Gold Old Yellered

Gold is finally reacting to the deflationary credit crisis conditions.

Gold Falls in London as Investors Seek Cash Amid Bank Turmoil

I think the headline pretty much says it all.

It is apparently not the miracle metal that can protect you in both an inflationary environment and a deflationary environment.

The optimistic bulls had it easy. They could simply buy with conviction and know that all will work out fine (it didn't though). The pessimistic bears did not have it so easy. We had to decide between deflation and inflation. If serious deflation was coming, you'd want cash and long-term treasuries. If serious inflation is coming, that's the last thing you want. You'd want hard assets instead. I tried to ride the line between the two camps by being in paper inflation protected assets (TIPS). I just wasn't all that sure what we'd be getting. I'm still not all that sure.

What we have now is clearly a deflationary/disinflationary environment. Today's CPI came out flat. How long it lasts is anyone's guess. I think once it is over we'll probably be going back to more stagflation, but I certainly can't prove it.

The key to gold's drop as far as I'm concerned was watching the price of oil and the price of the other precious metals prices. Oil's dropping again today. Platinum is also down big again to $875. Keep in mind it was over $2,200 earlier this year. How could some deflationists possibly think that gold's price could rocket past platinum's price (a precious metal that's much rarer)? I never could understand that line of reasoning.

Then there's palladium. It peaked at just under $600 an ounce earlier this year. It's now just $165. No joke. That's a jaw dropping drop.

January 26, 2007
Gold and the K-Cycle

Those that thinks gold always acts as an inflation hedge are simply mistaken.

Yes, but what's the point? Those who thought real estate (at any price!) always acts as an inflation hedge were similarly mistaken. Yet, real estate is generally a pretty good inflation hedge. Too bad deflation is the word of the day.

One quick glance at the above chart should be proof enough.

This statement really got my goat. A quick glance at a chart is one of the things that got us into this mess in the first place. In 2000, a quick glance at stock charts showed stocks only go up. In 2005, a quick glance at housing charts showed that real estate only goes up. A quick glance at a chart should NEVER be proof of anything. Heaven help me if I ever start to believe any of my charts actually prove anything.

Did we experience inflation from 1980 to 2000? Did gold fall from over 800 to 250 anyway?

Once again, what's the point? Did gold rise during the massive inflation of the 1970s? Yes. Did people buy gold in the 1970s because they were concerned about that inflation? Yes. Did it enter a bubble? Yes. When inflation finally did recede to more normal levels did gold sell off? Yes. Unlike the 1970s, did real interest rates remain positive throughout the 1980s and 1990s? Yes. Were people happy to earn positive real returns on paper assets in the 1980s and 1990s? Yes. Are real interest rates positive right now? Yes. Is gold well off its highs right now? Yes.

Obviously the answer to both questions is yes, and that disproves the idea that gold is always some sort of inflation hedge.

This disproves nothing. Of course gold is not always some sort of inflation hedge though. It is certainly not proof that gold is therefore a deflation hedge. In my opinion, like every other hard asset what really matters is the price it was bought at. If bought low (say $250 an ounce several years ago), it has been an excellent inflation hedge. If bought high (say $1000 an ounce recently), well, not so much lately.

This usually brings up the question of Japan and gold and why gold fell when Japan went into deflation. The answer is that Japan was one season out of sync with the entire rest of the world. When Japan was in deflation (Winter) the rest of the world was pretty much in disinflation (Autumn). It was the rest of the world that dictated what happened to the price of gold, not Japan.

The entire world is in sync right now. The entire world is attempting to fend off deflation right now. Gold's world price is tanking right now. It is breaking under the weight of falling oil, platinum, palladium, and silver prices. I do not offer this as proof though. It is simply an observation. Should my money wish to chase hard assets again at some point, based on today's prices I'd probably chase silver and/or platinum over gold. I don't wish to chase them though. I'm content on the sidelines.

To see how gold shares might act in the upcoming credit crunch, please consider a chart of Homestake Mining in the 1930's courtesy of Gold Eagle.

I think it is safe to say that we've been experiencing a very serious credit crunch over the last three months. Expectations, meet realizations.

Barrick, Goldcorp, Newmont, Kinross, AngloGold