This weekend, I went back to some of the primary resources I used over the last few years to come to my conclusions to invest in this sector. Specifically, I wanted to challenge and reinforce my beliefs about possible outcomes of asset deflation during a monetary inflation period.

There is no better case study on the extremes of monetary inflation than Turroni's "The Economics of Inflation - A Study of Currency Depreciation in Post-War Germany," so I went here as my primary reference. I wondered, during a period of high inflation, runaway inflation, and ultimately hyperinflation in Germany, what levels of asset deflation and currency appreciation-- both of which would be counter-trend movements within a primary direction of asset inflation and currency depreciation-- were seen during these periods?

This would help me to better understand whether or not a peak-to-trough 25% correction in gold prices, and 45% correction in equity prices, would disprove an inflationary outcome from the current reflationary efforts by the Fed.

My findings, from numbers published in the book, were as follows.

Fluctuations and timing in stocks and gold:

-The backdrop of the inflation in Germany consisted of doubling the volume of currency once every 12-18 months from 1914 - 1923. This was fairly constant and accelerated in the final few years. Keep this in mind when reviewing the following price movements.

-From 1917, the price of gold, having risen 70% in the previous three years, dropped by 30%, bottoming out in mid-1918.

-The industrial stock index dropped 39% from August to December 1918, dropping and bottoming both after the price of gold.

-The stock index then started a slow gain, finally recovering the losses by January 1920.

-It was after the point that the stock index bottomed and started moving back up that the price of gold began to move strongly and unrelentlessly. Prior to this, from 1914 - 1918, the price of gold went up 100%. From late 1918 (the bottom of the stock market) to early 1920, the price of gold increased 2,360%.

Counter-trend moves:

-At one other point, in late 1920, the price of gold dropped by over 60%, only to recover all those gains and thousands of percentage points more in the coming years.

-The German mark, which had been losing value to the US dollar relentlessly from 1914 - 1919, strengthened by 60% against the US dollar in 1920.

Final Result:

After these strong counter-trend moves, the final result was that the price of gold rose to over 1,000,000,000,000 marks. The stock market rose as well, in nominal terms, but from peak to trough in real terms lost 90% of its purchasing power. The foreign exchange rate of the dollar, being equal to gold, also approached the same value as the mark to the price of gold.

Analysis:

Certainly we are not yet in a hyperinflation as was Germany. Yet, my point was to determine, giving a strong underlying inflationary monetary response from the government, what are some historical extremes that may be seen over the course of 1-2 years in terms of counter-trend moves. Certainly a 60% drop in the price of gold in Germany would have been enough to scare away most investors, as a 25% scare here did with many. Yet, those who were scared away suffered massively in the long run if they ignored the underlying monetary inflation that was happening all the while, despite the temporary irrational moves in their inflation-protection assets.

We have, and still are, seeing irrational moves in the price of gold, silver, and the value of the dollar. Yet, the underlying monetary inflation has not subsided. Rather, it has increased. As demonstrated here, there can be counterintuitive moves even as the printing presses are running full speed. Yet the prices eventually do catch up, no matter now strong the scent of deflation is at any given time.

Finally, the real sustained increase in the price of gold seemed to coincide directly with the moment that the stock market started to rise again in nominal terms in early 1919. From a fundamental view, one could argue that the massive amounts of printing finally overcame the short-term deflationary effects, and both asset classes responded. Clearly, gold responded much quicker and more meaningfully, gaining in purchasing power as the stock market continued to lose in real terms.

I believe the Fed will print enough money to recapitalize its member banks and avoid a deflationary depression. When the stock market believes this, and starts to rise again, is when we should see these back and forth spasms in the gold market turn to a strong, sustained rise for a long time.

I already knew these ideas, but had not looked at the extremes and quantified them. This should help to calm the nerves if we continue to see irrational moves despite what we see and know to be worsening fundamentals for the value of the dollar in relation to gold. I believe that the gold shares, once the panic selling ends, will rise higher than gold itself, which will rise higher than the overall stock market.

I am not saying that we will see an exact repeat of the above numbers. Yet, this was the most extreme hyperinflation that is properly documented. If these extreme counter-moves were seen in Germany's hyperinflation, certainly nothing we have seen so far can be taken to mean anything other than we are still in an inflationary environment in which gold shares, gold, and the overall stock market will at some point begin to rise, albiet some in real and some in nominal terms.

Having re-solidified my beliefs this weekend, I can now approach the continued assault of propaganda, manipulation, and doubt with the assurance that I am right in the long run. Those with the balls to not get scared out will find a few years from now that even a 50-90% drop in gold shares during this correction will be nothing more than a blip on a long-term graph that looks more like a steady parabolic rise when all is said and done. I am going to make an effort to not get so caught up in the day to day action, stay off margin due to these extreme moves, and start preparing for the main event.

Best to all,

Hysteria