The ‘gold is bad in a deflationary environment’ myth

Ronald Stoeferle
Mineweb
Friday, July 10, 2009

The fact that gold is an excellent hedge against inflation should have established itself more or less as common knowledge. Investors use it to protect themselves against the erosion of their purchase power. However, the development of gold in a deeply deflationary environment has not been subjected to much analysis. The only relevant period that would lend itself to comparison is the Great Depression of the 1930s. However, those were the times of the gold standard, i.e. the gold price was fixed.

By 1934 the industrial production had fallen by 50%, and the unemployment rate was up at 30%. Governments around the world had to step up their spending drastically and stop the price slump. The Western currencies were gradually depreciating. However, the economic situation the USA was in in the 1930s could not be compared to the current scenario. Whereas the country used to be the big creditor nation, it has now turned into the single biggest debtor.

We can try to establish how the gold price would have developed by analysing the subsequent depreciation of the currencies after abandoning the gold standard. Great Britain depreciated the pound in September 1931 by 52%, and the USA followed by appreciating gold by about 60% in 1933 (from USD 20.67 to USD 35/ounce).

This means that enormous buying pressure had been building up during the period of the gold standard. When in 1933 the gold reserves had fallen to the minimum requirements, President Roosevelt instructed that all private gold holdings be confiscated. All gold exports were discontinued, and the dollar depreciated massively against gold.

Gold shares, on the other hand, were going from strength to strength. The development of the most important gold producer, Homestake Mining, can serve as reasonably approximate series for comparison. From 1929 to end-1935, the share price increased from USD 75 to above USD 500, and dividends totalled USD 130. However, the strongest increase only happened after the period of deflation (1929-1932) and as the sudden onset of inflation (1932-1935). We would envisage a similar scenario for the future. The stability of the gold shares during the general crash on the equity markets was probably due to the fact that the gold price was fixed and the revenues of the producers were therefore stable, whereas all other commodity prices collapsed.

Other gold mining shares outperformed the market at impressive degrees as well. Dome increased from 1929 to 1936 by almost 1,100%, and Battlemountain shares soared by 1,200%. That said, the performance came also on the back of substantially increased resources, higher production, and improved margins.

Gold AND silver have always been the only two metals of monetary importance and also have a highly positive correlation. Therefore it should be possible to resort to the price of silver – which was not fixed – as well for comparison’s sake. In 1931 and 1932 shares fell by 42% and 51%, respectively, whereas silver fell by 8% in 1931 and by 16% in 1932. Gold should have outperformed silver in this environment, given that silver is much more integral to industrial production and gold is influenced by demand that is contingent on the economic cycle to a much lower degree.

Seeing that in periods of deflation, cash outperforms all other asset classes, this should also apply to gold. Especially in an environment of expansive central bank policy, gold is surely a currency of highest quality and should therefore outperform the market. This means that gold seems to be an excellent investment also in times of deflation.

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9 Responses to “The ‘gold is bad in a deflationary environment’ myth”

1. The ‘gold is bad in a deflationary environment’ myth « Truth11 Says:
   July 10th, 2009 at 4:15 am

   [...] Read more… [...]

2. Stuck in the Matrix Says:
   July 10th, 2009 at 5:28 am

   Ill take Gold and Silver over toilet paper any day!

   

   AlteredStated Reply:
   July 10th, 2009 at 8:27 am

   That’s why I have been stock piling gold,silver,cases of whiskey,coffee beans,soap,toilet paper,tobacco,pure filtered drinking water,food,first aid kit,vitamins,and heirloom seeds. Not to mention my guns and ammo. I should be ok when all this happens. FYI, it’s best to devise an escape plan incase you can’t hold up on your own home.

   

   CivilianResistance Reply:
   July 10th, 2009 at 5:29 pm

   i do believe in being prepared and i do embrace the survivalistic attitude but what we should be embracing now is a patriotic attitude. Instead of hoarding gold and goods we should be hoarding people into town meetings and discussing our impending doom. We should be all forming militias across the country to send a clear and straight forth message to the Fed. We are ready, do not FUK with us.

3. amicus curiae Says:
   July 10th, 2009 at 5:58 am

   if you were going to buy it should have been over 6mths ago. and why bother, if there is no food or fuel available gold or money is useless. and besides you think the bankrupt government thats busy selling GOLD OFF just now, is Not going to requisition yours??
   if you have money to buy gold..then paying all debts off would be far wiser, and investing in security food and very small fuel efficient transport etc would be smarter. If all the grids go down, gold wont cook your dinner, a gas bottle and camp stove will, its how you may need to plan. not that it will magically all be ok soon…delusional, and encouraged. and wrong.

   

   CivilianResistance Reply:
   July 10th, 2009 at 5:33 pm

   Sometimes i wonder that the government is manipulating the Gold and Silver prices in the US. i have noticed silver and gold have been dropping steadily over the past month and there is no real change in the stock markets. The prices dont make sense considering the present circumstances in the markets…

4. savedman Says:
   July 10th, 2009 at 7:05 am

   In the soon coming kingdom of antichrist, after the true church of the Lord Jesus Christ is caught up to heaven (1Thessalonians 4:13-18), gold will be absolutely worthless. You need to read and believe Revelation ch.6-19, when there will be a world-wide drought that is going to last 3 1/2 years. Read James ch.5, where God has told you in advance that gold will be worthless during that time. You can’t eat gold, but there will be widespread cannibalism. You say,”I don’t believe it,” if you miss the catching up of the body of Christ unfortunately you will believe. It will be too late for you to repent of your sin and unbelief then, for God will send you a “strong delusion that you might believe a lie, that you all might be damned, because you received not the love of the truth that you might be saved.”-2 Thessalonians 2.
   Sinner, your time to repent is today, while the Lord Jesus Christ says, “Come unto me all ye that labour and are heavy laden and I will give you rest. Take my yoke upon you, for I am meek and lowly in heart, and ye shall find REST UNTO YOUR SOULS.”-Matthew 11:28-30; Romans 10:9-13; 2Corinthians 6:1,2.

5. X Says:
   July 10th, 2009 at 8:54 am

   Many thanks to everyone who voted in my U.S. dollar index poll. The results have been posted at http://houseofexile.blogspot.com

6. Geolibertarian Says:
   July 10th, 2009 at 9:24 am

   There’s no question that gold itself is a good private investment.

   But a gold *standard* would be a deflationary “cure” that’s even worse than the inflationary “disease” that the economic snake-oil salesmen who peddle it presume to save us all from:

   http://propagandamatrix.com/fo.....ml#msg6994