Thursday, February 16, 2012

The Deflationary Undertow Before The Inflationary Wave

Ride the wave, or drown. 

War between Israel and Iran now seems inevitable. Leon Panetta claimed that it would be this coming spring—and I see no reason to doubt him.

How an Israeli-Iranian war will play out—that is, whether it will draw in more geopolitical actors (such as the U.S.), or if it will be a series of limited attacks, counter-attacks, and then stalemate—is impossible to predict. War tends to take on a life of its own.

But we can predict how it will affect the global markets.

A very reasonable assumption is that oil supplies, especially to Europe, will be severely curtailed. Aside from the fact that one fifth of the world’s oil production passes through the Straight of Hormuz—ground zero of a war with Iran—the rest of the world and especially Europe depends on Iranian oil. As discussed in the SPG Scenario of this past June (“An Israeli-Iranian War?”), close to 10% of the eurozone’s oil comes from Iran—and the countries most particularly dependent on Iranian oil are precisely those most in trouble right now: The so-called PIIGS.

So oil prices will inevitably rise. And so—just like 1979, after the overthrow of the Shah of Iran and the subsequent Oil Shock—the world’s economies will experience another likely oil shock which will send up the price of oil, hurting the world economies rather badly—

—and driving up inflation.

Dollar inflation and euro inflation is in the offing, in the weeks and months following a war with Iran. The assets that will rise drastically in price will be precious metals, especially silver; agricultural commodities; and oil—obviously. The assets that will collapse in price will be sovereign bonds, corporate bonds, and equities, in that order. In the Scenario, I discussed which countries will hurt the most, so I won’t bother repeating what I wrote there.

However, notice I say that inflation will rise “in the weeks and month following a war with Iran”: A war with Iran which disrupts oil supplies will—inevitably—lead to an inflationary wave.

But before that inflationary wave hits—that is, in the days and hours following the beginning of the war—we will experience a deflationary undertow.

This deflationary undertow will present some interesting opportunities.

If and when there is a curtailment of Iranian oil due to a war in the region, inflationary expectations and a regular ol’ short-squeeze—paradoxically—would force both the dollar and the euro up, as traders and speculators sell off assets and positions and go to cash in those two currencies, in order to cover their exposure.

That is, as the markets digest the news of war with Iran and the subsequent disruption of the global oil supply, there would be a rush to cash before a reallocation of capital in the global markets.

This is the deflationary undertow that we can expect immediately following war breaking out with Iran.

How severe will this deflationary undertow be? It will depend on how expectant the world markets are.

The more build-up to the war in the mainstream media, the lesser the deflationary undertow. If a majority of market participants come to the conclusion that war with Iran is inevitable, and thus reallocate their capital before the war, then market panic following the outbreak of hostilities will be at a minimum: Therefore, the less severe and strenuous the reallocation of capital following the beginning of the war. Oil prices would of course go up—but there wouldn’t be a generalized market disruption and panic.

This, of course, is predicated on there being a steady drum beat to war.

If a war with Iran is sudden and unexpected, the market reaction would accordingly be more violent—more short-term deflationary.

As an example of this deflationary undertow, consider the period June–December of 2008, with respect to gold: Gold peaked at $930 on June 30, just before the Global Financial Crisis, only to fall all the way down to just below $730 on September 11, when the financial panic was at its peak. Then gold rose once more to over $900 by September 25—only to collapse to just below $700 on October 11: A yo-yoing of 23% up, and then 22% down, in exactly one month.

Why such huge swings? Uncertainty.

There is no question that there will be a deflationary undertow immediately following the start of war with Iran. This would mean a fall in the prices of precious metals and all other commodities (except of course oil), before the markets realized that rises in the price of oil mean widespread inflation of both the dollar and the euro, and thus a rebound and rise in the prices of precious metals.

The real question is, Will this deflationary undertow before the inflationary wave hits be severe? Or minor? Or barely a blip, before we shoot the inflationary moon?

It will depend on how prepared market participants are. The more priced-in the expectations of war, the less potent the deflationary undertow.

So watch the mainstream media, and keep an ear on the zeitgeist. The more mainstream discussion about the inevitability of war, the less the deflationary undertow.

