Gold to TUMBLE back to US$35 per ounce, page-2

  1. 1,816 Posts.

    I have been posting my thoughts about the high probability of a deflationary depression in the USA since early 2001.

    I seems parts of the mainstream media, and some sections of the public have also started adopting this theory in recent months.

    I have been bullish on gold since mid/late 2002 because:

    1. It made a double bottom at the $250 level
    2. Was forming a nice uptrend
    3. Historically has had a very strong inverse correlation with the returns from equities.

    I am still bullish on gold because of the above reasons, however, i have also come to realise that if the USA (and thus the world, ex China and India) were to enter a deflationary spiral, gold may outperform other assets in real terms, however, it will underperform cash in nominal terms.

    A massive contradiction to this argument is that for there to be widespread deflation, and a severe contraction in the economy, there'd have to be an accompanying collpase of confidence in the banking system, and the lack of sufficient capital for some banks to cover the loses from loan defaults....

    ... lack of confidence in the banking system, directly leads to increased risk aversion from deposit holders, and thus aversion to holding cash in the form of interest bearing deposits.

    (This is what has happened over the last twelve months in Japan, where the government has stopped gauranteeing deposits of >75000 USD... which lead to a significant increase of individuals withdrawing thier deposits, and placing it under the bed).

    The only alternative store of value in such a situation is to hold an asset that is not leveraged... aka gold.

    So we have very convincing arguments for, and against the case for an appreciation in the price of gold over the next decade.

    Some (Many, infact, the majority) of individuals would argue that the chances of the USA entering a deflationary spiral are so negligible, that it's not worth discussing to any great length.

    I disagree.

    I think the chances of the USA entering a deflationary spiral are greater now than they have been for any time since the 1930's.

    What we've witnessed in the USA over the last 24 months is a massive boost in liquidity. The Fed funds rate has fallen from over 6% to 1.75%. An unprecedented rate of fall in recent history.

    In spite of this MASSIVE boost in liquidity, we've witnessed negligible inflationary pressures, and negligible growth in the real economy.

    Consumer spending has held on strongly (aided by homeowners borrowing at record low rates against the increased equity in their own homes), and as mentioned, a massive increase in the value of home value accross the States.

    Now, if we were to take increases/decreases in home prices, interest rates, the federal budget, and consumer spending all as variables that effect growth and inflationary expectations in the economy, and realise that the current trends in each of these variables have been in effect for the last 24 months, and have interacted to lead to growth and inflation in the States in this time, we's see that:

    1. All the above variable are at their limits ie. home price growth, the federal budget, and consumer spending are at their upper limits (ie. further upside from here is likely to very beign)... whilst interest rates are fast approaching the physical floor of 0%.

    2. A change in any of the above variable in the medium term are likely to be of a negative nature. ie. a cooling of in the homes market, a decline in consumer spending, etc.

    The fact remains that all the important variables (expt. equity market) are at their maximum stimulatory limits (they can't move any further), and this mass stimulus is reflected in the current lack lustre economic growth and inflationary pressures.

    What happens when the above stumulatory variable revert to the mean, or heavens forbid, actually correct to levels that have a contractory impact on the economy?

    What happens when an edverse move in these variables
    are mixed with the highest level of aggregate debt the USA has experienced over the last 100 years?

    We're already experiencing talk about some major USA banks not having adequate capital to cover loses from recent corporate loses (Enron, Worldcom, and the like).
    .. and this in an environment where stimuli accross the economy are close their maximum.

    See the risks?

    They're very high and real.

    An economy built on debt is not sustainable- it's a type of pyramid scheme, where the individual holding the leveraged assets at the top cops a massive belting.

    I'm very sure that we're at the top now.

    The implications for gold?

    I'm cautiously bullish... yet am willing to accept that under the unique deflationary circumstances we're entering, a fall in NOMINAL terms is a distinct possibility.

    This is contradictory to my earlier overtly bullish stance on gold, however, i have re-evaluated my thoughts on this matter and the implications for gold in a deflationary environment, and have not come to a convincing opinion on the direction of the yellow metal.

    Have i changed my tune on gold? YES.

    Cautiously awaiting further developments...
arrow-down-2 Created with Sketch. arrow-down-2 Created with Sketch.