Does Gold Keep Up In Hyperinflation?


Dear Readers,

I've just returned from Victoria, BC, where I spoke at the HoweStreet.com Money Expo 2012. The show was smaller than many shows, but the location is beautiful, a major plus for anyone whose spouse doesn't want to go to Toronto in March for PDAC. I'd never been to Victoria before and hadn't expected the touch of Old-World charm the place has – it reminded me more of Quebec than western Canada.

Or maybe I just had the Old World on my mind, since the Greek elections could well have marked the beginning of the visible disintegration of the Eurozone. As of Sunday night, it seems that Greece will not leave the European Union – at least not yet. It remains to be seen if the slender majority that the pro-EU faction gained in Greece will lead to a coalition government that can actually deliver the austerity program needed to keep the bailout funds coming.

For now, the world keeps turning as it did last week. But thinking about the Old World reminds us of one of history's greatest lessons in hyperinflation, a lesson no one can afford to ignore. The Casey metals team has a look at gold during the Weimer hyperinflation of the 1920s in this week's article. Good food for thought.

Sincerely,

Louis James


Senior Metals Investment Strategist
Casey Research

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Does Gold Keep Up In Hyperinflation?

By Alena Mikhan and Jeff Clark

Inflation is a natural consequence of loose government monetary policy. If those policies get too loose, hyperinflation can occur. As gold investors, we'd like to know if the precious metals would keep pace in this extreme scenario.

Hyperinflation is an extremely rapid period of inflation, but when does inflation (which can be manageable) cross the line and become out-of-control hyperinflation? Philip Cagan, one of the very first researchers of this phenomenon, defines hyperinflation as "an inflation rate of 50% or more in a single month," something largely inconceivable to the average investor.

While there can be multiple reasons for inflation, hyperinflation historically has one root cause: excessive money supply. Debts and deficits reach unsustainable levels, and politicians resort to diluting the currency to cover their expenses. A tipping point is reached, and investors lose confidence in the currency.

"Confidence" is the key word here. Fiat money holds its purchasing power largely on the belief that it is stable and will preserve that power over time. Once this trust is broken, a flight from the currency ensues. In such scenarios, citizens spend the money as quickly as possible, typically buying tangible items in a desperate attempt to get rid of currency units before they lose value. This process increases the velocity of money, setting off a vicious cycle that destroys purchasing power faster and faster.

The most famous case of hyperinflation is the one that occurred in Germany during the Weimar Republic, from January 1919 until November 1923. According to Investopedia, "the average price level increased by a factor of 20 billion, doubling every 28 hours."

One would expect gold to fare well during such an extreme circumstance, and it did – in German marks, quite dramatically. In January 1919, one ounce of gold traded for 170 marks; by November 1923, that same ounce was worth 87 trillion marks. Take a look.

(Click on image to enlarge)

Inflation was at first benign, then began to grow rapidly, and quickly became a monster. What's important to us as investors is that the price of gold grew faster than the rate of monetary inflation. The data here reveal that over this five-year period, the gold price increased 1.8 times more than the inflation rate.

The implication of this is sobering: while hyperinflation wiped out most people's savings, turning wealthy citizens into poor ones literally overnight, those who had assets denominated in gold experienced no loss in purchasing power. In fact, their ability to purchase goods and services grew beyond the runaway prices they saw all around them.

One can't help but wonder how the people whose wealth evaporated in Germany during this time felt. In effect, they were robbed by the government – they were on the losing end of a massive transfer of wealth. Of course, there are two sides to the story, as those who held significant amounts of gold and silver were the recipients.

Could the US experience a wealth transfer like the one that wracked the Weimar Republic? While the federal government and most so-called economic "experts" dismiss the notion, the economic data suggest that it's already started.

We can't help but speculate about whether most citizens dismissed the idea of inflation during the calm period in 1920-'21. Did respected economists scoff at the idea that Germany could suffer hyperinflation, just before it struck? Did some politicians proclaim that "a little inflation would be good?"

Those who today argue that our obscene debt levels, runaway deficit spending, and money-printing schemes are sound strategies and believe they won't lead to out-of-control inflation might want to rethink those beliefs. We've seen this movie before: it doesn't have a happy ending.

The historical record is clear on what happens when countries embark on fiscal and monetary paths today's leading economies are embracing. If gold's recent price performance is anything like the calm before Germany's hyperinflationary storm, this is a time to be accumulating more gold.

