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Tuesday, November 22, 2011

Deflation, Depression and Deception

If you've been watching the PM market over the past few days, you'll have seen that it's been a wild ride.  On Thursday of last week, gold dropped $50 an ounce.  Up $5 on Friday.  Down another $50 on Monday, and up $20 today (at this time).  Net:  Roughly a $75 drop since late last week.  Ouch.

With yesterday's drop, I wanted to find out what the hell might be causing this.  Most of the "expert articles" I read really didn't say anything.  Most were technical chart driven BS.

But one article caught my eye:  "Gold prices slaughtered as deflationary fears reign" [link].

I'm thinking, "Holy crap - we all know that deflation precedes depression, so here it finally comes".

The theory kind of goes like this:  Demand is so low that producers have to sell the products they've got stacked up in their warehouses - at almost any price.  Prices in general plummet as other businesses drop their prices to keep pace with their competitors.  Income at the producer companies also plummets, and they can't keep their doors open.

This is repeated all over the economy.  Because all of these companies are out of business, unemployment soars, causing the economy to further sour, as with fewer workers, there are fewer dollars being spent, and it turns into this horrible self-perpetuating mess that we call a "depression".

How does this affect the price of Precious Metals?  If you think prices are going to drop, you want to get out of commodities, and into cash.  Those dollars you hold now will be able to buy more commodities-per-dollar in the future.

As I noted earlier, all depressions have been preceded by deflation.

Uhm, well, not so much.  In fact, it looks like there may be little to no correlation between the two.  A couple of economists went back at least 100 years and studied the data from 16 countries (including the US) regarding deflation and depression.  They used actual raw data, not the sanitized "seasonally adjusted" crap we get fed.

One period they studied was the Great Depression.  From the Ludwig von Mises Institute [link] -
In other words, a one-percentage point reduction in inflation is associated with a .40 percentage point decline in real output growth during the Great Depression, although even during this episode the probability that there is no relationship between deflation and depression (the level of significance) exceeds 10 percent. In the jargon of statistical inference this means that the relationship between deflation and depression is not "statistically significant. (emphasis added)"
Whoa.  So it's actually more likely that deflation is an indication that a depression is NOT coming?  This hurts my head 'cause my brains are all scrambled.

Why oh why isn't this study - published in 2004 - more widely discussed?  If it's crap, get a couple of eggheads out there battling to the death.  Disprove the study and move on.

But what if it's true?  What would it mean if deflation wasn't this big-assed Boogie Man that would plunge us into another depression?

For one thing, it would mean that the "justification" the Federal Reserve Bank gives for pumping money into the economy to combat deflation would be baseless.  In fact, it would actually be harmful.

And, holy crap, one of the authors of the study actually WORKS FOR THE FEDERAL RESERVE BANK!!  Well, he did at the time he co-authored the study.  I'm guessing that he might be bedding with Jimmy Hoffa right about now...

Accept The Challenge

The long and short of it is that deflation happens, but economies don't crater via this Domino Effect collapse.  History has proven that companies take their lumps, adjust their pricing and costs, and Git 'er done.  The strong companies survive, and the bad companies perish.... just like it's supposed to happen.

But back to PMs - if deflation is happening, should you get out of PMs and into cash?  I guess that depends on your economic outlook horizon.

If you're a Day Trader - speculating on what is going to happen over the near-term - you're going to have to break out your Ouiji board to get your answers.  I've got no clue if some sheikh in some sand country is going to fart in the face of some other sheikh, causing commodity markets to soar or crash.

I personally try to look out 3 to 5 years for the big picture trend.  I see a US government that conned the public into a "deal" whereby the debt limit was increased by $2 trillion in exchange for $1.2 trillion in cuts over 10 years.  That debt limit will be reached in under 12 months or so, and the cuts will likely never happen - Congress-critters are already talking about how to side-step the "mandate".

Nothing is going to change in this time frame.  We'll continue to spend more than we take in.  We'll either raise taxes, print more money, or both.  Probably both.

In theory, if the Eurozone craters, the euro dies, and the dollar soars - punishing commodity holders.  In reality, we'll be the Bail Out-er of Last Resort.  Our banks are tightly intertwined with their banks.  If they fail, ours fail, and Uncle Ben Bernanke will not let that happen.

Again, we'll print more money, debasing the dollar, pushing up the price of commodities.

Physical possession of commodities will be the only way to maintain your asset base.  I've only got so much room for beans and bullets, so PMs are my answer.

We'll continue to have these up and down blips on commodity prices.  When that sheikh gets gassy, we'll get a temporary rise or drop, but the overall trend will be upwards.

Now, go do YOUR homework to support or disprove these beliefs, the ACT accordingly.

Copyright 2011 Bison Risk Management Associates. All rights reserved. Please note that in addition to owning Bison Risk Management, Chief Instructor is also a partner in a precious metals business. You are encouraged to repost this information so long as it is credited to Bison Risk Management Associates.

1 comment:

TOR said...

I find deflation highly unlikely because we have massively increased the amount of money in curculation. Also prices are, after taking a back to reality hit in some areas like real estate, either staying up or going flat.

As for calls of deflation which mean we have to "increase liquidity" by creating another couple hundred billion magical computer dollars it is like a cop loudly saying "stop resisting" before taking out the billy club when somebody isn't doing anything.

In the 3-5 year range I like PM's at least to hold what purchasing power I have. Though I do think the time to buy to make a big profit is past.