Minyanville Professor Cody Tafel is pondering Gold: A Safe Place to Hide or Deflation Trap?

“…… This action in Gold leads me to an important debate between market participants right now. Should we still be concerned with inflation? If so, then Gold will be a great place to hide as defensive money is put to work. The Fed, up until the recent market turmoil, had been concerned with upside risks to inflation. However, it is quite possible we should be concerned about the possibility of deflation going forward (as Professor Sedacca has intelligently pointed out), and the warning signs are popping up with the recent contraction in credit. If the liquidity tide is truly flowing back out, even Gold will not be immune and could be a trap for those looking to the yellow mellow as a place to hide.”

My response appeared on Minyanville as follows:

I continue to believe, as many other Professors do too no doubt, that deflation is the concern, not inflation. But that issue has been debated enough and time will tell. What has not gotten enough play in the media yet is whether or not gold is really an inflation hedge in the first place.

If one defines inflation as an expansion of money and credit, then one look at M3 soaring for decades while gold sinking from $800 to $250 shows that for long periods of time (decades in fact) gold is an extremely poor hedge against inflation. In the longest of timeframes, however, every fiat currency in history has gone to zero and that is an unbeatable track record, unfortunately not a very playable one in and of itself.

Few seem to look beyond the myth of gold acting as an inflation hedge to the reality that gold is a better deflation hedge. With the help of Prof. Reamer, I discussed this idea in Is Gold an Inflation Hedge? (Warning: That is a very lengthy discussion with lots of charts and other commentary, so take a peek when you have time.)

The conclusion was “Given the current underlying conditions, with increasing chances of a deflationary credit implosion related to housing… the incentive to store wealth in the form of gold is massive.”

There is still one more way to look at gold. Gold does well at extremes. In other words hyperinflation and deflation, and poorly at other times. Again, the charts in the above article tend to show that taking the liberty of calling the massive stagflation of the 70’s and 80’s with interest rates soaring to 18% “hyperinflation”. But in “muddle through conditions” as well as moderately inflationary boom times of the 90’s where interest rates drop, gold is not where you want to be.

The pertinent question in my mind then is whether or not there will be a “final shakeout” of some sort, a deflation scare of sorts for those holding gold for the “wrong reasons” (ie an inflation hedge instead of a deflation hedge), panic out of gold or are forced out of gold in some sort of massive unwinding of derivatives and leverage. I do not the answer to that question, and of course no one else does either. But should things play out that way, I believe gold and gold miners will recover after that initial hit just as they did during the great depression. Homestake Mining was a massive 500%+ winner in the great depression even if it did drop initially.

I have a position in physical gold and gold miners.

Mike Shedlock / Mish/