Whether Inflation or Deflation?

January 6, 2009 Inflation, Physical Gold, Predictions No Comments

Good morning all! This morning I want to go around the Internet and test the waters on the subject of where we are headed. Is it inflation or deflation? Those of you that have read my posts know that I fall on the side of inflation, but this post is not about me, it’s about what the perception are that are out there on this subject.

There are many opinions from people with far greater credentials than I have, so let’s take a quick look at the market action and test the waters! The DOW is up 19.28 at 8972 (it seems to be having trouble stay above 9,000), the NAS is up 9.25 at 1,637 while gold struggles, down $12.70 at $845.60.

I ran across a cartoon this morning that kind of sums up who the “bad” guys are.

madoff cartoon Whether Inflation or Deflation?

Kind Of Puts Things In Perspective!

A picture certainly is worth a thousand words in this case. Judging by the media buzz about this scandal, I am sure that many millions of words will be written that will not come anywhere near as close to the truth as what emanates from this one cartoon.

Ok, now that we have started off on a light note let’s get into this deflation/inflation topic. In the interest of fairness we will start out with the deflationary side. Jay Taylor wrote this in his piece posted yesterday, January 5th.

At Milton Friedman’s 90th birthday celebration, Ben Bernanke quoted him as saying, “The Great Depression was deep and protracted because the Fed failed to inflate enough to stop it.” Bernanke reportedly said to Freidman, “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”

Well, here we are with unbelievable amounts of money being pumped into the system and all manner of unconventional policies implemented both by the Fed and by the Treasury, and what do we get? As noted above, we are getting some of the biggest deflation readings in the past 60 years! The response of course is not to acknowledge that the assumptions under which Bernanke and Paulson are operating are wrong, but rather that still more of the same plus much more vigorous fiscal policy is needed. When will it end? Trillions of dollars of financing that the government does not have will have to either be bid away from the productive private sector and/or printed to meet these new unconventional funding commitments, on top of Social Security and Medicare funding that, by themselves, threatened to bankrupt the system.

Could the basic assumptions upon which policy is being set be wrong? Could it be that Milton Friedman’s assumption the 1930s depression was caused because the Fed did not pump enough money into the system early enough and fast enough is the reason for the Great Depression? Or could it be that massive credit creation was the cause?

I think the evidence suggests that is likely the case. After all, the Fed was very aggressively pumping money into the banking system very early on after the October 24, 1929, stock market crash. By early 1930, the re-discount rate had fallen to 2% from 4.5% at the time of the crash. Some $116 million was pumped into the system. Controlled reserves increased to $218 million, and the gold reserve (which allowed the money system to expand, as the dollar was backed by gold then) rose by $309 million after England detached the pound from gold. Yet, despite these efforts on the part of the Fed to stimulate growth through an excessively easy money policy, the money supply actually shrank from $73.52 billion to $73.27 billion. Hence the pushing on a string analogy.

The same thing is happening now. Huge reserves are being pumped into the system. For example the money base has been rising very dramatically, yet banks are not lending that money out which is required to expand the economy through the fractional reserve banking system. And now with deflation numbers starting to hit us hard, it does not inspire confidence that our policy makers can avert a depression any more effectively than they did in the 1930s. Indeed, the headwinds in terms of GDP from which to fund debt are much stronger now than they were during the 1930s. As indicated in the chart on your left, from the November 11 article of MoneyAndMarkets, we can see that the total debt is now 350% of GDP, whereas it was only about 260% in 1932. Note how sharply debt to GDP dropped during the 1930s, thus indicating attempts by policy makers then to increase debt, failed utterly. Once that debt was run off the system and with WWII, the last K-winter finally ended.

The key for me in this piece is the increase in debt, aka the increase in monetary base, which can only lead to higher inflation sooner rather than later. (Sooner rather than later does not mean tomorrow, but it does mean that it is coming in 2 years, three or more depending on how severe the recession/ depression is) History repeats itself, but not identically. Deflation appears to be the head fake that has sent the Fed on the road to hyper-inflation. This should begin to play out around the mid point or towards the end of 2009-10.

Now from the inflationary side let’s take a peek at Howard Katz’s view written on January 5, 2009.

