World Economy

Inflation, Deflation and Gold

Inflation, Deflation and Gold Inflation, Deflation and Gold

There are two camps of investors which have diametrically opposed views on why one should own gold. One camp believes that gold is an excellent hedge against inflation, while the other camp believes that gold is a hedge against “down markets,” and deflation.

Both camps are wrong. It has been seen that gold goes up during periods of inflation, as well as during periods of deflation ... and vice versa. Therefore, it is not a question of inflation or deflation, but, rather, a question of market sentiment. That is the only constant that can explain why gold has gone up during periods of inflation and deflation, as well as down during periods of inflation and deflation, MarketWatch reported.

Along these lines, at a certain period of time, gold did not act as a “safe haven” during a deflationary event, while at another time, it did act as a supposed “safe haven” during such deflationary event. If such a period of time is found, then the deflationary camp will be wrong; if metals go down during a period of deflation, and the inflationary camp will be wrong if metals go up within the same period of deflation.

For, if one cannot rely on metals to act in a certain way during a specific economic event, then it is clear that one should not be investing in metals based upon these economic perspectives. Think about it. If gold goes down during a period in which one would need to rely upon it as a “safe haven,” and if it also goes up during a period of deflation, how can anyone in either the inflation or deflation camp be able to rely upon their respective perspectives?

 Period of Deflation

The 2007-2009 time frame was evidenced as the most recent period of deflation in the markets, since the Great Depression.

The S&P 500 topped in October of 2007 and began an estimated 300-point decline into March of 2008, and then it was seen a corrective bounce in the equities for a couple of months, before it continued to head down. During that same period of time, even while the markets were heading lower, the metals continued to rally strongly. Here there is “evidence” of precious metals supposedly rising during a period of deflation. So, here there is a strike against the inflationary camp, and a support for the deflationary camp.

But when one then looks toward the May 2008-March 2009 decline in the equity market, it is witnessed that the metals also experienced significant declines within that time period. In fact, gold lost a little more than 30%. But gold also found a bottom and began to rally four months before the equity markets. So, when one is presented with these facts, does it make sense that the metals are surely going to rise during periods of deflation? Are metals really the “safe haven” everyone believes they are during down markets?

So putting one’s personal biases toward precious metals, it can be  known that metals are not necessarily going to rise during periods of deflation. Oddly enough, metals can rally during periods of deflation, and they can fall during periods of deflation. The same applies to periods of inflation as well.

 Metals Not Driven by Inflation

Ultimately, one has to recognize that the metals are not driven by inflation nor are they driven by deflation. There have been clear periods of time in history where they have acted in the exact opposite manner in which each of the prominent camps would have believed. So, maybe there is another driver of metals which can be relied upon at all times?

Market sentiment is what can be relied upon at all times to point you in the correct direction for the precious metals. Tracking market sentiment is how one is able to call the top in gold in 2011, and also predict that its price would be cut in half. Furthermore, market sentiment also explains the seemingly contrary action in the metals during 2007-2009.

One other related comment is some have pointed out that it needs to be explained why a downtrend in Treasury would not result in a rise in gold, since a downtrend in Treasury portends inflationary pressure which “should” cause gold to rise.

In fact, a few years back, it was seen that the Treasury declined from mid-2012 until 2014, yet gold did not rally then. Rather, it followed the Treasury down. Even as the Treasury then began to rally during all of 2015, what did gold do? Well, it rallied for the first month, then it declined, and then it simply consolidated.