Gold, The Dow, Dollar And Deflation

By: Andrew_McKillop

IS GOLD POISED TO REGAIN LOST GROUND?
It is relatively easy to summarize the current global macro scene: private banks are recapitalizing using very low cost funds from central banks, which go on Quantitatively Easing but less so than previous. Interest rates are either not continuing to fall, or are slowly rising. Consumers and business borrowers are deleveraging, trying to pay down debt or not incurring new debt. Unemployment rates are massive in most OECD countries. Several major industries, from cellphones and carmakers to the construction sector face problems of market saturation, slow demand growth and declining prices. Despite a quick glance at the following table (below) from Gold Core possibly supporting the argument that gold price depreciation in dollar terms is overdone and that fiat money depreciation, devaluation or debasement "can only" make gold prices grow - Gold Core suggests price "highs over $2400 oz in coming months" - an alternate reading of the global macro picture says this is very unlikely.

Firstly - many or even most persons will agree that fiat paper stocks and shares are at present severely overvalued or overpriced. Gold has been and is priced with the fiat paper asset bubble, measuring the mix of hope-and-fear that characterizes the capitalist economy. Gold buying is above all a hedge against inflation fear. As we know from reports coming out of central banker conclaves, elitethink says: "inflation = economic growth", but if the economy is not growing, there is no economic inflation.

Since early 2008, for at least 5 years, the "real economy" in almost all OECD countries has deflated, defined here as low or no economic growth, even net and measurable contraction of the economy.

Some OECD countries, notably the US, Germany, Canada, Australia have shown "fits and starts" of what we can call conventional or classic economic growth. But compared with the reference period of postwar high and sustained economic growth, around 1955-1975, the difference is stark. Using only the single measure of unemployment rates, the average joblesss rate in today's Eurozone-17 countries during this period was as low as 0.3 percent of the workforce; today it is 11.9 percent. Neither gold price growth nor fiat paper stocks and share prices reflect this real world disaster.

MARKET SATURATION AND FALLING DEMAND
To be sure, this massive growth of unemployment and very slow or no economic growth can be attributed, by many observers, to the rampant intermixing and mingling of the State and large corporations in all major economic sectors. This could called "the Austrian explanation".

Other reasons for this decline of economic growth and massive joblessness certainly include "technological unemployment" and market saturation, that is machine-based mass production quickly swamping markets with products surplus to consumer needs or desires. A stark example is the cellphone and smartphone industry and end-user market. According to Gartner Inc. technology market research, late 2012 may have been the highwater mark for portable phone output of all types, running at a rate of about 1.65 billion-per-year, worldwide.

World total human population is about 7.1 billion, meaning the portable phone industry is now able to produce 1 hand-held device for every single person on the planet, every 4 years 3 months.

Given the highly classic capitalistic concentration of this industry - 5 companies control 75% of the world market - the possibility for a controlled decline in production, rather than "fight to the death" attempts to dominate and survive, are low. The probability of large corporate collapse in this industry is therefore high, in which case massive economic losses and job losses will ensue.

More important for the subject of deflation, the extreme high production capacity of the cellphone industry, continuing technology progress, near total saturation of several OECD markets for these devices, and a few other factors such as the extreme low cost of used models, will force unit prices to fall. Makers who try to buck this trend will be the first to go to the wall. Deflation is in march. 

The world carmaking industry faces similar production-consumption problems: global carmaking capacity as of late 2012 was estimated at around 83 - 86 million units annual, with probable capacity by end-2013 close to 90 million units per year. World human population growth, according to the UN Population bureau is continuing to slow. Annual growth now stands at about 69 million per year, according to many demographers, and is likely to go on declining: the world car industry can therefore say,  with trepidation rather than pride "For every baby a new car is born!".

Unit car prices can only fall and in some markets - especially Europe and China - sales growth is heavily concentrated in lower cost models, to be sure for different reasons: in Europe due to physical saturation of car fleets. In Europe, the on-road car fleet is more likely to contract in absolute numbers, before it will ever grow again.

MONETARY COST VERSUS ECONOMIC COST
Measured in fiat paper currency units, the price of some key industrial products ranging from cars and cellphones to food, transport and housing, could or might go on rising but this is unrelated to the economic cost of these items. Their unit production cost in economic terms, especially industrial products goes on declining, accelerating the "mature market phenomenon" characterized by the domination of replacement-only sales, recycling, and low cost "comfort sales" to physically saturated consumers. These consumers puchase a low cost model for the sensation of security or pleasure additional ownership procures, rather than its utility. This market segment, as is well known, can dramatically contract almost overnight given the right mass psychological or political triggers.

Major technology change, since the 1980s including IT, portable computers and cellphones, and since 2005 including shale gas and oil and renewable energy, all converge in reducing economic costs across the economy and worldwide. The price of US natural gas since about 2005 provides an excellent example of this effect, with major knock-on impacts on coal prices, and finally on electricity prices despite corporate-State attempts to extort rent or excess profits from power production and supply.

The degree or extent to which monetary units - currencies - reflect real economic costs and real economic trends is always variable, but given the weight of global macro trends pointing to deflation there is only so much leeway opportunity, or time for maintaining the myth of economic inflation.

