What happens to PM's during deflation?

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Johnny Oxygen's picture
Johnny Oxygen
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What happens to PM's during deflation?

Yes. I'm hung up on PM's right now. Laughing

I've gotten many different opinions but none seem to make sense so I'm hoping there are a few sages here.

What happens to PM's during a deflationary period.

leo0648's picture
leo0648
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Re: What happens to PM's during deflation?

The great depression was deflationary...Gold went from $20 to $35 overnight due to federal order.  Gold is not necessarily protection from inflation, but currency devaluation and economic collapse.  If oil spikes again, you can expect the markets to collapse again.

 

Some venezuelans probably wish they owned some PMs with the currency being cut in half yesterday.

JAG's picture
JAG
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Re: What happens to PM's during deflation?

Everybody sells it because they have no job, no money, and no food, (and have to pay the property taxes and mortgage if their lucky).

Technically, gold is a better deflation hedge than inflation hedge, but how well do you think the price will hold up if everyone is forced to sell to just survive? You better-off holding cash in deflation and taking advantage of the buyers-market galore. 

leo0648's picture
leo0648
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Re: What happens to PM's during deflation?
JAG wrote:

Everybody sells it because they have no job, no money, and no food, (and have to pay the property taxes and mortgage if their lucky).

Technically, gold is a better deflation hedge than inflation hedge, but how well do you think the price will hold up if everyone is forced to sell to just survive? You better-off holding cash in deflation and taking advantage of the buyers-market galore. 

You do realize that the people who are buying gold are central banks and the extreme wealthy.  The gold market is not priced based on whether or not the average joe can afford it.  It is priced based on what the wealthy, central banks, etc will pay for it.  Despite all of the average citizens scrapping gold for cash, the price continues to rise.  What happens when the average joe has no more scrap gold to cash in?

idoctor's picture
idoctor
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Re: What happens to PM's during deflation?

http://www.cnbc.com/id/34772171/

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nickbert
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Re: What happens to PM's during deflation?
leo0648 wrote:
JAG wrote:

Everybody sells it because they have no job, no money, and no food, (and have to pay the property taxes and mortgage if their lucky).

Technically, gold is a better deflation hedge than inflation hedge, but how well do you think the price will hold up if everyone is forced to sell to just survive? You better-off holding cash in deflation and taking advantage of the buyers-market galore. 

You do realize that the people who are buying gold are central banks and the extreme wealthy.  The gold market is not priced based on whether or not the average joe can afford it.  It is priced based on what the wealthy, central banks, etc will pay for it.  Despite all of the average citizens scrapping gold for cash, the price continues to rise.  What happens when the average joe has no more scrap gold to cash in?

JAG,

I have to agree with leo on that... the 'average' person doesn't own any gold.  I can see some price hits for certain, but a price drop of epic proportion (40% or more?) seems a distant possibility, at least as long as central banks and the wealthier individuals are still willing to buy on the dips.  I'm anticipating a better buying opportunity for gold in the year to come, but I still buy a little on occasion just to hedge against the possibility that physical availability becomes an issue in the future.  In fact my only real doubt about holding gold at the moment now is the fact that CNBC's Cramer is now bullish on it Tongue out (thanks idoctor for the link)

But stuff like cars, personal electronics, LCD/plasma TV's, furniture.... oh yeah, I can see some potential firesale prices there.  And I wholeheartedly agree with you on keeping a healthy amount of cash to take advantage of a huge buyers market.  Heck you can see it already nowadays.  Just a few weeks ago I had the opportunity to buy up a vehicle at a criminally low price, something I couldn't have done if I hadn't been keeping some cash handy.  Go cash go!

- Nickbert 

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macro2682
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Re: What happens to PM's during deflation?

"What happens to PM's during a deflationary period."

Great question.  The technical answer is:  During deflation, to few dollars are chasing to many goods, and as a result, It takes fewer dollars to buy things.  The price of everything (including metals) goes down.

But keep this in mind...  Deflation magnifies our debts as a nation (and as indeviduals), undermines our GDP (which puts futher pressure on our debts), and would cause the US to default, triggering a series of economic events that would destroy our financial system.  Recent events at the fed and treasury lead me to the conclusion that the current financial system will be upheld at all costs.

If we get a second deflationary dip, gold will go down - but probably not as much as it did at the end of '08... the government will kick in a new round of stimulus (since deflation is not an option), and PMs will rebound to new highs...  We may even get another iteration of this cycle, each with PMs falling less and less as market participants become more certain of the fed's intentions.  Interest rates will rise from external pressures, and then who knows from there...

So a better answer to the question "What happens to PM's during a deflationary period":   During a deflationary period, the Fed creates inflation, and PMs go up.

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JAG
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Re: What happens to PM's during deflation?

