Talks of Recovery Are Premature

The recent dramatic surge in stock prices has convinced many that the worst of this recession is over. Talks of "green shoots" have flooded the airwaves, while improving yet still horrific economic data are celebrated as a sign that the economy has bottomed.

Unfortunately, all talks of recovery are premature and the reality of the situation is much bleaker. Significant economic shockwaves are likely as the public comes to realize we are in fact, in a depression.

Recent moves in gold, oil, bonds and commodities as a whole are clearly warning of future inflationary pressures and economic dislocations. In an already weak economy, rising inflation will quickly dampen any hopes of recovery. Remember: rising commodity prices in 2008 precipitated the historic collapse in stocks and asset classes as a whole. There is a fine line between rising commodity prices evidencing recovery, and rising commodity prices laying the groundwork for the next round of economic collapse.

In terms of interest rates, economic orthodoxy suggests the Fed will raise interest rates to counteract inflation. However, the Fed continued to lower interest rates in 2008 in the face of rising inflation because of the countervailing threat of debt liquidation and the need for liquidity. Raising interest rates would utterly collapse an economy increasingly characterized by an overleveraged consumer.

Hence, I believe all talk of the Fed raising interest rates anytime soon are premature.

In a hazardous investment environment where assets are experiencing huge and rare moves, preservation of capital is paramount. Moving forward, gold appears best suited to serve the dual role of crisis and inflation hedge. Currently, gold appears to be basing for a powerful move to new highs as inflation rears its ugly head as the result of unprecedented quantitative easing, and negative real interest rates. There has been a stealth accumulation of gold from central banks such as China and hedge fund extraordinaires like John Paulson. The Dow to gold ratio currently sits at about 9. In previous asset class repricings, the Dow/Gold ratio has fallen to 1, which suggests this bull market in gold has a ways to go.

Recently, there have been talks of potential hyperinflation in the U.S. due to profligate spending, record budget deficits, and quantitative easing. While hyperinflation is far from a sure thing, it should be noted that hyperinflation of the Weimar kind is preceded by heaving selling in the foreign exchange market, which we have yet to see in earnest.

Regardless of business conditions, hyperinflation is a risk as confidence in the government and currency collapses. The dollar is currently under tremendous pressure, and coupled with talks of a new reserve currency, this may portend a currency crisis of sorts in the near future.

In an environment where confidence is quickly collapsing, gold should be bought on dips. What detractors of gold fail to realize is that gold has still not captured the attention of the mainstream retail investor. Once this happens, I believe gold will double in price rather quickly much like it did in the last bull market of the 70's.

While the short-term may bring almost anything, the long-term trend in interest rates, the dollar, and gold is clear. Ride the bull market while gold is still an unpopular mainstream trade.

Disclosure: Long GDX

Comments

[Dave Wrixon:]

Talk of recovery is ludicrous.

Before recovery can take place, somebody has to get a handle on what went wrong and do something constructive about it.

It is a bit like saying that most of the passengers have been rescued so it is safe to fly again. Indeed , it is business as usual.

The longer people talk about green shoots, the more I think sustainable recovery is decade away. Take Chrysler, is that seriously going to fly now. We have a partnership between a Union and foreign company that one put up one brass cent. Are you seriously going to go out and buy one. As for all this technological transfer, I have ever got the impression that Europeans think there is anything very special about Fiat, but to read the American press you would think it is the second coming.

Jun 11 04:53 AM

[stocknerd:]

Sorry all you doom and gloomers, the market will not crash, we are in a recovery, the market is up 35% (How high does it have to go before enlightenment doomers?) and inflation will not happen this year or any time soon.

Jun 11 09:40 AM

[Moses Kim:]

Thanks for the comment.

I agree that we have to sit down and think long and hard about what went wrong instead of merely throwing money at the problem. We are virtually guaranteeing some kind of major crisis in the future.


On Jun 11 04:53 AM Dave Wrixon wrote:

> Talk of recovery is ludicrous.
>
> Before recovery can take place, somebody has to get a handle on what
> went wrong and do something constructive about it.
>
> It is a bit like saying that most of the passengers have been rescued
> so it is safe to fly again. Indeed , it is business as usual.
>
> The longer people talk about green shoots, the more I think sustainable
> recovery is decade away. Take Chrysler, is that seriously going to
> fly now. We have a partnership between a Union and foreign company
> that one put up one brass cent. Are you seriously going to go out
> and buy one. As for all this technological transfer, I have ever
> got the impression that Europeans think there is anything very special
> about Fiat, but to read the American press you would think it is
> the second coming.

Jun 11 11:26 AM

[Larry House:]

Recovery is no where to be seen at this time. The green shoots are fading. Our problems are much bigger than most believe and will take years to work through.

Jun 11 12:11 PM

[The Geoffster:]

The crisis in California is foreshadowing the coming collapse of the dollar. Instead of exercising fiscal discipline, our politicians have just kicked off the largest spending binge in history and it will only get worse. The takeover of health care will bring us to our knees. Taxes will have to double to make the interest payments. Growth will be sluggish in the face of government spending crowding out private investment.

Jun 11 05:38 PM

[Old Trader:]

"Hence, I believe all talk of the Fed raising interest rates anytime soon are premature."

Mr. Kim,

The above quote from your article is one that I respectfully take issue with. The short end of the curve will, in likelihood, stay low, but the long end will face increasing pressure upwards. Long term rates will rise as more and more inducement is required to "entice" buyers to US long term debt, which will be issued in ever larger amounts to fund the US deficit. Unfortunately, because the downturn has been global, the US is not the only country issuing copious amounts of debt: the UK and the EU countries are in equally bad shape...perhaps even worse. Today, Italy issued in excess of 8 billion Euros worth of debt of several different maturities (per Bloomberg).

All of this debt certainly doesn't bode well for the corporate sector, either, since its no stretch to assume crowding out of private debt will occur.

Jun 11 05:44 PM

[Moses Kim:]

Old Trader,

I think we are in agreement here. The Fed has proven powerless to control the long end of the yield curve due to the reasons you stated above amongst others. In essence, the Fed has been overpowered by the market. My point is that the Fed certainly won't speed up the process by raising the Fed Funds rate.

On Jun 11 05:44 PM Old Trader wrote:

> "Hence, I believe all talk of the Fed raising interest rates anytime
> soon are premature."
>
> Mr. Kim,
>
> The above quote from your article is one that I respectfully take
> issue with. The short end of the curve will, in likelihood, stay
> low, but the long end will face increasing pressure upwards. Long
> term rates will rise as more and more inducement is required to "entice"
> buyers to US long term debt, which will be issued in ever larger
> amounts to fund the US deficit. Unfortunately, because the downturn
> has been global, the US is not the only country issuing copious amounts
> of debt: the UK and the EU countries are in equally bad shape...perhaps
> even worse. Today, Italy issued in excess of 8 billion Euros worth
> of debt of several different maturities (per Bloomberg).
>
> All of this debt certainly doesn't bode well for the corporate sector,
> either, since its no stretch to assume crowding out of private debt
> will occur.

Jun 11 07:16 PM