Dollar vs. Gold in a Dual Inflation-Deflation Economy
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March 04, 2011
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March 04, 2011
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Every time you hear "the dollar's down" or "the dollar's up," what exactly does that mean? If someone says the dollar is currently trading at 76.54, as it is today, what does that tell you about the relative strength of the dollar or its purchasing power? The truth is, it doesn't tell you much at all.
I began to make this case in Why Gold Is a Better Currency Indicator Than the U.S. Dollar Index. In this article I will further explain how looking at the dollar as represented by the dollar index alone doesn't paint a complete picture and how inflation and deflation are occurring at the same time - and what that means for gold investors.
The Dollar Has Been Up and Down the Last Three Years
We can see from the following chart that the dollar, as represented by the Dollar Index, has been above and below the 80 line a couple of times in each direction the last few years. Does this paint a picture of whether we have inflation or deflation? How?
Inflation and Deflation Have Battled It Out the Last Three Years
While the inflationists and deflationists battle it out, what's important to everyone is the purchasing power of the dollar. We have clearly had an inflationary bout the past 8 months with food prices and oil bouncing off their post financial crash of 2008/2009 lows. But is this really inflation, defined as an increase in the money supply? Yes, we have seen the Federal Reserve implement quantitative easing (QE2) to the tune of $600 billion at the end of last year and the dollar has fallen since that time versus other currencies. But didn't we have $2 trillion of the first round of quantitative easing? How come the dollar didn't fall like a rock during this first round of easing, which was more than three times larger than the latest round of easing? Why didn't the treasuries actually increased in value during the time frame of the $2 trillion easing? What excuse did the inflationists have for this result? Take a look at TBT, the ultra short 20 year treasury the last five years. Is there a sign of inflation in this chart? If so, then why has the 20 year treasury grown stronger during the last five years? Yes, I do realize there is a current upswing taking place, but does that paint a true picture of what's occurring since June of 2008?
All of this prior inflation was eaten up by the credit contraction occurring...the unwinding of all the credit that was extended during the boom period (see below for more on this) . There is still much of that credit hanging over our heads.
What Does the Price of Oil Tell Us About Inflation?
As of yet, oil is still 30% below its July 2008, high of just north of 130. Some of the reason oil is priced higher has nothing to do with the dollar, but rather Mideast turmoil surrounding the revolutions in Egypt, Libya and elsewhere. This disruption has driven the price of oil higher. This should not be misconstrued as a result of inflation.
The fact of the matter is, the BP disaster in the Gulf of Mexico contributed to the rising price of oil too and while the dollar was rising from November 2009, to May of 2010, oil went from around $50 a barrel to almost $90 a barrel. Look at the dollar Index chart above and notice the dollar rising in value during this time versus the chart below showing oil rising in value along with it. Does this indicate inflation? Does this paint a clear picture of the value of the dollar?
It's not all as black and white as some would have you believe.
What Does the Price of Corn Tell us About Inflation?
Inflationists will point to the CRB index and the price of corn for example to show how inflation has kicked into gear. But supply and demand also play into this picture too. China and India had an increase in demand and more recently there has been a shortage of corn supply. Jim Rogers predicted this in January of 2010. It's not just a dollar/inflation issue. Supply and demand also have to be taken into account.
Government Induced Inflation
Anything that the U.S. government is involved in that causes higher prices (health care, college tuition), can't be associated 100% with normal inflation (increase in money supply) because these are not free market programs. Colleges raise their fees and governments provide the bigger loans to the students. Cost of health care goes higher and Medicare/Medicaid pays the bill. There is no free market to allow companies to compete for business when the government pays the bill. In the end though, it is the student and the tax payer who end up paying more.
Deflation In Real Estate
Meanwhile, on the deflation side, we have real estate declining in price for four years and on the verge of falling further. Banks still aren't lending and still aren't marking to market the real value of their assets. Do people really believe that these assets are going to go back to their fantasy values of 2006 anytime soon? What would cause such an uptick in the economy? Is manufacturing improving? What are we building or making in the U.S. that anyone else in the world is buying? Real estate has the propensity to fall further or at best stay stagnant for years to come.
Baltic Dry Index Has Dried Up
The Baltic Dry Index provides some insight into the economy. Compare the Baltic Dry Index and the first chart below shows the current state of affairs while the second chart shows the pre-financial crisis glory years. The activity could be called the Dead Sea Index.
Does this look like the chart of an economic recovery? Where is the activity that can support such recovery? Is less activity inflationary or deflationary? The activity is just not there. Why again is the DOW over 12,000? How again will any economic recovery take hold?
Unemployment Picture Improved
Some will point to Friday's unemployment report showing the economy lost fewer jobs as a sign the recovery is in full force. To this I simply ask, "is your company hiring?" If it is, do you happen to work for a government related company?
