Oil Replaces Gold as the New Inflation Hedge 19 comments
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Since gold was first used to back the US dollar, it has been the basic hedge against inflation. As with many of my writings, you have seen that I have thought we would see increased inflationary pressures throughout 2008. I still believe this to be the case, along with the premise that the stock market will rebound sometime in the late first quarter or second quarter of next year. The agricultural and commodity stocks have been right on, but gold as of late seems to be losing steam. Many of these scenarios have ended the same, with the miners buying back all of their hedges just in time for gold to go down. This time it looks to be no different.
I believe that we have seen a change in the US economy. I know everyone believes this time is different until they see that history does indeed repeat itself. The reason for it being different is a major shift into other markets. The majority of the problems facing our economy are related to energy. Our uncontrolled use of oil has placed us into a very difficult position.
It is basic supply and demand. Countries buy and sell goods. Their currency is valued by how much of a surplus they have (sell more than they buy). If a country has a trade surplus, the value of their money goes up and if the opposite happens, the value of their currency goes down. When the value of currency goes up, so does the cost of items to buy, causing inflation and decreasing the attractiveness of their goods overseas because it costs more. On the other side of things, as currency goes down in value it causes a deflated currency, which will do better overseas as the cost of goods is cheaper. When inflation increases, generally their will be an increase in rates to slow the economy and when there is deflation, there will be seen a cut in rates. All of this is important due to the fact that most of the United State's imports are oil.
When the US imports oil, it goes against our exports. In turn, we see increased demand for oil, plus China has been filling up its strategic oil reserves. This has placed large draw downs in oil inventories, even in a slowing economy. Not only is oil more expensive due to demand, but also our weak currency makes it more expensive, while buying oil increases our trade deficit and further weakens our dollar.
Realizing this vicious circle, those wanting to hedge against inflation have turned to buying oil. There are only a couple of ways to decrease the price of oil. The first is to decrease demand. This can be done by increasing taxes, or providing stimuli or bonuses to those who use less. It can also be done by hiking rates to inflate the dollar's value. The only problem with this is one of the worst housing crisis seen since the Depression. With the inability to hike rates, the Fed is hoping our slowing economy plus additional oil from Saudi Arabia will bring the price down. To go back to decreasing demand, this can be done when oil gets to expensive and people cannot to drive as much, and this may be the only way to clear this up. No matter how you look at it, oil will be the center of attention and although I believe this will be where the hot money will stay until next year.
Look for the dollar to rebound very slowly, causing a gradual decrease in the value of gold. I believe the forward trend will cause rates to be hiked as oil prices are getting high enough that we will have the inability to cut anymore, even though I believe the Fed would still like to maintain a downward bias. Being stuck at this position will increase the time it will take to come out of this hole. Look for oil to be the main focus going forward and gold to continue to slide as the dollar recovers.
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This article has 19 comments:
buying good oil stocks may offer protection, too.
Picking the current bubble asset as a "hedge against inflation" seems a bit flawed, especially when it would appear that the monetary inflation pump has (currently) gone idle, with the Fed eschewing further rate cuts and (almost) threatening rate hikes.
Maybe using oil as a hedge against high gasoline prices, but the UGA ETF would seem to be better for that purpose.
'Countries buy and sell goods. Their currency is valued by how much of a surplus they have (sell more than they buy). If a country has a trade surplus, the value of their money goes up and if the opposite happens, the value of their currency goes down.',
...then why will the dollar turn around and go up. Our Gov't still has a negative balance of trade, and also a spending deficeit (sp?), so why would one expect the dollar to go up? We need to fix the twin deficiets, and then one could look for an increase in the dollar. We are trying to talk our way out of this problem, by saying we are for a strong dollar, when our actions say the opposite. Of course, our huge need for oil from foriegn sources is most of the problem, but I don't see how that is going to change any time soon. If it isn't coming from Mexico or the Saudi's, it will be coming from Canada, Brazil, or some other foreign source.
If you agree with that statement, then why would one expect the dollar to strengthen any time soon?
And that of course is what is driving the price of oil, and what makes it great hedge against the weak dollar.
Only when we start making progres on the twin defiecits, can we expect a more permanent strengthening of the dollar.......as I see it.
Gold is ridiculously inconvenient and inefficient to use as a currency. You MUST exchange it for "real" coin of the realm (aka, USD), and pay a hefty exchange premium to convert, in both directions.
That said, it DOES have a value as a hedge against a lack of faith in the currency of the realm, but only in terms of another asset class.