Keep in mind: I am not arguing that a war with Iran would be deflationary—not at all. War with Iran, and the curtailment of global oil supplies, would be radically inflationary. I am saying that the immediate, near term effect of a war with Iran could potentially be severely deflationary, if global markets are caught flat footed.

This deflationary spasm of a few days (a couple of weeks at most) before inflationary expectations set in and drive precious metals and commodity prices a lot higher could be the perfect buying opportunity—if you’re prepared.
This piece is adapted from one that appeared at my Strategic Planning Group, and is part of a longer discussion of a possible Israeli-Iranian war. If you’re interested, check out SPG’s preview page, to see what it’s about.


  1. Thanks for this interesting perspective. I will keep this in mind as I formulate my future investment strategies for metals, etc.

  2. If the sources in this article are to be believed then we should be worrying about drflation » inflation from a Greek default before any wars have a chance to get going

  3. Gonzalo, do you have any historical data, say for the first Gulf War in '91 and then again for the Iraq Invasion in 03, that would show this type of wave?

  4. Very Good Article. Thanks

  5. im still waiting for your hyper inflation...................

    1. Patience the lag could be eight to ten years.

      The famous seventies inflation had it's start with money printing of the Kennedy admin. Initially it was good for the economy, then it turned nasty. A little known fact that the oil embargo of 1973 was due in part by Saudi Arabia saying.... We don't want your debased dollars, so we will hold back supply and increase the price. (This occurred after Nixon took the US off the gold standard). The oil shock was essentially a monetary event....

    2. Exactly, and I wonder why GL kind of repeats the lie of "the oil shock caused the inflation in the 70's" here

  6. Thanks for the insights, Gonzalo. Interested in any response you may have to Anonymous @3:28PM above.

    I've been strongly considering moving mostly to cash in view of the:
    plummeting retail gasoline consumption
    plummeting electric energy consumption
    (extreme?) bullish sentiment
    over 5:1 lop-sided seller to buyer insider trading

    and this is "one more bullet".

  7. One of the many reasons we need R. Paul. The US needs to stay out of this BS!! We don't have the money and a rising oil price will KILL the economy!

    1. Iran is already destabilizing the market with the nuclear initiative and the terrorism export. Ron's isolationist politics doesnot respond to reality but to surreal preference of leises faire and the pre ww2 old times. It just can be done.

  8. Market predictions are worthless. Just buy precious metals and hold them through the Holocaust Of Inflation the world is going to experience. It's going to kill more people than Hitler ever dreamed of.

  9. Gold and silver is just a trade folks. Dump everything gold and silver related when the DOW:GOLD ratio hits 1:1

    1. Like 1980, when the Dow & Gold were both 800. Great time to buy stocks and dump gold. you are very smart.

    2. Not this time stays high for longer than you can imagine. This is an exception to the rule because the circumstances setting up GOLD are indeed exceptional.

    3. When the DOW/GOLD ratio hit's 1:1 you can bet gold will be high. Probably $6-$10k a tr/oz.

    4. That may be true ...but that doesnt mean its a sell. Gold at that level implies there is something deeply wrong with the system. To fix the system, it may need to be part of the solution.

  10. The 'Powers-That-Be' are already basically stating, that by THIS SPRING (2012) THERE WILL BE WAR WITH IRAN. So, there you have it - PLENTY OF FORE-WARNING. FEW, IF ANY, will be caught 'flat-footed' - except, of course, the perilously apathetic paper-invested, brain-washed American public. (Gold and silver - physical bullion - coins/bars - have outperformed EVERY OTHER INVESTMENT - over the past 11 years) So, I wouldn't expect much of a 'deflationary undertow', since the war with Iran is still months away (?) Of course, Israel may grow restless with Americans' lack of enthusiasm for fighting another war for Israel...and may just start the thing by themselves. I say America should let Israel start AND FINISH - IT'S OWN WARS! Imagine that - Israel starting a war on a neighbor!

