Disinflation: The elephant in the room (sitting on the gold price)
“The [U.S. Future Inflation Gauge] turned down early last year, and by summertime it was clear that a fresh inflation cycle downturn was taking hold. That inflation cycle downturn wasn’t obvious to the Fed, which hiked rates in September and December. Despite being forced to pivot hard early this year, Fed Chairman Powell just this month called low inflation ‘transitory.’ Bond markets were also caught flat-footed, with the 10-year treasury yield around 3¼% in October, and again in November, as inflation expectations remained high through last fall. This is the elephant in the room crushing bond yields. It’s really about the inflation cycle.”
USAGOLD note: Investors often ask why the gold price has been stuck at the $1300 level for so long with the amount of danger present in financial markets and the economy. Why didn’t gold rocket higher when trade negotiations between the United States and China broke down? Why didn’t gold react positively to the Fed’s transition from rate hikes to a rate pause? Why hasn’t gold responded to the upside with all the political turmoil in the nation’s capital? Etc. . .
The answer lies in a term rarely featured in gold market discussion – disinflation. At present, it is the elephant in the room, as ERCI describes it above. Just as it crushes bond yields, it sits on the price of gold – at least for now. But that could all change at a moment’s notice.
The problem with disinflation is that occasionally it slips the gate. General malaise gives way to a deeper crisis. Some of you who were clients during the 2008 financial crisis probably remember that gold was slow to react. In 2006-2007, it was bumping along in a narrow range on either side of the $650 mark in a disinflationary environment very similar to the one we are experiencing now. (Please see chart below.)
Then, in late 2007, the roof began to come down on financial institutions – Lehman Brothers, Bear Stearns, IndyMac, Washington Mutual, Fannie Mae, Merrill Lynch, just to name a few of the big-name casualties. Only then, as investors moved aggressively to gold for its safe haven and store of value attributes, did the price begin to move higher with some authority. In 2008 it reached $1000 per ounce. By late 2009, gold had kicked into overdrive. It began a rapid climb that culminated at a record high of over $1900 per ounce. The whole run – from $650 to over $1900 – occurred during a period when disinflation dominated the financial landscape.
During disinflationary periods like the one we are experiencing now, gold owners must practice patience keeping in mind the real reason for the investment – to act as a safe haven and store of value if the wheels come off elsewhere in the portfolio. Gold is wealth insurance first and a speculative investment second. As the old saying goes, you do not need gold until you need it, and then you might need it more than you thought.
Final note: Though disinflation dominates the markets today, that might not always be the case. With the announcement this past week of tariffs on Mexico, the Trump administration has now levied tariffs on America’s two largest importers accounting for almost one-third of U.S. imports. Some economists think that the tariffs could become a source of consumer price inflation in the months ahead (not to mention the potential for a myriad of other unforeseen and unintended consequences). In fact, several large retailers including Walgreens, the Dollar Store and Costco (among others) have already warned of higher prices in the not-too-distant future. Those warnings came before the recent announcement of tariffs on Mexican imports.
If the dominant economic paradigm shifts to inflation, gold will remain an important choice for prudent investors looking to hedge uncertainty. As I wrote many years ago in The ABCs of Gold Investing – How To Protect and Build Your Wealth With Gold, “Inflation, deflation, disinflation, stagflation, and hyperinflation—it matters not. Gold protects against any or all and no matter in which order they arrive. I is for the Inflation-Deflation debate—Buy gold and let others worry about what’s next for the world economy.”
–– Michael J. Kosares