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Inflation, Deflation, and Gold

Barry Ritholtz posted a link to this excellent piece by Bloomberg’s Alice Schroeder on bubbles throughout history: “Gold Tells You US Bubble Hasn’t Popped Yet.”

Echoing our thoughts on gold from last week, Ms. Schroeder writes:

I’ve never been a gold bug myself. They get no respect. They are associated with survivalists, conspiracy theorists and nutcases. They are always looking for the hyperinflation that never comes. Gold bugs pay a premium over the metal price for gold and silver coins on the notion that they will need the currency, come the Apocalypse.

Ms. Schroder does give the gold bugs credit on one count, however. While gold has had a mixed history as an inflation hedge, it has offered insurance-like protection from currency crises. Fair enough. But buying gold today to protect against a dollar crash seems a little like closing the barn door after the horses are already out. The dollar has already been in a grinding bear market for nearly a decade. Is now the time to buy insurance? Or, to use another analogy, is there much of a point in buying storm insurance after the hurricane has already hit your house?  Or buying life insurance after you’ve been hit by a bus?

Only time will tell, of course. And gold could very well soar higher from its current levels. This is the nature of bubbles. But we should be clear that at current levels, gold is in a bubble, and monies allocated to gold should be viewed as highly speculative.

Deflation continues to be the real threat. As Ms. Schroeder continues,

Some now blame consumers’ disinclination to spend and get the economy going again on banks’ newfound reluctance to lend. To the contrary, we are in the midst of a deflationary trend that is temporarily being masked by inventory restocking and free lunches like “cash for clunkers.” Consumers are done with borrowing. They will keep fueling the deflation by going through their attics and garages to find stuff they can sell on EBay to raise cash.

We agree. But where is the proof? Well, just this morning we see multiple signs of deflation from around the world:

“British Would-Be Borrowers Resist Approved Bank Loans” — “RBS has more than 27 billion pounds in approved corporate lending that’s going unused, said Peter Ibbetson, chairman of small business banking in London. HSBC Holdings Plc said it too was experiencing a “lack of demand” for credit, according to Noel Quinn, its U.K. head of commercial banking.”

“Deflation’s Return Weighs on Japan” — “Tokyo Says Old Scourge Is Back, Presses Central Bank to Extend Easing as Others Seek Tighter Policies.”

This is a theme we intend to cover and expand upon in the weeks to come.  We will be very interested to see what sales pricing looks like in the post-Thanksgiving shopping season.  Our guess is that it will be firmer than it was last year…but not by much.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy