The Inflation/Deflation Debate At Financial Sense Newshour

The first holiday-rerun installment of the Financial Sense Newshour focused on the inflation/deflation debate. All the participants were able exponents of their views, and the entire podcast is well worth listening to if you have time. [Note: The link to the Daniel Amerman/'Mish' Shedlock debate on the main page isn't active; a copy of the .MP3 file for the debate is here.]

What struck me about the debate was that each side claimed that history was on theirs. The deflationists said that there has never been a popped-bubble economy that has not led to a wholesale destruction of credit. Moreover, no bubble-economy-popping credit crisis has not led to a long-term drop in credit. Lenders always become more reluctant to lend, and borrowers always become more reluctant to borrow. Both the supply of credit and the demand for credit shrivel over time. There is never a short-term pause followed by a resumption of the credit spree. The popping of the bubble economy is too shocking, and its scope too wide, for the old attitudes to remain intact. What was prudent becomes risky, and what was normal becomes foolhardy. Since the bulk of the money supply is credit in our fiat system, this turn of the debt-tide means deflation is built into the monetary system. The central bank cannot inflate by itself; it can only increase the bank-reserves monetary base. It need the co-operation of the banks and their borrowers to expand credit to turn the monetary base into real money. Bank reserves are not spendable currency: they have to be used as the base of newly-created credit to expand the money supply. [If you need to, see this Wikipedia primer on money creation through the fractional-reserve system.] If both lenders and borrowers are refractory because they've been badly burned, then bank-reserve expansion will not lead to money-supply increases. The central bank will be "pushing on a string." The deflationists argue that the ballooning of excess reserves in the Federal Reserve system is proof that string-pushing is upon us, and that the credit system is maimed to the point where it cannot be counted on to inflate the economy out of its current difficulties. The U.S. is stuck in the same hole that Japan has been in for the last twenty years. Japan has had mild deflation during some of that timeframe, even though Japan's currency is not gold-backed.

The inflationists contend that history is on their side too, because every fiat currency is eventually inflated away. Since there is no gold brake on a fiat currency, there is no counteractionary impediment to the government inflating at will. The only brake is the pain of inflation itself, which tends only to be felt during an all-out inflation crisis. This license holds true particularly when there's widespread economic pain with little inflation on the horizon. Then the government has a lot of incentive to inflate and almost no (immediate) disincentive to do so. There's only one exception to the rule of "fiat money = inflation," and that's the above-mentioned Japan. Even in Japan, the deflation was mild and only intermittent. Moreover, deflation only took root at all because Japan is a creditor nation. Inflation is bad for creditors, because it depreciates the dollars received when the loans come due. As a creditor nation, one where creditors' viewpoints tend to prevail, Japan went with (what essentially was) price stability. On the other hand, the United States is a debtor nation. There has never been a case where a debtor nation with a fiat currency permitted even the slightest burst of deflation, except by accident, and there has never been a serious deflation in any nation with a fiat currency.

Thus, the deflationists concludes that all the relevant lessons of history point to deflation as the U.S.' fate. The inflationists conclude the exact opposite.


Evidently, the web of history has its tangles. I can say that both sides' appeals to history are solid.

Believe it or not, this leaves a wide path open for the incurable optimist. All it takes is defining each position as an "extreme," noting that they're opposing extremes, and express faith in the great American principle of moderation. The leadership, well-intentioned if not always wise or alert, will deploy pragmatic skill to sail the Ship of State between the shoals of both extremes and get the American economy moving again once the dust settles. Just wait and see; it'll be A-OK in a few years. You betcha.

The trouble is, the Pollyannas have a point. When crises hit, we look to extremes because they make sense and aren't mealy-mouthed. Normal moderation looks like temporizing. In addition, when an unexpected disaster hits, at least some of the so-called "extremists" were the ones who foresaw it coming. Optimists are discredited. It's this brew that inclines us to believe that moderation is counter-productive, even obsolete. We have a need to believe that it's one way or the other, that the normal slack that makes moderation work is gone.