Leo,

Take a look at this chart from www.sentimentrader.com :

The middle section is tracking the capital flow into the Rydex Precious Metals Fund. Individuals and retail traders (aka the dumb money) use this fund (and many other similar funds) to get exposure to the PM market. Notice how asset flows into this fund are recently higher than they have ever been? 

I agree that the "joe blow" is not likely to own physical bullion, but the price of gold has more correlation to the paper gold market these days than the physical gold market. Do you think these profit chasers in the paper gold market are going to sit on their trades if the price drops or cash out? And if they need cash to survive, do you think they will hesitate to click the sell button in their browsers?

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And while I have posted this chart for everyone to see, take a moment to closely examine it. Notice how every major downturn in the market was preceded by a rush of dumb money into the market (an extreme reading indicated by the dotted red line)? And notice how every significant rise in the price of gold was preceded by a rush of dumb money out of the market (an extreme reading indicated by the dotted green line)?

This is the kind of information that you want to base your trading on, not the speculation-de-jour in the goldbug blogosphere.

Granted, this chart doesn't indicate what the smart money is doing in the gold market, but it really doesn't have to. Because what the smart money is doing is inferred by what the dumb money is doing.

Disclosure: A have a small unhedged allocation to PMs and paper gold....looking to add to my allocation when the dumb money jumps off the bandwagon, again.

 

 

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JAG
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GLD Top ETF in 2009

Link

 

keelba's picture
keelba
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Re: What happens to PM's during deflation?

What you're talking about makes sense if the system makes sense. However, there is far, far more gold "owned" out there than actually exists in all the world. These ETFs and shares are printed at will just like our currency and there is an inflation and deflation in the PMs markets as these shares debase the "gold supply". No one cares because most people do not ever actually see what they're buying and as long as they sell at some point and get their profit they do not care if what they thought they bought never actually existed in the first place.

But the real price of gold is what you actually have to pay to get it, I mean the physical kind that you can hold in your hand. It's very hard to ascertain the value of gold when the price is constantly being manipulated and devalued. The price of real gold is held by an elastic band to the spot price of electronic gold that is stretching as dealers are now and will continue to charge larger and larger spreads per ounce to deliver to you.

Now that we have that out of the way, we can begin to look at what happens to gold during deflation. The last time there was a major deflationary event in this country was the Great Depression. During the Depression people lost their jobs and had a hard time finding money. Those that did have jobs saw wage decreases to keep up with the deflation as employers were not bringing in enough income to pay them. At that time nothing happened to gold because there was a gold standard and the price of gold was fixed at $20/oz. as it had been for a very long time. The value of the dollar decreased dramatically so that gold became more valuable even though the price was fixed. Then with the wave of a magic wand, FDR declared the price of gold to be $35/oz. and, just like that, literally overnight, the value of the dollar decreased by almost 43% (more dollars, same amount of gold). Those who owned gold (illegally as it was ordered to be turned in) saw a 75% increase in the value of their gold.

So what does that mean today? Since we are no longer on a gold standard the price of gold is free to move at will but there is still that huge difference between the price of gold and the value of gold. As long as these shares exist then the price of gold will go down with deflation as fewer dollars are there to buy the gold and all commodities should be expected to track down with the dollar. If there is true monetary deflation then the $FRN should survive and gold will continue to be traded electronically and things will continue status quo. The price of gold will represent the state of the economy. It is possible that the price could even drop as more people see the $FRN as a better investment than gold. However, if the dollar does not survive then gold and silver will be traded as money. Their value will go through the roof as its true value will surface and Adam Smith's basic laws of supply and demand will rule.

You're talking hypotheticals here but in the real world, the Fed has shown that it will do everything in its power to prevent deflation. Both QE1 and QE2 are extremely inflationary, not to mention the increase in spending and debt by the US government that also makes it into circulation. The beast of QE1 did not appear to cause as much inflation as it should have because most of that money never actually got out into circulation. It was only used to prop up the balance sheets of the failing banks. But that beast is still there and has not gone away. Its potential to devastate our money supply is still there and will eventually show up probably in conconjunction with the release of QE2 as I'm sure the big banks are dying to get that money out and start pillaging the public once again. The European Central Banks have been doing the same thing bailing out their own big banks and even countries. I see no reason to ponder deflation in today's world. What I expect to happen is that Comex will continue to try to suppress the price of PMs as long as possible by selling more and shares of gold that do not exist. This will keep the price from running away. It may continue to go up but it will be at a controlled rate. All the while, the spreads that dealers charge to those wanting to take physical possession will continue to grow (the price may look like $1,400/oz. but it will really cost you $1,800/oz. to get it). As this elastic band is stretched to the point of breaking, the spot price of gold will plummet in direct opposite proportion to the cost of physical as people race to get out of their electronic holdings and into the real thing. Then all hell will break loose.

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