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One of the
most common questions that I'm asked goes something like this: "If the
deflationary long-term cycle is in its 'hard down' phase until 2014, why
should we expect gold' value to rise? Shouldn't we instead expect to see a
rising dollar along with a falling gold price?"
That's a good
question and on the surface it makes sense. The dollar after all has
historically been inversely correlated with gold, and since the currency
tends to benefit from deflation it stands to reason that a rising dollar
during "runaway" deflation would lead to lower gold prices. The
answer is more complex than this, however.
Gold tends to
outperform other assets at the two extreme ends of the 60-year economic
"long wave" cycle, namely during the runaway inflation and runaway
deflation parts of the cycle which occur approximately every 20-30 years. The
last time we saw a strong performance in the yellow metal was the late 1970s
when the inflationary cycle was peaking. The latest gold bull market began
roughly 10 years ago with the start of the final deflationary portion of the
60-year cycle. The closer we get to the final bottom of this cycle (due in
late 2014), the more upside pressure there should theoretically be on the
gold price. There are of course some basic some fundamental reasons for this.
 
The simplest
way of understanding why gold directly benefits from extreme deflation (as
opposed to mild deflation) is because it results in not only a flight to
quality, but also in widespread fear and uncertainty. The flight to quality
may explain why there is a tendency for U.S. government bonds to benefit from
deflation along with the dollar (when there is panic). Gold benefits not so
much from panic as from the long-term fear and uncertainty generated by the
ravages of deflation. Consider the last decade: a tech stock bubble bust
followed by a real estate debacle and credit crisis followed by economic
trouble in the euro zone and a potential recession in China. All of these
factors have conspired to cause investors to re-evaluate their savings and
investment strategies, making gold a clear beneficiary of this fear.
The last
several years have caused millions to question one of the most basic of
economic assumptions Americans have always made, namely that real estate was
the single best long-term investment you could make. Clearly that assumption
has been turned on its head and its proven failure caused many Americans to
turn to gold as a long-term investment.
Another way
of understanding why gold benefits from runaway deflation is to look at the
tendency governments and central banks have of trying to inflate their way
out of a financial crisis. For a time, this monetary inflation results in
rising asset prices and gold is one of the assets that benefits from it.
Eventually, however, the monetary inflation subsides as governments and
central banks begin quarreling over how to address the underlying deflation.
Some governments choose the austerity route, which is the surest way of letting
deflation run its course. Other governments (namely the United States) prefer
the stimulus route. But additional monetary stimulus only goes so far, as
we're finding out now. Despite the confusion these conflicting monetary
policies breed, gold continues to increase in value while the deflationary
cycle is still raging.
Let's look at
just one recent example of how deflationary undercurrents are still ravaging
the global economy and threatening to get out of control. Europe's
fourth-largest economy is on the brink of having to ask for a bailout. Spain
has just announced that retail sales for the country fell 11 percent in
September compared to a year ago. The country also released data on Tuesday
which further highlighted the extent of the damage brought on by its debt
crisis.
Spanish Prime
Minister Mariano Rajoy was elected just under a
year ago on an austerity ticket. His government has signed off on a
belt-tightening program worth over 60 billion euros through to the end 2014
to cut the country's deficit. But as Reuters observed, "the spending
cuts have dented investment while tax rises have hit consumers' pockets and
driven prices higher."
Along those
lines, ECB President Mario Draghi recently
announced the ECB would do "whatever it takes" to end the euro zone
debt crisis. That announcement coincided with the launching of a $650 billion
bailout fund in early October. But while the European Stability Mechanism, or
"bazooka," as it has been nicknamed, is meant to help struggling
European countries by extending loans or making bond purchases, its
implementation is a far cry from what has been promised. Since EU member
countries have been slow to provide start-up reserves, the fund will only
have about $100 billion by 2014, according to reports. As one source pointed
out, "That suggests that troubled countries like Spain may not get much
help in the meantime."
Think of
austerity as oxygen deprivation for a hospital patient who's in desperate
need of air. By refusing the life giving oxygen to a dying patient, both Rajoy and Draghi are exposing
Spain to the ravages of the 120-year cycle decline as we head closer to the
fateful year 2014. While this won't bode well for the euro zone economy or
the people of those countries, it will benefit the gold price as investors
look for a financial safe haven in the coming storm in 2013-2014.
Clif Droke
2014: America’s Date With Destiny
Take a journey into the future with me as we
discover what the future may unfold in the fateful period leading up to
– and following – the 120-year cycle bottom in late 2014.
Picking up where I left off in my previous
work, The Stock Market Cycles, I expand on the Kress cycle narrative and
explain how the 120-year Mega cycle influences the market, the economy and
other aspects of American life and culture. My latest book, 2014:
America’s Date With Destiny, examines the most vital issues facing
America and the global economy in the 2-3 years ahead.
The new book explains that the credit crisis
of 2008 was merely the prelude in an intensifying global credit storm. If the
basis for my prediction continue true to form – namely the long-term
Kress cycles – the worst part of the crisis lies ahead in the years
2013-2014. The book is now available for sale at:
http://www.clifdroke.com/books/destiny.html
Order today to receive your autographed copy
and a FREE 1-month trial subscription to the Gold & Silver Stock Report
newsletter. Published twice each week, the newsletter uses the method
described in this book for making profitable trades among the actively traded
gold mining shares.
Clif Droke
is the editor of the three times weekly Momentum Strategies Report
newsletter, published since 1997, which covers U.S. equity markets and
various stock sectors, natural resources, money supply and bank credit
trends, the dollar and the U.S. economy. The forecasts are made using a
unique proprietary blend of analytical methods involving cycles, internal
momentum and moving average systems, as well as investor sentiment. He is
also the author of numerous books, including most recently “2014:
America’s Date With Destiny.” For
more information visit www.clifdroke.com
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