Crisis there was, but there's no evidence that a muddle-through option isn't possible. The muddle-through position, unlike the eternal-sunshine stance, does acknowledge that the economic wreckage will have long-term aftereffects. But, it also notes that the two "inevitable" forces of catastrophic deflation and economy-eroding inflation, at least apparently, cancel each other out. If the Federal Reserve is sufficiently skilled, it should be able to navigate the economy through the coming tough stretch without either catastrophes erupting. Because the money-and-credit system is hobbled, it won't be an easy task. The Fed is likely to cause more economic volatility, that being the main aftereffect of the credit collapse. Unemployment is likely to be high, and recovery tepid, because the economy is still bent out of shape. However, a sustained period of muddle-through, one where pragmatism rules and empiricism takes the place of theory, is likely to get the U.S. economy through without damaging it permanently. There will be more high-growth decades. This next one won't be one of them, but muddling through has the promise of making the one after next return to solid prosperity.


I presented the above case because it hasn't really been made, and it does provide a counter-balance to both inflationists and deflationists.

My own opinion in the matter - which is influenced by my own priorities; I do have money in a single gold stock - is somewhere between the inflationistas and the muddle-through'ers. As this Stockhouse columnist points out, we're in one of those times when the U.S. government can borrow at negative real interest rates. As long as the U.S. Treasury can, it can benefit from inflation. Note that real T-rates fell to negative despite foreign governments' large holding of U.S. Treasury securities. Those much-feared foreign holders have not provided much of a deterrent.

Nor have the much-fabled "bond vigilantes" of the '80s. That's because today's markets are very different from those of the '80s. Twenty-five years ago, many bond buyers still remembered the near-thirty-year bear market in bonds. The three-year rally, strong as it was, could have been (and sometimes was) called a sharp bear-market rally. Lots of people still believed that inflation had merely gone dormant, and was waiting to surge back up to double-digits. Inflationism died hard in the '80s - including amongst long-suffering bond investors. Naturally, they demanded an extra inflation premium and remained quick on the sell trigger. That's how the "bond market vigilantes" sent the message that inflation was counterproductive.

In addition, the stock market provided a lot more competition for capital back then. In a long-term bull market in stocks, why buy bonds unless they're going up too? Safety? Given a thirty-year bear market? Not unless there's an added risk premium! This competition for capital also helped push up the real return on Treasuries, and sent the U.S. government the message that inflation would hurt them too.

Today's markets are far, far removed from the markets where the bond vigilantes thrived. Instead of the looming shadow of a recently-ended bond bear market, there's the cheery backdrop of a twenty-eight-year bull market. Bonds have outperformed stocks this last decade, even though inflation did pop up before the credit crisis erupted. Stocks, on the other hand, have gone nowhere this last decade. The fears and uncertainties that made the bond vigilantes vigilant back then, are gone. Instead, there's largely complacency.

What if foreigners, disgusted with the U.S. dollar dropping, decide to unload Treasury paper? There's an already-discussed contingency that can be deployed in such an emergency: commandeering U.S. pension assets to replace those foreign holders. Forcing pension plans to invest some money in U.S. government paper can even be pushed as a for-your-own-good measure, given the recent stock market collapse. As long as foreign unloading hurts the stock market more than the bond market, the feds can for-you-own-good as much as they please.

More immediately, the feds can lean on the banks to get the credit machine rolling again. The string can be stiffened up. We're already beginning to see some talk towards this end from both Congress and the Obama Administration. Credit stinginess looks prudent when GDP's still dropping like a stone. When GDP turns up, especially if the up-turn's sustained, then stinginess looks obstinate. It could be argued that last quarter's 2.2% GDP growth was a mere blip. If the fourth quarter's number is positive as well, though, there'll be a lot less reason for credit shrinkage on the supply side. If deflation fades as last year's worry, the demand for credit will pick up too.

For the above reasons - most particularly, the re-emergence of an inflation seignorage in U.S. Treasuries, the fading of widespread deflation fears, and the complacency of the bond market - I think inflation's on the horizon. I'm not a full inflationist, because a serious bout of inflation will hit the U.S. Treasury hard once the bond market cottons on to it. The U.S. Treasury needs relatively low nominal rates, given its huge borrowings, because high rates would be a budget-buster. Going all-out down the inflation road will bring back those high rates. However, intermittent spurts of inflation can be explained as the aftereffects of the credit crisis. And the 1930s can be brought up again...

Gold closes above $1100 pre-holiday

It's not much of a Santa Claus gift, but it was one given gold's December debacle. After dipping down to about US$1,097 at about 8:45 AM ET, gold reversed course and drifted back up for the rest of the day. Going into the Christmas Day holiday, and ending the year's second-last trading week, spot gold closed at $1,105.20.


