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« Florida – Much Worse Problems Than the Oil Spill | Main | Reduced Exposure to Yamana Gold Incorporated »

If Deflation Wins, What Will Gold Stocks Do?

Gold Stocks vs Dow During the Great depression 13 August 2010.JPG

By Jeff Clark, Senior Editor, Casey’s Gold & Resource Report

The talk of a possible double dip is now common banter on TV investment programs. And indeed, deflationary forces seem to have the stronger grip right now than inflationary ones. So if deflation is the next reality we have to face, what happens to our favorite stock investments?

There’s lots of data about what gold does during periods of high inflation, but less so with deflation, partly because we don’t see a true deflation all that often. But of course we’ve got the biggie we can look at, and the seriousness of the Great Depression can give us a big clue as to how gold stocks behave in a true deflationary environment.

First, we know what happened to the stock market in 1929, and in that initial shock, gold stocks crashed too. A rally ensued in most equities until the following April, including gold stocks. Then the Dow took a one-way elevator ride down for the next two and a half years.

What did gold stocks do?

From 1929 until January 1933, the stock of Homestake Mining, the largest gold producer in the U.S., rose 474%. Dome Mines, the largest Canadian producer, advanced 558%. In spite of the gold price being fixed at the time, gold stocks rose dramatically.

At the same time, the DJIA lost 73% of its value.

And the chart doesn’t show that you could have bought both stocks at half their 1929 price five years earlier, which would have led to gains of around 1,000%. That’s not all: both companies paid healthy and rising dividends as the depression wore on; Homestake’s dividend went from $7 to $15 per share, and Dome’s from $1 to $1.80. 

Yes, volatility was high in the gold stocks throughout the depression, with occasional wild price swings. But after the 1929 crash, much of the volatility was to the upside.

The bottom line is that the two largest gold producers – during a time of soup lines and falling standards of living – handed investors five and six times their money in four years.

What about gold itself? On April 5, 1933, President Roosevelt issued an executive order forcing delivery (i.e., confiscation) of gold owned by private citizens to the government in exchange for compensation at the fixed price of $20.67/oz (you can read the original order here). And less than nine months later, he raised the gold price to $35, effectively diluting every dollar 41% overnight and swindling everyone who had turned in his gold.

We don’t know exactly what an untethered gold price would have done during the depression, but given its distinction in history as a store of value, we believe it would retain its purchasing power in a deflationary setting regardless of its nominal price. In other words, while the price of gold might not rise, or could even fall, your best protection is still gold.

But with all this said, the overriding concern isn’t deflation. Yes, economic growth will likely be flat for years, and many Americans will see some hard times ahead. But deflation won’t win; in a fiat money system, any deflation will be met with an inflationary overreaction (as we’ve seen). And the worse the deflation, the more extreme the overreaction will be.

In fact, I think there’s another round of money printing before this year is over. And sooner or later, that extra money is going to dilute every dollar you own, giving us an inflationary hit as bad as the deflationary one we got during the Great Depression.

It’s for this reason that I continue to urge you to own physical gold, in your possession and under your control, given its reliability as a store of value in both inflationary and deflationary environments. If you don’t have a meaningful portion of your investments in physical gold, I think you’re playing with fire. And those who play with fire eventually get burnt. 

Want an easy way to start buying physical gold? I arranged for some seriously discounted bullion in the current issue of Casey’s Gold & Resource Report, which you can check out risk-free here...

Stay on your toes these are treacherous waters and have a good one.

Got a comment then please add it to this article, all opinions are welcome and very much appreciated by both our readership and the team here.

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On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

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Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more. have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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Reader Comments (2)

Oh Yes? there is deflation? what deflation is that? everything I buy just goes up in price, Drip Drip Drip, up goes the prices. Oh uh, I forgot, the governments of the world are telling us that there is deflation so it must be true ofcourse. Yar. Inflation is a monetary phenomenon whereby the monetary base is increased to counter falling asset prices or to cover budget deficits or to devalue the currency in order to devalue the cost and the value of the debt. Money [Currency] once 'Out there' stays out there. the CNBC mantra that liquidity is withdrawn by raising interest rates is a canard which the gullible, that is those few still remaining gullible, believe. This is apart from rising commodity prices particularly the foods. That I think finishes the deflation argument AS REGARDS CURRENCIES. The gold price is priced in dollars, this is wrong, in fact the dollar should be priced in gold, if you think this way then 'Profits' obtained in dollars become a mirage If you want a reality check then check the value of your assets for the last ten years against gold. For this reason I am not impressed with the gold mining companies pricing their balance sheet assets in currency and not in gold thereby continuing the myth that the dollar and other currencies are a store of value when in reality they are not. Gold mining companies are in the business of mining gold, the Federal Reserve is in the busines of 'mining' dollars which they do by printing. If you sell your gold mining company shares you are selling them for Federal Reserve notes. Now in spite of what you may think about the merits of the various gold mining companies and I like Yamana, why, in view of the undoubtedly truth as written above would you exchange a share of a company which mines a substance recognized as money the world over for the last five thousand years for the produce of the Federal Reserve who can at will create as many notes as they think fit thereby having devalued that currency to nearly a hundredth of its value just ninety years ago merely for the possibility of purchasing the gold mining share for a few less Fed Notes. Why take the chance when if you really want to gamble you can do so via the option market. It just means taking on risk when the probable reward is much greater. I cannot say that is is wrong since I very well might be but in view of the circumstances I doubt it. You might want more bang for your buck but the real bang is what is going on with the gold price, the only bang with the dollar [ and other currencies ] is the bang of destruction. In my humble opinion is is not logical to sell any precious matal assets at this time, the essence of logic is patience and it is certainly not logical to sell. Roger.

August 15, 2010 | Unregistered CommenterRoger Levinson


We agree with most of what you say, however, we are adjusting out position in order to take the best advantage of the upcoming rally in gold prices.

On the subject of prices its the same here, nothing has gone down and prices in general keep on creeping up, some a lot faster than others.

August 15, 2010 | Unregistered CommenterGold Prices

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