This is the 9th in a series of 11 Posts that will be published on this Blog each Monday and Wednesday from November 3 to December 8. All 11 Posts will be filed under the Blog Category ‘Gold as an Investment’. For previously issued Posts in this Series click here. We hope you find this series of Posts useful.

While preparing this Post Series, I found two recently published books I think particularly helpful: The Goldwatcher: Demystifying Gold Investing, John Katz & Frank Holmes, 2008, John Wiley & Sons, Ltd. and Guide to Investing in Gold and Silver, Michael Maloney, 2008, Hachette Book Group USA. I highly recommend both. Where I have adopted ideas from those books, I have put them in italics. Page references to The Goldwatcher and Guide to Investing in Gold and Silver are denoted by (Goldwatcher – page xx) and (Guide – page xx) respectively. I also recommend www.theGoldwatcher.com Blog and www.GoldSilver.com, websites related to those respective books, to those of you interested in gold. Subsequently I found a 3rd recently published book, Buy Gold Now, Shayne McGuire, 2008, John Wiley & Sons, Ltd. Like the other two, Buy Gold Now is available at Amazon.com. Again, I recommend this book to you. Page references to Buy Gold Now are denoted by (Buy Gold Now – page xx).

General Conclusions

My reasoning behind my conclusions with respect to Gold as an Investment are set out in this Post Series. Succinctly, they can be summarized as follows:

1. Gold is ‘real money’, fiat currencies are not. This is because at any point in time gold satisfies all components of the definition of ‘money’ where as a ‘store of value’ that definition in part means that ‘money’ must be able to be reliably retrieved and ‘predictably useful’ when retrieved. Fiat currencies do not meet this test as ‘money’.

2. At any point in time the U.S. $ is a measure of the price of gold, not a measure of its value.

3. At any point in time Gold’s value needs to be thought about in the context of its then current and prospective purchasing power, having regard to prevailing and prospective macro-economic conditions.

4. Whether the future economic circumstance is inflationary or deflationary some gold is a good thing to own as a ‘safe haven holding’.

Conclusion #2 – Gold – in Inflationary Periods, in Deflationary Periods

1. Simplistically, in mainstream economics inflation means a rise in the general level of prices of goods and services over time. Deflation is the corollary, or a decrease in the general level of prices of goods and services over time.

2. The answer as to how commentators think gold can be expected to behave in inflationary times is an easy one. They to a person seem to believe that the price of gold measured in U.S.$ will always rise during periods of U.S. inflation. Having said that I have not found a single commentator that has focused on the supply/demand relationships in recent years of re-cycled gold, new jewelry, hedging/dehedging, and the psychology and needs of people in the context of jewelry supply/demand in times of inflation. If, as all commentators seem to believe, the price of gold measured in U.S.$ rises it seems to me the following things need to be considered in the context of gold’s price:

• In times of ‘normal inflation rates’, say under CPI increases of 5%, will the supply/demand relationship of scrap gold/jewelry sales continue at recent year levels and, if not, what will be the consequence to the price of gold?

• In times of ‘hyper-inflation’, say CPI increases over 15%, will scrap gold sales increase while jewelry sales decreases, new jewelry being a discretionary expenditure – and would that relationship become more out of balance the greater the rate of hyper-inflation? It strikes me that it might.

• Given (in particular) the hedging/dehedging supply/demand in recent years I don’t think it is certain the near-term demand for gold – except perhaps as a result of a flow of fiat currencies to gold as a safe-haven investment in societally turbulent and economically uncertain times – will significantly exceed supply (see Post #7 of this Series posted on this blog on November 24 that discusses gold supply/demand)?

3. Again, while the price of gold currently is measured in U.S.$, I believe at any given point in time it should be thought of in terms of its comparative ‘purchasing power’. It follows that inflation, be it comparatively minor in quantum or extreme, ought to – barring the supply/demand gold equation being thrown out of historic kilter by people selling more jewelry for scrap than they historically have done while concurrently buying less new jewelry (or some other combination of supply/demand factors) – continually have the effect of pushing the price of gold higher.

4. With respect to the behavior of gold in a deflationary or depressive economic climate, I find the following quote particularly interesting:

“Deflation raises unique fears. First, we know how to end inflation: Raise interest rates. There’s no limit to how high they can go, so there’s no doubt that at some point you can end inflation. But how do you end deflation, especially if your policy rate hits zero and you have exhausted the ability to further stimulate the economy by conventional means…? This is exactly what happen in Japan” (in 1990). Reported as said by former U.S. Fed Governor Meyer (Buy Gold Now – page 82).

