Gold and Stocks: Watch Out!

If I did not know better, I would think that the good Mr Katz was answering my response to his previous article on movements in the precious metals markets, particularly silver and gold.  Whether or not that might be true, I wanted to take the opportunity to mark clearly where I agree and disagree with the gold bug community.  I am extremely sympathetic to both their principles and their predictions about the economy and markets, but not for the next year or so.

First, let me start with where I am in agreement.  “The CRB is gathering strength for an attack on the July 2008 high.  The charts are not predicting ‘deflation.’  The charts are predicting ‘inflation,’” writes Mr Katz.  Setting aside the charts for a moment, I find this notion extremely plausible and likely from a fundamental standpoint.  But, I contend that this scenario is only possible if the credit machine sparks up again to ignite the massive pools of liquidity collecting in the depths of the financial system, in which case it is likely to produce a brief burst of economic activity that will likely exceed the predicted boom in commodities.  This burst is most likely to manifest itself in equity markets before it floods the economy with paper currency.

Katz also points out that despite the fear of deflation that gripped the world in 2008-2009, we have yet to have had a year of deflation.  But, we should also point out that we have had decades where inflation was accompanied by falling commodity prices and a booming stock market.  And we have had periods of rising commodity prices and high-flying stock and property markets.

Now, if commodities are going to boom sooner rather than later, that is important.  John Murphy, in his groundbreaking book on intermarket analysis shows that a rising CRB index is bearish for stocks and bonds.  And, I can think of no reason to doubt that observation, but are commodities that close to being in a position to threaten equities?  It doesn’t appear to me that they are.  Again, not without a more vigorous economic recovery that would show up in the stock market first.  Although it is not a perfect indicator, one should note that the Shanghai stock exchange has been a very good predictor of commodity prices, such as oil.  I am less sure that Shanghai will play such an obvious role this time around, but there is nothing there that indicates a run-away bull market in commodities at the moment.  Competitive devaluations emanating from Japan and other laggards will certainly help, but that money takes time to work its way through the system.

The third item in Mr Katz’s very interesting post is the following, wherein he explains how we can identify the tops and bottoms of stock markets:

“What, in fact, causes stock market tops is government intervention (via the Fed).  When the Fed eases (as in 1982 and 2008), stocks form a bottom.  When the Fed tightens (as in 1987 and 2006), stocks form a top.”

If that is the case, then aren’t stocks in position to continue pushing upward?  The Fed is not tightening, and they are unlikely to do so in the current economic environment.

I think silver is a fine investment, since it is more likely than gold to soak up the money that will start pouring out of the banking system soon, but I argue that the stabilization of the economic situation this summer bodes best for stock markets around the world—okay, except Japan maybe—and only secondarily for commodities.  Gold and then bonds would be pulling up the rear.  Moreover, I suspect that equities could shock even the most bullish investors.

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