Right now the full force and weight of the opinion molders in our society is trying to get you to believe that a wave of deflation has emerged out of nowhere and will cause all prices in our society to go down. The initial statement of this falsehood convinced many people and caused them to sell stocks and commodities. In other words, the thesis had a self-fulfilling aspect. Because people believed it, they sold, and this made most markets go down. What the breakouts circa Jan. 1 2009 tell us is that this self-fulfilling aspect is now ended. Gold bottomed on October 24, 2008. The stock market bottomed on Nov. 20, 2008. The CRB index (conventionally mislabeled the CCI these days) bottomed on Dec. 5, 2008. This is it, people. The great deflation of 2008 is now over. Now prices are going up (meaning that for most weeks, most stocks and most commodities will be higher).

Why are prices going up? Because Ben Bernanke is going crazy printing money. In the last 3½ months, he has increased Federal Reserve Credit (which ultimately translates into the money supply) by a factor of 2½ times. (And Dallas Fed chief Fisher is predicting it will settle at 3 times.) And the printing of money has a perfect record in causing prices to go up. (That is, there is no liquidity trap or other Keynesian nonsense to make you believe that 2 + 2 = 5 and that it is possible to get something for nothing.) If you believe the establishment, you are going to lose big time. You sold your holdings and are sitting in cash. You have flown to safety. Well, cash is trash, and what the establishment calls safety is just what they need you to do to take your wealth.

There have never been any periods of deflation in American history that were not caused by a significant decline in the money supply, which in turn was always caused by the Government. The deflation known as the Great Depression was caused by a 30% contraction in the money supply from 1930-32. Furthermore, this was a deliberate policy adopted by the Republicans in 1920 and named a good 5¢ cigar. The idea of a large scale decline in prices (whether you call it a recession, a deflation or a depression) to come out of nowhere with no cause is impossible. And this makes all of the media and the people with economic titles idiots.

But if this be idiocy, yet there is method in it. You see the bankers reward these people with economic titles by giving them juicy consulting fees. Then the bankers create money and make big profits. The bankers and their associated vested interests (the paper aristocracy) do well, and the banker economists call this economic growth. The problem is that during every period of economic growth the great majority of Americans get poorer. In the present case, if the final result is a 2-3 times multiple in the U.S. money supply from its levels of Sept. 1, 2008, there will be a major decline in the real wages of the average American worker. There is already a major decline in the income of the average American retired couple, and retired folks are now being forced to take the kinds of risks with their capital that they have never previously taken.

This is so right on the money! We may get stimulus packages and tax rebates, but our real wealth is being consumed by inflation at an ever increasing pace. My fear is not just inflation, but rather the threat of hyper-inflation. At the rate that the Fed is assuming debt and creating money out of thin air the more logical and likely the threat of hyper-inflation becomes. In this environment gold will thrive as the only real money and store of wealth around.

Gold currently is looking like it is in over bought territory and is starting a correction which should bring it back to the low $800 range. This will once again provide a nice entry point for the next leg up. This next piece comes from Bloomberg and is a bit lengthy, but it is well worth the read, as it gives us a look at predictions for the price of gold in 2009.

Jan. 6 (Bloomberg) — Gold, the best-performing metal in 2008, may appreciate for an eighth year as investors seek a refuge from declining interest rates at the same time that central banks inject more cash into the banking system.

The metal will average $910 an ounce in 2009, 4.3 percent more than last year, according to the median forecast of 20 analysts, traders and investors surveyed by Bloomberg. Silver and platinum, which averaged at least 12 percent more in 2008, will decline this year, the survey showed.

Gold prices may strengthen after about $29 trillion was wiped off equities last year, the Federal Reserve cut interest rates to as low as zero and governments sought to end the worst financial crisis since World War II. The metal was one of only four commodities to rise when the Reuters/Jefferies CRB Index fell 36 percent, the worst year in a half-century.

People fear inflation, they fear the credit crunch and they fear currency losses, and gold is the perfect insurance against all of that, said Frederic Panizzutti, a senior vice president at Geneva-based bullion refiner MKS Finance SA, who forecasts gold will average more than $900 in the first half of 2009. Panizzutti was the most accurate forecaster in the London Bullion Market Association’s 2008 survey.

Average gold prices have risen for seven consecutive years, the longest winning streak since at least 1949. While the return of 5.8 percent through 2008 was the smallest since 2004 in dollar terms, gold rose 11 percent in euros and 44 percent in British pounds, data on Bloomberg show.

