Why Peter Schiff is Only Half Right

It is no surprise to find out that Peter Schiff is bearish about stocks, but his most recent admonition to “dump stocks” could not be timed worse, in my opinion.  He applies the tried and true intermarket observation—that stocks and commodities have an inverse relationship—to our current situation.  Unfortunately, the relationship is not quite that simple.

Inflation has been very low for the last year and a half and there is no indication that inflation is absolutely imminent.  The mangled wreckage of a nearly totaled credit machine has prevented all the liquidity pumped into the financial system by the Federal Reserve and other central banks around the world from generating that inflation.  Moreover, there is considerable slack in the real economy.  Underutilized capacity and high unemployment should do a lot to mop up any incipient inflation, although once the recovery in the economy does emerge, Bernanke and friends are unlikely to recognize the correct time to withdraw that liquidity (in my opinion, about a month ago) and will fail to withdraw as much of it as will be necessary to choke inflation off.

I have argued over the previous weeks that the credit machine is back in working order, despite the rather lackluster year so far, and that because the global economy is in critical but stable condition, the credit machine is about to push markets towards riskier investments, including some of your old favorites:  stocks, foreign currencies, property, and eventually commodities.

I do not disagree that commodities are likely to go up, but commodities are so low at the moment that money is likely to pour into equities before the real bull market in commodities emerges and pushes inflation up wildly.

If my overall interpretation of the economy and markets is correct, this will be much like 1975 again, an Indian summer, the eye of the storm, call it what you will.  But, between the liquidity waiting to be deployed in the banking system and the stabilization of the economy, not only since 2008-2009 but the sovereign debt crisis of the spring, there is massive potential for a powerful bull market in equities to be followed by an even more powerful rally in commodities that will usher in inflation and bring an end to the brief return of the dominance of equities.

You can count on the Federal Reserve to pull back on quantitative easing at almost the exact wrong time, choking off credit by sharply raising interest rates just as commodities put the squeeze on the real economy, but that is probably a good year or so away.

One final word about gold.  It is often assumed that gold is a commodity and therefore it behaves like one on the market.  That is not true.  Gold is unlike any other commodity—except, to some extent, silver—because it is money.  Therefore, when the economy is or appears to be in mortal danger, gold can be seen rallying while other commodities are going the way of the stock market.  On the other hand, when inflation is the primary force in an economy, all commodities, including gold, can be seen to rally.

This year, gold has been a hedge against deflation and depression, not inflation.  Now that that risk has dissipated—again, momentarily—we can expect to see better returns in stocks and commodities other than gold.

As I have argued before, over the long-term, the gold bugs are right.  Gold and other commodities are going to destroy the stock market, and let’s not even talk about bonds.  Everything is in place and ready to go, but the time is not yet ripe.

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1 comment so far

  1. Dow 13000? « Herodotus Now on

    […] years, and that at these levels, including the depths of the bear market of the 1970s, particularly 1974 and 1979, stocks produced 47% and 31% returns, respectively.  Last year also saw a spike in the […]


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