Speaking of holidays: I hope yours is full of cheer. Happy Christmas, Merry Holidays, whatever suits you. Thankfully, things aren't bureaucratized to the point where I'd have to wish everyone a "Happy Statutory Holiday."

And, thanks for reading this blog. I can assure you, it's appreciated.

A clever gold-bull argument

It's by Andrew Mickey of Q1 publishing. After noting that Citibank has claimed there's little link between the gold price and the inflation rate, he concedes that they're not far wrong. But, he comes up with a more closely correlative metric: real U.S. interest rates. Gold bull markets, or bull trends, flower when real rates are negative.

No wonder why he entitled his piece "'Real' reason it's still too early to bet against gold.'" Currently, real rates are negative.

A Quick Pre-Holiday Point

In the ordinary sense of the term, gold has intrinsic value...as a status good.


[This point made courtesy of "Captain Obvious."]

Minyanville's Przemyslaw Radomski Suggests Buying Opportunity

His case centers around technical indicators, but he opens his article with a hat-tip to the Rothschilds - specifically, to Bank Edmond de Rothschild. Its analysts think it likely that gold will go up this year.


Also related to the bull case is a Commodity Online article by David Lew, headlined "Can China beat US in gold reserves in 10 years?" The bulk of it is a fact sheet on China's gold industry.

An Undeterred Gold Bull

Gold analyst Jeff Nichols seems undeterred by the December drop, as this opener to a Mineweb piece makes clear:

Gold has enjoyed a long and enviable climb, rising some 380 percent from a cyclical low near $255 an ounce in April 2001 to an all-time high just over $1,225 early this month. Nevertheless, the bull market in gold has a long way to go - both in magnitude and direction.

Looking ahead to 2010, don't be surprised to see gold trade at $1,500 or higher sometime during the New Year. And that's not all: I've been telling clients that the yellow metal's price will continue its long-term upswing for at least a few more years, very likely reaching $2,000 an ounce . . . and possibly hitting $3,000 or more before the gold price cycle begins its next long-term cyclical "bear" phase.

One point that can be taken from his piece is the much-feared Fed rate hike may not be as bad for gold as has been assumed. In his words: "As long as the rise in U.S. inflation outpaces each incremental increase in nominal interest rates - so that real interest rates remain near zero or in negative territory - monetary policy will be too accommodative and impotent to stem the rising tide of inflation."

A Developing Feud

As reported in Commodity Online, gold bull Jim Rogers has taken umbrage at Nouriel Roubini's bearish assessment of the metal:

The differences of opinion on gold forecast by Jim Rogers and Nouriel Roubini are turning sharp and deep. Global commodities investor Rogers has once again lambasted Roubini for predicting that gold price is on a bubble that will burst soon.

“I am flabbergasted at Roubini’s comment about bubbles because there is not a single market in the world making all-time highs except gold, US Government Bonds, Cocoa, and the Sri Lankan stock market. That’s hardly reason to call for a bubble. So, I am most perplexed about this alleged bubble which is out there,” Rogers, who is now settled in Singapore and an aggressive investor in Chinese agri commodities market, told Wall Street Cheat Sheet....

If only gold were more like stocks! Other investment classes lend themselves well to emotion, but gold is unique when it comes to emotional attachment or aversion. Goldbugs insist that gold is money, even though it's hardly used for barter, and gold skeptics insist that gold has no intrinsic value, in defiance of every price chart for the metal. [In technical economics, it's axiomatic that no specific good has intrinsic value, as all values for specific goods are held to be subjective. That's not what the gold skeptics mean by "intrinsic," though.]

With stands so diametrically opposed, and with each position so at odds with the facts on the ground, it's no wonder why so many arguments flash up between the two sides. The only parallel in the stock market is with high-flying stocks that have sparse earnings records. Bashers of these stocks "hate money," "hate growth" and are "down on everything." Promoters of these stocks are "not living in the real world," "nut jobs" and "crooks."

One wrinkle: in the high-flying stock arena, the two sides often moralize at each other. In the gold arena, we see politicizing.


This blog isn't intended to be an investment-advice blog, in part because I'm not qualified to be an investment advisor. However, I can offer this para-investment advice based upon the above: one of the most difficult skills to master in gold investing is emotional control. It's a rare bird that can see gold as just another asset class, which moves to a somewhat unique drum. Gold produces no return, and is primarily used as either a luxury item or an investment tool; it lacks the ties to the regular economy that industrial commodities have. Even silver has those ties. Because of those two lacks, there are no everyday, non-controversial metrics that can be used to assess gold's value. The "valuation gap" tends to be filled by emotions.

