsic value", to
> use goldbug terminology!
www.e-elgar.co.uk/Book...
On Jun 24 09:49 AM Jeff Nielson wrote:
> A very solid article.
>
> What might help people understand precious metals better is to simply
> point out that gold or silver can never "increase in value", since
> they are what they are. Rather, it is a matter of people losing confidence
> in paper money which causes the nominal price of gold and silver
> to rise.
>
> Calling gold (or silver) the ultimate "store of value" is just another
> way of saying it is the ultimate "store of confidence".
>
> P.S. Swashbuckler, as first predicted by John Williams, the U.S.
> is heading for a "hyperinflationary depression" (i.e. the worst of
> both worlds).
On Jun 24 01:35 PM Swashbuckler wrote:
> "hyperinflationary depression"------Terri... can't wait.
Also agreed that it is hugely underrepresented in investment portfolios. However, one must be aware that jewelry demand (which forms a significant portion of overall gold demand every year) is inversely proportional to gold price. If you see gold buying in China, India and the Middle East, it is highly elastic and tapers off during price spikes. Furthermore, looking at the rise in investment demand, a great deal of demand is coming from the ETFs (GLD bullion holding stands at over 1.1K tonnes up 83% for the year). The majority of GLD holders are retail investors and the fast money crowd (HFs). That is not stable demand -- the sentiments there could change on a drop of a hat.
The biggest risks to gold is economic growth and stability. While we might trade around our opinions there, I wouldnt want to bet against it long-term. In other words, other than insurance (a low/mid single-digit %age of portfolio), it would not be part of my long-term portfolio. Trading opportunities do come along from time to time, but I bear no illusion as to gold saving my wealth during rampant hyperinflation (such "revolutionary" periods change too many variables).
Q1 for 2009 data is now available on the World Gold Council site, and investment demand exceeded jewelry demand by 80%. Jewelry demand is now irrelevant to the gold market.
On Jun 24 01:40 PM odin wrote:
> Over the long-term, I am bullish on gold and believe it has a valid
> place in a portfolio.
>
> Also agreed that it is hugely underrepresented in investment portfolios.
> However, one must be aware that jewelry demand (which forms a significant
> portion of overall gold demand every year) is inversely proportional
> to gold price. If you see gold buying in China, India and the Middle
> East, it is highly elastic and tapers off during price spikes.
> Furthermore, looking at the rise in investment demand, a great deal
> of demand is coming from the ETFs (GLD bullion holding stands at
> over 1.1K tonnes up 83% for the year). The majority of GLD holders
> are retail investors and the fast money crowd (HFs). That is not
> stable demand -- the sentiments there could change on a drop of a
> hat.
>
> The biggest risks to gold is economic growth and stability. While
> we might trade around our opinions there, I wouldnt want to bet against
> it long-term. In other words, other than insurance (a low/mid single-digit
> %age of portfolio), it would not be part of my long-term portfolio.
> Trading opportunities do come along from time to time, but I bear
> no illusion as to gold saving my wealth during rampant hyperinflation
> (such "revolutionary" periods change too many variables).
"It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."
Funny point, but I disagree with the assertion that gold "has no utility." Gold has a multitude of uses:
geology.com/minerals/g...
And remember, Buffett was the guy who made the HUGE bet on silver about 10 years ago, at something like $5 an ounce. He famously said: "I bought it too soon. I sold it too soon. Other than that, it was the perfect trade."
On Jun 24 03:38 PM Trent Hauck wrote:
> What is gold good for besides looking shiny. I think that this idea
> is starting to be perpetuated among many investors and that is why
> I don't like gold really at any levels. It may hover around 1000,
> it may break out, or it may fall, but I wouldn't want to bet any
> of those. Usable hard assets will rule it I were to guess.
Interesting hypothesis ... I'm not sure I completely buy it, but it does have some merit.