5. “During deflationary periods, asset values fall due to lower earnings on assets. Jobs are lost, and those who remain employed are often forced to take wage cuts to allow companies to stay profitable. But debt remains unchanged (italics added). And since asset values decline, debt becomes a larger burden on the balance sheet and individuals’ net wealth falls” (Buy Gold Now – page 82). I have spent many hours reading and thinking about how gold will respond in a period of deflation or depression. I have found no statistical data that has enabled me to reach a definitive conclusion on this.

6. Some commentators state, without (as best I can tell) statistical evidence to back their conclusions, that gold will not perform well during times of deflation or depression – while other commentators take a polar position and state their belief that gold will perform well in a deflationary or depressive period. What I take the first group to be saying is that gold, denominated in U.S.$, may drop in price during such times. If this indeed is what they are representing they may well be correct. However, I think if that is their conclusion they are addressing gold in the wrong context. I see the second group to be focusing on the ‘purchasing power’ of gold which I think is the ‘right’ context in which to contemplate ‘Gold as an Investment’. I see gold as being about ‘comparative value’ or ‘purchasing power’. In that context, it seems to me the right question to ask is: ‘in a period of deflation or depression will gold hold its purchasing power better than will fiat currencies?’ I suspect the answer is that gold almost certainly will hold its purchasing power at least as well as will fiat currencies, and likely will hold its purchasing power better than fiat currencies.

7. I suspect that the answer to ‘how much better’ will gold hold its purchasing power than fiat currencies is a function of at least the following subjective and non-subjective things:

• First, from a subjective perspective, which perspective is continuously influenced by local, national, and world events, the ‘confidence level’ of people at any given point in time – which ‘confidence level’ is reflected in people’s willingness to borrow, lend, and spend.

• Second, from a subjective perspective, the level of understanding and confidence level of people with respect to a fiat currency system generally. If one assumes that people tend to focus more on what is affecting them when something bad happens to them – i.e. a reduction in their standard of living in a deflationary or depressive time – I do not consider this a trite observation. If people broadly begin to develop an understanding of the fiat currency system we live with daily, their confidence in it may erode quickly. If this occurred I intuitively would see a ‘flight to gold’ which ought to push gold’s price higher. Concurrently, I would expect gold to increase in its comparative purchasing power.

• Third, in a period of deflation or depression, people across the world – given the current extent of economic globalization – would see their standards of living erode. This would not make them happy. In turn, this well might promote fractious behavior at local, national and international levels – leading to (among other things) supply service disruptions, escalating crime rates (witness New Orleans during Katrina), escalated terrorism, and perhaps increased world military activity. None of this would be positive, except that it seems to me it likely would be positive to the price of gold and gold’s purchasing power – likely as a result of a ‘flight to gold’ as a ‘safe haven investment’.

• Fourth, I suspect that in a deflationary or depressive environment the scrap gold/jewelry supply/demand equation again might change and influence the price (and hence ‘value in exchange’ of gold) as more scrap gold may come on the market than otherwise would have been the case. I have no empirical or other evidence to support this.

Concluding Comments

1. So where does all this leave me. Essentially thinking that in an inflationary environment the price of gold is more likely to rise than it is to fall, and that in a deflationary environment gold is more likely to retain its purchasing power more predictably than will fiat currencies. Hence my conclusion stated at the beginning of each Post in this Post Series that: ‘Whether the future economic circumstance is inflationary or deflationary some gold is a good thing to own as a ‘safe haven holding’.

2. If one accepts that Gold’s ‘value’ as ‘real money’ it seems to me that it is a wise thing to hold some physical gold as a ‘safe haven holding’. That is not to say that based on my thinking to date I am recommending a physical gold holding to the exclusion of owning one or more fiat currencies, equities and other investments. I have simply concluded that I think ‘some physical gold is a good thing to own as a safe haven holding’.

For previously issued Posts in this Series click here.

The views expressed in this Post are those of the author. They are offered to readers for information and general guidance only. They are neither intended to, nor should be taken to, constitute economic or investment advice. See Legal Disclaimer.

© 2008, Stock Research DD Inc., all rights reserved.

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