Deflation gold relationship
The deflation gold relationship
is one that sparks heated debate, especially among
gold bugs.
On March 14, 2008, financial analyst Robert Prechter
called for a top in gold and silver prices. The next
trading day, March 17, silver topped. Soon after,
gold began a precipitous decline.
In that March 2008 Elliott Wave Theorist, Prechter
discussed in detail the deflation gold relationship.
Many gold bugs say that because gold was a good investment
during the Great Depression, it is a "deflation hedge."
Prechter addresses this topic in Conquer
the Crash (chapter 22). At the time, government
fixed gold's price, so it didn't go up or down relative
to dollars. Gold was a haven then because its price
was equal to the dollar by law. Gold's price was fixed
while everything else was crashing in price during
the period of deflation. Gold bugs make an argument
for a deflation gold relationship by claiming that
gold would have gone up during that period had it
not been fixed, but the crashing dollar prices for
all other things suggest that in a free market gold,
too, would have fallen. It would have fallen, however,
from a higher level given the inflation of 1914-1929
following the creation of the Fed. So gold became
worth more in dollar terms than it was in 1913, which
is why it began flowing out of the country. In 1934,
the government finally recognized the new reality
by raising gold's fixed price. Since 1970, markets
have been in a large version of 1914-1930, except
that gold has been allowed to float, so we can clearly
see its inflation-related, pre-depression gains.
The research in Prechter's March 2008 Theorist (contact
customer service for reprints) shows that even
after Congress created the central bank, no one made
money holding gold in a recession or depression for
two generations (see data below).
In 1970, things changed dramatically. Investors lost
interest in stocks and for a decade preferred to own
gold instead. The same change occurred again in 2001.
But, as we will see, recession had nothing to do with
either of these periods of explosive price gain in
precious metals.
To understand the deflation gold relationship, the
time period one studies can make a huge difference.
If we were to show the entire record from 1792, gold
would show almost no movement on average during economic
contractions or deflation. If we only showed 1969
to the present, it would show much more fluctuation.
To give a balanced picture of the entire modern, wild-gold
era, we compiled statistics that begin at the end
of World War II. This is what most economists do,
because they believe "modern finance" began at that
time and that things have been "normal" since then.
It's also when many data series begin. So our study
fits the norm that most economists use. It also provides
results entirely from the Fed era, making it relevant
to current structural conditions.
To see if there really is a reliable deflation gold
relationship, we created a table that shows the performance
of gold during the 11 officially recognized recessions
since 1945. One could make a case for different start
times, so we took the 15th of the starting month and
the 15th of the ending month as times to record the
price of gold. The results speak for themselves.
For more on deflation, Download Robert Prechter's FREE 60-page eBook, The Guide to Understanding Deflation.
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