When we cut our teeth as amateur investors and market observers one of the first investing "truths" that we learn is that gold is a good inflation hedge. In theory (the theory taught in universities around the world), gold should perform poorly in a disinflationary/deflationary economic environment; money is getting tighter (again, in theory) and thus there is less of it to bid up assets like gold that don't offer any yield. Makes sense, in theory. 

This common wisdom is about as valuable as it costs someone to read a blog post and regurgitate it ad nauseum... i.e. zero.

The 2020 macroeconomic environment is unlike anything the world has ever seen and that means that many long held economic truths are being turned on their heads. A few examples:

  • The government can't run massive deficits/debts without interest rates on government debt skyrocketing. The US Treasury has shown this to be completely useless as interest rates have never been lower and debt has never been higher.
  • If the central bank creates money with keyboard strokes it will create Zimbabwe style runaway inflation....wrong again!
  • Governments and central banks can't bail-out private industries because it creates moral hazards and doesn't allow the system to reset..... tell that to Ben Bernanke, Jerome Powell, Tim Geithner, and Steven Mnuchin.

And so it is the same with gold only rising during times of inflation. The current monetary policy regime around the globe (ultra-low or negative policy rates coupled with extraordinary monetary stimulus actions such as the Fed buying bond ETFs) is actually ideally suited for a gold bull market, regardless of whether the economy is in deflation or mild disinflation. In fact, if inflation actually started to pick up substantially I would become extremely concerned as a gold investor because it could mean tighter liquidity and a higher price of money (higher interest rates). 

Remember, the Fed can always crush all asset classes by aggressively raising interest rates like they did in the early '80s. Of course, in the current economic backdrop the Fed would never consider doing such a thing because it would mean 50% unemployment and a depression worse than the 1930s. So the Fed is stuck with no alternative but to continue the game of expanding its balance sheet and giving into the market's every whim.

Here is an excellent graphic from Nordea showing what might be right around the corner in terms of economic growth and core inflation:

Yesterday, legendary hedge fund manager Stan Druckenmiller differed with many of his hedge fund peers when he suggested that as a result of government stimulus efforts he sees deflation being more likely than inflation.

This is an interesting take because I agree with him. On the surface trillions of dollars of debt being used to support a flailing economy would appear to be inflationary, however, if you think about it more deeply you might see the genius in his logic.

First of all, someone has to buy all this Treasury paper the government is issuing - this creates a misallocation of capital from productive industries that could help expand the economy to what we know to be the worst allocator of capital, the government. That in itself is bearish, and deflationary.

Second, let's take a look at what the Democrats are proposing in their massive second stimulus bill:

If this passes it will ensure the slowest economic recovery in the history of the United States. By extending unemployment payments to 2021 the government is skewing the risk/reward of returning to work in favor of staying home and rollerblading every day. We are creating a culture of citizens who are looking to the government for handouts instead of relying on their creativity and ingenuity to create, survive, and eventually thrive. This is not what the United States was founded on.

While there is a lot of money creation occurring, this money is moving around at an increasingly lethargic pace as evidenced by the 20-year chart of the Velocity of M2 Money Supply:

Druck is correct, a deflationary outcome is more likely than any possibility of significant inflation taking hold. This means that global central banks will continue making money as cheap as possible and liquidity as plentiful as possible in a futile effort to fight the structural disinflationary/deflationary forces. These two conditions are fertile soil for the gold bull market to thrust into overdrive in the coming months. 

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