It is no surprise that the U.S. dollar is finally mustering a bear market rally in late April. And it is no surprise that gold prices are pulling back, either. But what is quite shocking is the newfound consensus on Wall Street this week that the Federal Reserve is approaching the end of this easing cycle.
Investors are growing increasingly optimistic that the United States will escape this recession quickly, similar to the 2001 recession. I think they are dead wrong.
With housing prices still plunging, job losses mounting each day at major corporations, and a contraction in credit to both companies and individuals, it is almost lunacy to believe the Fed has reached the nadir of this monetary easing cycle. In fact, I am projecting the Federal Funds rate will head to at least 1% or maybe even 0% before this bear market is over in 2009.
Why am I so bearish? This economic cycle marks the first time in the post-WW II period whereby inflation and deflation are running side by side. It is unprecedented. Consumers are spending less, losing their jobs, increasingly denied credit and blown away by soaring food and energy costs.
Housing, however, is my primary concern. New home sales tanked 8.5% in March to their lowest levels since 1991. Housing shows absolutely no signs of bottoming; it is the biggest deflationary tug on the economy.
What we are seeing now is a long overdue bear market rally for stocks, including the homebuilders and REITs. This is the biggest sucker’s rally since April-May 2001.
After topping out earlier last month at $1,033 an ounce intraday, the June gold contract has pulled back to $887 an ounce this morning in New York, a 14% decline. This marks the second time in six weeks that gold prices have corrected below $900 an ounce on the heels of a U.S. dollar rally. The dollar, of course, has been dumped relentlessly for the last several years with a brief bear market rally in 2005. This will be no different.
The Fed is under immense pressure by world central banks to stabilize the dollar because of resultant inflation now spreading just about everywhere. The Fed talks a good game, but, in the end, has no choice but to grow the money supply to arrest housing and credit deflation. The broadest monetary aggregate available to the public, M2, shows a massive 16% gain year-over-year. That tells me the Fed is desperate to grow inflation at all costs.
I would use any intermittent weakness in gold prices to accumulate positions. Gold should hold above $850 on this correction. Supplies remain very tight, especially in South Africa. Plus, new mined supply is virtually nil, with the majors absorbing huge input costs to replace declining reserves or net new supplies.
In 2005, gold prices rallied 18% even as the dollar posted a bear market reversal. I expect the same to occur this year, especially as the European Central Bank (ECB) starts cutting lending rates over the second half of the year. As the ECB starts cutting, gold will head off to the races once again as that part of the world joins the Fed in reflating the money supply. Germany is now slowing and several other countries are faring even worse, mired in real estate deflation.
Investors have seriously miscalculated a bottom in financial markets. The Bear Stearns bailout was not a “buy” signal. Instead, it marked an acceleration of desperation as the Fed prints money like there is no tomorrow. The war is against deflation. Buy gold on weakness.
Have a good weekend.
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