Emotionality does tend to spill over into gold stocks, making for more volatility. Emotional control can pay off by selecting better entry and exit points, or accumulation points for steady buyers.

As far as gold-exploration stocks are concerned, there's an entirely different emotionality in play. Have you ever dreamed of being a merchant-adventurer? Gold exploration stocks hook in to that dream. Finding and building a mine is risky, particularly at the financing stage, which keeps gold-exploration stocks low. Except in the scarce instances when the property values are so compelling that the stock's pushed up near done-deal level, exploration stocks with viable properties are typically penny stocks. One of the earmarks of an all-out bubble is many exploration stocks selling at done-deal levels, with an associated faith that a good (validated) property is a "sure thing" because "the banks are killing each other to lend." Yep, one of the earmarks of a big bubble is seeing lenders as the holders of a money-cornucopia. Remember U.S. real estate in 2005?

That's when many people lose it, getting "stuck on cornucopia" when the bubble finally bursts. We can't reboot our brains.

From a trading (or even accumulating) standpoint, these emotionalities are costly and sometimes dangerous. Sadly, there seems to be no way to get around them except though being burned. Happily, though, it may not be necessary to be scorched by an all-out bubble-and-collapse to pick up the habit. The recent "mini-bubble" serves as an object lesson. ["Object lesion" for those with a sense of humor.]

Gold Climbs Above $1,110

The U.S. dollar's rally fizzled last night, which pushed gold up slightly to above US$1,110/oz. As I write this post, spot gold's hovering at $1,099.00. This Wall Street Journal report which ties the two together quotes some unnamed traders as saying, "the rise in commodities as a whole could be an end-of-year push amid holiday-thinned trade and that any renewed dollar strength at the start of 2010 could again cause some selling."

The attributed guess is still for a trading range:

The market will watch data out of the U.S. including weekly jobless claims and November durable goods orders later Thursday, said Afshin Nabavi, head of trading and physical sales at MKS Finance. He said the metal is likely to trade between support at $1,075/oz and resistance at $1,125 an ounce in the short term.

This particular range is slightly higher than the ones mentioned in the last few days. However, sentiment is still beaten down right now.

A more optimistic analyst is quoted in this Globe and Mail report:

“Gold's rising because of a weaker dollar,” said Daniel Smith, analyst at Standard Chartered. “But also the recent selloff was a bit overdone as a lot of the factors that supported gold are still in place,” he said....

“Investor flows have held up pretty well. Physical demand in places like India has been strong and I think that's going to be supportive of the prices,” Mr. Smith said, adding he expected a volatile trade due to holiday-thinned liquidity.

Also in the Globe is a tabulation of the twenty-seven worst performing stocks in the Toronto Stock Exchange / Standard & Poor's Composite Index of 300 stocks. Three of them are gold stocks: Agnico-Eagle, Kinross Gold and and Barrick Gold. Given gold's rise this year, the stocks don't seem to have done all that well. The financial crisis was to blame, of course.

Interestingly, there were several integrated oil, upstream oil-and-gas, and related-energy stocks on the list. Crude oil's also done quite well this past year - better than gold, actually.

So, it wasn't just gold stocks that were banged down stay-down hard by the financial crisis. Oil stocks have been too, and have been reluctant to rally even though the resource plummet is long over. Believe it or not, the oil-pipeline stocks have done better than the oil stocks is the past few months. Even the electric utilities have done better in recent weeks.

Gold Best In Class For This Decade

That's according to a person who seems immune to gold's charms. As the chart in the post shows, "Gold Outshines All Other Assets For Past Decade."


What's interesting about that chart is the fact that gold would not have been the best-performing asset class had the financial crisis not erupted. As of early 2008, both crude oil and the commodities index solidly outperformed the metal.

Gold Torched Over At The Business Insider

The post itself is neutral, dealing with the drop below US$1,100, but it serves as the backdrop for some gold skeptics to pick on the goldbugs. I haven't been reading the BI's gold posts long enough to get a solid sense of what's normal in the comments section, but it seems that the gold-bashers are getting bolder. Contrarians may be interested in this datum.

A piece by Kishori Krishnan, webbed at Gold Investing News, is actually pessimistic in tone. The goldbug case rates only a passing mention.