    1. That might be true but I remember reading war with Iran was going to happen last May 2011 as well.

    2. How did gold and silver do in the 11 years previous to that? Contrary to popular belief gold and silver is not magic and many people have in the past lost a lot of money by investing in gold. maybe not this week or this year but eventually the gold bubble will burst like all bubbles burst. The wise will ride this bubble and get out of gold and silver at the peak. They will also talk up the value of investing in gold to make the bubble larger and last longer. But larger bubbles simple cause more havoc then smaller bubbles. So invest in gold and silver but be ready to get out when things turn and expect everyone else to be dumping their gold and silver at the same time.

    3. Wrong again. Only 1-1/2 percent of all portfolios around the globe are alloted to any kind of gold. Where is the bubble?

      The economic lightweigts of the world are yelling gold bubble but the truth, facts and portfolios belie this fallacy.

    4. so in 1980 what was the percent of portfolio allotment in gold? probably smaller-- there was still an excited herd of gold bugs buying it up and up, then dropping it like a hot potato til it dropped to 1/4 of its value.

      look, I own shit loads of gold and silver at present,(I bought silver at 4.60)
      but its just a trade, not holy matrimony so my eyes are open to the next ascending value, and I will let go of dollars & gold in order to grab coal or copper or hog bellies or uranium if thats the next ride

    5. So your saying people lost a lot of cotton paper with someone's face on it that is only backed by an entity that is between 15 trillion and 150 trillion in debt. So you would accept an i.o.u. from bankrupt corporations for hard assets and say the person that received the hard asset lost in the deal because I have more i.o.u.s that are worth nothing. I suggest you learn the difference between money and currency before you make such ignorant statements. What if the person never sold their gold back then and held onto it? Did they lose money, according to your definition, at the price it is at today? What about the schmuck that bought gold at 35 an ounce in the 70s. Should he/she sold in 1980? The other farcical argument aside from dollars are money is the bubble. Give me the definition of a bubble and apply those factors to current gold, u.s. bonds and the dollar trends and tell me what is in a bubble.

    6. This ain't 1980 pal. Back then there were a few billion people in commie countries that were not even allowed to own gold or silver. That is all changed now. Now their governments are promoting the idea of owning it, while the US govt and the fed call it an anachronism.
      Just wait until the bottom falls out from under this phony economy built on debt and lies. When the world wakes up to the currency printing that is going on, the people who bought into precious metals will be sitting pretty.

  11. Gonzalo,
    There will be no war with Iran, it is just a drama to divert attention from Syria. Syria will be the battle field, because the strategy of Libya will not work in Syria. It is also hard to sell a war with Syria to American people, I mean there is no Oil there.

    I guess only time will tell!!!!!

  12. "The Deflationary Undertow Before The Inflationary Wave "
    ...take a ticket.....
    What comes first ... The Chicken or the Egg...??
    The analogy in this case is a "Default" event taking precedence(having birth) over the "War" that all and sundry are talking about..and yet the market keeps making new highs....hmmmmmmm !!!
    What's wrong with this picture I ask. ???
    Markets aren't living in denial forever.
    With vast amounts of cash/liquity sitting on the sidelines already (>$9.0TLN) ...just waiting for the "opportunities to present" dont get to experience the undertow..... because the "smart/in the know" money has already moved. ( this case "go to cash /cash in" on the rumour...sell the out and go to stocks.
    That being the case...what is driving the markets (higher)now, because surely with all that money sitting idly by, wouldnt you expect profit taking to be driving the markets down ?

    One school of thought is that those nasty little creatures taken out as insurance contracts against default on debt obligations, are going to be triggered. There seems to be some urgency on the part of those that issued the paper in ensuring that there is enough tangible assets behind the paper to meet their obligations. Deleveraging has nasty consequences aside the expected ones. One of the unexpected, is the boyancy of markets in light of extreme uncertainties.

    Predictability of markets and reactions in these days of uncertainty and extremes, could lead one to the poor house very quickly, if you are not on the right side of the ledger (or in the know).

    Perhaps its more appropriate to just buy PM's and close your eyes and block your know one thing is certain that TPTB will attempt to retain their control and attempt to keep the system functional ...and that necessarily creates an extreme inflation environment.Ultimately know what that leads to........and so should enveryone else who has a vested interest financial markets.

