The new bull market theory of gold

Every bull market has a theory behind it. The bull market theory of gold has been that gold is a hedge against inflation. Eventually, the value of all paper currency reaches the "real" value of the paper it is printed on i.e. practically zero. This happens primarily because the government goes about printing too much of it as they don't have enough money to meet their expenditures, and the world at large is not willing to lend. With too much money chasing few goods, it leads to high inflation. To protect themselves against high inflation, people buy/hoard gold. This is for the simple reason that gold does not rot. It does not stink. And it holds its value. It always has over the centuries. The act of buying and hoarding gold is not an infringement. If you were to buy and hoard onions to protect your wealth, other than stinking, it would also have political repercussions. If you were to buy and hoard grain, in a world where 79 million people are being added at the dinner table everywhere, you will be seen as a heartless villain. Owning gold doesn't hurt anybody. So people buy gold whenever they feel paper money is in danger. Investors who are most bullish on gold are referred to as gold bugs. As John Mauldin and Jonathan Tepper write in Endgame - The End of the Debt Supercycle and How It Changes Everything, "A gold bug is someone for whom the answer to the question "Where should I invest?" is always gold, with a smattering of natural resources. They assume that fiat currencies (paper money) will go the way of all flesh, which is historically not an unrealistic assumption. The question is when, and the when can be a long way off, making gold a boring investment for long periods of time." Gold bugs have been coming out of their closets over the last 10-11 years. Some of them started recommending gold after the dotcom bubble burst. And in the process have made a killing on the investment as gold prices have gone through the roof and currently quote at a price of around $1750 per ounce giving a return of around 20% per year in dollar and rupee terms in the last decade. And now it seems that the likes of JP Morgan, one of the biggest banks in the world, have also turned into gold bugs (that also raises the question, is that a contra signal, with conventional Wall Street banks betting big on gold). JP Morgan's year-end target for gold is $2500 per ounce (nearly 50% up from the current price). But the irony is that despite all the money printing, high consumer price inflation is still to arrive, something that the gold bugs have been shouting about from the rooftops, for a while now. First, countries printed money big time to limit the impact of the dotcom bubble going bust. The money printed gave rise to a real estate bubble. Once this went bust more money was printed, in the hope of reviving economies all over the world. The US Federal Reserve has printed $2.3 trillion till date, and there are rumours going around that there will be another round of quantitative easing. But why hasn't inflation set in? Mauldin and Tepper have an explanation for this in Endgame. "Most gold bugs subscribe to the Austrian school of economics founded by Ludwig Von Mises. Von Mises did not factor the velocity of money into his equations," they write. So, central banks can print all the money in the world, but if it doesn't go anywhere, and stays in the vaults of banks, it doesn't lead to inflation. And that's what has happened. Central banks around the world have printed tonnes of money. They have used this money to buy previously issued government securities, in the hope that this money pumped into the financial system would be lent to citizens. Citizens would then go out and buy things, pushing up prices. This would benefit companies, who in turn would employ more people and so the cycle would work. This did not happen, because banks and citizens decided to keep their money in their pockets. Banks were not in a mood to lend. Citizens who already have enough debt want to pay it off and hence are saving. The savings rate in the US has now reached 5% from negative territory. People are in no mood to buy, which in turn is leading to firmsoffering lower prices. Once lower prices set in, people wait for further lower prices to buy. This does not help corporates and overall economy, and a slump ensues. When inflation is negative, deflation is said to set in. Gold bugs thought with more money chasing fewer goods it would lead to high inflation. Alas, the central banks and gold bugs were wrong. Currently most of the western world is now staring at deflation or low inflation. Every time fears are raised about the dollar crashing, investors get out of other financial assets, move their money into US government securities. This in turn ensures that the US dollar stays stable. Recently, S&P downgraded US debt to AA+. Theoretically, this should have meant that investors should have sold US government debt and bought other financial assets. The corporate profits in the US are freakishly high, feels hedge fund manager Jeremy Grantham. This makes US stocks a reasonable bet. But the opposite happened. Investors sold US stocks and bought US government securities or to put it more precisely, US government securities denominated in US dollars. And the dollar remained stable. So it's classic Catch-22 situation. Every time dollar is doomed, investors invest more in it, ensuring its continued stability. The logic in selling stocks was the deflationary environment that seems to be setting in, would hit firms hard. The investors bought gold as well driving up gold prices to nearly $1800 per ounce. So all this makes me wonder, has gold now become a play against deflation, which in turn would mean slow, stagnant and moribund economies all over the world? Typically, gold and dollar prices move in different directions. But now investors are buying both gold and dollars (indirectly by buying US government securities). So is gold a hedge against deflation now? With stocks expected to crash, investors are buying gold hoping it will continue to rise. Or are we just waiting for inflation to eventually set in one day. But who cares as long as the price keeps going up. And the gold bugs are still at it. As William Bonner, author of Dice Have No Memory - Big Bets and Bad Economics from Paris to the Pampas, wrote "years ago, we guessed that the price of gold and the price of the Dow would converge. We also guessed that they would meet around $3,000 (per ounce)."