Here's a gold-bull post that's laced with a conspiracy theory popular in the gold world: the gold bull market is deliberately hobbled by active suppression of its price. Ironically, this fellow's on the right side of the contrarian wind by saying it's an "Excellent Opportunity To Buy Gold."

In the gold world, conspiracy theories often serve as a faith-substitute. A cynical lot, goldbugs can't resort to the usual mantras found in the regular stock market. They can't urge themselves and others to stay the course by saying "it's undervalued," "stocks always go up," "don't bet against Uncle Sam," etc. They can't even come up with their own boosterisms because, by their own admission, gold can be nothing more than a savings device or a speculation. And, of course, their entire case is built upon the assumption that the U.S. economy is headed for a gigantic reckoning due to the distortive effects of government (primarily monetary) intervention.

So how can they come up with a slogan to match, say, "you can never go wrong, long term, by buying a stake in U.S. productivity"? You can never go wrong, long-term, by betting on governmental stupidity? It's too oppositional - the kind of stance that provides a fertile soil for, yes, conspiracy theories. After all, stupid people should be easy to play off against...

Gold Takes A Breather

After making a new near-term low late yesterday morning, gold's been in a trading range. Spot gold's meandered between US$1,080 and $1,090 in that time period, and is currently at $1,085.40. This Marketwatch report ascribes yesterday's plummet to good economic data from the U.S.

A Wall Street Journal report quotes a gold skeptic:

"It's quite possible we have seen the peak in gold," said Erik Davidson, Wells Fargo Private Bank's managing director of investments in the western U.S. "In 2010, I think things will go back to normal, i.e. a growing economy, and normal takes a bit of fear away from gold."

Mr. Davidson says he thinks gold will trade between $800 an ounce and $1,200 an ounce for the "foreseeable future."

There's a balancing quote from a gold bull, who's cautious right now.


Speaking of caution, Mark Hulbert's latest column points to growing pessimism amongst gold advisors. His Hulbert Gold Newsletter Sentiment Index, a measure of optimism contained in short-term gold timer advisory services, has plummeted from +53.8% to +10.9%. Although not indicative of a bottom as of yet - typical bottom ranges are negative - it's veering in on one, from a contrarian standpoint. No wonder the column's entitled "Building a wall of worry: Sentiment picture for gold is rapidly improving."

Gold Drop Makes Yahoo! Finance/CNN Money

Courtesy of this article, "The gold 'bubble' takes a bow to the dollar." I note the inverted commas around the word "bubble."

From it:

"There are a lot of people throwing in the towel as gold moved below $1,100 for the second day running," said Adam Klopfenstein, senior market strategist at commodities brokerage firm Lind-Waldock. "I do think the bull case for gold is going to be on hold for the rest of the year."

Also quoted in the article is senior Kitco analyst Jon Nadler, who says that investors got carried away by a lot of hype - some ridiculous in retrospect. What's interesting about these two is that Klopfenstein is a longer-term gold bull, and Nadler's employed by a big gold seller/information depot.


Some things have to be learned the hard way. Unfortunately, the investment markets have a definite tendency to make fools of us all. That's why so much investment education comes courtesy of the school of hard knocks. The markets are so confounding, it often takes recovering from a spell of foolishness to even understand many oft-quoted market lessons.

I've found that understanding is helped by realizing that many investment consensuses, the kind that fall apart, are plausible; many are logical. The thorn on the rose is on the blind side. Consequently, many consensuses are blindsided by what an honest and reasonably well-informed observer would consider an extraneous or irrelevant factor. ["A real-estate decline? Won't matter, because declines in one region have been made up for by gains in another." "A general real-estate decline? Not possible unless there's another Great Depression. That's the last time we ever saw one of those."]

Consensuses can be negative as well as positive. Remember how many people thought that the United States would become like Japan? Now, a recovery is in the offing. It's been tepid so far, and largely goosed by government action right now, but the U.S. is still the U.S.; it's not Japan. I think one of the reasons why so many people are cynical about the recovery is because they remember the Bush stimulus, and what followed it. I was one of the people who thought that the Bush stimulus marked the end of a slowdown, rather than a prelude to a vicious recession. That fake-out made a lot of people wonder how fragile the U.S. economy really was. However, the U.S.-as-Japan case was always based upon "this time, it's different." Just because that slogan was used pessimistically instead of optimistically this time, doesn't change its nature.

