Gold Enthusiasts – Still Waiting for Inflation

Gold Enthusiasts: Still Waiting for Inflation

Pacifica Partners’ Financial Post Weekly Column – July 19th 2010

This and other articles also available online at: Financial Post & Investment Waves Blog

One of the underlying premises of the investment merits of gold is that “reckless government printing of money” is debasing paper currencies and this will ultimately lead to runaway inflation. While the theory sounds reasonable, the problem is that the facts do not back up this inflationary thesis – so far.

Over the last eight months, gold bullion is up about 6% and an index of gold mining stocks is down almost 5%. The momentum in gold and gold stocks does not seem to conform to the notion that inflation is an imminent danger and investors should begin to take refuge in gold.

As the charts below show, the adjusted monetary base, which is basically defined as the sum of currency in circulation and bank reserves, has been essentially flat over the last eight months. The second chart shows that bank credit has been on a downward trend for over two years.

Monetary Base & Bank Credit

(Data Source: Federal Reserve Bank of St. Louis)

An additional component of inflationary pressures is rising wages. Yet, with unemployment in the US stubbornly high and much of Europe embarking on an austerity drive, we have a further weakening in the case for investors to be too concerned with inflation for the time being. Wages are considered by many economists to be a driving force of inflation. This is especially powerful when workers begin to incorporate expectations about rising inflation into their wage demands.

However, recent data from the St. Louis Fed shows that inflation expectations are very subdued. Further helping to keep wages constrained is the fact that many workers who had envisioned early retirement are staying in the workforce longer than they expected. New college graduates are finding a less than welcoming job market in many parts of the world leaving employers facing a “buyer’s market” when it comes to adding workers. Even still, many employers seem to be preferring to have their existing workers work overtime rather than adding new employees.

Given the recent economic data and talk about the economy beginning to slow down in the US, the Fed has hinted that they are prepared to step into the markets to attempt to add more monetary stimulus. If that were to occur, the proponents of the “currency debasement” school of thought would certainly have some ammunition for their argument that gold is the best alternative for investors.

One point of caution: despite the limitless amounts of virtually free money that has been made available to the financial markets, the economic data continue to point to the fact that it will take longer than many thought to get a self sustaining economic recovery. With that, inflation seems to be something in the far off horizon.

Legal Disclaimer

This report is for information purposes only and is neither a solicitation for the purchase of securities nor an offer of securities. The information contained in this report has been compiled from sources we believe to be reliable, however, we make no guarantee, representation or warranty, expressed or implied, as to such information’s accuracy or completeness. All opinions and estimates contained in this report, whether or not our own, are based on assumptions we believe to be reasonable as of the date of the report and are subject to change without notice. Past performance is not indicative of future performance. Please note that, as at the date of this report, our firm may hold positions in some of the companies mentioned.

Copyright (C) 2010 Pacifica Partners Inc. All rights reserved.

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