Monday, July 19, 2010

Deflation Theme Getting Too Popular

An increasing number of financial, governmental and academic types are signing on to the idea that (duh!) the economy is entering a slow spot. Jeremy Grantham has joined the crowd (see #1). The deflation argument is getting popular now that Treasuries have surged in price, lowering their yield to ridiculous levels. Where were these deflationists when David Rosenberg was one of the few such proponents 100 basis points of yield higher (10 -30 year bond)?

Supposedly according to this growing alliance of deflationists/economic gloomsters the economy needs more amphetamines, or is it opium? Or is it hopium?

Concomitantly, even the commentators on's commentator site are either bearish for the short term or don't comment at all on the short term, taking a long-term view that paper money devalues (thanks for the insight!).

Mark Hulbert's Gold Sentiment Newsletter Index (HGNSI) was said to be at a contrarianly bullish 9% recommended gold allocation about 2 weeks ago. Given the tone on Kitco and the price action in gold, I wouldn't be surprised if it were below zero now.

In evaluating the main asset classes, certainly cash is the most overvalued. Treasuries are in the late stages of a recovery from a horrible bear market and now are in a Neverland of manipulation. Stocks are looking worse from both a price and earnings momentum standpoint.
Silver is looking like a metal proxy for stocks.

The conditions for the recovery from the multi-year gold bear market that finally ended (for now!) in 2009, when the 1979-80 price range was exceeded for an entire year for the first time since then, are easy money and a desire to fight "deflation".

No matter that the only important deflation is that of houses and stocks, namely assets individuals own. The cost of living is undoubtedly rising in a thousand ways that are uncounted by the Bureau of Labor Statistics. But government statistics are to statistics as military music is to music.

While the Internet was new, tech advances were not new. There was no New Era in the 1990s. There was just a massive stock and investment bubble which extended to property and other lending a few years ago. The sovereign debt bubble is now on the plate in richer countries than the usual defaulters of the past 65 years.

Thus the gold vs. fiat money battle is only now getting going for real. The current fad that deflation is a serious risk is the best argument for gold right now. Short term sentiment amongst gold traders is depressed. Bonds are in fashion. Whatever you own, the financial powers that be want to destroy you if you are leveraged.

As economic activity sputters, Big Finance's potentially insolvent position will make it call once again for money-printing, which aligns with what governments trying to fit a guns and butter agenda generally do. I for one can't come close to timing this. My sense is that once again Nassim Taleb is correct, namely that big-time inflation is the underpriced "fat tail" possibility.

Traders such as Dr. Taleb can take advantage of derivatives such as futures and options, but identifying those opportunities is far beyond my capacity. Gold (and in up-moves silver) is the slow-moving investor's core hedge against these sorts of outcomes. Better to buy when traders are gloomy than when they are ebullient, yes?

And I wouldn't sell gold on a downtick when the trade is into cash yielding nothing. At least not until fiscal sanity is forced upon Washington.

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