Jeff Nichols

The Battle of the 'Flations

Gold as a deflation hedge:

During periods of deflation, we postpone spending in anticipation of lower prices. Instead, households hoard cash and cash-equivalents such as short-term U.S. Treasury debt, bank deposits, and money-market instruments. Gold is also a cash-equivalent . . . and some will choose to hold more of their savings in the yellow metal, particularly during times of economic stress and uncertainty when gold just feels safer.

Moreover, deflations are also characterized by very low interest rates. Rates are low because the demand for credit is depressed, savings are high, and the Federal Reserve and other central banks will pursue low reflationary interest-rate policies to encourage economic recovery.

As a result, the opportunity cost of holding gold – that is, the income forgone by holding these metals rather than interest-bearing assets – is also extremely low, further encouraging some investors to favor the precious metal over alternatives because of its other attractions and attributes.

For more on gold, deflation, inflation and the economic outlook, see my blog, NicholsOnGold.com