Is Deflation Still a Threat to Gold?

When you talk to investors as to why they buy gold, many look to the precious metal as being a hedge against inflation. But since 2011 we have been experiencing deflation and the yellow metal has felt the affect of an overall declining commodity market.

Many that have been relentlessly bullish on gold since 2011 point to inflation in the money supply. Indeed we do have inflation in M2 Money Supply as you can clearly see from the following chart. The problem is it’s not circulating.

M2 11-18-2014


Money Velocity Zilch

What about Money Velocity? With all that printing going on, money is not circulating in the economy. The Fed doesn’t like this but even putting interest rates to zero won’t force consumers and businesses to spend. We have not seen this much of decline in velocity for as long as the Federal Reserve Bank of St. Louis reveals on their chart; 54 years. This is a modern day unprecedented issue the Fed is fighting and is a possible precursor to more QE down the road if necessary to get money moving (inflation target of 2%).

Money Velocity 11-18

Bernanke when he was Fed Chairman was clear in what the Fed would do during deflation in his 2002 speech Deflation: Making Sure “It” Doesn’t Happen Here. And people complain about Fed transparency (j/k Austrian economists). There is no doubt in my mind that a Yellen led would implement more QE if interest rates started to shoot up past 3.06%.

Higher Interest Rates Coming?

The financial media keeps telling us the economy is moving along just fine and higher rates are coming based on the fact the Fed says higher rates are coming. But what does the price action of rates show us? Interest rates are still low. The 3.06% rate mentioned above comes from the high of the last 12 months reached last year.

10 Year 11-18-2014


A decline of .02 on the 10 Year Treasury Note was the reaction for interest rates today despite the better than expected PPI report.

Commodities Declining

While we will get bounces in various commodities from time to time, like Natural Gas of late with the onslaught of winter snow hitting 50% of America earlier than expected, they are still mired in deflation and the Fed just can’t see it.

Have you seen commodity charts since 2011? Below is a chart of the Continuous Commodity Index (CCI). The Continuous Commodity Index is the CRB index in its original equal weight form from 1957.

CCI Index


As you can see from the chart, the 17 commodities that make up the index, including grains, oil and metals, all are falling in price since 2011.

Sure, when you go to the grocery store you’ll see many products that have higher prices. But some of that is related to the California drought driving up food prices.  You also should consider the fact that more in America are on Food Stamps than ever before. If the government is buying a lot of the food, guaranteed, then the prices will move higher.

One cannot consider higher college tuition costs or government health care related prices being higher inflation related because anything the government guarantees in price gives the companies doing the selling carte blanche to raise prices.

Dollar Still Bullish

As you can see from the chart below the dollar has been bullish since 2011. This just so happens to be the year for the top in gold and silver. Deflation has a tendency to be dollar bullish, the opposite of inflation.

I had mentioned in an article from August of last year where I said I was dollar bullish that I eventually will become bullish on the dollar and precious metals at the same time. We’re not there yet, but I explained this scenario as to why in Chapter 4 of my first book Buy Gold and Silver Safely and will be explaining it further in my next book Illusions of Wealth.

Dollar Index 11-18-2014

What the Fed Can’t See

Dollar Strength Hurts Producers

Japan and Europe sure know that in order to become more competitive and see your economy grow you have to make your currency weaker. Does the Fed know this? Can they even do anything about dollar strength when perception out there is it’s a safe place to keep your wealth right now. If you are Japanese do you want your wealth in Yen or Dollars? Same goes for Europe right now with the decline of the Euro. What about South America countries like Brazil and Argentina? All of these countries want weaker currencies so they can improve their exports. Japan seems to be the most proactive.

A stronger dollar hurts producers here in the U.S.

Currencies that are too strong or too weak not only affect individual economies, but tend to distort international trade and economic and political decisions world-wide. This is compounded by the fact that individual consumers can benefit from changes in the value of a currency, while producers in the same country are hurt.

Europe and Japan Experiencing Recession and Deflation

Japan and Europe had worse than expected data come out yesterday. Economic data showed the Japanese economy in the last quarter contracted fueling hopes of more stimulus or a postponement of a sales tax hike due next year.

The IMF came out last week and said that the euro zone growth could be worse than expected.

Does the Fed not see that this could have an effect on the U.S.? Are some of the M&A deals offsetting the fact that American industrial production declined? Is the stock market possibly overvalued or does price action trump everything and follow the trend higher with stops? The trend is your friend and it sure hasn’t hurt those with 401k’s.

Perhaps the Fed Only Looks at Consumer Confidence

Does consumer confidence really mean anything? Aren’t they the last to know what’s going on? Did the majority of consumers not see the 2008 crisis coming? Perhaps the Fed believes the consumer knows all, but clearly they don’t despite October’s good consumer confidence numbers. Maybe the Fed should listen to the Measure of CEO Confidence where “slightly more than 44 percent of business leaders anticipate economic conditions will improve over the next six months, down from 53 percent last quarter.” Of course you can expect the bank CEO’s to keep their high salaries without a care for the economy since they know the most about how to make money; get it from the Fed!

The Fed is Reactive

The Fed reacts AFTER the fact. See the 2008 financial crisis which followed the Fed’s lowering of interest rates pre 2008 to do what; stimulate the economy. And when this current lower interest rate experiment fails we will see more intervention. Anyone see a pattern here? If not, study Japan. Then look to Europe for more problems. Eventually the U.S. will be swallowed up even more into this deflationary spiral and the Fed will fight it all the way.

The Fed also has their own issues to worry about now too as funding the government may be an issue again with the new Republican controlled Congress installed in 2015.

The Fed is going to be under more scrutiny with Republican control of the House and Senate in 2015.

A proposal was introduced in June to curtail how the central bank sets monetary policy…The measure would mandate the Federal Open Market Committee to map a plan or rule for how it would adjust interest rates.

Of course Fed Chairman Janet Yellen doesn’t like this claiming “the measure would interfere with the independence of monetary policy, by bringing political pressures to bear on the committee’s judgment.”

The Fed also ignores things like U-6 unemployment rate which is still over 11% and believe the economists who predict stronger fundamentals. How can you ignore this?

How All this Deflation Relates to Gold Today

Gold prices are still feeling the effects of many of the issues I brought up above. This includes a stronger dollar, no real inflation, commodities in a downward trend, countries experiencing deflation, strong treasuries, no money velocity and you can add a stock market that keeps money moving towards it rather than a beaten down asset like gold. One can’t ignore this.

My advice is to still dollar cost average into a position in the metals. While many utilize ETFs such as (GLD) or (SLV) to play the metals I prefer an investor hold the real thing.

My thoughts are that many of these indicators I follow will see gold break to lower lows after this run up we are experiencing and I do think the psychological figure of $1,000 will be taken out. After we take out that price level we may test the $850 level to break the back of gold bugs and get the CNBC cheerleaders to claim the gold bull dead. It is between this level that I will be writing my all in article. My indicators haven’t let me down so far and hopefully they won’t in trying to provide further good analysis.

For those that don’t know I write my current thoughts on my website 5 days a week, Sunday through Thursday. While we do concentrate on the gold and silver markets, I try to give my micro analysis on the miners and other investments (JNUG), (NUGT), (GDX), (JDST), (UGAZ), (TNA), (TZA), (USO)) where I see opportunity. Many calls have done quite well the past few weeks and I’ve received a lot of emails from readers thanking me for this recently added section to the site.



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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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