  13. Oh btw GL,
    The Straight of Hormuz is not only vital for oil flow.
    I can see your logic in terms of extrapolating the oil/inflation argument, but what about the Gulf States that rely on these waters for the goods that they import (Saudi, Kuwait, Iraq, UAE). They may be the world's supplier of Oil, but heaven help us all should they be restricted access to necessities. Rich in Oil and sand is one thing...but they have little else by way of natural resources/commodities.

    Dont you think the planners have thought about this.
    War is not a good thing ....but when it indirectly involves the nation states of 90% of the world's oil supply, things get pretty hairy damn quickly. Last time I checked you have Iran (the eastern front) facing Saudi Arabi(western front)with Kuwait, Iraq and Syria blocking the clear view of Israel on the other side.

    Oh what a dilemma...(those damn Greeks again)...!

  14. You all remember that morning on 9.11 when you woke up turned on the TV and watched the WTC collapse. Well, one morning soon Iran will bring a replay. It may be the closing of the straits with an attack on oil tankers or American warships. It could be an all out attack on Israel using a nuke. It could even be a terrorist attact on NY City or DC. But it will happen. Iran's leadership is a suicide bomber and they are willing to die and allow their people and country to die to kill Jews or attack the great Satan. It will happen, Iran is not preparing for no reason at all, they are preparing for war so they can destroy Israel and maybe take the great satan down a notch or two.

    1. I totally agree. The solution? I suggest a preemptive stike on those suicidal maniacs. That way the american people will pay for a war with their blood and taxes so that their oil companies can make "some" profit on iranian reserves. Now if a preemptive strike doesn't look good they can also try a "false flag" operation. Anyways, those fanatic ragheads have it coming

  15. All these moves have been planned well in advance.

    All the big players are prepared with cash to begin the real war - financial terrorism.

    Want to "predict" the market - just look back to the last 3 wars in the region. Price action only varies by magnitude - the action is repeatable every war, every conflict.

    Look to the big players who have been around for the last 7 conflicts. Watch and follow their moves - they have a playbook that they follow closely.

    What is happening now is NOT random chance. This is ALL planned, and planned very carefully. You think the Arab Spring was a facebook phenomenom? Pfft! Designed I tell you!

  16. I'll bet Israel attacks with unconventional methods, maybe a small pox break out in Iran. If Iran were to develop a nuke they couldn't use it on Israel without all of Iran being turned to glass. I don't want to pay for another war, unless it lands on our shore. Russia and China will quickly back Iran compounding the difficulty of the situation. If Israel attacks I hope they got a good plan that doesn't involve the United States.

  17. Say what? You have written an entire article about a "deflationary undertow" without ever once describing what a "deflationary undertow" is. No less befuddling is your dubious assumption that a war between Israel and Iran would do no worse than send a ripple through the global economy. In fact, it is quite likely to set in motion forces and events that would bring global business to a halt for a decade or longer. How does one "play" that scenario? You are kidding yourself if you see opportunity, for the challenge may be surviving, not profiting.

  18. The effects will be severe. If you want to survive this, the best book on it is Jim Sinclair's book, "A Pocketbook of Gold"; A Survival Manual for Monetary Mayhem

  19. Why the emphasis on Silver?

    Just curious :)

    Thanks for the article!

    Regards & Best Wishes to All


    1. Historically the ratio between gold and silver is 16 to 1.
      If (as many believe, including myself) that ratio returns, the ratio at present is 51 t0 1. So you see, there is more "upside" to the silver trade. If we were at 16 to 1 today, silver would be $108 per ounce.

    2. Thank you Anon, much appreciated :)


    3. Just like Oil to NG used to be 10:1
      Now it's closer to 40:1

  20. Despite all the war talk, I don't think it will happen for many reasons. One of the most important is the only real beneficiary of closing Hormuz will be Russia, one of the few oil producers that has no need for Hormuz. An embargo of Iranian oil by Europe will be an enormous windfall for Russia.

  21. Hi,

    American politicians and corporate media gleefully promoting another war? Whatever, as the kids say.

    Maybe it's all just a sick ploy to raise oil prices in the face of declining gasoline usage as I've been reading, and the war will never happen. And that would be far better result than seeing more working class kids come home dead, or worse, for nothing that concerns them, their families, or the core interests of their own country.

