Does gold already price in the future inflation that may or may not happen?

Vitaliy Katsenelson's picture

This is the fourth in a series of what some may consider as “gold bashing” articles. I am not short gold in any shape or form. I have no axe to grind against gold bugs. I am simply presenting the other side of the argument in response to what I deem to be dishonest, gold-pimping commercials (e.g., “If gold prices went up to $5,000 this pile of gold would be worth $300,000”) that we are subjected to all day long on TV. I may be wrong, but I am honest.

Inflation is a possible but not a guaranteed outcome of what is taking place in the economy today.  Deflation or a muddle-through economy with very low nominal growth are possible and probable outcomes.  We are seeing signs that point away from inflation: the money supply declined at a 12% annualized rate over the past four weeks, according to David Rosenberg of Gluskin Sheff. 

Though gold bugs argue that gold will perform well in either an inflationary or deflationary scenario, history doesn’t support that conclusion. Gold has done well in inflationary environments but not during deflation or low nominal economic growth.  In the 1970s, when inflation in the US was raging, gold performed better than any other asset class (though remember, at the time gold had no competition in the inflation trade, no TIPS, or ETFs that long other commodities, short US Treasuries etc..).  However, one had to know exactly when to get on and off the gold bus.  If gold was bought after considerable appreciation, that investment/speculation resulted in losses.  Gold has more than doubled in price since 2005, but has it already priced in future inflation?  I have no idea; you cannot value it.


Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007).  To receive Vitaliy's future articles by email, click here.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Anonymous's picture

I suspect Mr. Katznelson does not believe in his own words. In my humble opinion it is a clear example of black propaganda designed by the smart "chosen people" for us, silly "goyim", to consume.
Best regards to all who participated in discussing these 4 pieces of bullshit,
Russian Behaviorist

Anonymous's picture

I am constantly amused by the unfailing bullishness of most of you who believe so strongly in the validity of the thought that gold is a "store of value".

It isn't - it's just a compilation of all of the pump and dump of those in power. No, I am not one of those conspiracy guys. What I am is a realist.

There is and has been some inflation over the last few years. But not enought to justify the current price of gold.

What I believe is that the big guys have taken massive long positions in futures. They did this over the years by encouraging producers (read Barrick) to "hedge" their future output. Now, those same big guys have convinced those producers to raise billions to eliminate the potential losses of "future gold price increases" by covering their hedges. Of course the producers are buying the hedges back from the same big guys that went long as they sold. Huge profits for the big guys - huge losses for the producers - Billions of $$$.

Here is what happens over the next two-three years. These same "big guys" will convince the producers that they need to go long futures to cover the risks that, over the years, their production will fall and that they need to be long to be able to deliver gold to the ever increasing buyers that are "surely going to take the price higher."

You heard it here first.

Mediocritas's picture

Anon #69398,

When Barrick forward sells to a bullion bank, that bank onsells (or leases) into a short position, not a long position, trading gold that effectively does not exist yet, and can only cover its position when Barrick actually gets around to mining said gold and delivering it.

When Barrick bailed on a portion of its hedge, it did not deliver physical metal, it simply cashed out (at the expense of shareholders who were diluted). That's all well and good if all participants in the paper trail are prepared to accept cash, but if somebody big stands for physical delivery then the counterparty is going to be left holding an obligation to deliver gold that doesn't even exist.

For the price of gold, such a situation is....rather bullish.

Gunther's picture

Anon #69398,
have you checked COT numbers lately?  The commercials are heavily short. Do you have any proof that the big American guys are long?
An alternative scenario is that somebody bought and buys bullion and big guys and miners like Barrick try to suppress the price of gold. 
How do you explain the shortage of bullion last fall?
Is the financial crisis over? If not, golden insurance helps a lot.

ED's picture

thanks for throwing these articles out there vitaliy.

But with the graphs I think there are two things you can do with it.

1-in a fiat currency system, draw a line connect the 2 peaks and extend it back to 1913 and forever into the future, else

2-flatline at $50 and extend it back to 10AD and forever into the future.



TumblingDice's picture

the severe lack of imagination prominent in this article disturbs me.

