Deflation Drives Prices Higher
Owning gold does not create value. The price of any commodity is a function of the marginal supply and demand. The largest motivational force in the world, fear, is driving gold prices higher. The fear of what? Right now, the fear is a deflationary spiral. The reason gold tends to do well during periods of deflation in my opinion is that the prevalent global monetary powers prefer low inflation to deflation, and as such can be expected to increase the money in circulation during periods of economic slow-down and malaise.
The debate continues to rage whether gold is a store of value or not. At this point in time, the demand for gold has effectively never been higher. The question is ... is that marginal demand going to increase or decrease over the coming months. We are already at a point where you can buy gold out of vending machines, gold advertisements are all over the TV, people are standing outside of gold stores waving signs for you to come and trade cash for gold or vice versa at their establishment. As for me, this is perfect. The best part about bubbles is that their rate of ascent continues to accelerate higher just before they topple over.
If you're buying gold and silver to protect your portfolio against hyperinflation, you might want to think twice. When you have depressed labor markets, falling bond yields, and corporate profit margins hitting all-time highs, the only way you'll be able to subsidize a case for hyperinflation is by using Chinese accounting or Hollywood accounting.
Reality vs. Perception
Sometimes, perception is more important than reality. I think that this is the case at present. Eventually, reality catches up, but until it does, everyone thinks that the U.S. is heading for default, is spending money in such a way that it will cause inflation. Most of the inflation that I see is related to oil demand catching up with the oil supply thanks to peak oil capping our ability to produce. Sometimes, it makes sense to bet on stupid. In this case, there is a huge push to run away from conventional currencies and into hard assets. As long as this push persists, might as well ride the wave.
When it Ends
I'm looking at what's going on and thinking that the marginal demand for gold is perhaps a bit frothy. That said, speculation can drive prices far beyond what everyone agrees is rational. Some cues that I am looking at regarding time to exit include:
- Markets finally crash, led by economic weakness, the inability to bailout Italy, Greece, Portugal, etc. Note my belief that corporate profit margins are unsustainably high, and a lot of this is effectively tax avoidance and higher commodity prices driven by a surge in negative ROI infrastructure spending in China.
- Gold and silver reach a price where it makes sense to trade an ounce of gold or silver for a whole heck of a lot of another real, tangible asset.
- Charts start to look toppy and are unable to set new highs.
- Margin hikes.
Bubbles are Fantastic
If you can identify bubbles in the marketplace, why not ride them up? They tend to have the strongest, most reliable trends and detecting the end of the trend tends to be fairly obvious. I'm not saying gold or silver is an investment. They are not. That said, why not take advantage of the stupidity of the masses who all think that it is and be ready to take your profits when the signs point toward the exit? My thoughts, if you're a supporter of the hysteria -- I'd be a bigger fan of silver than gold, and I'd be a bigger fan of AGQ than SLV. AGQ is a 2x leveraged silver ETF. My advice would be to avoid owning PSLV. Even Eric Sprott is selling PSLV because it is trading at a premium to NAV.
With this trend, global fear and uncertainty is your best friend.
Disclosure: I am long GLD, SLV, AGQ.