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I’ve been asked to talk about what could happen to the price of gold in counties that are battling deflationary conditions such as Switzerland, Sweden and Denmark. Recently these countries began a negative interest rate policy to combat deflationary pressures.
In a deflationary economy, most would prefer to hold a liquid hard asset like gold. There will be some who would hoard cash leaving it out of the banks as most refuse to pay the banks to hold their money. This becomes a very dangerous situation for any economy. When money hoarders take cash out of circulation to use it as an insurance policy for tough times ahead, it creates a self-fulfilling prophecy. In the end businesses will close as they will be selling less goods and services. This strategy in turn creates higher unemployment. Not a good outcome. This might also spur a governments control over actual cash. Governments want cash in circulation to increase money supply. Hoarding is the opposite. Once governments move to control real cash, demand for physical will spike.
Did anyone hear of the term beggar-thy-neighbor? Beggar-thy-neighbor is an international trading policy that utilizes currency devaluations and protective barriers to alleviate a nation’s economic difficulties at the expense of other countries. While the policy may help repair an economic hardship in the nation, it will harm the country’s trading partners, worsening its economic status.
I guess you can say using the policy of beggar-thy-neighbor sounds like someone sticking their nose up at a former friend and ally.
Since the negative rates went into effect in these countries, gold purchases have been on the uptick. There is no doubt that the smart money will turn to gold hoping for a strong return on their investment.
What seems to be the case today with the majority of countries I mentioned experiencing negative interest rates (and let’s include Japan in that group), we are witnessing better than average physical demand.
Here in the states, the majority of the gold purchasing has been in the form of ETFs. The reason? Recent strong volatility in the equity markets along with a strong view that equity prices have peeked. And no one can ignore lower oil prices.
With everyone witnessing depressed commodity prices for a long time, (along with my reasons above), a good number of retail investors, along with some fund managers, have decided to diversify a portion of their equity holdings into gold. Since the beginning of the year, these trades have created momentum to the upside in the price of gold.
So I expect, if the rally in the gold market continues in March and there is no increase in the Fed Fund Rate, a strong interest in the physical metal will be in order.
To summarize: in the end, either in an inflationary environment or a much dreaded and dangerous deflationary environment, “Gold as an investment increases in interest.” But if I had to choose one, a deflationary environment would get the nod.
Author Name: Walter Pehowich
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