The same consideration applies to the hype - negative hype, of course, but still hype - about the U.S. dollar. Greenback bears have been fairly logical in their case, and still are. The exploding U.S. deficit isn't going away anytime soon, and foreign buyers of U.S. Treasury securities are beginning to show reluctance. However, there are no signs of serious U.S. inflation as yet. And, as we now know, the greenback is far from being dethroned as a safe-haven asset class. The problems that the U.S. dollar bears point to haven't really kicked in as of yet; they're largely potentialities as of now.


Now that I'm finished sounding off, I'd like to make this point: more gold bulls are folding their hands near-term. Contrarians may be interested.


An afterthought: One possibility that the deflationistas haven't considered is tepid growth while debts are whittled down. Case in point: the 1950s. [Graph here.] That decade saw two recessions and a growth rate that was much lower than that of the '60s, '80s and '90s - even lower than the '00's. The two recessions in that decade were relatively mild, but the overall slowness in growth was an issue in the 1960 election.

Granted that the 1950s didn't have a huge debt bubble, but it did have high marginal tax rates combined with a restrictive fiscal policy and a not-very-expansionary monetary policy. I think that this outcome may be the one that government planners are counting on, where a restricted consumption budget combined with loose fiscal policy is a rough stand-in for moderately expansionary private spending combined with rectitudinous government spending.

Of course, an alternate scenario is the slow-growth 1970s. The chief difference between the 1970s and now is that the U.S. government found it much easier to export inflation back then. On the other hand, it's a lot easier to sell Treasury securities now - even with the deficit as huge as it is.

I'm not a conspiracy-minded fellow, but one possibility to consider is that the U.S. government has an interest in the U.S.-as-Japan trope propagating. If the U.S. is widely believed to be in for a "Lost Decade," then the bond-market vigilantes will nod off and become torpid. Any resurgence of inflation is likely to be greeted as aberrational, buying the U.S. Treasury some time when it can borrow at low (or even negative) real rates.

The capacity-utilization argument already serves in that capacity. "If capacity utilization [currently 60%, well below this decade's norm of about 80%] is so low, how can there be any sustained inflation? A blip, nothing more. You'll see."

If inflation ramps up in the face of sub-normal capacity-utilization rates, we're looking at stagflation - the kind that can fool the credit markets. It may be a homely truism, but inflation policy always seeks to turn the creditor into the patsy. There are times when creditors do act like suckers; at such times, inflationary policies are pursued.


There's another way to kick the can: covertly encourage the banks to shift more of their assets into U.S. Treasury securities. Not only does it keep demand for U.S. Treasuries higher, making the rate the government borrows at lower, but also it short-circuits the usual expansion of the monetary base. When banks loan to the general public, they create new balances that add to the money supply. That's what happens when a loan is approved: the borrower's account is credited with the funds once the loan is agreed to. As long as the bank in question has more reserves than required, the bank need not deploy already-existing funds into the credit. The new loan (a new asset) balances the credited funds (a new liability) in the bank's books.

When banks lend to the government, on the other hand, they buy securities with already-existing funds; no new balances are created. Thus, lending to the feds doesn't push up the money supply - unlike lending to the public. This charmed circle keeps both real and nominal rates low, preventing U.S. Tresury debt-servicing needs from crushing the fisc.

Under this scenario, unlike the previous one, gold won't fare all that well. That's because this approach will turn the U.S. economy into Japan's! Makes for a neat self-fulfilling prophecy...

Seeking Alpha Article Recommends Getting Your Guard Up

Using a slick ad that's in the CNBC loop, Jeff Miller points out that some ads are too optimistic to be believed - and some heavily-advertised gold plans have commission and transaction costs that are pretty steep. His article's titled, perhaps incongruously, "The Gold Debate: Here's Why You Should Be Wary." He goes out of his way to show that he's not down on gold, which seems to explain his title.

Hope's Still Springing

As reported in the Financial Post Trading Desk section, another bullish forecast for gold has been issued - this one, by J.P. Morgan. Analyst John Bridges has set a target of US$1400-1450/oz for gold to be reached in the second quarter of next year. After that point, gold should decline. Bridges has built his target on the assumption of further U.S. dollar weakness, which hasn't been that much in evidence lately. He also assumes that gold demand will remain strong, that the market will become increasingly discomfited by the Fed's ultralow interest rate policy, and that the greenback will reverse its recent uptrend and hit new record lows. I note that his target date is consistent with the Fed raising rates in the middle of 2010, which the overall market seems to expect also.


