Gold and Deflation

By: David Morgan | Fri, Oct 17, 2008
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The question has been pouring in: "What happens to gold during a deflation? Of course, many of my readers are equally if not more interested in what happens to silver in a deflation as well.

The views on this topic vary. Some insist that both metals will do well under almost any economic conditions; some, like Bob Prechter, think neither gold nor silver will do well; and others, like Jim Sinclair and Bob Hoye, believe gold and gold alone will be the only thing left standing.

In all matters such as these, studying the past can be beneficial, but -- as you have read so many times before -- knowing the past is not a guarantee of future results. Personally, I like to let the market speak, and for many years I have forecast that a day would come when the price of the physical silver market would separate from the price "set" in New York or London. Alas, this is the case when looking at the retail market versus the commercial market.

In all fairness, the COMEX price is being used as predicted to capture profits by purchasing COMEX bars and selling 100-oz. silver bars. Jason Hommel of Silver Stock Report has stated:

"I own over 200,000 oz. of silver. I'm not selling out. I'm only selling 12,500 ounces, and I plan to buy more silver, cheaper, but in a different form, such as 1000 oz. bars.

"The price manipulation at the COMEX is so severe, that it has now created the profit incentive to create a free market in silver, through this auction, in order to arbitrage between the two markets, by buying in one, and selling to the other."

Readers might recall I wrote an article titled Silver Arbitrage, back in August.

Looking at the Opinions

Dr. Marc Faber: "Therefore, under both scenarios -- stagflation or deflationary recession -- gold, gold equities, and other precious metals should continue to perform better than financial assets." See article here.

Castrese Tipaldi wrote on, "I don't know if in the last week we saw the last gasp of those usual subjects trying to cap gold, and I don't know if we now have the very last possibility to get silver at a price so cheap." What makes this quote so interesting to me is he wrote this on April 20, 2004. See article here.

Steve Saville of the Speculative Investor writes, "The most important difference between then (the 1930s) and now is that gold and cash US Dollars were interchangeable during the early 1930s (the deflationary period) by virtue of the fact that the Dollar was defined as a fixed weight of gold. A typical effect of deflation is an increase in the purchasing power of cash. The fact that gold and cash were officially linked during the 1930s meant the deflation caused the purchasing power of gold to increase along with the purchasing power of cash. In other words, under the monetary system that was in effect during the 1930s gold was a hedge against deflation. Furthermore, under such a system the purchasing power of gold would decrease during periods of inflation; that is, when the dollar was defined in terms of gold, it would have made sense to shift investment away from gold during periods of inflation." See entire article here.

Adam Hamilton of Zeal LLC wrote, "Anything typically financed by debt is likely to see its prices plunge dramatically, like houses and cars, as the ongoing Great Bear bust continues to destroy the gross excesses of debt via higher long rates. Conversely, anything not typically 'paid for' with debt, including groceries and general living expenses, is almost certain to rise in the coming years. We are staring down a brutal environment of widespread inflation marked by various sectors witnessing falling prices as debt leverage implodes." See entire article here.

One of my favorites is from Dan Ascani, who wrote essentially about Professor Jastram's very long-term study on gold, and he essentially states that Jastram studied four pronounced price deflations taking place. In all four deflations, operational wealth in the form of gold appreciated handsomely. When one sees that just by holding gold for 13 years, from 1920 to 1933 operational wealth would have increased 2½ times, one realizes that gold can be a valuable hedge in deflation -- however, a poor one in inflation. See full article here.

Gary North states, "There are a few contrarians who think that deflation is coming: both monetary deflation and price deflation. As far as I know, there are only about a dozen of them who write newsletters or run websites. For some reason, most of the deflationists seem to think that gold's price will rise in a mass deflation. They do not warn their subscribers, 'Don't buy gold or silver!' If they did, they would have fewer subscribers." See entire article here.

Bob Prechter has written much on the topic; his overview of defining Inflation and Deflation can be found here. Further, Bob goes on and states that neither gold nor silver will do well in the deflation he had predicted for so long. Specifically, "I'll cut right to the chase: Unless you're about 80 years old, the United States economy is undergoing the worst downturn in living memory. Every measure of growth is grim. The world's most recognized stock index -- the Dow Jones Industrial Average -- is down 30% from its October 2007 all-time high.

"If ever there was a time for the 'Safe-Haven' lure of precious metals to surface -- now, yesterday, even seven months ago when the Bear Stearns' bailout launched the historic reshaping of Wall Street -- would have been it. Yet, from its March 17 record peak, GOLD prices have plummeted more than 20%." The entire article can be found here.

So we can read many varying views on what will happen to gold and/or silver under a deflation. Right now the financial marketplace is so unstable that it is difficult to put too much faith in anyone's opinion based upon such a short snapshot. Doug Casey has repeated often that the metals, and particularly gold, are a CRISIS HEDGE. I think this is the way to look at the situation. As I stated so many years ago in my Ten Rules of Silver Investing...

Rule # 1. When ALL else fails, there is silver.

"No one likes to be a prophet of doom, but the simple truth is that silver is the world's money of last resort. Should a severe economic collapse occur, leaving paper assets worthless, silver will be primary currency for purchase of goods and services. (Gold will be a store of major wealth, but will be priced too high for day-to-day use.) Thus, every investor should own some physical silver-and store a portion of it where it's accessible in an emergency."

When the editor of the book who published all ten rules called me back, he was "all over" this first rule and stated he had never really thought of silver's role before. Of course, he was quick to scoff at the idea of an economic collapse. I wonder what his thoughts on the subject are, currently.

It is an honor to be,



David Morgan

Author: David Morgan

David Morgan

David Morgan

David Morgan ( is a widely recognized analyst in the precious metals industry; he consults for hedge funds, high net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, the author of Get the Skinny on Silver Investing, and a featured speaker at investment conferences in North America, Europe and Asia. You can receive a free 30 day trial subscription here

Mr. Morgan has been published in The Herald Tribune, Futures magazine, The Gold Newsletter, Resource Consultants, Resource World, Investment Rarities, The Idaho Observer, Barron's, and The Wall Street Journal. Mr. Morgan does weekly Money, Metals and Mining Review for Kitco. He is hosted monthly on Financial Sense with Jim Puplava. Mr. Morgan was published in the Global Investor regarding Ten Rules of Silver Investing, which you can receive for free. His book Get the Skinny on Silver Investing is available on Amazon or the link provided.

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