Gunther's picture

what about answering comments to prior articles?
As well as others, I took your arguments apart and – no response. If you believe government statistics, gold quadrupled since 2001 without apparent reason. There was neither big inflation nor deflation. If you trust, and be it only for the purpose of having comparable numbers, there was moderate inflation and more important a negative real interest rate. Defined as ten-year-government-bond yield minus pre-Clinton-CPI the real interest is negative since the start of 1997.  Interestingly, the trend in real interest rates turned in late 2008 but is still negative.
In history when gold was money, it did very well in deflationary times. Keep it under the mattress and it gains value! Please provide any example of a deflation in a paper money system where gold did bad.
What timeframe does your chart use?
On 01/21/08 I found a London PM Fix of 850$, see
On 09/01/99 the PM fix was 254.2$
Again, better arguments, please.

RagnarDanneskjold's picture

Vitaly should have spent more time on the question, "Does gold defend against inflation or inflation expectations?" There are plenty of places to poke at the inflation scenario, but Vitaly's not bringing the arguments to the table.

As Hugh Hendry asked, "What if we've seen the inflation?"

There are several ways the inflation scenario dies. One is that the public isn't buying it. (see consumer credit). Another is that the expectations exceed the reality. Another is that the extent to which the expectations are correct, they are in fact deflationary. High interset rates, high oil prices, etc. act as a tax on the economy and are the cure for the disease. 


Anonymous's picture

inflation, contrary to the nonsense of bernanke
and others, is not a phenomenon of the mind,
expectations, fear, belief etc....

it is always a real phenomenon driven by currency

there is no "as if", "what if we close our
eyes and imagine" or any other such drivel...

lookma's picture

Price level is driven by fiat currency and debt chasing goods.

The debt level faces default and more deleveraging - this debt deflation leads to a fall in the price level.

With a full fiat currency, the money printers face enourmous pressure to print/create more fiat to counter-act debt deflation and maintain the nominal price level (e.g. the FED monetizing 1.75 trillion)

As debt faces default, more fiat is printed (monetary inflation). 

Debt deflationary pressures in a full fiat currecy ultimately = hyperinflation (a currency crisis from too much fiat money being printed).


Evaluate gold as money/currency compared to fiat money/currency, which is being rapidly created (monetary inflation).

Anonymous's picture

I own gold not because of future inflation but of currency devaluation like in Iceland last year or Argentina in 2001.

Anonymous's picture

hey yo,

check out the noble metal today.....standing tall, standing firm, closed out at 1000.60

man that is cutting it real close, ha ha :)

Anonymous's picture

hey Vitaliy...

what are you going to do when there is no more money for you to manage? what then? yard man perhaps? tree climber? :)

Anonymous's picture

Can we PLEASE take this guy out back and shoot him already? Joke has gone too far.

Anonymous's picture

he is entertainment...not be taken seriously -
kind of like the paris hilton of monetary

Anonymous's picture

I don't think it does. How can it? What does gold at 800 1980 dollars equate to in 2009 dollars?

ellidc's picture

The reason why gold does all right in deflation is suggested in this article

highlighting the renewed appeal of barter transactions when cash is short.

Just like the first time around, it is a logical step from barter to a system of

what we call "money" by using a commodity as a universal medium of exchange.

Just like in the article, how a coupon at a restaurant could be readily re-traded,

barter systems short on cash will eventually come to rely on alternative "money"

that has many of the attributes of gold.

But yeah it could all be priced in already and the economy, fed and congress might all

get their act together and make gold unappealing again.

Anonymous's picture

all of this is almost irrelevant. inflation, deflation...whatever. what is important is the credibility of a currency, and ours is losing all credibility at an accelerating pace.

i know i am sitting quietly waiting for the next "decline" in Comex gold (brought to us by JPM and HSBC courtesy of the CTFC) 965, i'm turning all my cash into bullion.

i want out of this market, and beyond Ben's clutches. gold, silver. its that simple. its the ticket to surviving what's coming.

roadlust's picture

You're right, Vitaliy, there IS no way to "value" gold.  But we DO know that it has enjoyed an almost uninterrupted run up, and physics tells us that simply can't continue.  

