Deflation Pulling More Than Inflation

Deflation and inflation pressures have both been pulling at the markets. This explains the volatility we’ve been seeing. But so far, deflation has the upper hand.

That’s why the world’s biggest central banks have been stimulating their economies, buying bonds and keeping interest rates near zero. This is all a huge attempt to spur economic growth and boost inflation in order to get things rolling again.

The big challenge, however, is that this has not been a normal recovery. It’s been weak and lackluster, and totally dependent on the Fed and other central bank stimulus.

In other words, the rebound following the massive 2008 financial crisis has not been a healthy one. Here it is five years later and only about half of the losses incurred during that global recession have been recovered. That’s why the stimulus programs have become a crutch the feeble world needs.

IT’S ALL RELATIVE

Taking a quick look at what’s happening around the globe, you can understand why…

Despite buying over $2 trillion in bonds, the U.S. economy is barely growing by 2%, yet it’s one of the stronger developed nations. Nevertheless, deflationary pressures persist and banks still aren’t lending like they should.

Europe is in recession and it has been for over a year. Unemployment is a stubborn factor and here too, deflationary signs are keeping a lid on a possible recovery.

That’s essentially why Japan has embarked on the biggest stimulus plan ever. This comes after more than two decades of deflation, resulting in Abenomics. That is, the strongest most unprecedented efforts yet to boost economic growth, in large part because of an aging population bulge and not enough young workers to support them.

Meanwhile, China’s economy is slowing down and that spooks the rest of the world because China has been the global locomotive. There are also concerns the Chinese real estate bubble is about to burst.

But China’s economic growth is still among the world’s highest at 7.7%. Plus, stories of China’s collapse have come and gone over the decades, but they haven’t panned out. On the contrary, China has been consolidating its power.

WATCHING & WAITING

So the world watches, essentially on standby, waiting to see if the global economy can pull it off or not. And that’s where the markets will help provide direction…

The bottom line for gold is uncertainty. It continues to be the driving force because just about anything is possible.

Nothing has really changed since many threw in the towel on gold’s 12 year old bull market. Do you really think the financial problems have gone away? Is the debt not a problem anymore, even though it continues to climb to considerable heights?

Do you really think the Fed will end its money creation smoothly?... Will Japan?... Will the ECB? These are the big unknowns and they’re unlikely to end well.

SCRAMBLE TO BUY PHYSICAL

With this backdrop, many feel that gold’s steep decline was manipulated, and almost assuredly violations occurred. But one thing is certain, the huge demand to buy gold during the drop has been impressive and very telling for the future.

Large interests jumped in to buy gold at the cheaper price. Demand soared in Russia and India, while Asian central banks’ demand hit a record. In India, gold purchases were so strong, the Finance Minister complained that India’s hunger for gold was widening the trade deficit.

As Eric Sprott of Sprott Asset Management explains… the gold market hasn’t changed its supply fundamentals in 12 years. But since 2000, we’ve had much more demand... This has come from central bankers becoming net buyers, to a fourfold growth in annual gold coin sales in the U.S. and Canada, to China’s consumption quadrupling, while India’s consumption has grown by 30%. In other words, the fundamentals remain bullish.

That’s why we continue to recommend accumulating, at least a small position in gold during these seasonally weak Summer months.

Gold is our insurance against financial bubbles and crashes. Many say the deflationary pressures that have taken hold are not a good environment for a rising gold price.  This, in part, is true. Gold generally tends to rise during inflationary times. But there’s just too much uncertainty in the world today to ignore gold.

THE DOWNSIDE LOOK

Considering June tends to be the worst month for gold, when more gold bottoms have taken place, gold may have already reached a bottom area.

For now, gold is still very weak below $1320 and it’s very oversold (see Chart 1). Normally, this would be a bottoming sign, but if the $1200 level is clearly broken, we could see gold hit the $1000 area in a worst case scenario.

The bottom line is... the time of truth will be seen in the months just ahead. We’re most likely looking over a shallow valley, and if gold has any life to it, the upcoming intermediate rise will tell the story.