|ORO Y PLATA INTERNACIONAL S.A.
Gold Price and Deflation
New Highs in 2010
26/12/09. As the gold price heads into its final trading week of 2009, there is
heated debate as to what lies ahead in 2010 for the price of gold, gold
mining stocks, and the U.S. dollar. The path going forward will depend on
numerous macroeconomic variables - notably employment, housing, and
price inflation data - as investors attempt to gauge the monetary policy
response from the Federal Reserve. In recent weeks there has been a
notable shift in financial markets towards an increasing likelihood of
inflation, evidenced by the yield curve steepening to record levels and the
widening spread between the 10-year yield and the 10-year Treasury
Inflation Protected Securities (TIPS) yield. Rising inflation expectations has
helped halt the slide in the U.S. dollar as investors have begun to
anticipate higher interest rates on not only the long end of the curve, but
the short end as well.
The chorus of inflation hawks has been slowly rising and calling for an
end to the Federal Reserve’s crisis-driven monetary policies - particularly
near-zero interest rates and quantitative easing programs - in order to
lower the probability of potential future inflationary consequences from the
rising money supply and the bloated balance sheet of the Federal Reserve.
If economic data continue to improve and inflation expectations continue
to rise, then the current correction in the gold price and the gold mining
stocks will be at risk of deepening. If the Federal Reserve were to assume
a more hawkish stance and raise interest rates to more aggressively
combat inflation risks, the U.S. dollar would most likely strengthen - an
outcome that would likely pressure the gold price and gold mining stocks.
While inflation is becoming a greater concern to many investors, there a
few noteworthy high-profile economists and investment strategists who
are more concerned with the risks of deflation. One is David Rosenberg,
Chief Economist at Strategist at Gluskin Sheff and former Chief Economist
at Merrill Lynch, who accurately predicted much of the financial crisis and
deflationary shocks that gripped financial markets in the fall of 2008. In a
recent BusinessWeek piece titled “Why 2010 Looks So Dicey” Rosenberg
lays out the case for deflation. Rosenberg reminds readers that despite the
stock market recovery in 2009, household net worth has contracted nearly
20% during the past year and a half - a staggering figure of approximately
$12 trillion. He goes on to say that while many people are understandably
concerned about inflation, “the history of post-bubble credit collapses
shows that even with massive stimulus, deflation pressures can dominate
Rosenberg argues that the U.S. government will stop at nothing to reflate
the economy in order to improve GDP and the unemployment rate.
Another well-known market pundit who is squarely in Rosenberg’s
deflation camp is Gary Shilling, who recently spoke at the Financial
Advisor Symposium in Orlando. Shilling emphasized the “death of the
consumer” as the preeminent factor supporting his deflation call, stating
that “America’s 25-year spree of profligate spending is over, and it will be
supplanted by a decade-long retrenchment that will ultimately bring the
consumer savings rate from 4% to double-digits, where it has not been
since the mid-1980s.” He goes on to argue that the unemployment data
reported by the U.S. government is misleading because it does not take
into account voluntary furloughs and wage cuts, which are aggravating
the employment situation and forcing consumers to cut back even further.
Shilling also predicts that the government will be forced to pass another
stimulus package - this time focused more on job creation and
infrastructure - in order to stem the tide of deflation.
Further stimulus programs will lead to greater deficits, more severe
sovereign debt loads and more money printing - leading to further
debasement of the U.S. dollar. The end of result of the government’s
deflation-fighting efforts equates to a rapid expansion of the money supply
- a positive for the dollar-denominated prices of gold and silver. Gold bulls,
while correct to focus on the debasement of currencies that has resulted
from loose monetary policies as a chief rationale for higher gold price in
the future, would actually see gold hit significantly higher levels if deflation
remains the larger concern over the course of 2010.
If another deflation scare materializes such as what occurred in the fall of
2008, the gold price and gold mining stocks would likely decline initially as
deleveraging and liquidation of all assets would dominate in the short-
term. Over the longer-term, the policy response, as articulated by
Rosenberg, would ensure significantly higher gold prices in coming years.
2010 promises to be a more challenging year for asset markets. However,
for the investor who believes that the economy faces further headwinds
and policymakers will remain committed to defeating deflation, the gold
price and gold mining stocks could be one of the few places to achieve
appreciation over the coming years.