Inflation-Hedging Hard Assets Will Soar In 2009
Dec 10th, 2008 | By Eric Roseman | Category: Gold MarketIt’s inflation or die for global central banks, says Eric Roseman. The market is pricing in a deep recession and a stretch of deflation. But in the coming year, these desperate reflation policies will work. And when they does, inflation-hedging hard assets will soar. Eric says this makes now the perfect time to accumulate gold.
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The time to start building fresh positions in oil, gold, silver and TIPs has arrived. Even distressed real estate should be accumulated if credit can be secured.
Over the next 6-12 months the United States, Europeans, Japanese and Chinese will eventually arrest deflation. And long before that materializes, hard assets will begin a major reversal following months of crippling losses.
Since peaking in July, the entire gamut of inflation assets has collapsed amid a growing threat of deflation or an environment of accelerated price declines. The last deflation in the United States occurred in the 1930s, purging household balance sheets, corporations, states, municipalities and even the government following two New Deals.
Thus far, U.S. CPI or the consumer price index has not turned negative year-over-year. Yet as oil prices continue to lose altitude and other commodities have been crushed, input costs and price pressures continue to decline dramatically since October. The only major component of CPI that continues to post modest year-over-year gains is wages. And with unemployment now rising aggressively this quarter it’s highly likely wage demands will also come to a screeching halt.
Plunging Bond Yields Discount Danger
In the span of just six months, foreign currencies (except the yen), commodities, stocks, non-Treasury debt, real estate and art have all declined sharply in value in the worst panic-related sell-off in decades. More than $10 trillion dollars’ worth of asset value has been lost worldwide in 2008.
What’s working since July? U.S. Treasury bonds and the U.S. dollar as investors scramble for safety and liquidity.
On December 5, 30-day and 60-day T-bills yielded just 0.01% – the lowest since the 1930s while the benchmark 10-year T-bond traded below 2.55% – its lowest yield since Eisenhower was president in 1955. Even 30-year bonds have surged as the yield recently dropped below 3% for the first time in more than four decades.
The market is now pricing a severe recession and – possibly – another Great Depression. Despite a series of formidable regular market interventions by central banks since August 2007, the credit crisis is still alive and kicking. The authorities have not won the battle …at least not yet.
Heightened inter-bank lending rates, soaring credit default swaps for sovereign government debt and plunging Treasury yields all confirm that the primary trend is still deflation.
To be sure, credit markets worldwide have improved markedly since the dark days of early October. Investment-grade corporate debt is rallying, commercial-paper is flowing again and companies are starting to issue debt once more – but only the highest and most liquid of companies. For the most part, banks are still hoarding cash and borrowers can’t obtain credit.
The real economy is now feeling the bite as consumption falls off a cliff, foreclosures soar and the unemployment rate surges higher. These primary trends are deflationary as broad consumption is severely curtailed, with consumers preparing for the worst economy since 1981 and rebuilding devastated household balance sheets.
But at some point over the next 12 months, the market might transition from outright deflation or negative consumer prices to some sort of disinflation or at least an environment of stable prices. That’s when inflation assets should start rallying again.
Inflate or Die: The Name of the Game in 2009
The battle now being waged by global central banks, including the Federal Reserve is an outright attack on deflation. Through the massive expansion of credit, the Fed and her overseas colleagues are on course to print money like there’s no tomorrow to finance bulging fiscal spending plans, bailouts, tax cuts and anything else that helps to alleviate economic stress.
Earlier in November, the Fed announced it would target “quantitative easing” and “monetization,” unorthodox monetary policy tools rarely or never used in the post-WW II era.
Without getting too technical, the term “quantitative easing” means the Fed will act as the buyer of last resort to monetize Treasury debt and other government agency paper in an attempt to bring interest rates down. Quantitative easing aims to flood the financial system with liquidity and absorb excess cash through monetization or purchasing of government securities.
Through monetary policy, the Fed controls short-term lending rates but cannot influence long-term rates that are largely set by the markets; the Fed now hopes it can influence long-term rates through quantitative easing. And since its announcement two weeks ago, long-term fixed mortgage rates have declined sharply.