Once the people who bought in at $999 get burnt, and start selling, the mass exodus will begin.  Good luck finding buyers at that point.

Gold is the "investment" vehicle most subject to "perceived" value, and with the deflationary scenario we're facing for the foreseeable future (years) the only justification for gold continuing to go up is the political (as opposed to economics based) perception that "Obama is trashing the dollar!" and thus we must all pile into gold (and canned food and ammo, presumably.) 

When the meltdown finally begins, unfortunately for gold bugs, the rich bastards from around the third world who have been looting their "emerging economies," will start buying dollars and treasuries.  (They know we protect our rich bastards here at all cost.)  

Since nobody can eat gold, or in most cases even get possession of it, GLD will be one of the first casualties of the next leg down.   (There's simply no reason to believe that you'll be able to fly into Heathrow and pick up your bars at the GLD storage depot, when the real shit hits the fan.)

Somebody is gonna get very rich shorting gold. 

Anonymous's picture

so third world gangsters are going to bail out the good ol' US of A?

and since when is 'protecting rich bastards at all costs' the recipe for stability, let alone genuine growth?

if that's the plan, and that's all we have to fall back on, then the game's already over and you just made the case for gold.

methinks third world thugs know a rat when they see one and they aren't going to invest in another guy's racket. plus, protecting rich bastards gives progressively diminishing returns until they go negative. like now.

when the rats jump ship, all you're left with is what's in your pocket- be it an IOU from Lehman or X discredited gov't or a genuine store of value. easy choice.

Anonymous's picture

And to your comment, I'll add this.... YOU DON'T WANT TO SEE LIFE with gold at $5k... Gold is a hedge in politically unstable times...commodities, as a whole, are a hedge to a depreciating dollar, that's it!! It is as speculative as everything else in every other regard. If gold bugs get their day in the sun with gold north of 3k, 4k,etc., the world as we know it will have practically self-destroyed. If you believe this scenario as likely, then by all means buy all the gold you can. But, again, do you want to live in a world where gold is worth $5,000 an ounce???? I guarantee you, you don't know what you're asking for. That's WW3 type of scenario... As for hyperinflation??? We already HAD IT!!! Oil went up to $146 dollars a f'n barrel, homes exploded in price... in the span of about 3 years... Leave it alone... And for those who want to return to a gold standard... don't hold your breath on that one!!! We're more likely to see the Colombian Peso as the reserve currency of the world before we see a gold standard again!!!

Anonymous's picture

gold is money...he who owns the gold makes the say that it is a hedge in politically
unstable times is an expression of vast unstinted
ignorance about money....

gold is vastly underpriced in terms of frn
through decades' long gold price suppression by
the treasury and fed and thus should be priced
substantially higher...

how much higher? not sure - the free market
has not been allowed to speak....

your hysterical henny penny nonsense about the
price of gold as a marker for ww3 is hillarious...
there is absolutely no warrant for the statement
other than your bald faced stupid assertion that
high gold prices equal political instability....

i agree with your pessimism regarding a gold
standard for the flames of totalitarianism burn
strongly in the likes of you and your companions of
the plutocratic oligarchy....

we either have a gold standard and freedom or
we have paper and tyranny....the battle lines
have been drawn and are being waged fiercely...

in the shot term the totalitarianists will
prevail - in the long term they will be crushed..

Anonymous's picture

@ Anonymous #69102

Are you Dave in Denver or Matt Douchamp from Clusterstock?

These articles seem to be hitting quite the nerve...

Anonymous's picture

I'm neither and in fact have never heard of either of them.

Vastly more insight can be gained from this 2 and half year old article:

And of course the bullish view on gold is best read at JS Mineset and FOFOA.

Hephasteus's picture

You don't get it. Fractional reserve currency systems always distort. They always get so out of whack that they are useless they always use gold to correct. In 2006 it costs 140 million dollars to make 100 million dollars worth of pennies. Can you not get the distortion and manipulation that has occured? There is no gold bus. You simply buy it and wait to get paid.

Lionhead's picture

The fourth installment of "rubbish." No further comment necessary.

Uros Slokar's picture

Well put. By far the weakest writer on ZH, and by a country f-ing mile at that. His "4" articles could have been rolled into one, medium-length crappy piece instead of making us suffer.

