Deflation is making headlines again. And while falling prices may seem like a good thing from a consumer perspective — cheaper gasoline, cheaper beach houses, cheaper whisky — over time, deflation erodes the demand for goods and services.
This happens for two reasons:
1. People postpone purchases in anticipation of prices falling further.
2. People receive less money for what they are selling and, in turn, have less money to spend, which equates to no or slow economic growth.
Deflation isn’t anything new. If one counts assets such as homes, commercial real estate, shopping malls and stocks, you could argue that it set in near the end of 2007.
The biggest problem for policymakers when confronting deflation is the lack of tools to fight it. It seems the only recourse policymakers believe can help is the printing of money — what the Fed calls “quantitative easing” (QE) — in hopes of creating inflation to counter deflationary trends.
The Street believes this is exactly what the Fed will do, and yesterday’s FOMC minutes indicated that there is a good chance it will happen, so traders should be on the lookout for ways to capitalize on this trend.
2 Ways to Profit From Deflation
I believe the best way to trade this is by going long gold and silver, as no currency is safe from quantitative easing and debasement.
We are at a critical inflection point in the price of gold — $1,300 an ounce — but all signs are bullish. And while silver had been trailing gold, it no longer seems to be doing so.
The cries that we are in a gold bubble are receding, given the acceptance of deflation and zero percent interest rates for the foreseeable future. Top technical analyst Louise Yamada recently said gold will not be in a bubble until it hits $5,200 an ounce, a far cry from today’s prices.
I recommend that options traders buy calls on precious metals ETFs SPDR Gold Trust (NYSE: GLD) and iShares Silver Trust (NYSE: SLV). In my own account, I own these ETFs and sell calls on them each month to generate cash, which is the ideal strategy for those of you familiar with writing options.
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