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USDX Versus Gold Indicates Inflation Not Yet Dead

Submitted by The World Complex

I have been plotting the US dollar index against the US dollar gold price for some time, looking for a sign.

Since about Halloween, the graph of USDX against gold price in USD has suggested deflation, as both parameters were increasing. I have previously argued that this behaviour benefits gold miners outside the US, as the number of US dollars they get for their product increases along with the purchasing power of those dollars.

In the past couple of weeks, the graph has reverted to the historical norm, wherein a rising US dollar is met by a falling dollar price for gold.

The blue line represents the deflationary trend discussed here and here, and the gold hyperbolae are isoquants, described here and here. An isoquant is a locus of points where the product of the USDX and the USD gold price is constant. The "traditional" behaviour of gold with respect to the US dollar is for the system to evolve along an isoquant--with the gold price rising as the US dollar falls and vice versa.

In the graph above we have plotted the isoquants for the 1000 and the 1150 level. The 1000 level has been important in the past. The initial rise in the gold price in 2010-11 began by migrating along the 1000 isoquant level, and the collapse in gold price in 2013 resulted in the graph bouncing several times off the 1000 isoquant (and penetrating it slightly twice).

Over the last few weeks the system has been moving along the 1150 isoquant. The 1150 isoquant has had some small influence on the system in the past--there is a knot just below the 1150 isoquant as the gold price rose sharply in 2011, suggesting that 1150 was a difficult level to break above. Similarly, during the collapse in 2013, the curve bounced twice off the 1150 isoquant before running down to the 1000 level.

In the last few weeks, we have seen what looks like a transition from deflationary behaviour to a more traditional behaviour in which gold acts as the "anti-dollar". I don't think this represents a sea-change--I still think there is more deflation to come. But we might see a change in behaviour for some time before deflation returns.

As noted before, deflation was temporarily overcome by the various central bank interventions since 2010. We then had over four years without deflation, before it re-established itself late last year (at least in this index). It is unclear whether we are seeing the result of a new intervention, which will once again probably be temporary (but this could be a long time). Alternatively, we are seeing a battle between investors who see inflation and those who foresee deflation, with the inflationistas holding the better hand, for the moment.