Thursday, April 08, 2010

The Course of Inflation II

After posting The Course of Inflation, a reader asked me to expand on the projections and risk analysis - gladly. The risk optometry appears below. Note that simulated generalized brownian motion was used to extend the forecast past 2009 through 2025. The trendline that travels through the historical data is based on the power function depicted. Finally, take careful note that the 1% and 99% projections do not bind the potential outcomes as the chance and risk of higher and lower prices still exists, albeit unlikely. Of course, I made the assumption that gold prices since 1968 proxy the real inflation rate, which some economists might question.

The main point of the forecast and previous article was to show that the most likely path of gold prices (and therefore inflation) is not likely to extend beyond risk free rates based on the historical data since 1968. Gold fundamentals were not considered in the projections (other than historical prices), so do the additional analytical work before investing in gold...


Related Posts:

The Course of Inflation

The Course of Inflation III

4 comments:

Max J. Pucher said...

Thanks, William. PERFECT! So you are telling me to go all out for gold?

Hm. But should I go with your assumptions on gold to inflation or do I consider gold fundamentals or ... that tells me now what???

Could you please add to the calculation the added risks of your assumptions being wrong or that the 20/20 hindsight does not project into the future ? Thanks.

Max

PS: I got to be real sure ...

Dr William J McKibbin said...

Hi Max, with gold prices at over $1,000/oz these days, I would hold off on purchasing gold until a correction occurs, at least according to the projections. Again, no regard to fundamentals are considered in my analysis. My advice to "gold bugs" these days is to be very careful. Thanks for commenting...

Jeff said...

Trendlines are all well and good in a stable environment, but relying upon that view alone seems about as dangerous as driving a car exclusively by looking through the rear view mirror.

From the fundamental side, I think one needs to take note of the fact that our country is currently the largest debtor nation in the history of the world and counting our "unfunded" "off-the-books" liabilities owes more than $1 million per taxpayer, and that debt is growing by an additional $20,000 per year per taxpayer. Last year we spent 86% more than we took in. The first of our baby boomers reach age 65 next year and many of those unfunded liabilities are going to start coming due with increasing frequency.

In short, I think there will be enormous pressure on the Federal Reserve to monetize more and more of our deficit. If that happens, all bets are off on the inflation front. It's a whole new ballgame.

Dr William J McKibbin said...

Hi Jeff, my analysis certainly does not rule out the possiblity of a sharp rise in inflation as a scenario (e.g., trace the 99th percentile line). However, I agree that a look at fundamentals is in order before reaching any conclusions. Thanks for commenting...

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