Government's, at taxpayer's expense, can always hire more people for temporary work to build bridges, roads or implement a greener environment agenda. But these jobs come to an end once the project is finished. What will the employment picture look like moving forward? Let's not forget that there are still many folks who just aren't counted in the unemployment statistics as they have been unemployed too long to even be counted. How can the stock market go up Thursday almost 200 points on anticipation of Friday's better outlook? Ask Ben.
As I have mentioned in past articles, Bernanke and the Fed would have you believe that everything is ok. If your 401k is going up every month, just maybe you'll think you are wealthier and go out and spend. And just maybe this spending will get businesses going again and they can hire more people.
Then maybe, just maybe...we will get the economy on the right path and return to the glory years. Don't count on it lasting. In fact, that's what we've had the last few months. The consumer thinks all is well because quantitative easing has propped things up again. Consumer spending is up, but it is the consumer who always gets burned in the end. The smart consumer is hedging against the coming collapse by taking a position in gold and silver, not going out on shopping sprees.
Bernanke and the Stock Market
In September 2010 I said I was bullish on the stock market when the DOW was 10,800. I am less bullish now than I was then with the DOW today at 12,250.
Bernanke still has some game in him and I can't be a bear just yet. But I would be close to taking profit by lightening up on any longs. While gold and silver may be due for a pullback, the DOW could go up another 2,000 points. Who knows what it may do. But the data doesn't back up any rise in the DOW.
The Baltic Dry Index is dried up. P/E ratios are too high to be of value. Dividends are still less than 2%.
Businesses still aren't borrowing to grow their company, but are increasingly laying off workers (independent study). The DOW moving higher is not the real economy. Things are not what CNBC would have you believe.
And finally this brings us to the analysis of gold.
Various Currencies Priced In Gold
How fast is the world currency ship sinking? If you looked at just the Dollar Index, you'd think the ship has a slow leak, but everything is still ok, while watching to see if we bust into the 70 - 74 range closely. This is the danger zone and we're not too far away from that level now.
But by looking strictly at the Dollar Index as an indicator of strength, people don't realize that the ship is already filled with water, the life boats are about ready to drop and they should be rounding up the women and children!
The following table shows the return of gold in the major currencies that make up the Dollar Index. It's not a pretty sight.
It comes down to this....
If 82.20% of the Dollar Index has lost on average 19.10%, 125.36%, and 281.20% the last 1,5 and 10 years versus gold, how can anyone call this stable? And the dollar itself has lost 25.98%, 158.59% and 446.10% to gold the last 1,5 and 10 years. Whether this kind of a reaction is because of inflation, perceived inflation, or even deflation, the purchasing power of gold is increasing. That's because illusions of wealth are chasing the real wealth found in gold and silver.
And you're sitting there with no gold or a small allocation to gold and silver in your portfolio. What do you think will change in this dynamic over the next five years to get you to invest in gold? Will you wait till gold is up over 500% before making the decision to diversify? 600%? 1,000%?
Don't let a debate on whether there is inflation or deflation in our future hold you back. Buy some. And if it falls in price, buy more.
There is no doubt inflation will rear its ugly head even further in the years to come. But as shown earlier, rising prices are also the result of supply and demand issues and political turmoil for oil and grains. Deflation is still a concern hence the second round of quantitative easing as revealed in the following chart showing the velocity of money depressed.
There is still a lot of credit unwinding (see chart below). How will the unwinding of this debt occur? Is it inflationary or deflationary? What about the over $4 trillion of sub-investment grade derivatives are coming due in the next 1-5 years for the nations top five banks? Who will be the most likely counterparty to that debt?
Answer: the lender of last resort, the Federal Reserve. This is reason enough to have an allocation into gold and silver. Gold and silver are insurance against the unknown.
What To Do: Buy Gold and Silver Now
I have a specific request for you to insure your portfolio from what's to come, whether it be inflation or deflation; buy 1 ounce American Gold Eagles, 1 ounce American Silver Eagles and 90% bags of silver (aka "junk silver"). These are all American coins that offer the investor the most gold or silver for their money while at the same time are easily liquidated if there ever is a reason or need to convert back to U.S. dollars. You hold onto these metals for five years minimum and see what transpires. You can sell half of your allocation once you have doubled your money, but you'll have the tough decision of what to do with the proceeds. This will of course depend on where the stock and real estate markets are at that time. You may not be taking your profit if they haven't bottomed out yet.
As much as we want to believe in this great nation and have faith our government will make the right choices in getting us back to the glory days, the simple fact that it got us here in the first place should be reason enough to buy gold. I have more faith in my Cubs winning a World Series this year than I do in the government and Fed not messing things up even further. And I've been disappointed for 41 years now since I became a Cubs fan at the age of 11. At least at Wrigley Field I can have a beer and forget about all this stuff for a few hours....oh...and root, root, root for the home team!
