Monday, October 26, 2009

Inflation, Deflation or Just Gold?

The whole inflation versus deflation debate is actually much less important to me now that I understand the role of Gold. Gold protects against financial and fiat currency instability and a loss of confidence in "the powers that be." It is Gold's time to shine as an asset class during this Kondratieff Winter, whether the Dollar does a Prechter deflationary death dance higher first or a straight Sinclair inflationary flop down to the 52 U.S. Dollar Index level (from the 75 close on Friday). People who only see "Dollar Up, Gold Down" and vice versa are missing the bigger picture. All global fiat currencies are sinking together, just at different rates. It is simply Gold's turn as an asset class. Cycles. Greed. Fear. Gold will be a lousy investment again in 5-10 years, but it's WAY TOO EARLY in the cycle to be worried about "the" top in Gold. Wake me when we get to $1500/oz. and I'll be happy to revisit the issue (with another bullish commentary about how the next stop is $2,000).

So, whether its deflation or inflation or both, Gold is going higher. This a confidence issue and a secular cyclical phenomenon. "Gold good, stocks bad" is a trend set to continue.

Having said this, I still enjoy the inflation versus deflation debate. From a practical standpoint, as Martin Armstrong has said (see below), big money that moves currency markets can flow almost anywhere in the world to find a safe haven. In the early 1930s, capital flowed into the United States once the major economies like Britain and Switzerland abandoned the Gold standard, causing a crisis in confidence in these previously "good as Gold" currencies. This global flow of capital into the U.S. Dollar caused our Dollar to rise in relative value, aggravating the natural state of deflation we were experiencing at the time.

Naturally, Europeans sought the safety of a foreign currency backed by Gold once their own currencies were aggressively devalued by discontinuing their respective Gold pegs. In fact, if the United States stuck to its guns, it probably would have lost all its Gold to the hoards of paper note-bearing European souls looking for real money. American citizens followed suit and traded their notes for Gold (benefit of a true Gold standard: no commissions or premiums!) - these evil Gold hoarders of course had to be stopped and/or punished. Gold was thus confiscated from American citizens (with safety deposit boxes at times watched by officials to prevent clandestine Gold ownership) and the American Gold standard was finally weakened to help break the cycle of Gold loss and deflation. An overnight 69% currency devaluation ($20.67/oz. to $35/oz.) and the criminalization of private Gold ownership in the United States (ending a "true" Gold standard period in this country) was all it took. As destructive as they were to confidence and people's savings, these Roosevelt mandates helped fuel a weak reflationary cyclical general stock bull market (1933-1937 was not a weak cyclical bull market for Gold miners, by the way).

Will we repeat a 1930s deflationary "collapse" scenario? Will we have a major currency event? Though deflationary forces are strong due to real estate and banking/credit/debt fiascos, confidence in the Dollar is low. The world's greatest debtor nation has not inspired much confidence in global market participants seeking a safe haven. And I am not talking about bear market currency rallies here, I am talking about the dominant long-term trend.

Will Bernanke and his U.S. Treasury lackeys finally destroy the last shred of confidence in Uncle Buck with their idiocracy? Will capital flow into or out of the United States when the next wave of the global crisis occurs? Again, not talking about dead cat bounces here, talking about the dominant long-term trend. Global capital flows have more control over the fate of the Dollar (and every international currency) than Ber-spank-me, but Benny's actions can certainly cause some of our creditors to figure out sooner that it may be better to walk away and simply write off their bad debts. Whether you've chosen sides on the inflation/deflation debate or not, this debate does allow you to recognize the nasty war of fundamental forces that is sure to cause further economic chaos in any scenario.

Me, I see further capital flight away from many financial casinos/markets around the world coming. I see a further loss of confidence in bankstas, Wall Street hustlers and paper magic notes designed to explode. I think some of this global money will be seeking a safe haven in Gold. I am not talking massive amounts of money, as Gold is a small market. I am talking about a few more "elephant" investors (i.e. governments, large private institutional funds) around the world deciding to up their physical Gold insurance from 1% to 5% of their portfolio. That's all it would take to start/continue a big move higher in the Gold price from current levels.

Gold is safe, it is reliable, it requires no government assurances or bail-outs to stay in business, it does well when there is little confidence in the system and it is not debt-based. These are all things you want during a contractionary secular bear market in general stocks and real estate. Sure, governments can try to further tax or even confiscate Gold (again), but the government historically gets too tyrannical in trying to tax or confiscate all kinds of personal property at this stage of the economic cycle (including stocks and real estate). This is hardly a unique problem for those who take the plunge with Gold, despite paperbug concerns. At least Gold can be held quietly "off-ledger" until more rational minds prevail (this is not as easy with stocks and real estate).

In fact, if the government does "ban" Gold or tax it more excessively than it already does, nothing could be more patriotic than to completely ignore such a decree as a moral act of civil disobedience. By the way, if anyone in officialdom is reading, I sold all my Gold last year and this is just an academic intellectual exercise designed to make sure Americans follow everything their mama guvmint sez by pointing out the insanity of messing with Big Brother, who is all-knowing, all-powerful, and should never be disobeyed. I am a paperbug after all, I swear.

I believe the global paper fiat system is breaking down. I believe people will increasingly trade their paper for Gold regardless of whether we undergo deflation or inflation. After a 20 year bear market from 1980-2000, Gold ain't done after a 4 fold gain. Has everyone forgotten how paper fiat market bubbles and Gold manias work?

I suppose that the economic events of the 1930s or 1970s, both inducing Gold and Gold stock manias, could not possibly happen again. Ever. 40 year intervals (if this is, perhaps, say a normal repetitive cycle) would put us at the 2010s for a new Gold mania, but Gold is dead as an asset class forever. Gold will never again have a serious bull market. Oil can go up 14 fold in 10 years but Gold couldn't possibly go up even 10 fold in the same rough period (which would put us at $2500/ounce). The last bull market in Gold on a fiat paper system took Gold prices up 24 fold in 9 years ($35 to $850). The S&P 500 went up 16 fold from 1980 to 2000. This time, a 4 fold gain over a decade in a hated asset still considered worthless by the mainstream crowd is a bubble mania waiting to pop any second and take the Gold price back to Prechterite levels?! No sale, sorry...

I believe $2,000/oz is a minimum conservative upside target for Gold and it wouldn't shock me to get to $10,000/oz. Until the Dow to Gold ratio gets below 2, I wouldn't even consider that the Gold bull market might be over. We've got a long ways to go. Ignore the short-term noise and the paperbugs. Forget the $25-50 swings. Sit tight and be right.

Below is a Martin Armstrong essay that inspired this post, courtesy of Scribd:

Deflation or Inflation--Which is More Likely? 9/29/09

Wikinvest Wire