I'm not an investment professional, but I suggest that forecasts of this sort be treated with a little caution. As a trend-watcher, the extent of the greenback's rise surprised me. There have been so many reasons for the U.S. dollar to sink, and so few indicating a rise, that I was expecting little more than a blip. The same expectation may be going through the minds of the professionals.

Moreover, investment targets are not often met - particularly when they seem outrageous when they were first made. Gold at $1200 was one of those targets. There seems to be a suspension of disbelief as a result of that met target, which is encouraging more bullishness at a time when it may not be appropriate.

As far as the U.S. dollar is concerned, its hidden strength suggests that the bear case has something missing right now. My own guess in the matter is the greenback carry trade being unwound as it becomes apparent that the U.S. economy will not track Japan's of eighteen years ago.

Royal Canadian Mint Gets Swamped

A recurring scandal involving the Royal Canadian Mint, purveyor of the popular Maple Leaf bullion coin, has now been resolved. As webbed by Joe Wiesenthal of the Business Insider, an audit squad has finally tracked down what happened to about $20 million' worth of gold. Some of it was miscounted, but about $6 million of it was sold as slag to refiners. The Mint blames the explosion in demand for Maple Leafs in 2008 for the mistake.


I have to say that this kind of mistake is, by my lights, all-Canadian. We Canadians respect burden-bearers, and our vanities encourage us to think we can bite off more than we can chew when crunch time comes. Although I have no inside info, I'm sure that's what happened at the RC Mint.

This Toronto Star article goes into further detail, and includes Parliamentary reaction to the report.

Gold Continues Its Slide

The price of gold has now reached a six-week low; as I write this post, spot gold's at US$1,092.50 after dipping to just over $1,085 at 8 AM ET. That new, lower trading range talked about in the press is becoming a reality. The two-month tear that began in Halloween is about 80% reversed.

Needless to say, the U.S. dollar index has risen. And, I need say, U.S. stock futures have risen too. As one day turns into another, a negative correlation between gold and U.S. stocks becomes more firmly established.

This U.S. dollar chart shows the greenback is higher than it was as of the end of October:



and shows what appears to be a solid trend reversal. It looks like the oft-mentioned carry trade is reversing, as the U.S. economy recovers and the U.S. dollar shows it's not obsolete as a safe-haven destination. Gold isn't widely seen as the ultimate safe haven, at least as of yet.

A Wall Street Journal report ascribes gold's latest reversal to strength in the greenback, and quotes another expert as saying that gold could trade between $1050 and $1080 as the end of the year approaches. Still, according to the report, the SPDR Gold Trust's gold holdings increased Monday. There's evidently buying in the face of the recent weakness.


Gold's had quite a drop recently, and yet I've encountered little comment about the gold bubble bursting. The people who claimed that gold's been in a bubble should be crowing over the decline, or saying the recent slump is evidence that they were right about the frothiness. Gold's decline over the last three weeks has been steep, but it's also been orderly. For precedent-hunters, I point to the decline from about $730 to about $590 in 2006, from late April to early June. The gold price dropped about 25% in that interim, and stayed in a $600-$700 trading range for the next fourteen months. [The present decline's been about 12% as of now.] Only a resurgence in U.S. inflation got the bull marker resuming in August '07-March '08.

We could have seen a mini-bubble in gold, or froth in the midst of an underlying bullish trend.

Gold Mine In U.S. National-Security Incident

As reported by Kishori Krishnan at Gold Investing News, the sale of 51% of Firstgold to the PRC's Northwest Nonferrous International Investment Company has been blocked by the U.S. government on national-security grounds. The story compares the takeover to the blocked "acquisition by Dubai Ports World of Peninsular and Oriental Steam Navigation Company’s US ports management business."


The mine isn't that near the U.S. naval base that's the object of the block. The U.S. government doing so could be seen as sending the PRC a message.


Update: Northwest Nonferrous has now withdrawn its offer.

Another Morning Spill, Followed By An Afternoon Plummet

And, another hole poked in the supposed positive correlation between gold and U.S. stocks. As I write this updated post, the three major averages are up about 1-1.1% each. Spot gold, after taking a spill from about $1,117 to $1104.20 in mid-morning, collapsed to about $1,090 just before 1 PM. The U.S. Dollar Index partially explains the drop [live chart here], but not all of it. The index was higher in the early morning, when gold was still above $1,110.