These and other open market operations directed by the Fed and Treasury will eventually arrest the broad-based deflation engulfing asset prices. It will take time. Inflation is the desired goal and is the preferred evil to deflation, a monetary phenomenon that threatens to destroy or seriously compromise the financial system. Policy-makers have studied the Great Depression, including Fed Chairman Bernanke, and the consequences of failed central bank and government intervention in times of severe economic duress are unthinkable.
Ravenous Monetary Expansion
According to Federal Reserve Board data, the Fed is now embarking on a spectacular expansion of credit unseen in the history of modern financial markets.
The total amount of Federal Reserve bank credit has increased from $800 billion dollars to $2.2 trillion dollars (or from 6% to 15% of gross domestic product) as the central bank expands its various liquidity facilities in an attempt to preserve normal functioning of the financial system.
The Fed’s ongoing operations to arrest falling prices are targeted namely at housing – the epicenter of this financial crisis. It is highly unlikely that the United States economy will bottom until housing prices find a floor. Quantitative easing hopes to stabilize this market.
Buy Gold Now
Relative to other assets in 2008, gold prices have declined far less. The ongoing liquidity squeeze has forced investors to dump assets, including gold to raise dollars. I suspect this short-term phenomenon will end in 2009 once the ongoing panic subsides and credit markets become largely functional again.
Gold should be accumulated now ahead of market stabilization. As the financial system gradually comes back to life over the next several months or sooner, the dollar should commence another period of weakness; there will be little incentive to hold dollars with short-term rates at or close to zero percent. The Fed will be in no hurry to raise lending rates.
Still, the Japanese experience in the 1990s warns investors of the travails of long-term deflation.
The Japanese, unlike the United States, only started to seriously attack falling prices in the economy in 1998 through massive fiscal spending. In contrast, the U.S. is already throwing everything at the crisis after just 17 months.
I expect the United States to print its way out of misery and, over time, and conquer deflation. But the cost will be humungous and at the expense of the dollar, U.S. financial hegemony and calls for a new monetary system anchored by gold.
It’s literally “inflate or die” for global central banks. Inflation will win.
Source: Inflation on “Sale” as Deflation Dominates Global Markets
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Monetary Reflation Today, Price Inflation Tomorrow
(Excerpted from speech to China Gold Summit, December 4, 2008, Shanghai — by Jeffrey Nichols, managing director of American Precious Metals Advisors and NicholsOnGold.com)
I remain bullish on gold because — even as the global economic recession deepens — governments will find the only way out of this mess is to print more money. In other words, to inflate.
The United States Treasury and the Federal Reserve have already thrown a few trillion dollars, more or less, into the banking system and are now also lending directly to businesses and households. And, there’s surely much more to come when the next Administration moves into Washington.
It’s not only the U.S. monetary authorities pumping up the money supply. Their counterparts in every major economy – including the United Kingdom and the Euro zone, China, Russia, Japan and on and on – are doing likewise.
We have never in the history of money seen such an expansion in its supply without, after a period of time, a rapid deterioration in its value – in other words, without a rapid increase in the overall price level. More than any other factor influencing the gold market, it is the inevitable devaluation of money and the corresponding rise in price inflation that will propel gold skyward in the next few years.
As sure as day follows night, reflationary monetary policies — however necessary — have long-term implications for global inflation. Typically, monetary creation affects price inflation with a lag of six months to a couple of years – and in the current environment, the lag could be still longer . . . so it may be some time before inflation is recognized as a serious problem. But gold prices have shorter lags and could begin moving up before rising inflation becomes apparent or worrisome.
Longer term, gold-price prospects remain as bright as ever — and I firmly believe we will see record high prices in the next few years with gold back over $1000 an ounce in the coming year.
With the right confluence of economic and geopolitical developments we should see gold break through $1500, then $2000, and possibly still higher round numbers in the next few years – particularly if we get the type of buying frenzy or mania that often occurs late in the price cycles of financial and commodity markets.
This is hardly an audacious forecast when looked at relative to the upward march in consumer prices over the past 28 years. After all, the previous high of $875 an ounce in January 1980, when adjusted for inflation since then, is today equivalent to more than $2200.
Let me end with a warning about the days and weeks ahead. In the short term, gold remains volatile and vulnerable, if only because market psychology is nervous, anxious, and fearful. In this environment, we could still get a quick sell-off that would bring us back to the recent lows. But, day by day, I think that becomes less likely and, day by day, I think the base is building for a lasting longer-term recovery.