NEW YORK -- Investors with money in gold securities have been getting a lot of official help lately. First Treasury Secretary John Snow gave the nod to a weaker dollar. Then financier-philanthropist George Soros told television outlet CNBC that he was short the dollar and long gold. That was topped off by Alan Greenspan, chairman of the Federal Reserve, today weighing in with some characteristically opaque mutterings on the threat of deflation.
It has all been good for gold. The metal gained a further $3.70, or 1% to last trade at $371.80. The day’s trade was opened at $368.10 and slipped to a low of $363.90 before the customary 11am takeoff that boosted it to a high of $373.50 an ounce. It wasn't an especially impressive day for gold stocks though which continue to wallow at par compared with where they were this time last year when gold was still priced well below $320 an ounce.
Deflation was a hot topic at the New Orleans Investment Conference in November last year. At the time, there was considerable consensus that deflation was on the cards and its implications for gold were considered in some depth.
The principal positions were laid out by Bob Prechter, of Elliot Wave International, and Bill Bonner, publisher of the Daily Reckoning. Prechter said gold would be a bust in a deflationary climate, whilst Bonner advised clients to buy buckets of it. Both claimed history to support their positions.
The debate became more intense when “Mr Gold”, Jim Sinclair, bolted the Financial Sense Web outlet to start his own when Prechter’s gold bearishness was promoted. The Connecticut Midas has challenged Prechter to put a sizeable bet behind his forecasts.
Sinclair thinks deflation is not a threat since its classic character – a contraction in money supply and credit as well as declining prices – is most unlikely. Indeed, in late January Sinclair said that: “Central bankers and Treasury officials are going to let the dollar fall” in reaction to a 19 December speech by Greenspan in which he said a repeat of the Great Depression would be avoided at all costs. Fed governor Bernanke echoed those views in a more direct fashion.
That gave Sinclair confidence to put everything on the line: “I want to go on record telling you that Gold is coming back into the US Dollar within five years. Its form of remonetization will be a modernized and revitalized Gold Cover Clause not tied to interest rates, as it was as in 1929 - 1930 as the Federal Reserve Gold Certificate Ratio, but tied to the ability to expand M3 directly.”
Sinclair’s main fear now is stagflation – essentially inflation without growth. Either way, he sees a multiply higher gold price to compensate for a dollar with declining purchasing power.
Greenspan gifted Sinclair more guru power in his address to a congressional Joint Economic Committee today, saying price deflation was not “imminent.” That is Fed codespeak for “deflation is no idle threat.”
As a result, he admitted, between the lines at least, that the Fed is literally pulling all-nighters to understand deflationary dynamics and how to combat them. And yet again it led him to make a gold positive statement – the Fed has has "plenty of ammunition" to fight deflation, which is further codespeak for credit and money supply expansion.
This Fed regime and its immediate predecessors are all long anti-inflation knowledge which worked a treat until real American interest rates turned borderline negative more than a year ago. That has left economists haunted by the specter of Japan which has tried every trick in the book to reflate its economy, including ones suggested by the much vaunted Clinton Treasury team, all to no avail.
Unemployment has continued to rise, hitting 6% in April, whilst consumer prices farther than they have in the past year and half. That has been offset by relative stability in financial markets though it is not clear how much of that has been achieved through government stabilization efforts.
The Federal Open Market Committee, which sets monetary policy, is due to convene next in late June to consider interest rates. The current consensus seems to be that rates will remain unchanged at that meeting with the next gathering scheduled for August. This would allow the FOMC more time to assess domestic and foreign growth potential with Greenspan having hinted today that he is expecting some growth in coming quarters.
Without a rate cut, that growth would likely be driven by the injection of more money into the system by buying back bonds or even by outright printing of money. Indeed, it is reasonable to look beyond interest rates given how low they are and how further cuts without results would spook markets. And consider what Greenspan himself said: "We believe that because in the current environment the cost of taking out insurance against deflation is so low, that we can aggressively attack some of the underlying forces, which are essentially weak demand" for goods and services, Greenspan said.
“Insurance” probably means that commodity price rises will be tolerated for some time to come.
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