Will Inflation Or Deflation Cause Precious Metals To Rise?

This past week, noted bond fund manager Jeffrey Gundlach reiterated his perspective that gold will see $1400 in 2015.  How many more times do we have to see these types of predictions made year after year fall by the wayside?  While this will likely get all the gold bugs excited, and give them hope one more time, unfortunately, this prediction is not based upon reality, as the long term correction has not yet completed, even if we see a rally into the end of May.  So, while we certainly can see the gold price exceed 1300 over the coming month, do not be fooled into believing that the final lows have been seen. 

Supposedly, Gundlach’s perspective is based upon the negative interest rates in Europe, and his belief that rates in the US will not go up.  Moreover, Peter Schiff was interviewed recently and he noted that “what is holding gold back  . . . is the idea that the Fed is going to be raising interest rates.”

But, wait a second.  For years, all I have been hearing is that a rise in interest rates evidences inflation, which is the driver of gold.  So, isn’t the common theme that gold prices will go up when rates go up, because that is supposedly a signal of inflation?  Yet these two prominent pundits are now suggesting that low interest rates are needed to cause gold to rally? And, is not a drop in rates commonly viewed as being associated with periods of deflation? So, is it deflation which will cause gold to rally or is it inflation?  

The answer is that gold price movement is not based upon either if you look honestly at the history of gold’s movements.  Let's take a look at the 2007-2009 time frame, which evidenced the most recent period of deflation in our markets, and see if we can glean anything from the metals action in relation to deflationary market pressures.

We all know that the S&P500 topped in October of 2007 and began an estimated 300 point decline into March of 2008, and then we saw a corrective bounce in the equities for a couple of months. During that same period of time, the metals continued to rally. So, here we have “evidence” of precious metals supposedly rising during a period of deflation.

But, when we then look towards the May 2008 - March 2009 severe decline in the equity market, we witnessed the metals also experienced significant declines within that time period.  In fact, gold lost a little more than 30% (yet, rallied again, thereafter). So, when one is presented with these facts, does it make sense that the metals are surely going to rise during periods of deflation and/or low interest rates?

I seriously hope you can all put aside your personal biases towards precious metals, and recognize that they are not necessarily going to rise during periods of deflation.  Oddly enough, metals can rally during periods of deflation, and they can fall during periods of deflation.  And, the same applies to periods of inflation as well.  I know you are likely thinking to yourselves, "Avi has really lost it this time." But, in all honesty, how can you come to terms with the reality of how they reacted during the 2008 broad equity market carnage, which was clearly a deflationary event?  Did they act as the supposed “safe haven” during the strongest period of deflationary pressures experienced since the Great Depression?

My point is that it is not deflation or inflation which will drive the metals.  Rather, it is purely mass sentiment which will drive the price metals.  And, that sentiment can be very different during times of inflation or deflation.    When sentiment towards the metals are near a pattern low, and we are heading into a fear-driven event, that is the optimal time to use the metals for “protection.” And, if you take it another step further, you will recognize that there are times within a deflationary period where metals would serve as protection for a period of time, as well as times within inflationary periods where they would. In fact, would this not explain why the metals served as seeming "protection" during certain parts of the decline in 2007-2009 and not in others?

So, I would urge anyone reading prominent pundit “expectations” about precious metals to test them against the reality of their price action history.  And, if someone suggests to you that it is a matter of interest rate sensitivity or an inflation/deflation argument, you need to think long and hard about if the price history of metals supports their proposition.  I suggest that it will not.  Rather, metals are purely a sentiment trade, and unless you understand how sentiment drives metals, you will more than likely be caught on the wrong side of a popular fundamental argument whether you are in the inflationary or deflationary camp.  In fact, both camps are wrong as to the primary driver of metals, as we clearly witnessed in 2007-2009.

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See chart illustrating the wave count on the gold at https://www.elliottwavetrader.net/scharts/Chart-on-GLD-daily-20150510712.html.