How global asset deflation will quickly morph into consumer price inflation and higher gold prices

Volatile financial markets make if very difficult for most investors to keep track of what is going on. It can also be very confusing when gold, for example, suddenly loses value for no particular reason and both stocks and bonds sell-off.

That’s because most financial commentators are just momentum followers. They tell you how prices are not moving and do not examine the underlying monetary conditions behind this change.

Why’s gold down?

Higher interest rates, for instance, are immediately blamed for a decline in the gold price. That is the immediate effect. Indeed, any asset with a lower return will be impacted, so we see falling prices for commodities across the board (except oil because the geopolitics of the Middle East), and lower bond and stock prices.

However, when assets are liquidated they are liquidated into cash. Remember that. Central banks will also respond to these market deflations by printing even more money.

Now we have seen a historically huge creation of money by the global central banks over the past five years to combat a deflationary financial collapse, anything between $7 to 12 trillion, the numbers are so big as to be meaningless to most people.

Some of this money has gone into asset price increases. That’s why house prices are so high for the state of the economy and the same is true for share prices. But most of it got stuck in the system on bank balance sheets.

Inflationary consequences

The problem now in a global asset sell down is that this money is being released into the economy. Too much money in circulation and you get consumer price inflation. Won’t people then demand higher salaries? Well that’s certainly happening in the UAE where salary increases are running at the highest levels for four years.

See how pulling money out of stocks, bonds and even gold can have nasty inflationary consequences? And what will investors buy to protect themselves from such inflation?

What you need is a money that cannot be printed. Who’s supply is limited by natural constraints and outside the control of central banks. Gold and silver are the only monetary metals available.

That’s a tough sell these days to holders of the GLD gold ETF who have sold half of the fund’s holdings to leave it with $38 billion in gold. Still it is not been so bad for long-term GLD holders.

It has returned more than doubled the total return of the Standard & Poor’s 500 Index since its 2004 inception with a 158 per cent return since launching; that compares to the S&P 500’s 63 percent gain for the same nine years.

What’s next for gold?

What happens next for gold is that consumer price inflation starts to emerge unexpectedly and in unexpected places like the supermarket trolley as there will be just too much money in circulation in the economy. Higher gas prices are a no-brainer.

The snap back for gold prices will be swift as Mr. Market sees his recent error. In 1998 the Nasdaq pulled back 40 per cent but still went on for its huge final dot-com crash spike into the millennium.

Gold has just not seen its spike yet but it could be coming quickly, just around the corner. Investors who abandon gold now will be kicking themselves in the near future like those who dumped tech in 1998.