Gyroscopic Investing

I recently heard the statment that "gold rises more in inflation and falls less in deflation."

I get the inflation part, but am not sure about the "falling less in deflation" part. 

Does anyone have an opinion? 

I think simplifying our situations into terms of "inflation" vs "deflation" is false precision, especially in terms of what gold is going to do.

I think the easiest rule to follow would be that gold rises when real interest rates are negative, and falls when real interest rates are positive... by "real," I mean as tracked/estimated by CPI.

If people can envision REAL gains by owning short-term bonds for a year, they'll be much less likely to buy gold in frustration, even if inflation is 6% and those rates are 10%.

I previously wrote a post about my thoughts on this topic, I hope you find it somewhat relevant.

"A key symptom of deflation is a flight to currency over risk assets; the exchange value swings in currency’s favor. In a deflation, currency is king because it allows you to sit on the sidelines and scoop up assets and commodities as prices drift (or plummet) lower and lower.

When comparing the price movements of gold to a basket of other commodities, it is very clear that gold is different because gold has unique price movements that do not correlate with the rest of the commodity universe. This low correlation exists because gold trades as an alternative currency. Even though it is not twintopt in any modern economy, wealthy individuals (and governments) still trade it as if it were a currency.

So, when gold and Treasuries are both going up, you are not witnessing a market contradiction but a flight to the broad asset class of currencies. Within this broad asset class, investors have choices and sometimes they prefer gold over Treasuries or vice versa.

It’s pretty simple to understand when viewed from a perspective of relative exchange value. The confusion arises because we are conditioned to always view exchange values in dollars. In reality, exchange values can be expressed in an infinite number of ways and one way of expressing exchange value is no more correct than others. When investors stampede into gold and dollars simultaneously, we see big movements in the price of gold measured in dollars because the market for gold is much smaller than the market for dollars. It is entirely plausible for investors to want both, but we see relatively higher prices (in dollars) for gold.

This argument does not dismiss gold’s use for inflation protection. Significant inflation normally manifests itself in fiat currencies (unless we have massive gold discoveries). Therefore, in an inflationary environment people value the relatively fixed currency of gold more than the expanding fiat currency experiencing the inflation. In this situation, the shift is happening within the currency universe.

In summary, inflation expectations are a sufficient but not necessary condition for gold to rise. In fact, gold can still perform very well relative to risk assets during a deflation as investors stampede into currencies. "

I tend to agree with meveyr.  That was my basic point when I posted the following back in August on another thread about reconciling HB's thoughts on gold and inflation/deflation:


I seem to recall in one of his radio shows (when discussing the 1930s) and in a few of his newsletters over the years he raised the possibility of gold as a form of money doing well under deflationary conditions.  He just didn't believe we could reliabily count on it to perform well like we could under highly inflationary conditions.

Gold did perform well in the early 1930s (for people outside the U.S.) after President Roosevelt arbitrarily raised the price in 1933 by nearly 70% from $20.67 to $35.00 after outlawing domestic ownership.  Having the U.S. government guarantee a price and a market while production costs remained relatively low was also quite a benefit to gold miners during the 1930s.  I think Newmont Mining was one of the best performing stocks in the U.S. during the 1930s.  I doubt that things will unfold exactly this way again, but it does show a complex relationship between gold and deflationary conditions.

Why is it performing so well now?  Obviously we can't understand the motives of everyone involved in the market, but it may simply be that many people around the world see the governments and central banks of the major countries increasingly painting themselves into a corner as they create more promises and liabilities (some of which gets monetized) to prevent their economies from crashing.  While this credit and monetary expansion (which can be traced back at least to Greenspan's reaction to the dot.com crash -- but probably much farther back) has not created generalized price inflation like we saw in the 1970s, it has undoubtedly distorted relative prices in the world economy and created booms and busts in real estate, stocks and bonds (especially derivatives) and food prices in various places and times in recent years. 

That under these circumstances investors would "rediscover" and bid up the paper currency price of what has historically been the ultimate form of non-liability money isn't surprising.  HB talked often of the desire to "hold money" during times of uncertainty.  While the dollar's lead over gold as the most popular form of money seems to be shortening, this overall response to uncertainty seems to be bolstering both right now.  How long can this go on?  Probably longer than we think, but who knows?       

Thanks for the great replies.

Here's an interesting opinion, from Chris Martenson, about the performance of Gold during an economic decline:

http://www.chrismartenson.com/blog/gold ... line/63730

this topic is raised from around 19 minutes http://mcalvanyweeklycommentary.com/#po ... yerSpace_1

Something about gold and deflation:

http://jessescrossroadscafe.blogspot.co ... ll-in.html

"So, the frustrated investor says, when will gold finally start topping?
Gold have topped when the smart money is convinced that the real economy is becoming naturally sustainable, robustly organic in its credit creation and allocation, and healthy in the growth of the median wage to support consumption, without subsidy or interference or new unpayable debt from the Federal Reserve, or the draconian 'taxes' from an outsized financial sector that stifles real growth."