Deflation is now the Primary Trend

I find it very interesting to see advertisements all over the radio and on late night television about gold. This has been happening for a few months now.

We have even seen conservative talk show hosts on American prime-time cable television recommending this or that gold dealer, while letting it be known they too own some gold.

I suppose one could look at this in cynical fashion and conclude that if you can turn ‘Joe the Plumber’ into a star and media darling to help your cause, you can certainly scaremonger the people into buying some gold in pursuit of another.

It is certainly true that gold hasn’t been loved as an investment for a very long time but that trend appears to have changed in a big way, with the drumbeat over runaway inflation fears and talk of the Federal Reserve “inflating the debt” away, and making the US dollar worthless, getting louder by the day.

But is inflation the real threat the majority of analysts make it out to be?

Before we answer that question, it is important to state that gold is money and that it is a good idea to own some gold. Gold is the only real money the world has known for over five thousand years. I think those before us were certainly onto something with respect to gold as a store of value, and I for one have no qualms with that.

The only question in my mind is how much gold to own, and that will depend on whether we expect inflation in the years ahead.

Capitalizing on the notion that government deficit spending off the 2009 stock market lows would be highly inflationary, the banks and other beneficiaries of that cheap credit speculated in stocks, commodities, metals and emerging markets, catapulting them off their lows into a banner year of gains for 2009.

Earlier this year, the buzz around inflation-oriented bulls was anecdotal evidence confirming their investment strategy (or so it seemed), of price rises across several industries in the latter half of 2009. But it must be remembered that end user price increases are lagging indicators of economic conditions, and that we need to be looking at leading indicators for clues on future direction.

In my view, after the financial equivalent of defibrillator shock treatment was applied by the world’s governments and central banks at the March 2009 crash lows, it wasn’t at all surprising to see stock markets rally for a year; nor was it surprising to see commodities, oil and emerging markets such as China, which for years had been a major purchaser of those commodities to run its factories, come back strong as well.

But was this a result of conditions forewarning of a real inflation? I don’t think so. It was simply a synthetic demand for the purposes of engineering quick financial profits at the expense of the real economy, brought about by a liquidity rally within what I believe to be an unfolding deflationary depression.

And what has happened since December, 2009? Commodities as measured by the Thomson Reuters/Jefferies CRB Index have come down, suggesting that government infusions of liquidity are wearing off; and if the recent G20 meeting was any indication, further infusions shelved for the time being. Along with other measures, the CRB is a leading indicator of economic activity and its decline since late last year might have correctly forecast the slowdown in 2010 that more economists are now calling for.

It is also argued that we might continue to see certain sectors of the economy heat up and follow an inflationary tract, while others buckle over into a deflation. The American writer F. Scott Fitzgerald did write the following in an essay for Esquire magazine in 1936 titled The Crack-Up: "The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind, and still retain the ability to function."

The opposing ideas of inflation and deflation, however, cannot hold equal weighting in the generalized deflation that I expect and have previously written about on these pages. At best as far as the inflation argument is concerned, we might on occasion get a few warm days, perhaps a week or two, in what the history books will in all likelihood record as a long, deflationary winter.

As such, applying pedal to the metal, as opposed to a 5-10% gold position at this time, may not get the results that so many in the inflation camp expect.

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