    Of course the effects of a war with Iran could be beyond merely serious for the world economy, and so be somewhat unpredictable except for oil prices.

    Right now America has a clever morally unprincipled bought and paid for opportunist for president*, a witch like looking, increasingly unhinged hag in a pants suit in charge of foreign policy, a megalomaniac military bureaucrat running the CIA, a career influence peddler in charge of the Pentagon, an opposition party obsessed with that great 21st Century issue of Western Civilization, the use of contraception by married adults, along with a Congress whose true loyalties are now the stuff of so called conspiracy theorists. Really, what could go wrong? Oh, and then there's Europe.

    Good luck investing in this mess. Maybe the gold bugs are right. In any case, I'm adding Antal Fekete to my reading list just to be on the safe side.



    * well, which country doesn't....

  22. Don't see any reason for American Soldiers to come home in Body Bags for Israels insecurities... surely by now they can fight their own battles..At this stage of the game the US should be focused on its own problems without the Jewish Lobby complicating matters..If they are keen on a dust up let them sort it out themselves ...The US may have many problems but Iran shouldn't be one of them...I wonder if Rahm Emanuel will be partaking in Gold and silver during this Crisis -(opportunity)..Thats life innit..

  23. I find Santorum distasteful in many respects, but he has made clear that his comments on contraception are personal views (that led to his having seven living children), and that he has no intention of imposing them on the nation.

    Obama's minions are using Santorum's personal weirdness to change the subject, specifically, to stop people from thinking about their decision to force Catholic churches to buy insurance that (must) cover abortion - which is like forcing Kosher delis to sell ham.

    First they came for the Catholics, but I was not Catholic. So I stayed silent. Then they came for the gold bugs....

    1. There is a movement afoot by insurance companys to further separate the well from the sick. The latest is the "wellness" push. The want to get your personal wellness profile and will give you a discount to get it. This means those that don't participate get to pay the bill.
      Insurance is a collective sharing of risk. Can the churches also decide that they don't want to cover blood transfusions? Some might not want to provide that coverage.
      And think about your employer providing health care as a group plan. Unsurers must love to provide health care coverage to people who work. Think about it! They are well enough to work. They are in the age group that works. And when they can no longer work, they get dropped from the insurance plan! So if your joints are wearing out from working, don't expect the insurance company to jump up and volunteer to pay for a joint replacement. I is in their interest to delay until you can't work anymore.
      This latest over abortion is one more trick to fragment the pool of insured. A nose under the tent, if you will.....

      There should be ONE provider of health insurance in the U.S. Everybody should pay premiums in one way or another. And elected representatives should use medical boards to decide what gets paid for and how much gets paid.

  24. There will be no war without US participation - Israel can not do the job by itself. The Israeli problem is how to pull the US into attacking Iran.

    Obama’s main preoccupation is getting reelected - at this time it looks like he has a better then even chance of being reelected. A war where he voluntarily jumped in with both feet, would no help his reelected.

    So a war this year would mean that Obama would have to be forced into it. That means some kind of a false flag operation, forcing Obama‘s hand. What would it be - probably a fake missile attack on Israel proper.

    Whatever the Israelis do - they can count on the US media backing them 100%.

  25. If Israel attacks Iran, I think there is a good chance there won't be an Israel after that. It wouldn't take much to destroy that tiny country.

  26. As long as Obama is President there will be no war with Iran.

    1. At most you will see the Drones in Syria to help Israel fight the Iranians ......

  27. That's Right!!
    He won the Nobel Peace Prize!!

  28. I'm surprised war is viewed as inevitable. Crude is already at $105/bbl for WTIC, on 02-20-2012, before a shot is even fired. Do the 'powers that be' want $300 oil? Who knows, maybe they do, but it is a stretch to say it is a certainty that they do.

    There won't be any deflationary undertow. Where does all this 'defaltion' talk come from? Is there any precedent for a pure fiat currency to do anything but go to zero in purchasing power?

    In the immediate wake of any serious disruption in oil supply, oil and its refined products will be hoarded, and dollars will be spent recklessly in a desperate attempt to take possession of same. I would expect oil to increase in value to gold and silver, but not near as much of an increase as it will go up in dollar terms.