Historically and traditionally, gold was negatively correlated with U.S. stocks. As for today, there's rationale for negativity. Not only does a rise in stocks foreshadow a rise in U.S. interest rates, but also a rising stock market induces foreign demand for U.S. stocks and (indirectly) U.S. dollars with which to buy them. We may see the eclipse of the positive-correlation.

Cautious Bulls

Over at Minyanville, gold bull Przemyslaw Radomski has written an analysis of gold whose conclusion is becoming more common amongst his fellow bulls: the long-term trend is intact, but the near-term deline has a ways to go. His case, based on technical analysis, hinges upon a near-term bearish reading of the U.S. stock market and the oft-noted positive correlation between gold and U.S. stocks. The first part of his article reviews the state of the gold market at the beginning of the current bull.


There's a certain wryness for me in the comparison of the U.S. stock market to gold. Traditionally, that relationship has held true for the Canadian stock indices...because there's more than a few gold stocks listed on Canadian exchanges. The correlation vis-a-vis the U.S. averages is, of course, more abstract in the mechanics.


Another analysis, from Andrew Butler at Seeking Alpha, looks at the oil/gold correlation and why it's gone out of whack in the last couple of years. He attributes oil getting ahead of gold last year to a now-popped bubble in the former, and gold getting ahead of oil because of ETF buying.


Thankfully for gold bulls, ETF demand looks solid as of now. However, ETF selling could add a lot of downward pressure on the price if a plummet convinces some big holders that the bull run is over.

Quant Weighs In On Gold,

and doesn't much like the odds in place now. The benchmark used by Dundee Securities strategist Martin Roberge is growth in the U.S. M2 money supply; that growth rate is shrinking. So, despite the 'til-recent plummet in the U.S. dollar, the odds of gold going up are low right now.



It's interesting that he uses M2. Back in the 1970s, monetarists used M2 as a forecaster for economic growth. For consumer prices, M1 was used. The graph of the M1 money supply gives a different picture. Here's a graph, from the St. Louis Fed, showing the % changes from a year ago of M2 and M1:








Both measures were actually discredited in the 1980s and '90s because the inflation rates no longer tracked either. The demand for money shifted.

[Note: The M2 graph begins at 1980. The M1 graph begins at 1975.]

Quiet So Far

After dipping to a five-week low last Friday, gold recovered somewhat to make it above the bottom of the previously-oft-mentioned US$1,110-$1,140 trading range. Early this morning, spot gold hovered between $1,110 and $1,115. As of the time of this post, spot gold's at $1,115.50

This Wall Street Journal article says that trading is light, and quotes an analyst proffering a new, lower trading range:

"We would look for speculative and investment bargain hunting buying to provide further support in the coming sessions, although with the stronger dollar still the primary driving force, the metal remains at risk to a dip back to the $1,050 a troy ounce to $1,080-per-ounce area," said James Moore, an analyst at TheBullionDesk.com.

Commerzbanks' predicting that gold will end the year at $1,050/oz.

Interestingly, the rest of the article reports that both the net speculative long open interest and SPDR Gold ETF holdings both increased on Friday. The former is attributed to short covering.

Year's End Take From The Financial Sense Newshour

This weekend's Financial Sense Newshour show is the last new podcast of the year. The others in the next two weeks will be re-runs. The hosts have adopted a four-stage model for the gold bull market which John Hathaway of the Tocqueville Gold Fund came up with (on Scribd doc, p. 2). The first stage is the "beginning," which starts off slowly and eliminates an investment's undervaluation. The second is the "end of the beginning," which features "noisy and dynamic behavior." Mr. Hathaway believes the second stage ended when gold reached US$1,000/oz. The third stage, which we're in now, is the "beginning of the end," when frothiness enters the market. The fourth and final stage is "the end," or the final blowoff.

In this model, a bubble is reached in the fourth stage and incubates in the third. Hathaway is on record as expecting irrational exuberence to enter the gold market:

Hathaway believes cultural lag is the key to understanding why gold, "ridiculously undervalued for an extended period, could be on its way to becoming an investment bubble, perhaps several years from now."

"In our view, public expectations are about to pivot in a way that will ultimately take gold to valuation that cannot be explained by dispassionate and reasoned discourse," he predicted. "Irrational exuberance lies ahead for gold."

However, he believes that gold isn't in a bubble right now: "'Gold is a bubble only for those who maintain faith in the politicians and financial authorities to swim against the tide of deflation. For the rest of us, it is protection against monetary damage still to come.'"