And as I mentioned in the previous post, for the past few weeks (a short time, to be sure) the USD has been looking more like the strongest currency around, stronger than gold, as the Fed talks it up with veiled threats of rate hikes, which will become less veiled as higher prices stoke inflationary expectations.
Full disclosure: I currently hold WAY too much gold, in the form of ETFs and mining stock mutual funds, at around 30% of net financial assets -- the only thing keeping me in it is the possibility the Dubya will drag us deeper into a worsening fight in the Middle East, and his current efforts to push nuclear technology into the hands of the folks who gave us 9-11, the Saudis. But I keep gold as a hedge against crazy uncertainty, not against the dollar or oil.
quotes.ino.com/chart/?...
While the 3-month interval it has been showing support over is still too brief (and too weak) to be conclusive, it sure looks better than gold over the same period.
We'll have to see what ensues from this point forward. If Bernanke is forced to tighten the screws and hike rates a bit to dampen inflationary expectations (it will not dampen the price hikes, unless he cranks up rates so high as to crush the economy), then gold will continue to do nothing while the dollar will continue to increase in value against gold. If Bernanke turns out to be the typical spineless political creature that most federal (and state) officials are, then he will cave in to demands for easy money and Paul Volcker (or his clone) will be getting ready for his turn at the wheel.
We'll just have to wait and see -- but for the past three months, gold has sucked as an investment. If after another three months things continue in the same vein, you can expect to see a lot of true believers selling their gold holdings at a loss and the true believers will be facing another quarter-century of lackluster performance.
Myself, I think that there is at least one more good run-up left in gold, but as always, I can be wrong.
OK-- what happens when the oil bubble blows but inflation or wild geopolitics takes its place as the evil of the day? A lot of other bad things are masked by the oil hoopla. Will oil and gold drop together or will gold decouple and rise in a reverse crossover due to a new speculative bubble in gold? Dunno--At this point it seems that gold is moving down faster than oil in each oil dip.
I think that the etf's have made gold or silver much more of a "regular" investment. GE, MSFT, commodities, gold. silver-- who cares-- just analyze, buy, hold and sell. Part of the reason for the decoupling may be a new attitude about gold. The etf buyers jump in and out. They really don't see it as a lifestyle or political statement. It is just another potential investment that is now a mouse click away.
BTW--I dropped about a third of my gold and silver three months ago. 50% was enough gain and I was getting nervous. I am nervous again as well.
Too much time on our hands, eh?
You talk about supply and demand, yet you do not take this into account when talking about the dollar. The dollar is not backed by anything except the government's credibility (which is always a risky thing to rely on in and of itself), and the Fed is printing insane amounts of money, increasing the money supply, thereby decreasing the purchasing power of the dollar and creating the inflation that we see today. It's silly to think that the dollar can increase over the long run as long as the money supply is increasing.
We saw the markets tank along with the fall of bear stearns in march: then the fed injected capital and later the stimulus package was inacted. Now look what happened. Immediately after that injection, the markets rallied past DOW 13k...only to test new lows now as those funds have been depleted. This stimulus package is close to its conclusion. Now the fed is stuck: they cannot raise rates; and they wont this year. They have committed to the economic growth premise: and it has failed. Europe and Japan are set to increase rates. The spread against the dollar will worsen. The housing problem is not going to improve because of the pressure on the consumer and the press. Even fixed rate loans with 20% downpayments way underwater: so bad in fact that people who can afford payments will walk away. BAC is buy CFC's worthless loan portfolio; thinking it is an act of genious but is reflective of a overtly speculative maneuver that housing will recover to the 2005 levels.
Bear stears showed us the investment houses like LEH and MER are comprised entirely of paper asset equity and have no hard value: if clients abort these conglamorates, they will surely fall. Foreign countries like Russia, China, and the middle east are working to undermine our economy, and americans themselves depend on their entitlements like social security and medicare; and will continue to lobby that they remain as they are. Americans have become fat, lazy, greedy and incompetent, and maladaptive. Obama will surely enact record socialist 'people pleasin' initiatives from the gov't. Mcain represents the failure of our judeo-christain economic philosophies; and the Bush stigmata will remain with us for years.
How can you imply there is any hope for the dollar to recover? If there was ever a time to not have faith in the financial system, it is now.
where can we run? nowhere is safe. at least gold cannot be taken or frozen. put it in a safe deposit box. buy it by the oz. it at least holds value internationally, where dollars will eventually not. There is the question of whether gold is indeed an inflation hedge, but in a hard and sudden dollar crash, gold will be.