  29. Wow, fantastic article mate, we are absolutely sympatico here! Deflation will be the initial reaction, followed by massive, panicked QE that will drive up inflation. A double whammy. Great post, and its always good to come across a blog where one's own opinions are validated:)

  30. Netanyahu is coming to Washington in two weeks - Obama wants to be reelected - will Netanyahu blackmail Obama with Jewish media power and money into another war?

    1. A possible outcome from this meeting is this scenario - Netanyahu says to Obama - “we elect you - you make war on Iran after the election.”

      Bush waited to attack Iraq until after the mid term elections - he kept saying “I have not made a decision” - of course that was a lie. This gave him time to build up our military assets around Iraq. Iran will require far more air assets than Iraq did. We will have to kill any military capability that Iran has to attack Saudi Arabia.

      The tricky part of this is how they will handle this summers high gas prices - the high prices will be a negative for Obama’s reelection. The Jewish media will have to sell the American people on the notion that Iran is to blame for the high gas prices. Of course that is a giant lie - Israel’s interests are responsible for the sanctions that are pushing up the gas prices. Everyone’s disposable income in the whole world will be adversely effect by Israeli interests.

  31. Since the USA exports a lot of the oil we produce, would we not be able to sustain to a certain extent by not exporting any oil and importing as much as we can?

    Am I wrong to assume the energy Dept is not already working on a contingency plan??

  32. Brilliant as usual. If you can, please post more frequently here or un the SPG, your posts inspire me.

  33. Gonzo,

    Will this be as good as your hyperinflation by the end of 2010, or hyperinflation by the end of 2011 predictions?

    I thought so.

    1. haha!
      you have to be a member of the Strategic Planning Group to get an answer.

  34. I am a bit confused. I thought inflation was a monetary issue and not a price issue?? Or are you confusing the school of fish theory where everybody seems to turn on a dime all together with inflation.... Just curious.

  35. A well written and thoughtful article. Gonzalo is a master of predictions!

  36. Whatever happens I believe Soros when he says that it will be bloody and terrible. For the USA it has absolutely zero value for the majority but I don't think that will stop them one bit, considering they swallowed the arabs in caves attacked and brought down three buildings in NYC in 2001. They also linked Saddam to it and the country went whole hog on the invasion. Lie big, and make it outrageous as that old nazi said. Some people have really taken that lesson well.
    China will be insulated, they can get oil from Russia, and others. Russia just needs to make sure a Facebook/AIDS/CIA condum people revolution doesn't tip him out and they seem to have very low debt levels. Plus the populace over there has some experience with war, suffering, survival ect. Plus the new Russians aren't as easily duped as a whole.
    Sad to say USSA is easily duped, effectively broke, and the gov seems to be busy as bees passing laws left and right regarding protest, the ever catch all terrorists could be vets, OWS, people who use cash, or actually form an opinion...add in all the private contractors hunting the terrorists and you have a big stew that would make a cabal of witches proud.
    I see default, maybe a nice EMP to knock out pesky internet terrorist types, work style FEMA/ARMY/SPOOK run prisons and the sheep cheering the Central Casting Spook actor into one more ever loving term of destruction. Anal rape would be more gentle than whats coming for the benighted USSA, and no I don't believe China, the Russians, the Iranians, mooslims, or Satanists in Illuminati covens really are the causes. Collectively all Americans played some part, if only by willful ignorance. Obviously some did a lot but like the time you passed all the exits on that drunk drive on the highway you have no choice on the destination's EXIT.
    Inflation is the least of it. Apparently the history books in the USA public school system are wretched. I don't know since I went to private schools, my parents forbid TV, and I loved reading history. The French Revolution to be exact.

  37. Dear Gonzalo:
    So where is the hyperinflation that you said in 2010 would be flowing by mid 2011

  38. Yes, technology-not only which has a computer mouse button or even touchpad, yet it's meant to cause you to intuitively wish to faucet using the cheap office 2010 key pc screen, and also swipe the idea. With no touchscreen display, factors behind upgrading an old technique as well as getting a pc together with Home windows 8 diminish engaging.


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