I am currently shorting gold and silver through GLL and ZSL, which has netted me a small return to date (about 5% over the past week). I am, however, bullish on gold for the longer term, and am ready to hop back on the bus as soon as my indicator says so.
More simply put, the price of gold goes down in nominal dollar terms in periods of deflation, but its purchasing power is maintained or goes up. To the extent the author states the latter, he is correct. But it is wrong to suggest (as I believe this article does) that you will make (fiat) money if you are long gold in a deflationary environment.
Conversely, in a hyperinflationary environment, gold prices will go up in nominal dollars, but its purchasing power will be eroded.
Consider that gold has a dual-nature: 1) it is a medium of exchange (money); and 2) unlike fiat money, it is a hard asset that has intrinsic uses/demand outside of its usefulness as a medium of exchange. In deflation, the prices of hard assets decline; money becomes worth more and can buy more hard assets. Gold's monetary aspect means that gold will buy more hard assets with more deflation. But gold's hard asset flipside means that the fiat money price of gold will go down with deflation. Thus, relative to fiat money, gold gets cheaper, but relative to other hard assets, gold buys more. Conversely, with inflation, the hard asset aspect of gold means its price should increase in fiat money, while its monetary aspect means that that you should not be able to buy as much oil or real estate, for example, with your gold.
I am long gold because I believe that inflation will be a major issue in the years to come. But I am also long commodities because they will outperform gold in inflation. I also plan to leverage up into more real estate with fixed rate debt (which is effectively like shorting long-term treasuries because you profit from rising interest rates). In sum, I believe diversifying away from fiat currency is the best long-term bet you can make right now, but gold is only a piece of the puzzle.
If you believe that the USD will purchase more gold during periods of deflation, then you must believe the USD is the ultimate store of value.
If your version of deflation appears and the purchasing power of the USD increases with respect to gold, what will the supply and demand look like with gold at $200, $300, $400 /oz.? There would have to be absolutely no demand for it.
On Jun 24 09:49 PM long roh wrote:
> More simply put, the price of gold goes down in nominal dollar terms
> in periods of deflation, but its purchasing power is maintained or
> goes up. To the extent the author states the latter, he is correct.
> But it is wrong to suggest (as I believe this article does) that
> you will make (fiat) money if you are long gold in a deflationary
> environment.
On Jun 25 05:44 AM hopschoko wrote:
> There are some people that believe that gold is the ultimate store
> of value (or confidence as Jeff Nielson points out in an earlier
> post). This means that its purchasing power will INCREASE during
> deflation; gold will buy more USD and the USD will buy more goods.
>
>
> If you believe that the USD will purchase more gold during periods
> of deflation, then you must believe the USD is the ultimate store
> of value.
>
> If your version of deflation appears and the purchasing power of
> the USD increases with respect to gold, what will the supply and
> demand look like with gold at $200, $300, $400 /oz.? There would
> have to be absolutely no demand for it.
You are missing the point that for most of the period covered, England was on a gold standard: gold WAS money. In periods of deflation, the purchasing power of money increases and, since gold WAS money, the purchasing power of gold increased (see values in the table given).
Now, we have fiat money systems: gold is NOT money (and perhaps gold is ANTI money). If the purchasing power of gold increased during a future (current?) period of deflation, it would not be for the same reasons that it did in the past.
seekingalpha.com/artic...
On Jun 24 10:11 AM Ivan Kitov wrote:
> I would expect gold to decline at a five-year horizon
> mechonomic.blogspot.co...
I would realy like to draw peoples attention to gold prices from the last 7 years, you will note it went up in a (stocks) bull market, down in a bear market, and now up in a rally.
The proof is in the pudding.
Why would gold suddenly go up if the (stock) market went down, when it normally goes down?, and go up in deflation, when it has been going down in deflation? Very strange thinking IMO.
Following the SIMPLE theory that works, we will continue to see gold go up if the market continues up and gold to go down when the bear market rally ends.
I will continue to bet (my own) money on it.