I began to make this case in Why Gold Is a Better Currency Indicator Than the U.S. Dollar Index. In this article I will further explain how looking at the dollar as represented by the dollar index alone doesn't paint a complete picture and how inflation and deflation are occurring at the same time - and what that means for gold investors.
The Dollar Has Been Up and Down the Last Three Years
We can see from the following chart that the dollar, as represented by the Dollar Index, has been above and below the 80 line a couple of times in each direction the last few years. Does this paint a picture of whether we have inflation or deflation? How?
Inflation and Deflation Have Battled It Out the Last Three Years
While the inflationists and deflationists battle it out, what's important to everyone is the purchasing power of the dollar. We have clearly had an inflationary bout the past 8 months with food prices and oil bouncing off their post financial crash of 2008/2009 lows. But is this really inflation, defined as an increase in the money supply? Yes, we have seen the Federal Reserve implement quantitative easing (QE2) to the tune of $600 billion at the end of last year and the dollar has fallen since that time versus other currencies. But didn't we have $2 trillion of the first round of quantitative easing? How come the dollar didn't fall like a rock during this first round of easing, which was more than three times larger than the latest round of easing? Why didn't the treasuries actually increased in value during the time frame of the $2 trillion easing? What excuse did the inflationists have for this result? Take a look at TBT, the ultra short 20 year treasury the last five years. Is there a sign of inflation in this chart? If so, then why has the 20 year treasury grown stronger during the last five years? Yes, I do realize there is a current upswing taking place, but does that paint a true picture of what's occurring since June of 2008?
All of this prior inflation was eaten up by the credit contraction occurring...the unwinding of all the credit that was extended during the boom period (see below for more on this) . There is still much of that credit hanging over our heads.
What Does the Price of Oil Tell Us About Inflation?
As of yet, oil is still 30% below its July 2008, high of just north of 130. Some of the reason oil is priced higher has nothing to do with the dollar, but rather Mideast turmoil surrounding the revolutions in Egypt, Libya and elsewhere. This disruption has driven the price of oil higher. This should not be misconstrued as a result of inflation.
The fact of the matter is, the BP disaster in the Gulf of Mexico contributed to the rising price of oil too and while the dollar was rising from November 2009, to May of 2010, oil went from around $50 a barrel to almost $90 a barrel. Look at the dollar Index chart above and notice the dollar rising in value during this time versus the chart below showing oil rising in value along with it. Does this indicate inflation? Does this paint a clear picture of the value of the dollar?
It's not all as black and white as some would have you believe.
What Does the Price of Corn Tell us About Inflation?
Inflationists will point to the CRB index and the price of corn for example to show how inflation has kicked into gear. But supply and demand also play into this picture too. China and India had an increase in demand and more recently there has been a shortage of corn supply. Jim Rogers predicted this in January of 2010. It's not just a dollar/inflation issue. Supply and demand also have to be taken into account.
Government Induced Inflation
Anything that the U.S. government is involved in that causes higher prices (health care, college tuition), can't be associated 100% with normal inflation (increase in money supply) because these are not free market programs. Colleges raise their fees and governments provide the bigger loans to the students. Cost of health care goes higher and Medicare/Medicaid pays the bill. There is no free market to allow companies to compete for business when the government pays the bill. In the end though, it is the student and the tax payer who end up paying more.
Deflation In Real Estate
Meanwhile, on the deflation side, we have real estate declining in price for four years and on the verge of falling further. Banks still aren't lending and still aren't marking to market the real value of their assets. Do people really believe that these assets are going to go back to their fantasy values of 2006 anytime soon? What would cause such an uptick in the economy? Is manufacturing improving? What are we building or making in the U.S. that anyone else in the world is buying? Real estate has the propensity to fall further or at best stay stagnant for years to come.
Baltic Dry Index Has Dried Up
The Baltic Dry Index provides some insight into the economy. Compare the Baltic Dry Index and the first chart below shows the current state of affairs while the second chart shows the pre-financial crisis glory years. The activity could be called the Dead Sea Index.
Does this look like the chart of an economic recovery? Where is the activity that can support such recovery? Is less activity inflationary or deflationary? The activity is just not there. Why again is the DOW over 12,000? How again will any economic recovery take hold?
Unemployment Picture Improved
Some will point to Friday's unemployment report showing the economy lost fewer jobs as a sign the recovery is in full force. To this I simply ask, "is your company hiring?" If it is, do you happen to work for a government related company?
