Tuesday, March 10, 2009

Gold still suggests inflation, not deflation

It seems like almost every day I read something from another analyst saying something to the effect that we are doomed: deflation is pervasive, our living standards will never recover, global demand is on strike, the Fed's balance sheet is shrinking, etc. I offer this chart of gold prices to make the point that even though gold has not done very well in the past year or so, it is still in what looks to me like a seven-year rising trend. If you had told me two years ago that gold today would be around $900/oz., I would have said "that would be a clear indication of inflationary monetary policy."

I don't see any deflationary signs in the commodity markets. Shipping rates are still rising. Copper is up 34% from its December lows. The JOC, JOC metals, and CRB indices are all flat to up over the past several months.

M2 growth has slowed in recent weeks, but it is still up at a 15% rate in the past 3 months, and 9.5% in the past year!

Core CPI is still rising, and energy prices have been rising for the past few months. So I don't see how CPI is going to be negative going forward. This obsession with deflation is just the Phillips Curve deja vu. Weak demand does not dictate deflation. Indeed, the weakest economies that I have ever seen were those that were afflicted with plenty of inflation. Inflation is bad for growth. Slow growth is not necessarily good for inflation.

I think the deflationary part of this current bear market reached its maximum intensity around the end of last year. Most of the deleveraging had occurred by then, and spreads and commodity prices support that view. Things were all set to get better in the new year. Since then the bear market has been driven mainly by Obama and his radical promise to increase the size of our federal government by 15% in the space of just a few years (from 20% of GDP to 23%). That is a level that we have never seen post-war, and it implies a totally unprecedented rise in tax burdens. That is what has caused capital to go on strike (Atlas Shrugged is surging in popularity for a good reason). That is enough to explain almost any bit of bad news.

The market is severely bogged down by oppressive government and the promise of more to come. And also by details such as mark to market and cap and trade. Today we saw the promise of some relief from MTM. And I recently noticed that the Senate does not have the votes to pass Obama's budget. That is extremely good news. If only something like cap and trade would be taken out, this would be very good news. Cap and trade is simply awful. It is a guaranteed recession-extender. Surely if people have a chance to think about this, it will fail to pass. If reason prevails, the economy will survive and the markets will recover. I'm still an optimist, even thought I admit to feeling awfully bad.

Meanwhile the skiing has been excellent, and although we didn't have a problem finding a table at the Skier's Buffet at Deer Valley yesterday or today, there were still plenty of people enjoying what has to be the best lunch at any ski resort I have ever been to. Deer Valley demand is not dead.


brodero said...

Isn't Gold a more coincident indicator than a leading indicator?? Won't we need the Baltic Dry to be much higher to worry about inflation???

Scott Grannis said...

Gold is definitely a leading indicator, as its price responds immediately to changing perceptions of the future. The Baltic Dry responds only to concurrent demand for shipping in the context of the existing supply of ships. Gold only dropped by a fraction when the recession hit, but commodities and shipping rates plunged. The gold market kept its eye on the future, other markets simply responded to a sharp drop in consumer demand.

The Therapist Is In said...

Would going short long term treasuries, ie TBT, make the case as a hedge against future inflation and a bet that the next bubble might be cash?

Scott Grannis said...

Going short long-term Treasuries or buying TBT shares would make sense if you think interest rates are going to rise significantly in the future. Higher rates would be the likely result of a recovering economy and/or rising inflation.

Daniel said...

This is why most gold analysts predict $1600 gold in the near future. 700 gold is out of the question, and $900 gold has been holding for over a year now, even as the dollar gets stronger, and commodities plunge.

Most importantly the skiing. Glad to hear you are enjoying Utah...again..:) I just came back from Squaw Valley and it was amazing. I see so many people enjoying life and often ask myself "what recession?"

Scott Grannis said...

The skiing has been fantastic! Today was one of the best days I've ever seen. Lots of people out there skiing.

Mark A. Sadowski said...

I sold my gold at $993.80. I have no regrets.