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Since the pressure of deflation results in a much stronger dollar, expectations for higher gold prices are illogical and ill-advised. [Let me explain further.]
…The expectation among participants in the gold trade today is for much higher gold prices going forward and…and quickly, too…[based] on two assumptions:
- That the new unlimited amounts of cheap credit made available by the Federal Reserve is hugely inflationary and
- that the effects of the inflationary avalanche will destroy the US dollar, thus resulting in higher gold prices.
On the surface, both statements are logical and rooted in correct fundamentals but there is a fly in the ointment (meaning that there is something wrong hidden, unexpected somewhere) and in this case the fly in the ointment is deflation.
Coming Deflation Means Lower Gold Prices
Deflation is the exact opposite of inflation. It is characterized by an increase in purchasing power of the currency involved, in this case, the U.S. dollar. The result is that the USD would actually buy more, not less although the supply of USDs would be significantly less…[so] if you are betting on higher gold prices, a stronger USD could also be considered as the fly in the ointment.
There are a couple of reasons why deflation, a stronger USD and lower gold price, and a full-scale depression are possible; maybe even likely.
1. The Fed’s intentional inflation is having less and less impact. Federal debt as a percentage of GDP was declining in the sixties and seventies and reached a seemingly moderate level of about 30% in 1980. Since that time it has doubled and then doubled again. See the chart below.
(Chart of historical data comparing the level of gross domestic product -GDP – with Federal Debt.)
Think of how much money and credit was created in response to the credit crisis of 2007-08 and how laborious and inefficient was the attempt at economic recovery.
- how concerned the Fed was that they were not hitting their 2% inflation target?…and
- the expectations for…
- much higher prices for all goods and services,
- and possibly runaway inflation.
Both of the above examples might be compared to a drug addict who, after years of substance abuse, and continually higher doses with the drug of choice, shows no signs of response from the latest fix…It is quite possible that the current efforts of the Fed will be greeted similarly, or worse. In other words, maybe no amount of help from the Fed will be enough to turn things around.
2. The ensuing price – and credit – collapse could very possibly overwhelm the efforts of the Federal Reserve. With prices of all assets lower by 60% or more, the relative strength in the USD will show up in a much lower gold price…
Some will argue that all of this is temporary; and that the USD, whatever strength it might currently enjoy, is doomed. After all, the amount of inflation that has already been created by the Fed appears to be such that the dollar could soon be better used as wallpaper.
- The USD has already lost more than 98% of is value over the past century; and we owe it all to the stellar efforts of the Federal Reserve who continually attempt to “manage the stages of the economic cycle”. Actually, all they do now is react to the problems associated with the mess they have created.
- Over time, the effects of inflation created by the Fed show up in a USD that continues to lose value and the price of gold reflects this by moving higher over time so, it seems realistic to assume that an overdose of new money and credit could kill the USD for good and send gold prices higher…That is shown on the chart immediately below…
[That may be so,] but…there are some variables that gold bulls have overlooked…
- Some assume that weaker economic activity, even recessions or depressions, will translate into higher gold prices. They watch the headlines and reports about housing starts, unemployment, etc. expecting to see higher gold prices as a result of disappointing economic statistics [but] those things have nothing at all to do with gold prices. NOTHING you can think of will change the price of gold in USD except changes in the USD.
- Some say that even if the USD doesn’t totally collapse, we will still see much higher gold prices…basing their expectations on non-fundamentals such as the ongoing pandemic, slowdowns (or stoppages) in economic activity, social unrest, wars, interest rates, political upheaval, etc.
The Price Of Gold Is All About the USD
Here is the same chart (source for all charts) as above, except that the one-hundred year history of gold prices is adjusted for inflation. It illustrates clearly the link between the USD and the price of gold:
The major price points on the chart correspond with the years 1920, 1934, 1970, 1980, 2001, 2011. They also coincide with changes in value of and sentiment for the USD.
- Throughout the 1930’s and up until 1970, the actual purchasing power of the USD was stronger, resulting in a lower inflation-adjusted gold price.
- Then, a huge catch up phase from 1970 until 1980, re: the effects of several decades of government inflation, took the USD lower and gold prices higher.
- The pattern continued, with lower gold prices and a stronger USD between 1980 and 2000. From 2001 until 2011, a weaker USD resulted in higher gold prices.
- Since 2011, the USD has continued to strengthen and gold has declined. The current retracement in gold prices for the past four years may be likened to the period leading up to its price collapse in early 1988.
Since the pressure of deflation results in a much stronger dollar, expectations for higher gold prices are illogical and ill-advised.