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Thursday, September 23, 2010

Am I Deaf? Gold Up... Inflation Down Edition

Mark Gilbert over at Bloomberg in an article titled Investors are 'Deaf to the Screams of Gold, Cotton':

If you told Rip van Bondtrader that gold had risen to a record during his decade-long slumber, he’d want to know what the inflation outlook was, and how badly he’d gotten killed on his bond investments. He’d be astonished to discover that he’s made a total return of about 8 percent since January on Treasuries maturing in more than a year.

“What makes the gold story so interesting is that bullion has so many different correlations -- with inflation, with the dollar, with interest rates, with political uncertainty,” according to David Rosenberg, chief economist at Gluskin Sheff & Associates in Toronto. “This year, for example, gold has shifted from being a commodity toward being a currency -- the classic role as a monetary metal that is no government’s liability.”

Gold may be screaming more about a general mistrust of the securities markets than about the prospect of rising prices. Rip, though, would be similarly horrified to see cotton trading near a 15-year high at more than $1 a pound, or wheat surging more than 30 percent in the past year, helping to drive a UBS/Bloomberg index of food prices up by about 28 percent. The official figures say inflation is dormant; the phrase “lies, damned lies and statistics” springs to mind.



While his points are interesting, I don't see the paradox that he does (i.e. call me deaf).

Why?
  • Tons of liquidity
  • A slow(ing) economy
  • A deleveraging economy
  • Very few remaining places for that liquidity to go
Mark and many others believe this liquidity should have / will lead to an increase in headline inflation. While I think it can (and hopefully will) lead to inflation, it hasn’t for simple reasons. In the actual economy, there has been no excess demand (or liquidity) plowing into goods, services, investments (in fact capacity far outweighs demand) or for hiring (price of labor is a large feed to price levels in the U.S.).

As for the “conundrum” of commodities (including gold) and Treasuries both outperforming, look no further than the above simple reasons... the liquidity in the market has not being used to buy things for actual use / investment. Combined with the fear of putting the money to risk in financial assets (i.e. stocks) and the inability to buy a levered asset (i.e. real estate) and there remains very few places for it to go.


Summary

Money is not going to:
  • The economy
  • Financial assets
  • Levered assets

And is going to:

  • Commodities (including gold)
  • Paying down debt (which reduces supply of debt outstanding – a benefit similar to demand for debt)
  • Fixed income (including Treasuries)
  • Cash
For more, please search for gold or Treasuries in the EconomPic search for details of why I have been bullish on both since the inception of this blog back in early 2008 (also please see Investing in a Low Return Environment for more detail of my thoughts on investing in this market environment more broadly).

I am less bullish on both as they have both done quite well on both an absolute and relative basis, I am in not a bear on either now.

Source: BLS