Here’s the latest barrel of goods chart update. Click on the chart for a larger version.

Interesting to see where oil has been heading versus the barrel of goods and other commodities… Opinions?

Discuss this at the gold investment forum.

SCHAUMBURG, IL

By A.B. Dada
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During my late Summer writing hiatus, many were perplexed with the huge “fall” in the dollar price of gold. Looking at the gold versus barrel of goods chart over the past few months, we see that gold is down in dollar value about US$100 in 5 months. In that same time frame, the DJIA is up about 5%, silver is way down, and oil has plummeted the most. The graph doesn’t plot median housing prices, but I’m considering adding it.

So why has gold fallen? Gold is an excellent hedge against inflation, but it is not perfect. It responds to inflation slowly — with peaks and valleys and sometimes huge gains and drops. The investor market really is not healthy for gold, it is the long term holders that really keep gold in the spotlight in terms of history: because the supply of gold over time doesn’t increase as quickly as the supply of anything else (housing, paper dollars, big screen TVs, drugs, prostitutes, education, medication, food, etc), the value of gold versus the other goods tends to go up over time. But what about during the short run? We don’t live forever, and gold hasn’t been very glorious during most of our lifetime.

Yet it is also during most of our lifetime that gold has been reborn — it is barely 30 years since gold was demonetized completely. We have two histories for gold: the history of antiquities (gold was the first metal found and used by early man), and the history of the modern currency. Looking over the history of antiquity, gold has always gone up — always — in any comparison longer than a decade. In modern currency history, gold hasn’t really found a foothold because the modern mindset is that paper is king. If we rewind a few decades, or centuries, and focus on little timeframes of “modern currency,” fiat currency seems to always have been powerful for a very short period of time. People are duped easily by those in power. Mass delusions always seem to be more powerful than common sense.

The current dilemma with gold is that the average investor (who en masse has billions if not hundreds of billions of dollars of liquid capital) believes there is deflation right now — oil prices have dropped, housing prices have dropped, some wages have dropped (or at least you have to work more for the same net paycheck). This is what the Federal Reserve wanted. After decades of terrible inflation — terrible because everyone saw paychecks increase but ignored the fact that their buying power decreased, hence the overcredit problems — the Fed decided to slowly raise interest rates to give the impression that we’re in a deflationary period. The actual growth of the money supply has not contracted in recent months — it is still expanding, we’re just seeing it expand a little slower. In a market with intelligent investors and consumers, they’d know that expansion always means overall inflation. Instead, we see specific-market deflation due to investors exiting certain markets together.

The Fed loves this. The short term “deflation” in some markets gives the Fed the ability to call for added liquidity — or the creation of new money. The targetted deflation in oil has been good for the politicos, too — both sides can say they fixed the oil issue, especially during an election. But the opportunity to inflate faster in the near future is something that the Federal Reserve Bank and the member banks beneath are rubbing their hands together for. The weaker national banks weren’t the wisest — they’re going to get hammered by the politically connected banks. Washington Mutual and New Century are going to be falling apart if they don’t get capital soon. The Federal Reserve can put both under if they decide to increase their reserve requirements. Additional foreclosures on their high-risk mortgages are certain. And the largest national banks are chuckling: an FDIC bail-out hurts the member banks (they pay for the failures, not the FDIC), but a national buy-out by another bank gets them a bundle of assets at a delicious price. Buyout a bankrupt bank for today’s dollars, knowing full well that any major bank buyout means the Fed will inject liquidity/raise inflation, so that the buying bank will pay off that debt with future dollars worth a lot less.

So where is gold to go? After the election, the Fed will be force to “fix housing.” The only fix for housing is total collapse of the price to a market-accepted value, but that won’t happen — too many small banks will get hurt (the big banks will love this), too many families would be homeless, and too many politicians won’t get re-elected in 2008. The Fed’s fix for housing will be inflation, maybe even massive inflation again. And when the fake currency deflation goes away, you can be sure that more and more people will see gold as a protective store of wealth. If a few banks fail, or a few large bond issues fail, or a few major blue chip firms fail, the dollar will find itself much weaker against gold.

Today gold is hovering above US$615 and holding. It will likely fall again below US$600 around the election, especially if the Republicans lose ground in the House and Senate (at which point the Nation of liberal investors will be happy and push gold even further down). But as soon as the Fed is given a kick in the head by the new Congress, the spigots will be open — there is no doubt that now is the time to really focus on what your priorities are for the next 2 years before the next Presidential election.

The fall of gold should have been expected by all of us — we should have seen the deflation of the rate of inflation by the Fed pre-election; we should have noticed the rise in interest rates to try to push around small national and local banks; we should have realized that ending a period of high inflation never lasts — it is only a temporary dip so that the Fed can self-congratulate itself in the long run.

Discuss this article at the gold investing forum.