Has The World's Recessionary/Deflationary Trend Been Broken?

 |  Includes: HL, MUX, RBYCF, USSIF
by: Paul Nathan

It's almost July and we still have no idea what policy makers here in the U.S. or around the world intend to do to solve the problems that face us. Here, the political fate of tax policy is yet to be resolved; if no decisions are made, this will lead to substantially higher taxes in 2013. The debt ceiling dilemma will also have to be dealt with again soon. Growing debt and deficits are out of control. Medicare and social security are bankrupt with over 67 trillion dollars of outstanding unfunded liabilities. And a recessionary/deflationary bias is dragging the U.S. economy down.

Internationally, policies are being drafted "on the fly." There is no central government in the EU, no coordinated fiscal policy, and no monetary flexibility. There is no EU architecture to deal with the problems Europe faces. It may seem harsh, but my call would be to end all assistance and loans to Greece and marshal remaining resources in an attempt to defend the rest of the nations in the euro-zone.

The resulting meltdown in Greece would serve as an example to any nation that chooses to ignore economic reality and its own fiscal condition - which Greece has done and still does today. That alone would "encourage" every other nation in the eurozone to take the necessary measures to get its fiscal house in order - or be next in line to fall. It's tough love, but it would likely do more to quickly end this crisis than any other proposed policy.

Even though Greece has temporarily averted total collapse and Spain has been given a credit lifeline, the eurozone and its currency are not out of trouble. Alan Greenspan just referred to the euro as a "noble but failed experiment." I agree. The euro was set up as a rigid monetary system, but lacks rigid fiscal requirements. For years, I've argued against returning to any form of rigid fixed exchange rate system in a fiscally irresponsible world. Without first establishing fiscal integrity, any such attempt would lead to chaos. The eurozone is a vivid example of such a failed attempt.

The international crisis will not be solved unless the EU establishes a unified budget moving toward balance, lower debt to GDP levels, and encourages economic growth through labor and regulatory flexibility. Most nations, however, are still moving in exactly the other direction; and until they reverse their course, the crisis will continue.

This should serve as warning to the United States, which is now alarmingly following in Europe's foot steps. US growth rates have fallen from 3% as of the first of the year to under 2% today. And, as commodities have fallen, we've moved from 4% inflation rates to 2% inflation rates year over year, with sporadic deflationary rates on a month over month basis. The recessionary/deflationary bias is taking further hold of the economy and until the policies change, we will continue to languish in what I call a World of L; with stagnation and high unemployment for as far as the eye can see.

In response, resource stocks have gone defensive along with gold stocks since May. It has been a painful decline, but the fact that most of the stocks I hold are nicely above their recent May lows provides some perspective. McEwen Mining (NYSE:MUX) was 1.96 and is now 3. Rubicon Mineral (RBY) was 2.54 six weeks ago and is now above 3. U.S. Silver Corp (OTC:USSIF) was 1.08, now 1.37. And Aurizon (AZK) has risen from 3.82 to 4.50. We may have seen the lows with resource stocks clawing their way back to more reasonable valuations.

Last week's end saw gold rally up 50 dollars an ounce, with the market up over 200 points. The meetings in Europe led to an unexpected TARP like move. The EU is now acting more like the Fed - which up until now it claimed it wouldn't. The next step for the EU, as well as the U.S., is to tackle the fiscal and growth sides of their problems. This is a long-term proposition. At least the EU continues to address short-term liquidity and solvency concerns. Their efforts have eased interest rate pressures and back-stopped banks and sovereign debt as well. And this may be the beginning of an attempt to construct a structure for a new monetary system that will be both more flexible and less rigid.

But while the EU's temporary moves have provided some short-term relief, they do nothing to forestall a further slide toward recession. The U.S. and the rest of the world continue to move toward lower growth rates (even negative rates). Downward commodity prices however, may have halted. The six-dollar-plus jump in oil and 5% move up in copper last Friday is testimony of the power of central banks to successfully fight de-leveraging and deflation when they put their minds to it.

A positive sign would be if gold leveled off in the next quarter. Gold has been signaling the recessionary/ disinflationary bias for over a year. Gold must stabilize if we are to nip this deflationary trend in the bud. I believe the 1535 level on gold is the line in the sand. Breach it and gold could be at 1350 or 1400 by year's end. And if that should happen, other commodities will go with it, followed by consumer and producer sentiment.

So the recessionary/deflationary battle continues. Will the world's central banks successfully stave off deflation? Or will the markets overwhelm them? Watch the price of gold for a possible clue.

Disclosure: I am long AZK, MUX, RBY.