Government's, at taxpayer's expense, can always hire more people for temporary work to build bridges, roads or implement a greener environment agenda. But these jobs come to an end once the project is finished. What will the employment picture look like moving forward? Let's not forget that there are still many folks who just aren't counted in the unemployment statistics as they have been unemployed too long to even be counted. How can the stock market go up Thursday almost 200 points on anticipation of Friday's better outlook? Ask Ben.
As I have mentioned in past articles, Bernanke and the Fed would have you believe that everything is ok. If your 401k is going up every month, just maybe you'll think you are wealthier and go out and spend. And just maybe this spending will get businesses going again and they can hire more people.
Then maybe, just maybe...we will get the economy on the right path and return to the glory years. Don't count on it lasting. In fact, that's what we've had the last few months. The consumer thinks all is well because quantitative easing has propped things up again. Consumer spending is up, but it is the consumer who always gets burned in the end. The smart consumer is hedging against the coming collapse by taking a position in gold and silver, not going out on shopping sprees.
Bernanke and the Stock Market
In September 2010 I said I was bullish on the stock market when the DOW was 10,800. I am less bullish now than I was then with the DOW today at 12,250.
Bernanke still has some game in him and I can't be a bear just yet. But I would be close to taking profit by lightening up on any longs. While gold and silver may be due for a pullback, the DOW could go up another 2,000 points. Who knows what it may do. But the data doesn't back up any rise in the DOW.
The Baltic Dry Index is dried up. P/E ratios are too high to be of value. Dividends are still less than 2%.
Businesses still aren't borrowing to grow their company, but are increasingly laying off workers (independent study). The DOW moving higher is not the real economy. Things are not what CNBC would have you believe.
And finally this brings us to the analysis of gold.
Various Currencies Priced In Gold
How fast is the world currency ship sinking? If you looked at just the Dollar Index, you'd think the ship has a slow leak, but everything is still ok, while watching to see if we bust into the 70 - 74 range closely. This is the danger zone and we're not too far away from that level now.
But by looking strictly at the Dollar Index as an indicator of strength, people don't realize that the ship is already filled with water, the life boats are about ready to drop and they should be rounding up the women and children!
The following table shows the return of gold in the major currencies that make up the Dollar Index. It's not a pretty sight.
It comes down to this....
If 82.20% of the Dollar Index has lost on average 19.10%, 125.36%, and 281.20% the last 1,5 and 10 years versus gold, how can anyone call this stable? And the dollar itself has lost 25.98%, 158.59% and 446.10% to gold the last 1,5 and 10 years. Whether this kind of a reaction is because of inflation, perceived inflation, or even deflation, the purchasing power of gold is increasing. That's because illusions of wealth are chasing the real wealth found in gold and silver.
And you're sitting there with no gold or a small allocation to gold and silver in your portfolio. What do you think will change in this dynamic over the next five years to get you to invest in gold? Will you wait till gold is up over 500% before making the decision to diversify? 600%? 1,000%?
Don't let a debate on whether there is inflation or deflation in our future hold you back. Buy some. And if it falls in price, buy more.
There is no doubt inflation will rear its ugly head even further in the years to come. But as shown earlier, rising prices are also the result of supply and demand issues and political turmoil for oil and grains. Deflation is still a concern hence the second round of quantitative easing as revealed in the following chart showing the velocity of money depressed.
There is still a lot of credit unwinding (see chart below). How will the unwinding of this debt occur? Is it inflationary or deflationary? What about the over $4 trillion of sub-investment grade derivatives are coming due in the next 1-5 years for the nations top five banks? Who will be the most likely counterparty to that debt?
Answer: the lender of last resort, the Federal Reserve. This is reason enough to have an allocation into gold and silver. Gold and silver are insurance against the unknown.
What To Do: Buy Gold and Silver Now
I have a specific request for you to insure your portfolio from what's to come, whether it be inflation or deflation; buy 1 ounce American Gold Eagles, 1 ounce American Silver Eagles and 90% bags of silver (aka "junk silver"). These are all American coins that offer the investor the most gold or silver for their money while at the same time are easily liquidated if there ever is a reason or need to convert back to U.S. dollars. You hold onto these metals for five years minimum and see what transpires. You can sell half of your allocation once you have doubled your money, but you'll have the tough decision of what to do with the proceeds. This will of course depend on where the stock and real estate markets are at that time. You may not be taking your profit if they haven't bottomed out yet.
As much as we want to believe in this great nation and have faith our government will make the right choices in getting us back to the glory days, the simple fact that it got us here in the first place should be reason enough to buy gold. I have more faith in my Cubs winning a World Series this year than I do in the government and Fed not messing things up even further. And I've been disappointed for 41 years now since I became a Cubs fan at the age of 11. At least at Wrigley Field I can have a beer and forget about all this stuff for a few hours....oh...and root, root, root for the home team!
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