There seems to be a tug-of-war going on over the past month between the forces proclaiming a nascent economic recovery and those that believe there is still a long road of economic contraction and increased joblessness still ahead. Truth be told, gold is likely to continue to shine no matter how this ultimately plays out.
Gold has shown remarkable resiliency over the past year, despite claims from some quarters that broad-based deflation was likely to weigh on all commodities including the yellow metal. We on the other hand have consistently maintained that the major economic powers in the world were simply not going to let that happen.
Through massive fiscal stimulus package, near zero interest rates, bailouts and various liquidity schemes, the global economy is awash in currency. This is not to say we're out of the woods yet, but if things take another turn for the worse, monetary authorities around the world will once again turn to whatever means are at their disposal to prevent a deflationary spiral.
For those countries with interest rates at or near zero percent, there's not much more they can do on that front. However, when it comes to printing money and funneling into the economy, they really have no limits. But, there are consequences.
In the US and UK, the governments have turned to quantitative easing as a means to drive the effective borrowing rate lower still. In fact, a recent study by the Fed determined that an appropriate interest rate based on unemployment and inflation would be -5.0%. Other countries are contemplating similar unconventional policies.
Their goal is to create an environment conducive to the antithesis of deflation, which of course is inflation. Be assured, they will achieve that goal.
Are the economies of the world bouncing along a bottom at this point, or is this simply a brief respite before the next round of dire news? Most traders will tell you that picking bottoms is a fool's game. I agree, and I think you can apply that same thinking whether your talking individual stocks, commodities, gold or macro-economic trends.
Physical gold is going to remain a critical component in the modern portfolio in either case. If the global economy does continue to contract with even higher unemployment rates still to be seen -- and all the negative implications of that -- gold will continue to serve as important diversification against the more traditional asset classes that would suffer under this scenario.
This scenario also puts the banking system under considerable additional pressure, possibly even beyond the worse case scenarios of the much discussed bank stress-tests. Gold provides protection against the possible reemergence of broad-based systemic risks.
On the other hand, if the economy is indeed on the mend -- as the stock market seems so desperate to prove -- gold will once again reestablish itself as the classic hedge against inflation.
We've seen glimmers of that this week when both stocks and gold have rallied in tandem. Hints of recovery, be they false or not, are going to bring the specter of inflation back into the investor's consciousness.
Upon recovery, whether it is happening now or whether it doesn't happen until next year as most economists believe, there is simply no way for all the liquidity to be drained out of the system quickly enough to prevent substantial inflation. Of course the government will not risk tightening monetary policy too soon, raising the risk of hyperinflation as they wait to be sure a recovery is underway.
The funds may already be trying to front run confirmation of higher inflation, building positions in gold under the assumption that their risk is limited even if they are ultimately proven wrong. Gold will then be underpinned by resurgences in risks to growth and systemic risks.
Not a bad strategy, with gold still well over a $100 off the all-time highs. By the time we see that first big jump in CPI or if some other big risk event -- and there are plenty out there -- turns things the other way, gold may have to be bought at much higher levels.
USAGOLD
