Despite conventional thinking, the price of gold can rise outside of increasing inflation rates. Gold’s history as currency shows this to be the case. During periods of substantial deflation or inflation, a government reacts either too slowly or by creating policies and either situation is positive for gold.
When 90-day Treasury bill interest rates are lower than the inflation rate, governments attempt to stop deflation. This is the current situation in the U.S. and it makes gold attractive. Governments increase borrowings, adding to their deficits. People turn to gold for its attractive quality of providing a safe haven investment.
Research done by Deutsche bank reveals that over the past forty years, silver and gold do well when a country experiences negative or low real interest rates. At the current time, the main interest rate of the Federal Reserve is close to zero and the inflation rate is just over one percent. This has created a negative real interest rate environment and it seems the Fed will not change this in the near future by raising the interest rate.
Deutsche Bank analysts believe that the U.S. dollar will depreciate more rapidly to stop pressures from deflation. According to these experts, “the road map to resolve deflation is therefore bearish for the U.S. dollar and another factor which will propel gold prices to new highs.” The Federal Reserve plans to inject more money into the economy and there is pressure for additional federal stimulus spending. Both factors will increase the deficit in the federal budget.
Deficit spending devalues the dollar, leading investors to turn to gold for refuge. Not to mention that September, historically a banner month for gold equities and bullion, is fast approaching. When the world money supply grows, interest rates are low, and the stock market is volatile, things look promising for the most valuable of the precious metals.
Source: Holmes, Frank. U.S. Global Investors. Gold and Deflation.