Keep in mind that hyperinflation is not a rare event. Since Weimar Germany, there have been 29 additional hyperinflations around the world, including those in Austria, Argentina, Greece, Mexico, Brazil, Taiwan, and Zimbabwe, to name a few. On average, that's one every three years or so.

While hyperinflation devastates those who experience it, there is a healing aspect to it. Since the responsibility for this type of disaster lies solely at the feet of government, there may be some Darwinian justice to the way hyperinflation purges the perverse fiscal and monetary imbalances from an economy. After the Weimar Republic hyperinflation, the second half of the 1920s was a strong period for Germany, with low inflation and steady growth.

It's no secret that many currencies around the world, including the US dollar, are choosing the path of inflation. If we were to slip into hyperinflation, there will be disastrous consequences for those unprepared. Given that the US dollar is the world's reserve currency, the problems would spread to practically every country on earth. Hyperinflation will shake people's confidence not only in the US dollar, but in the paper currency system as a whole.

What will actually come to pass, we don't know. What we do know is that the measures to cure hyperinflation include tying the currency to a hard asset or even replacing it with one. When creditability in fiat money dissipates, gold may be the only viable option left standing.

Again, the investment implication is obvious: continue to accumulate gold.

How much is enough? Well, how many ounces do you own in relation to your total assets? Anything less than 5% will not offer you a sufficient level of protection in a high inflationary environment.

Another way to look at it is this: how many ounces do you need to cover your monthly expenses? In Weimar Germany, inflation rose uncomfortably for two years – and then pinched harder, spiraling into a destructive hyperinflation for another two. Consider what it would take to maintain your standard of living for a couple years instead of just a couple months.

And don’t listen to any government's ongoing pronouncements of confidence in the current system, along with the mainstream media's noisy and frequently inaccurate portrayals of the gold market. (For example, these two headlines appeared on the same day: Gold Edges Lower as Worries over Europe Simmer; and Gold Settles Higher on Spanish Bailout Plans.) In a world awash in ignorance about real money, if not deliberate obfuscation, you have to study the relevant history, draw your own conclusions, and stick with them.

This example shows how gold can perform during hyperinflation. If that worst case scenario comes to pass, will the example your family's finances sets be a positive or a negative one?


Gold and Silver HEADLINES

Kazakh Central Bank Intends to Have 20% of Reserves in Gold (Reuters)

Kazakhstan's central bank plans to boost the share of gold in its foreign currency reserves to 20% from the current 14-15% level.

Last year the central bank bought 5.3 tonnes (0.17 million ounces) of gold, but this year their purchases accelerated, already purchasing 10.3 tonnes (0.33 million ounces).

Kazakhstan is one of a number of countries that have been increasing their official gold holdings in recent years. Others include Mexico, Russia, Colombia, and South Korea. Last year central banks bought a record 450 tonnes (14.5 million ounces).

Even if the amount of gold purchased by central banks this year ends up slightly less than last year, as some analysts expect, it's still a big share of total gold demand and lends strong support to the price.

Gold Coin Collecting a Deadly Business as Metals Prices Rise (Mineweb)

Criminal syndicates now consider thefts of gold, silver, and rare coins to be both less risky and more profitable than robbing banks or other well-protected targets. As precious metals increase in price, more and more cases of larceny are taking place. The FBI estimates that only about 4% of stolen precious metals and jewelry is recovered annually.

While many investors know it's not wise to talk about the gold you own, this article shows that that behavior can have dire consequences. Besides being a valuable asset, gold coins can also be viewed as art, lulling the vigilance of the owner. Showing your collection even to friends and family is tempting, but don't overlook the potential consequences.

Learn more about how to safely store gold at home; Jeff Clark offers some good, practical tips.

Indian Gold ETF and E-gold Investments Swell as Rupee Remains Weak (Mineweb)

In India, the gold price in rupee terms reached an all-time high of $544.74 (Rs 30,420) per 10 grams. In Mumbai, standard gold prices have risen by 27% over the last year. On one hand, a weak rupee makes gold less affordable, while on the other, it makes it a robust investment asset.

Indian ETFs are said to have seen a marked rise in activity, as investors continue to buy the yellow metal as a safe haven and diversification from equities.

Assets under management of gold funds in India were $1.83 billion (Rs 102.18 billion) in April 2012. The assets held under India's gold ETFs nearly doubled year on year. The assets were valued at $981 million (Rs 54.63 billion) a year ago.

Recently another gold-purchasing option became available for Indian investors: e-gold trading at the Singapore Mercantile Exchange (SMX). Since its launch on June 1, volume has soared nearly 300%, with US$16 million traded.


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