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A Once–in-a-Century Deflationary Setup?

Tuesday October 08, 2013 14:47

Many if not most gold bugs and especially those who believe a hyperinflationary outcome is inevitable, dismiss Robert Prechter’s predictions.  True, he has been a mile off on his predictions about gold, but he has been quite good on picking major turns in stocks and bonds.  Moreover, when it comes to the “real” price of gold, Prechter himself agreed with my view that it would rise vis-à-vis everything other than the dollar. So even if Prechter is right and gold falls temporarily below recent lows in nominal terms, he expects a basket of commodities, stocks and bonds to fall further than gold. In Prechter’s view, the dollar is the safest place to park wealth because he thinks it will gain value. But he also agrees that gold is money. Because of that fact plus the fact that gold has not risen as much as all those other markets, he thinks its decline will be less than everything else. In other words, with the next major deflationary credit implosion about to begin, we can expect the real value of gold to rise. And as an investor in gold mining stocks, that is a very agreeable view for me because it means gold mining companies should do well as their margins improve.

We saw this dynamic in play following the Lehman Brothers failure in 2008-09.

The chart directly above shows how the “real” price of gold exploded to much higher levels when the Lehman Brothers deflationary event led to plunging commodity and stock prices. As you can see the trend in the real price of gold was increasing until it broke down around August 2012.  The two charts on the right show the aggregate effect of changes in the real price of gold and the earnings of seven major gold producers that I track on a regular basis.  As the real price of gold has broken down, so have earnings of major gold mining companies.

Of course, not all of the decline can be blamed on the real price of gold.  Many of the majors are now seeing earnings plummet because they took on very large, low-grade project that required huge capital costs. One of the reasons their earnings have declined so much is because some of those major projects are now being written down given lower real gold prices. A more cautious management posture may have kept the decline from being as great as it has been for the earnings of these companies. But there is no denying that the “real” price of gold plays a major role in the profitability of the gold mining sector.

But let’s get back to Prechter’s view that we are poised for the next major leg down in the equity, bond and commodity markets.  Following is a chart he displayed in the September issue of “The Elliott Wave Theorist.”

Regarding the charts above, here is what Robert Prechter said in his latest monthly issue: “Here late in the summer of 2013, stocks, bonds and commodities are poised in the same manner they were late in the summer of 1929. At that time, stocks were rising to a new all-time high, bonds had peaked a year earlier, and commodities were trading at lower prices after having topped out several years before. The aftermath was a crash in all three markets: stocks, bonds and commodities. In 1929, the DJIA topped on September 3, and the Dow Utilities peaked on September 20. This year, the DJIA has topped so far on August 5, while the NASDAQ just made a new high on September 10. It’s a similar development the same time of year.”

Copper Says It’s Over

With reference to the chart on your right, another interesting comment from the September 12, 2013 issue of The Elliott Wave Theorist talked about how copper is pronouncing the end of this asset inflation cycle: “There is an old saying, ‘Every bull market has a copper top.’ Over the past decade, no fewer than three giant investment manias peaked with a copper top: housing in 2006, commodities in 2008 and precious metals in 2011. We think copper is now in a major bear market. Thus, housing, commodities and metals remain in bear markets, too. And the economy on a long term basis is about to accelerate downhill along with them.”

I have no problem believing Prechter may be right on all fronts because the underlying market dynamic is deflationary. The powers that be are having a very difficult time in inflating the debt away. Failing to understand that the reason the depression lasted through the whole 1930s decade was because fiscal and monetary policy could not work. Because in fact the problem was caused by fiscal and monetary policy that kept markets from operating freely and efficiently as they always do absent manipulation by politicians. The fact of the matter is printing money and deficit spending dig us into a deeper debt situation because late in a credit expansion as we are in now, debt continues to grow more rapidly than does income (GDP).

To receive free weekly samples of J. Taylor’s Gold & Technology Stocks, as well as other publications such as Resource Opportunities and Hard Rock Analyst Journal, please visit: http://www.newsstandexpress.com/s/Home.asp

By Jay Taylor

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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