In the wake of the Fed’s announced record monetization, some gold bugs remarked about the significance of the date and decision. Moreover, the airwaves were littered with commodity bulls (not the familiar faces). There were a few non-gold bug analysts on live television showing currency from Zimbabwe and relating the Fed decision to what has transpired in Zimbabwe. Hyperbole aside, Fed policy of currency debasement and inflation of the money supply is hardly anything new. News is important in that it highlights and reinforces trends. It doesn’t create them.
Keen market watchers and seasoned Fed observers were hardly surprised at the Fed action. We all knew it was coming. The question was when. Remember, news highlights trends. Commodities had been forming a bottom for five months. Just two weeks prior we wrote about our positive near term view on commodities. How about Gold? It rose from trough to peak over 40% in just four months. It seems that only the shorts were surprised.
Now to expound upon last week's missive, reflation isn’t always so advantageous for the precious metals, especially gold. That holds true for both the economy and markets. With stocks and commodities now recovering, money is to be put to work in those markets and also potentially diverted away from gold. We aren’t expecting a full-blown correction in Gold but rather a consolidation that, for a matter of time diverts attention (like an idling engine) away from itself as it prepares for major liftoff.
This is a temporary respite in a bear market and in an economy stuck in deflation. The first period of deflation (and strengthening dollar) in the Great Depression lasted three years. The Yen increased nearly 100% from early 1990 to early 1995. This bout of deflation isn’t even one year old yet. In other words, don’t expect commodities to enter a cyclical bull market anytime soon. There isn’t enough demand on the horizon. The recession and accompanying deflation should last into 2010. It may be a while before both run their course, thereby allowing an inflationary recovery to begin in earnest.
In conclusion, be aware that the current rebound in stocks and commodities, though large, is just a temporary recovery. A single news event won’t change that nor alleviate the current deflationary pressures on the economy. Finally, holders of gold and gold shares should be patient. The major breakout will occur this year, though not within the time expectations of the gold bugs.