On Jun 25 10:41 AM chap08 wrote:
> Unfortunately, you can not draw these conclusions from the data.
>
>
> You are missing the point that for most of the period covered, England
> was on a gold standard: gold WAS money. In periods of deflation,
> the purchasing power of money increases and, since gold WAS money,
> the purchasing power of gold increased (see values in the table given).
>
>
> Now, we have fiat money systems: gold is NOT money (and perhaps gold
> is ANTI money). If the purchasing power of gold increased during
> a future (current?) period of deflation, it would not be for the
> same reasons that it did in the past.
Japan's recent history provides an example of the scenario you describe and, in summary, the purchasing power of gold increased in Japan over this time. However, would this have happened if the rest of the world had been in defaltion at the same time? Because of Japan's unique circumstances, the Yen was pushed down by the carry trade and gold was bid up by the rest of the world, which was anticipating inflation. What would happen if the USA, Europe and Japan were simultaneously experiencing deflation?
On Jun 25 12:53 PM Sheik Rattle Enroll wrote:
> Right, it's like saying whoa the purchasing power of the dollar increases
> in deflationary periods and decreases in inflationary ones. What
> we need is an analysis of gold purchasing power during a deflationary
> period under a fiat money system.
The only real industrial uses gold has are because it doesn't oxidize - it can be used in microscopically thin layers to protect electrical contacts from corrosion, and that it is very ductile meaning it can be drawn into microscopically thin wires used to connect integrated circuits.
The price of gold has nothing to do with these industrial uses. It is 100% tied to its use as a currency and somewhat as its use as a decoration.
It has a great long term acceptance as a medium of exchange because of its history. It is pretty likely that will continue in the future, but in reality there is no fundamental reason for it other than the rarity and physical stability make it well suited for this application.
It is ok as a hedge against economic collapse. But as an investment it should be viewed as a trading vehicle. Buying gold is akin to taking a short position or hedge against industrial society.
Other investments offer the prospects of real returns because of the growth of the underlying asset. Gold will never provide that potential.
On Jun 24 05:13 PM relayer75 wrote:
> I love the famous Warren Buffett quote on gold:
>
> "It gets dug out of the ground in Africa, or someplace. Then we melt
> it down, dig another hole, bury it again and pay people to stand
> around guarding it. It has no utility. Anyone watching from Mars
> would be scratching their head."
>
> Funny point, but I disagree with the assertion that gold "has no
> utility." Gold has a multitude of uses:
>
> geology.com/minerals/g...
>
> And remember, Buffett was the guy who made the HUGE bet on silver
> about 10 years ago, at something like $5 an ounce. He famously said:
> "I bought it too soon. I sold it too soon. Other than that, it
> was the perfect trade."
>
That is gold's utility. As a function of trade, commerce and investment or as a bauble, with major populations, it still commands a buying power which transcends our own western SPOT PRICE notions. While Keynes was undoubtedly motivated to take us out of the slime of past failed economic systems he may have inadvertantly planted the seeds of another. A credit based economic system works relatively efficiently as long as it expands. Bubbles therefore are not only inherent but encouraged in the belief that some are lasting and are signs of economic health.
But when expansion becomes a prolonged contraction, things return to fundamentals. A store of wealth or value is a result of making/having more than you spend or at least in some measure, allocating for profit or future needs, some portion of your earnings/wealth. I will leave it to you to decide if prudence dictates spending more than you earn and live day-to-day paying into a credit cycle which charges you a premium (tax of a kind) for the privilige, leaving the principal of that debt unchanged or larger than before. The money creation, which Keynesian economics precipated began long before the recent events which came close to unhinging our entire economic system.
