There goes the stock market short squeeze.
After peaking at 18,167 points a fortnight ago, the US Dow Jones hit a roadblock last week. The institutional money index plunged to 17,773 points.
Billionaire investor Carl Icahn sold his entire stake in Apple [NASDAQ:AAPL]. This is big news. Apple is one of the world’s most loved institutional stocks. When the share price falls, punters tend to panic.
Unfortunately, the stock underwhelmed last week. Apple announced its first ever decline in iPhone sales.
This is concerning.
While it affects the stock’s valuation, it has wider implications. I’m talking about ‘deflation’. Deflation isn’t good for stock earnings in the medium to long term.
But it’s a different story when it comes to gold stocks.
Sam Volkering, Editor of Australian Small Cap Investigator, talked about deflation in Saturday’s Money Morning. He wrote:
‘What is deflation? Why is it bad? Is it bad? What does it mean for stocks?
‘That’s what most people want to know when they hear the ‘D’ word. What does it mean for you?
‘After all, if you really think about it, aren’t cheaper prices better for you? I know I’d like to pay less for transport. I’d like to pay less for energy. I’d like to pay less for everything – that’s why I’m not impartial to a trip down to an outlet shop, or Lidl.
‘If prices are cheaper, why aren’t we all celebrating?
‘Well the theory goes that if there’s deflation then an economy is struggling. A struggling economy leads to a bleak future.’
Sam hit the nail on the head. Deflation is dangerous. At this rate, it’s not going to end well for the world economy.
You don’t need an economics degree to figure out why either.
When people don’t have jobs, they don’t have any money to spend.
When people don’t spend money, profits fall and businesses fail.
When businesses fail, tax revenues fall.
When tax revenues fall, government collapses.
When this happens, society collapses, and dark ages are born. Deflation began in the Roman Empire as a consequence of poor governance. But later it became a huge contributing factor in the accelerating collapse. That led to a Dark Age that set much of humanity back for centuries.
Fortunately, this time could be different. The world economy can be saved.
But it probably won’t happen any time soon.
Deflation’s end game for gold
As you’re aware, politicians don’t like making tough decisions. For example, before being elected, the Abbott government promised to cut spending. Four years later, and another Liberal Prime Minister, nothing’s changed.
For the record, I’m not a fan of either political party. At the end of the day, I believe there’s no difference between Liberal and Labor. They both over-promise and under-deliver.
Instead of helping the economy, (Liberal and Labor) politicians are destroying it. Regardless of which party is elected next, the government will try to raise taxes to pay their bills. Meanwhile, spending will remain out of control.
This is a problem.
Increasing taxes reduces disposable income, which causes deflation. Remember, you’ll have less money to spend.
Of course, we’ve been brainwashed. Politicians have told us that they’re targeting ‘the rich’. But, ‘the rich’ are typically small business owners — not your Donald Trumps of the world.
On this note, Australian small businesses aren’t exactly thriving. In fact, the Sydney Morning Herald reported last week:
‘Australia saw deflation for the first time in seven years in the first quarter, as falling petrol, food, and clothing prices drove down the cost of a basket of goods and services.
‘Subdued inflation, a global trend stemming from weak demand, low energy prices and flat wages, gives the central bank scope for another cut to the cash rate.
‘Falling prices discourage spending and investment as both consumers and businesses hold off.’
It’s clear the Australian economy is declining. If business owners are hit with more taxes, they’ll have to cut wages. And, potentially, downsize their businesses to survive.
If this happens, the Australian economy will grind to a halt. Gross domestic product (GDP) will crash, unemployment will jump, and deflation will rise. Meanwhile, as debt skyrockets and the budget blows out, the Australian government will have no choice but to default on their sovereign bonds.
Only at this point will the government restructure. They’ll have no other choice.
Unfortunately, it will be too late. Everyday Australians will have lost confidence in government. They’ll be buying gold — the hedge against government. For this reason, if you own best gold shares, you’ll outperform the market. That is, if you buy at the right time.
You might disagree. But either way, that time isn’t now.
Short term gold
Gold hit a seven-month high last week. On Friday, the precious metal smashed through its March high of US$1,284 per ounce. This marked gold’s first four-month winning streak since August 2012.
There’s clearly plenty of momentum. And gold will probably re-test the 2015 high of US$1,307 per ounce this week. If this happens, Aussie gold stocks should benefit. But be careful.
As explained above, we’re facing a major financial crisis in the years ahead. This could kick-start in the next couple of months, which I’ll explain another day. If gold performs like it did during the Global Financial Crisis of 2008/09, the bottom hasn’t arrived. Gold should crash sharply when the financial meltdown starts to heat up. It will start to rally only when a solution becomes clear.
In my view, there should be a better buying opportunity. If I’m right, this is just another bear market rally. So, I’d sell in May and go away!
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Resources Analyst, Money Morning