Gold Outperforms the US Dollar During Deflation

Karl Denninger over at Market Ticker just came out with his 2009 prediction review bashing Gold and Robert Prechter has considered the entire run in Gold since 2000 some kind of weird Elliott Wave correction despite a 300% advance from the early 2000s. Deflation and Gold are not incompatible and it seems odd to me that such seasoned commentators are blind to it. I respect both of these gentlemen and their opinions but I disagree with their views on Gold.

Don’t get me wrong, I’m currently in the deflationist camp. I’m not calling for the collapse of the US Dollar. But I think both of these gentlemen and others in the deflation camp who seem to despise Gold and call for its price collapse would be reasonable enough to look at the actual data. And no, I’m not talking about the 1930s because I know we were on a Gold standard then and now it’s different.

If Gold is not a safe haven, then pray tell me what is? If you say the U.S. Dollar, how about we look at some inconvenient facts that prove Gold is doing better than the U.S. Dollar during an actual fiat deflation? The current debt deflation bear market began 10/11/2007. If you bought Gold and the US Dollar at the closing price on 10/11/2007, here are your real, actual returns since this bear market began:



So, why again isn’t Gold a safe haven in a deflation? Yeah, sure, you can call for a pending collapse in the Gold price any day now and call for a stunning rise in the U.S. Dollar index any day now. But you need to admit when you’re wrong and so far many deflationists have been absolutely and entirely wrong about Gold. Are there any deflationists out there who would like to dispute the actual facts? In the end, aren’t the facts more important than what someone believes should happen?

By the way, as far as Denninger’s prediction for 2009 on the scoreboard so far, Gold closed on 12-31-2008 at 884.30/ounce and now is at 929.50 (a 5% gain – pretty good 6 month return for a safe haven, eh Karl?). The US Dollar Index closed at 81.21 on 12-31-2008 and is now at 80.26 (a small loss negated by a 1-2% yield over the past 6 months). So, Gold has been a more profitable safe haven than the US Dollar in the middle of a deflationary storm.

Gold is money. I don’t agree with the hyperinflationist crowd for this cycle (we just finished a hyperinflation in asset prices!), but it is naïve and shows an ignorance of history to assume that nothing could cause a one-off event to devalue the US Dollar literally overnight by 20-70%. This would wipe out the entire “safety” concept of the US Dollar and make that 3% yield seem a little foolish to chase, no?

Now, I understand that some people are traders and I understand that you can’t eat Gold. I am not calling for the end of the world, I am not calling for the US Dollar to become completely worthless, I like shorting the markets when it is profitable to do so and I am a believer in deflation. But if cash is king during deflation, then Gold is the emperor and king of kings.

It’s time for deflationists to stop their antagonism towards Gold and recognize Gold for what it is - money, not a commodity. I understand the aggravation deflationists experience when trying to argue with hyperinflationist Gold bugs, but that doesn’t mean such deflationist commentators should steer people towards the wrong investment. In a global fiat system with no apparent anchor, it is foolish to assume that those seeking safety around the world will as a rule prefer the US Dollar to Gold given global sentiment towards the US. It’s Gold-dispensing ATMs that are now popping up in Europe, not US Dollar-dispensing ATMs.

The US Dollar can rise and Gold can rise – these concepts are not incompatible to those who understand that Gold is an independent international currency with no debt or other political promises attached to it. There is a limited amount of physical Gold in the world versus a seemingly endless barrage of fiat promises despite their relative decrease due to deflation/credit contraction. As a believer in Exter's liquidity pyramid concept during deflation, I believe even a small further global move into physical Gold will cause its price to remain firm and likely rise further during this deflationary depression.

Prechter has been calling for people to be in T-Bills and bank CDs since the 2000 stock market top. That protected people from wicked stock market declines. But before we praise him for all his amazing calls (and some of them were), let’s look at a strategy of holding Gold instead of his call to hold cash, using the closing price on 12/31/1999 and the current price levels of Gold and the US Dollar Index:



Now, I have ignored yield and returns on the US Dollar, but I didn’t want to be presumptuous and pick a yield that would be considered unfair. I would rather hear from one of the Gold-hating deflationists to put in the correct yield on cash and tell me what the appropriate return on cash is since the start of 2000. No matter how you slice it, it falls way short of Gold.

The risk of a US Dollar currency “event” is not even close to negligible over the next few years and the added insurance Gold provides as a hedge against such an event is of high value. For a deflationist to say that a geopolitical event couldn’t knock the US Dollar down a notch and wipe out the paltry yield on cash over the past 2 to 10 years is unreasonable in my opinion now that we are the world's great debtor nation. I am happy to give up the current safety of a 2% (or lower) yield on short-term US government debt for the safety of Gold during deflation.

Apparatchiks can decree that Gold is not money but they cannot prevent people from swimming for the lifeboat that has worked for thousands of years. Gold can thrive in a deflationary collapse and has already shown it can outperform the US Dollar in this deleveraging cycle. And if you think China, Brazil, Russia, Germany and India would rather be paid in US Dollars than Gold for their goods and services right now, I think you’re the one who needs to wear the tinfoil hat.