A Follow-Up To My Bullish Gold Call

by: Paul Nathan

In my last article, Why I've Turned Bullish On Gold, here at Seeking Alpha , I stated that I believed that 2014 would be the year gold turned and resumed its move upward. I said it could be the trade of the year. Since that call, gold has turned and many precious metal stocks are up 10% to 25% in the month of January, and some penny gold stocks have doubled.

My reasoning for a resumption of the bull market in gold is that if we have higher world growth and inflation, gold should go up with the demand for more resources and commodities. And if we have even the fear of recession and/or deflation as the IMF cautions, the Fed will ease or at least stop tapering, and that will shock the markets that are expecting further tapering - and gold will go up. And if we have more cyber-attacks which seem to be a monthly occurrence, or if financial or banking problems emerge in China, South America or Europe, fear could take hold and a run to safety would result, and gold will go up. I will leave it to the bears prediction of 1100, 1000, and 700 dollar gold, to explain why it will fall.

What I find interesting is the continued clash of data between the growth/inflation scenario, and the recessionary/deflation scenario. In the last week, the latter has taken front and center stage.

The stock market has fallen dramatically as the first quarter of the year opens and could be foreshadowing bad things to come. Retail sales continue to disappoint as consumers have pulled in spending. Worries of declining future earnings have set in. A slowdown in China, default possibilities from Argentina and financial and banking concerns in Europe and China have developed. Argentina is running out of reserves and devalued its currency and may default on its debts. This could affect Venezuela, which is vulnerable to a political and financial panic, and Brazil could tumble in the wake of the other nations possibly imploding.

Deflation concerns plague Europe as delineated in a speech by Christine Lagarde of the IMF. Turkey's currency is falling like a rock, and Russia and many of her neighbor's currencies are falling as riots increase. Puerto Rico is another nation threatening debt default and is making waves throughout the world. The contagion of any or all of these nations could amount to a mini-monetary crisis, and oil could spike as natural gas has already, which will cause higher prices for all consumers and affect all nations. Another Black Swan raises its ugly head. Both the bond market and the VIX are telegraphing these concerns.

Yet, it was just the opposite one week earlier. The CPI reported inflation increasing the most in six months. It has been in the 0-2% monthly range. The most recent report of .03% has it running in the 2 to 4% range. And there are further signs of growth here and abroad. Europe appears to be on the upswing. So much so that analysts are raising their forecasts for world growth for the year from 2% to 3%.

Obviously the forces of inflation and deflation, growth and recession are still at play.

The very real effect of all this was the profits it left in the pockets of gold traders and those lucky enough to hold penny resource companies. Gold has penetrated many of the chartists' resistance levels. With gold going up as interest rates are going down, the fear trade appears to have taken over - at least for now. But in both scenarios gold moved higher, and that is my point. All roads lead to higher gold prices, save the one scenario that could kill the gold rally and that is the onset of a deflationary recession.

The stock market has recognized these threats and has for the first time in years fallen impressively for the month of January, a bellwether month in a lot of investors' minds. ("As goes January goes the rest of the year.") The money supply as defined by M2 is now down for the month of January. If the GDP is falling and deflationary fears are increasing in Europe, and emerging markets are on the verge of a currency crisis, and default is threatened from various nations - by all means tighten! And that is just what the Fed has done and may do again this week.

So the jury is still out. Will the inflation/world-growth scenario play out? Or will a deflationary recession engulf the world? As a great commentator use to say many years ago, "we will know in the fullness of time." But I for one am betting on a resumption of the bull market in gold.

The battle between the forces of inflation and deflation continues. In spite of all the talk, neither the US nor Europe has been able to reach their 2% inflation target, and this in the face of the greatest amount of money printing in history. Why?

And if they have not been able to inflate, what is the rationale for reducing money growth in the face of an accelerating deflationary trend? Rational economic analysis dictates that the Fed must concentrate on M2 money supply figures which are falling, not balance sheet figures that have done little to achieve any of their goals.

A new monetary policy is called for that focuses on money in circulation, not money in excess reserves. Hopefully, that discussion will begin at the Fed's upcoming meeting. Meanwhile, keep an eye on GLD as the best barometer of inflation versus deflation, and growth versus recession and which forces are winning out.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.