Mr. Mandelbrot's picture

I emphatically second your comments.  I'm sorry I wasted my time reading these four posts and I won't bother reading the fifth.  The intelligence level doesn't warrant any time or effort on my part to try to be original, witty, combative, or even a little educated or intelligent sounding on the subject.  The discussions that have followed all four posts have been in near unanimous agreement that the guy is clueless, stupid, handicapped, hired, high, Hungarian or something.  Why bother posting?  Does this guy deserve an audience anywhere?

Anonymous's picture

Gold outperformed in several deflationary episodes in the seventeenth, eighteenth, nineteenth, twentieth, and apparently twenty first centuries.

I oft hear of gold underperforming during deflation. It's a myth.

Anonymous's picture

inflation is the increase in the money supply. rising prices are a result of this. one inflates a money supply, not prices. the sooner people understand this (the author) the better.

Anonymous's picture


the relationship between money supply and prices
is not linear or direct nor is the effect instantaneous

Anonymous's picture

gold is so suppressed by the government / fed that it's message is heavily muffled.

Anonymous's picture

People just don't want to lose what they have worked for, that is why they buy gold! It is not that hard to figure out.

I mean, are you seriously suggesting the price of gold has not been gamed since ATLEAST when the US went off the gold standard?

The last 30 years of trends means very little.

What should be taken into account: The world needs a sound financial system. Using a gold standard is one simple way to accomplish this.

Therefore, we may see a return to the gold standard in a few years (hopefully), which would price gold at probably 2-5 times what it is 'worth' today.

It doesn't mean gold will keep climbing forever. It is not an investment in that sense.

But it does mean gold has taken on a very important role in our financial system, once again, and it is unlikely to relinquish its grip.

Down with paper gold, up with the return of the gold standard!

Anonymous's picture

Depends how you define inflation. has the money supply already been increased by 25 trillion + ??

Daedal's picture

Vitaliy, you are once again missing the purpose of gold. People ought to look to gold to preserve their spending power, not to generate income.

Having said that, Gold outperforms in times of economic uncertainty/distress -- not inflation, per se, see 1980-2000, where inflation was prevalent but there was economic certainty/calm for the most part -- and that certainty made people hold income generating assets, instead of 'currency'. Thus, your statement "Gold has done well in inflationary environments but not during deflation or low nominal economic growth." is False.

Mediocritas's picture

You are exactly right Daedal. Far too many people think of gold as an inflation hedge and are then puzzled when the historical correlation of inflation to gold prices is weak.

As you say, precious metals are a hedge against uncertainty, being favoured when central banks are playing fast and loose with money supply in an unpredictable manner. Consequently, if inflation is ongoing, but very stable, gold will not do anything of note. Precious metals are favoured now because the future is highly opaque and central banks are behaving like bulls in a china shop.

Viewed this way, it can be understood that high precious metal prices are equivalent to a vote of no confidence in the fractional reserve system, fiat currency, and governments, inversely explaining why central banks desire to keep precious metal prices low.

Finally, I add the tale of Homestake (a gold miner) to demonstrate how gold can do extremely well during deflation:

"Homestake stock sold for about $65 per share in 1929. By 1933, the average stock price for Homestake was around $370. This represents a gain of more than 450% over the course of four years. The Dow Jones Industrial Average fell 89% over the three years between its 1929 peak to its 1932 bottom. Not only did stock prices increase for Homestake, but dividends also skyrocketed. In 1929, Homestake paid dividends of about $7 per share. By 1935, dividends had increased to $56, a staggering rate of 800% over six years. During these deflationary times, gold stocks not only retained their values but provided significant returns for investors."

Gold was confiscated in 1933 so it's hard to know how it would have continued to perform.

Anonymous's picture

Is the rest of this article missing? If not, is this intended seriously? It's like a college freshman's lame attempt at a term paper after drinking for the prior week. Two paragraphs of hemming and hawing followed by a single chart does not usually equal meaningful commentary, and certainly not in this instance.

There are reasoned questions about gold's performance in the next few years, but this doesn't seem to come close to hitting on them.