The plunge in equities spurred some investors to buy precious metals. Gold in the SPDR Gold Trust, the largest exchange-traded fund backed by bullion, reached 780.23 metric tons on Dec. 29, up from 627.88 tons at the start of the year. The total is equal to almost four months of supply from mines.

Gold producers were among the top performers in the 162- member Bloomberg World Mining Index last year, which fell 61 percent. Royal Gold Inc., the Denver-based owner of rights to gold sales from companies including Barrick Gold Corp., rose 61 percent. Randgold Resources Ltd., the Jersey, Channel Islands- based owner of two gold mines in Mali, advanced 60 percent.

There is every reason to believe gold’s going higher and a lot sooner than most people think, said Randgold Chief Executive Officer Mark Bristow, head of last year’s best performing company in the FTSE 100 index, which it joined last month. Our estimate is that new gold supply is going to be reduced by 15 percent over the next three years.

Governments across Europe are selling more debt to fund bank bailouts and revive economies mired in their worst slump since the Great Depression. The U.S. Treasury Department estimated it will auction as much as $2 trillion of debt this fiscal year, which began Oct. 1. Euro-region nations will borrow as much as 880 billion euros ($1.2 trillion) this year, according to Royal Bank of Scotland Group Plc.

The flood of cash may undermine confidence in currencies, spurring investors to buy gold, said Mario Innecco, a futures broker at MF Global Ltd. in London. Innecco correctly predicted two months ago that gold would trade at $850 to $950 by the end of December.

People will flee away from paper currencies because central banks are throwing everything at the market to try to revive things, Innecco said. People will flee to gold.

The incoming administration of President-elect Barack Obama will seek as much as $850 billion in new spending and programs, congressional officials have said. China unveiled a 4 trillion- yuan ($585 billion) economic stimulus plan in November and European Union leaders are drawing up packages worth about a combined 200 billion euros.

It’s to some extent a trade war, said Marc Faber, publisher of the Gloom, Boom & Doom Report. You cheapen your currency so you export problems to somebody else, but since the whole world is engaged in trying to lower the value of their currencies, it may very well happen that all currencies lose value against the hot currencies like precious metals.

Michael Jansen, an analyst at JPMorgan Securities Ltd. in London, said gold should average $800 this year. A deep recession will likely mean a clear lack of demand from jewelers, and fewer mining companies are seeking to buy gold to cancel forward sales, he said in a Dec. 11 report.

The so-called global producer hedge book stood at 585 tons at the end of June, the lowest since 1987, according to London- based consultant GFMS Ltd. Miners can agree to sell future production at current prices to protect against losses caused by sudden declines, a strategy known as hedging.

The risk of deflation is higher than that for inflation, particularly in the first half, Jansen said in his report. Some investors buy gold as a hedge against rising prices.

U.S. inflation will drop to 1.1 percent in the first quarter, compared with 1.95 percent in the preceding three months, according to a Bloomberg survey of economists. Prices will drop 0.45 percent in the third quarter, the survey shows.

Gold will go to a new record in 2009, said Philip Klapwijk, chairman of GFMS and the second-most accurate forecaster in the LBMA survey. There really is scope for a major collapse in confidence in the U.S. dollar. In 2010, we could see 10 percent inflation in the U.S.

Silver, platinum and palladium are all likely to average less this year, Bloombergâ€™s survey showed. The metals, more reliant than gold on industrial demand, tumbled last year as economies weakened.

Silver will average $12 an ounce, compared with $15 in 2008. The metal, used in applications such as photographic paper, fell 23 percent through last year.

Platinum, mostly used in jewelry and auto catalysts, will probably average $975 an ounce this year, compared with $1,574 last year. The metal slumped 59 percent from a record $2,301.50 set in March. Palladium, also used to remove noxious fumes from exhausts, will average $220 an ounce, down from $350.90 last year.

European car sales plunged 26 percent in November, the biggest monthly drop since 1999, while sales in the U.S. fell 37 percent to the slowest annual pace in 26 years.

Automakers account for about half of global platinum and palladium consumption, according to estimates by Johnson Matthey Plc, a London-based metals refiner, trader and researcher. The figures take recycling into account.

There you have it. The predictions span the gamut, but the consensus puts the price of gold in the $910 range. I will stick with my prediction of $1000 per ounce for the price of gold by years end. Time will tell the tale.

Till next time, good luck and good trading!