If Deflation Wins, What Will Gold Stocks Do?

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by Jeff Clark: How
to Buy Your Kids a House

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?

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

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

13, 2010

Clark is editor of Casey's
Gold & Resource Report
in Casey’s Daily Dispatch.

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