The Monetary Battle Continues

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Includes: FCX, GLD
by: Paul Nathan

I ended my previous article by stating:

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 confidence.

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.

As of the end of July, the price of gold has stabilized, in fact it has rallied. Still, gold and some metal stocks continue to flirt with their 52 week lows and the rallies have been timid. The realization that we are slowly moving toward a 1% GDP-or worse-is pulling interest rates, employment, and prices down into an economic morass as consumers retrench.

In the midst of an era of unprecedented money creation we actually have tight money. Proof of this can be seen when comparing the 70's to the present. In the 70's, inflation increased progressively higher and higher, year after year, for a decade. Today, inflation rates are declining. Interest rates also climbed to historic highs in the 70's unlike today's historic lows. And while the velocity of money rose vigorously during the 70's, it is now virtually non-existent, and hasn't risen for years. In the 70's and 80's we fought credit expansion and inflation. Today it is de-leveraging and deflation that we have to ward off.

As the world continues to spiral toward a deflationary recession, there will come a point where all central banks find it in their interest to launch a coordinated monetary response to the deflationary threat. Recent tendencies toward looser monetary policy by the U.S., Europe, China, and Japan, have paved the way for what I consider an anti-deflationary stance.

The central banks, especially when acting jointly, are powerful. They have as much power to move markets as presidents, prime ministers, legislators, or dictators. I don't know what the central bankers have up their sleeve for a last ditch effort to save the euro (or the world) from a deflationary recession, but the words of Mario Draghi, president of the European Central Bank, are telling:

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro… believe me, it will be enough.

Whatever Draghi has in mind, I would not rule out the possibility that it involves changing the mandate. Investors will want to be in gold and silver stocks, as well as resource stocks, when that day arrives. We are ever closer to a coordinated world central bank move to fight what amounts to a growing recessionary deflationary threat to the world economy, and markets sense this. It will not come in the form of stimulus as much as prevention. In the 30's, central banks contracted the money supply. In today's world, central banks aim to increase money supply, but only to the degree that it does not affect long-term inflationary expectations, yet fights deflationary expectations.

Central bankers walk a tight rope and they will only move to reflate when absolutely necessary. Hence, a world in which we go right to the brink and then a safety net is thrown. For investors, that means buying when things look bleak, and selling when the "all clear" is sounded. I'll be watching both (NYSE:FCX) and (NYSEARCA:GLD) as barometers for where we are at. Both have come off their lows when monetary loosening statements were made from world central bankers. Actions will speak louder than words from here on.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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