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Deflation May Be Fueling a Gold Bull

Economic tensions continue to rile markets leaving many wondering if a global recession is imminent. Financial Sense Newshour spoke with John Roque and Bloomberg’s Mike McGlone for insight into what is happening and how gold will be affected.

See Inverse Capitalism: Domestic Interest Rates Heading Negative? for audio.

Trade War Heating Up, Bonds Inverting

A global recession seems likely. Asian economic indicators have been negative for some time, Roque said. After the G20 meeting ended with the promise of good news that Trump and Xi Jinping had come to an agreement, Asian markets did not respond positively, especially in Hong Kong. This plays into bonds yields falling and going negative around the world. Roque said it’s not out of the question to see every major interest rate in the world go negative in the next few years.

“If you look at the U.S. 10-year considering what the rest of the G7 is doing, there's almost no way that the U.S. rate can go up without the others going up, given their historical correlations. So, we think rates will at the very least stay low but are more likely continue to work lower.”

Good News for Gold?

Gold is likely to be a beneficiary in a deflationary environment. One reason for this, Roque noted, is that gold doesn't cost anything to hold if rates are very low or negative. If this deflationary cycle plays out, Roque believes gold will make a new all-time high during this cycle.

There aren’t very many obvious reasons for gold to head lower, McGlone stated, but he sees many reasons for it to head higher. Dollar strength is traditionally inversely correlated to the price of gold, but as the dollar continues to show strength, McGlone added, gold is showing divergent strength.

The global race to debase currencies, lower interest rates around the world, negative-yielding debt and Fed rate cuts are all positives for gold. On top of these factors, with stock market volatility on the rise, gold showed a multi-decade low in volatility a few months ago.

“All gold indicators point up,” McGlone said. “Typically and historically one of the key things that drove the price of gold was inflation or debasement of currencies. Now it's more the opposite. We're getting deflation or disinflation, negative-yielding debt and for that store value, it actually enhances gold’s value. … People are looking for more diversification and value, and they’re certainly seeing it gold.”

Race to Debase Afoot

The Fed is likely to continue to lower rates, especially with inflation seemingly in check. This follows the trend around the world of countries seeking to debase their currencies. Central banks will continue to print, hoping to stoke inflation, McGlone explained. This is driving capital into a safe-haven rush for the dollar and gold. On a two-year basis, the trade-weighted broad dollar is up 8.5 % and gold is up about 16 %, McGlone noted. If the dollar peaks, it should accelerate the trend in gold prices, he added.

Governments appear to believe they have a lot of runway to continue easing and money printing, McGlone stated, and that makes him more bullish on gold. In a global deflationary environment, there seems to be little incentive for central banks not to print more. Under their operating theory, until they see inflation, they likely won’t slow easing.

“We've had this massive expansion and debt-to-GDP continues to increase,” McGlone said. “There's no end game in sight until inflation shows up and the market tells central banks not to ease, which is again bullish for gold and precious metals.”

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