The key symbolic physical product and financial asset - gold - has only small economic roles. Global demand for metallurgical or "technological gold" as defined by SPDR remains at around 10 percent of world total gold demand, resulting in industrial gold demand of about 300 tons/year, since the early 2000's. This demand segment has declined with jewelry end-demand since the most-recent peak periods of Q2 2010 and Q3 2011. See: http://www.numbersleuth.org/worlds-gold/
http://www.spdrgoldshares.com/media/GLD/file/GDT_Q2_2012.pdf

The most recent peak annual value for gold was probably year Q2 2011-Q2 2012, with an approximate annual total value of about $123 billion. This can be compared with WalMart turnover in 2012 of about $444 billion. In strictly economic terms, therefore, gold is a side issue measuring rod, and occasional lighning rod, for inflation fear. When or if inflation fear retreats - and we must at all times consider both economic inflation, on one hand, and monetary inflation on the other - gold prices can only fall. The ultimate limit for price contraction is the physical mining cost of gold, which itself is increasing for a large number of reasons, among which the economic rent issue is important.

Major miners such as Barrick Gold estimate their 2013 mining cost as around $940 per troy ounce.

MONETARY INFLATION VERSUS ECONOMIC DEFLATION
The excesses of Quantitative Easing or QE in the US, Europe, Japan and China are well known and abundantly commented. Less commented at first, but increasingly, the actual velocity of "new money" circulation - which is declining - signals further economic deflation either in the short term or medium term. In the US, the trend of rapidly falling velocity of circulation since 2010 of all major money aggregates (M1, M2, MZM) is well documented, for example by the St Louis Federal Reserve:
http://www.distressedvolatility.com/2012/06/money-velocity-has-been-falling-since.html

We are certainly confronted by soaring deficits in all major OECD countries, both budgetary and for sovereign debt servicing, enabling "gold bugs" to predict there can only be massive monetary inflation "just around the corner", and a radical increase in the dollar-price of gold. However, it is also easy to argue that declining money velocity and soaring deficits reflect a contracting, post-credit bubble economy of slow, very slow or no real economy growth.

Certainly until 2007 in the US, M1 velocity increased, most intensely through the period of about 1995-2007, matching the peaks in producer prices, stocks and shares, and housing prices almost perfectly. M2 however did not do this, and attained a lower peak in 2007 after which it collapsed. The MZM aggregate defined as an aggregate of zero-maturity highly liquid funds able to replace M2 + M3 in monetary analysis, has in fact never regained its peak attained in 1982, in the US. Its growth is now at most 2 percent per year. http://www.safehaven.com/article/16185/measuring-the-money-supply.

Very similar trends apply in Europe and Japan, in Japan's case for over 20 years. Printing money, and making it circulate are two different things.

In this context, we can view the recent and present unprecedented deficit spending by governments, and allied central bank money creation as a misguided attempt to compensate for the implosion of money velocity. For the US Fed, its "backstopping" of the US finance industry has attained about $16 trillion since 2008, but real economy growth has been very weak while real wages have declined by about 7 - 9 percent. In the case of Europe's most-indebted PIIGS countries, declines in real wages to date have been as high 15 percent, and above.

This is impossible to describe as an economic inflationary context, because it concerns economic deflation. Gold prices can only and finally reflect that context.

ADMITTING DEFLATION
The reality of a flatline physical economy is at least possible, even probable. Deflation of the real economy is the only possible readout. Annual rates of the deflation process are surely subjective, but could be around 1.5 - 2.5 percent. Declining asset prices, followed by declining consumer prices may seem great for consumers, except that the drivers of economy-wide deflation feature a long-term drop in demand and especially international demand - shown by falling international trade growth.

Unfortunately, a drop in demand means that recession is real, so it is rejected by all means possible - especially by media spin in government-friendly business news outlets. Deflation means what we have now: job losses, declining wages, declining home values, and despite the Dow's all time high, an ongoing decline in the value of general stock portfolios and "fetish refuges" - against inflation - led by gold and silver.

As we know, combating deflation is the stated goal of the US Fed and other central banks - stimulating the economy "Keynes style" with expansionary monetary policy and deficit spending. This strategy can supposedly "jumsptart the economy", but after 4 years of trying, the results are disastrous. Reducing interest rates to near zero only destroys the will to save of ordinary citizens while it spoliates what they have put aside "just in case": depriving the economy of savings further harms investment.

Japan, with a minimum of 12 years experience in "Orthodox Keynesian" recovery attempts has made the struggle against deflation a politically-charged concept. The readout from Japan's "twelve lost years" is that allowing deflation to take hold highly complicates the prospects for a conventional or "meaningful" economic recovery. Like other OECD countries, in Japan today, the underside of the fight against deflation and in favour of inflation will finally include rising interest rates, raising the real cost of borrowing, making Japanese industry even less competitive in international markets, intensified by rising costs inside Japan of imported industrial raw materials and energy, due to its official policy of monetary debasement.

Lnked with austerity policy, with its official goal of driving further decline and deferral of consumer spending (although presented as "limiting state budget deficits"), rising interest rates will increase the real-debt burden of corporations and the State. By the processes described above, further QE can likely have the "unexpected effect" of further slowing money velocity, and further blunting GDP growth.

This is an OECD-wide process: an economists' survey published by Bloomberg on 1 March forecast GDP growth in the US at 1.8 percent in 2013, in Europe at 0.3 percent, and 0.95 percent for Japan.

In this recessionary-and-deflationary context, the potential for growth in the price of gold, among other physical raw materials and financial assets can be judged to be low, very low or zero.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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