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Gold During Inflation, Deflation and Chaos

By Doug Casey        
December 18, 2002

New production and industrial consumption are relatively unimportant determinants of gold's price, even though many pundits make much of them. Unlike any other metal, most of the gold that has ever been mined is sitting in the vaults of central banks and the safe deposit boxes of investors. It's not being "used" for anything: its raison d'etre is simply to be an asset. What determines the price of gold therefore, is the desire of its owners to own it or to liquidate it and own something else.

And that, in turn, depends on the inflation rate (how fast paper money is losing value), the chances of a credit collapse (the likelihood of deflation wiping out paper assets), and the general level of confidence in the future.

The most likely alternatives are much higher inflation or uncontrolled deflation. The creation of more currency and credit are the only ways for the government to fund its deficits, transfer programs, bailouts and other disasters waiting in the wings. And if we have a financial accident, that in itself will be an excuse for the authorities to expand the money supply further. High inflation rates would send gold skyrocketing, much as they did in the 70s.

Yet serious deflation would likely also cause the price of gold to explode. It is the only financial asset that's not simultaneously someone else's liability. And if we have deflation this time around, it won't be possible to buy government paper and wait in safety, as was possible in the 30s, for at least two reasons.

First, a deflation would set off all kinds of spending programs and bailouts. The USG would go from being a questionable risk to a bad risk as it was forced to borrow on a huge scale to finance emergency spending, much of which is already mandated by law, while tax revenues were falling. Second, a deflation would almost certainly result in calls to reinflate as rapidly as possible-a course of action unlikely to inspire confidence in the dollar. Gold would soar in a serious deflation.

Gold is a big winner in either scenario; it is a matchless crisis hedge. It's the only financial asset that's completely invisible and private. There are no social security numbers stamped on gold coins, and they leave no paper trail when they change hands. Unlike real estate, for instance, a government cannot easily find gold to tax or confiscate. Unlike stocks, gold doesn't represent a value that can be dissipated or mismanaged. Unlike bonds, gold cannot default. And unlike currency, gold cannot be inflated away.

There are not many low-risk places for wealth to hide today. But plenty of wealth exists and, as the world's greatest coward, capital will look for a place to hide when things get scary. Gold is the perfect financial asset in times of uncertainty.

This is not the 70s, when gold was a great speculation. You should view gold as a vehicle for savings and for conservation of capital. When you save, you're not expecting to hit a long-ball home run; you are simply trying to put away assets for future consumption. You want safety. You do not want to have to trust a government, a banker or the management of some corporation. You want the asset itself, something you can hold in your own hands.

Gold is not a trading vehicle; it's a core holding. Buy it as privately as possible, put it away, and forget about it.



I was reading over an article in Forbes, dated July 30. I'm often months behind on periodicals, as much by intention as happenstance. The reason for that is twofold: First, I can see, with 20-20 hindsight, what information is worth knowing and what isn't, so I save a lot of time reading. Second, it gives me perspective on the value of various people's opinions; I don't have to guess how much of what they thought was right or wrong.

In any event, Forbe's reporter took every opportunity to make snide comments about gold and it's buyers. Among his opinions was that "the great gold rally of 2002 may already have run its course" and "The more paranoid among us can buy some Krugerrands and bury them in the backyard as a hedge against the complete collapse of the financial system." Along with a passing mention of Goldmember, "a gold-obsessed villain," in the recent movie of that name. Perhaps this last is understandable, in that it's well known that the gold-obsessed (unlike the dollar-obsessed, or the stock-obsessed) all tend to be villains. Clearly the reporter, and his editors, don't believe the recent strength in gold will amount to anything. That's good.

One thing you should keep in mind, which I've often emphasized, is that the big percentage gains in a bull market occur at its beginning, not at its end. An example. Fidelity Select Gold (FSAGX) had its best year in 1993, the first year of the last bull market for gold stocks, when it was up 78.7%. Its worst year was 1997, after the 1996 peak, declining 39.4%. It's a very bad idea to be late to the party, either coming or going, especially when you're dealing in volatile speculations.

The tail end of a bull market is typically wild, and covered with press ink. But the big percentage gains are made at the beginning, when few even know it's underway, and those that do either pooh-pooh it, or are too scared to join it. That's especially perverse, in that not only are the biggest percentage gains made at the beginning of a bull market, but it's where the risks are lowest. It' a paradox, like so many things in the world. By the time Forbes (and they're far from the worst offender in the press) is running cover stories on gold, the way they all did on the Internet stocks, it's going to be time to play different game.