Are Falling Gold Mining Stocks Signaling Deflation?

Gold mining stocks in the US seems to have diverged from prices of gold.

There have been suggestions that such divergence could be indicative of “deflation”. For some of the hardcore devotees of the Keynesian religion, any price declines (be it consumer, equities, commodities) represents “deflation”. The definitional context of the term has been lost out of the desperation to prove the merits of their case.

However it’s really not just gold, but the same underperformance can be seen in prices of oil stocks.

Charts above from US Global Funds

Commodities, in general seem to have foundered since March whether in Agriculture (GKX), Energy (DJAEN) or Industrial metals (DJAIN) [chart from stockcharts.com]

And feebleness in commodity prices may get reflected on consumer prices.

Yet the current price weakness in commodities seems coincidental with the price declines of the Spain’s equity market via the Madrid General Index…

…along with China’s Shanghai index, both of which saw significant slumps in March.

Nevertheless global equity markets, overall, remains buoyant in spite of the reemergence of the euro debt crisis and of concerns over China’s economic slowdown.

Yet current conditions suggest that following the strong surge from the start of the year, global equity markets may be in a natural consolidation phase, perhaps awaiting for the next round of central bank actions. You see, no trend goes in a straight line.

And lower CPI prices will likely motivate central bankers to go for more credit easing measures.

So the above exhibits the divergences playing out between stocks and commodities.

Does this signal "deflation" in the monetary sense? Obviously not.

What we are seeing instead has been the relative effects of money on asset prices. While commodity and commodity related stocks have generally underperformed (perhaps partly due to China or the Euro crisis) much of the money from easing policies of major central banks have been flowing into equity and other financial “credit” assets. In short, central bank policies have produced more asset (price) inflation than commodity (price) inflation

Proof of this is of the record flows of investor money into hedge funds.

From Reuters,

Investors poured billions of dollars into hedge funds in the first quarter, helping to send total industry assets into record territory, data released Thursday shows.

Investors allocated a net $16 billion to hedge funds in the first three months of the year, according to Hedge Fund Research, which tracks industry flows and performance.

With the new capital, as well as average gains of about 5 percent for hedge funds in the first quarter, total industry assets reached $2.13 trillion, HFR found. An earlier record was set halfway through 2011, when total capital invested with hedge fund managers hit $2.04 trillion.

In one of its worst annual performances in history, hedge funds lost about 5 percent in 2011. However, the industry seemed to get its groove back in the beginning of 2012 as global equity and credit markets rallied, and managers recorded the best first quarter of performance in five years.

Thus the weakness in the commodity sector may have filtered into oil and gold stocks which have caused their divergences with the prices of gold and oil. Such anomaly will likely be resolved soon as gold and oil prices should move higher.

Outside the policymaking actions, seasonal factors could also be a factor

Chart from US Global Investors

But I won’t give so much weight on this

And finally falling commodities, which may translate to lower consumer price inflation, does not translate to the absence of a brewing boom-bust cycle.

The great Murray Rothbard explained that consumer prices had not been a factor in 1920 recession or boom bust cycle (America’s Great Depression p.169-170) [bold emphasis mine]

Actually, bank credit expansion creates its mischievous effects by distorting price relations and by raising and altering prices compared to what they would have been without the expansion. Statistically, therefore, we can only identify the increase in money supply, a simple fact. We cannot prove inflation by pointing to price increases. We can only approximate explanations of complex price movements by engaging in a comprehensive economic history of an era—a task which is beyond the scope of this study. Suffice it to say here that the stability of wholesale prices in the 1920s was the result of monetary inflation offset by increased productivity, which lowered costs of production and increased the supply of goods. But this “offset” was only statistical; it did not eliminate the boom–bust cycle, it only obscured it. The economists who emphasized the importance of a stable price level were thus especially deceived, for they should have concentrated on what was happening to the supply of money. Consequently, the economists who raised an alarm over inflation in the 1920s were largely the qualitativists. They were written off as hopelessly old-fashioned by the “newer” economists who realized the overriding importance of the quantitative in monetary affairs. The trouble did not lie with particular credit on particular markets (such as stock or real estate); the boom in the stock and real estate markets reflected Mises’s trade cycle: a disproportionate boom in the prices of titles to capital goods, caused by the increase in money supply attendant upon bank credit expansion.

For as long as central bankers remain on a monetary expansionary mode or continues to adapt rampant inflationism, my expectations is that current weakness represents a temporary and natural outcome of the relative effects of money.