Monday, June 21, 2010

Gold: Less Inflation Hedge Than Crisis Hedge

That's the diagnosis of Ambrose Evans-Pritchard, who says "Gold reflects fears." Surveying the Euro landscape, Evans-Pritchard points to the risk of a deflationary spiral and consequent populiast politics bubbling up.
It is not inflation as such that is worrying big investors, though inflation may ultimately be the response before this is all over. The core consumer price index in the US has fallen to its lowest level since the mid-1960s.

If there is any theme to the bullion rush, it is the fear that the global currency system is unravelling. Unlike the gold spike of the late 1970s, this rally has echoes of the 1930s. It is a harbinger of deflation stress.

Capital Economics calculates that the M3 money supply (M3 is the broadest measure) in the US has been contracting over the past three months at an annualised rate of 7.6 per cent. The yield on two-year US Treasury notes is 0.71 per cent.

This is an economy in the grip of debt destruction. Albert Edwards, of Societe Generale, says the Atlantic region is one accident away from outright deflation. That accident may be coming. The Economic Cycle Research Institute's leading indicator for the US economy has fallen at the most precipitous rate for half a century, dropping to a 45-week low, now reading minus 5.70, the level it reached in late 2007 just as Wall Street began to roll over and then crash.
He also notes that Fitch said the total Eurobond purchases needed to right the monetary system is hundreds of billions of Euros' worth. The Bundesbank president has already said that the first purchases, in a much smaller amount, is potentially destabilizing.

It's an open question whether gold is discounting future inflation or responding to fears. Would gold rise in a deflationary crisis? The experience of '08 says "no," so it looks as if the metal is discounting future (or hoped-for) inflation.

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