It is too long a story to relate here and I am sure you all know the score but in all cases of History where currency debasement took place, the results were dire for the empire. Today the world is held to ransom by a USDollar which, according to many is heading lower or tanking altogether. But that ransom creates a consensus which props up the USDollar because, put simply, it is to no one's advantage even if they could, to see to its complete destruction. The amounts of money wealth blown off the tops of the past few years stock slide and subsequent institutional maladies by failures in markets hence liquidity squeezes is hard to quantify with the exactness to know for certain if the money created by the Fed and its counterparts is excessive thus inflationary. That and the timing factor is the core of the problem and will play out in the years ahead.
I think we can bank on interest rates going up within a few years. I think we can count on the USDollar remaining the world's exchange currency but with increased fx volatility. In the end, I think it wise to restore some balance on an individual level by reducing debt and allocating excess or at least some portion of your earnings/wealth to savings of some kind. Smart people do that. On a macro level, smart governments like Norway, have done so and our governments must follow suit. It is the only way I can see that we all, as a society, will be able to manage black swan events (just as certain as bubbles), keep faith in our assets and not suffer the consequences of needing to exit an asset class en masse thus lowering that assets' market value. For me, gold bullion is cheaper than a house and easier to deal with notwithstanding vaulting costs and all associated arguments decrying the metals value going forward. It is an asset that will not, or at least has not in 5000 years, become non-liquid. Whatever the market will pay for it in kind, is its utility. Have a great day and don't forget to do an unsolicited kindness to someone. Just because we have a fire or two to deal with doesn't mean we are bereft of virtue.
www.scribd.com/doc/167...
If we have deflation I want dollars or govt t bills. If we have inflation I'm perfectly happy with the yellow metal or silver. It did fine from 2001 - 2008 - better investment than most !
My point is that the demand you see is a "hot" flow. You are seeing retail buying, Paulson & crowd buying: that demand could suddenly become supply. There was huge demand and rapid appreciation in real estate just a few years ago (and the transaction costs in trading real estate are MUCH higher). Follow the gold price spike in the Jan 80 -- the buyers at the top have yet to break even in real terms (and are barely up in nominal terms).
My point is not that gold shouldnt be bought for investment (as a small part of a overall well-diversified portfolio) or that it cant be traded over the short-term. SImply that if you are advising that it should replace income-generating assets in your portfolio, which I hope form the significant portion of any portfolio, with the expectation of multi-bagger gains, you are likely to be disappointed.
On Jun 24 02:34 PM Jeff Nielson wrote:
> Odin, investment demand has just ZOOMED past jewelry demand - in
> just TWO quarters.
>
> Q1 for 2009 data is now available on the World Gold Council site,
> and investment demand exceeded jewelry demand by 80%. Jewelry demand
> is now irrelevant to the gold market.
.
On Jun 25 08:21 PM secmaven wrote:
> If the US did not have the largest reported gold reserves in the
> world would the dollar be the reserve currency of the world? The
> answer is no. So if China wants its money to have reserve currency
> status guess what? It will be adding to its gold reserves every chance
> it gets. Other wanna be central banks like Russia and India will
> emulate the Chinese. This combined buying power will destroy the
> hiplock JP Morgan as instructed by the Fed has on the price of gold
> through shorting on the CRIMEX and the price of both gold and silver
> will zoom upward.
On Jun 27 08:38 AM DONE_SONZ wrote:
> My thoughts as well.I wonder what are (reported) gold reserves really
> are though.
> .
On Jun 24 05:13 PM relayer75 wrote:
> I love the famous Warren Buffett quote on gold:
>
> "It gets dug out of the ground in Africa, or someplace. Then we melt
> it down, dig another hole, bury it again and pay people to stand
> around guarding it. It has no utility. Anyone watching from Mars
> would be scratching their head."
>
> Funny point, but I disagree with the assertion that gold "has no
> utility." Gold has a multitude of uses:
>
> geology.com/minerals/g...
>
> And remember, Buffett was the guy who made the HUGE bet on silver
> about 10 years ago, at something like $5 an ounce. He famously said:
> "I bought it too soon. I sold it too soon. Other than that, it was
> the perfect trade."
>