Don't Fight the Fed : Buy of A Lifetime

May 2, 2008

When I first started investing I heard those words many times- “Don’t fight the Fed.”  In light of the bull market in the general markets that phrase generally meant that the Fed can affect interest rates, and interest rates can be very powerful motivators to the markets.  Generally that phrase seems to be repeated during stock market bulls, but I guess it certainly also made a lot of sense when Volker raised rates back in the early 80’s, just in the reverse.  Still, that phrase seems a bit arcane to me since the Bond markets really set rates with the Fed just confirming them with their official statements.  Now, that makes a lot of sense to me since the investors in the Bond markets make their investment decisions based on the environment of the markets.  Still, the concept works.

Recently I read where somebody suggested that real inflation is much higher than what the CPI Index suggests, and I certainly have to agree with that.  Then, the same person wrote that if Mr. Volker was in charge of the Fed, he would be raising rates to head off inflation.  I am sorry, but I cannot agree with that second statement.  You see, markets go through different cycles or environments, much like the seasons of the year.  I don’t care how hungry you might get- deciding to plant your garden in January if you live in a Northern climate just won’t work.  Deciding to ski in July usually won’t work either.  Invariably the environment you are in will dictate your choices in everyday life.  The environment of the markets will also dictate what will work, and what will not work.

The current market environment is analogous to the hard freeze of winter.  In that hard freeze life becomes more about surviving than it does about more superfluous activities. The current hard freeze of the markets has been caused by massive debt buildup in all sectors of society.  In fact, all of these derivatives we hear about sound a lot to me like just another way to pile debt upon debt while the banks sought a synthetic way to try to protect them from what they were creating.  It doesn’t look like it worked.  Now, all of this debt must be unwound, plus all of the esoteric derivatives look like they need to collapse.  What a web we have woven.  In terms of surviving, Richard Russell has suggested that the current environment is not about “return on principal, but the return of principal.”  I certainly agree with that concept, but with Dollar inflation one must also take the fall in the value of the Dollar into account.  We have shown through charts how a Dollar today is not worth a Dollar back in 2000.  We have also shown how the Dow is around the same levels as 2000, yet your buying power has been reduced by about 73%.  Return of principal in this environment sounds great, but you better understand how “principal then” relates to “principal now.”

Bringing back Mr. Volker to raise rates would only cause the whole mess to collapse into a pile so the Fed will keep printing.  Thus, there is no choice at this time in terms of warding off inflation coming down the pipe.  Along with the inflationary environment we still have the massive debt to be worked off.  That means that the economic environment will be weak, or stagnant at best- thus we are looking at a period of Stagflation.  Stagflation is simply a weak economic period with inflation- dollar inflation that creates price inflation.  We saw such a period back in the 1970’s when the price of oil rose sharply while the economy was slow.   This time around we were headed into the dead of the Kondratieff Winter due to the massive debt build-up- what could have been the Mother of all deflationary economic conditions except the Fed has elected to print Dollars to try to avoid deflation like back in 1929.  In effect, they are trying to convert a deflationary environment into a period of Stagflation.  Still, the economy will be exceedingly weak to go along with the price inflation caused as a result of the Dollar Inflation.  In terms of financial survival, Gold and Silver are moving from their place as commodities to their lead role as Real Money in times of economic turmoil.  To see how Gold and Silver performed in a period of Stagflation, all one needs to do is to look back at the long-term charts of Gold and Silver in the 1970’s.  In fact, we have been tracking the current movements in the Gold chart since they have been almost exactly the same as the moves in the 1970’s.  That chart suggests that Gold and Silver have not even come close to the parabolic move that they will be embarking on over the next several years.  Yet, there seems to be a major question about the Precious Metals Stocks at this time, though I see nothing that says anything other than the environment will continue to track the time period of the 1970’s since the Fed cannot quit accelerating the Dollar printing; much less stop the printing completely.  

If the Fed must keep printing Dollars at an accelerating rate to stave off deflation, then what will happen to the value of the Dollar as the supply grows?  The value of the Dollar will fall as supply increases while demand does not.  Though we will have reflex rallies in the Dollar Index at times, supply and demand metrics will always win out.  Just like people always worry about unforeseen tops in a bull market, the dollar bear will constantly have people worrying about a bottom, me thinks, but constantly accelerating Dollar supply will win- causing a continued fall in the value of the Dollar.  This time around I think, “Don’t Fight The Fed”, needs to be defined differently.  It is not about interest rates in this environment- it is about Dollar supply.  In the current environment “Don’t Fight the Fed” means that the Fed will continue to print Dollars so Gold and Silver will go to the moon like in the 1970’s.

What Ya Know, And What Ya Don’t Know

I spend my days playing dentist in my office.  When I reach a tough point in a treatment case I always go back to the basics.  I ask myself one question, “What do we know, and what do we not know?”  In making critical decisions we can only base our decision on what we “know”- facts.  So, let’s step back a bit at this time to consider where we are in the historical Gold Bull Market.  We know that the driver of this Gold Bull is Dollar Inflation and all other factors are really secondary to it.  We know that the economy is weak and the world is flush with debt so the economy will be slow going forward.  In fact, we know that bank reserves have fallen off a cliff.  We know that Gold and Silver will be going much higher, but how about the PM stocks?  Well, we know that much higher Gold and Silver prices suggest that the Precious Metals stocks should continue to rise rapidly as they did in the Stagflation of the 1970’s.  The only thing that could prevent that is if the Fed quit printing Dollars, and outright deflation caused investors to sell everything.  Yet, the Fed just reconfirmed their Dollar Inflation policy when they recently created all of these “loan facilities” for the banks and investment banks.  I see nothing that suggests anything except that the PM stocks will be going aggressively higher.

In the last two editorials, I built the case for the Precious Metals stocks going higher.  In the editorial I wrote 2 days, ago, I suggested that Gold, Silver, and the PM stocks will bottom this week.  I still believe all of that will prove to be true with an aggressive move up in all three of them over the coming months.  But for the time being, let’s consider the risk reward of Gold, Silver, and the PM stocks at this level, regardless of whether we see an acute rise over the coming months.  For long-term buy-and-holders of Gold, Silver, or the PM stocks, I don’t think you are going to find a better time to buy than, right now.  The chart, below, was one I created on 4-20-08.  The chart has changed very little over the last week.  On the chart I have drawn two arrows to show you where I think we are in the current giant 5th Wave of this Gold Bull versus the equivalent point in the 1970’s Gold Bull market.  If you look at the arrow on the left side of the chart, you can see that we are still in the very early stages of the parabolic move yet to come.  Personally, I think that this run higher in Gold and Silver still has a ways to go before we have one final drop into a deflationary scare that will come late this year or into early 2009, but if it turns out that we are already in the final drop before the real parabolic move starts- it still is a great time to buy. 

That brings us to the Precious Metals stocks.  If the Fed continues to print Dollars, then I see Stagflation on the horizon with the PM stocks also going parabolic.  Yet, the PM stocks have not had the large run that Gold and Silver had recently so I think that at this time the Precious Metals Stocks are the “Buy of a Lifetime.”  That means in “all time-frames” especially after this recent sell-off.  There has always been a question of whether Gold and Silver lead the PM stocks, or visa-versa.  Many times in short-term time-frames I think the PM stocks lead, but I have shown in a chart two weeks, ago, that the chart of Gold is clearly leading the PM stocks in this PM Bull.  That is part of the reason that the PM producer stocks have lagged Gold and Silver in recent times since Gold and Silver are well into their Third Wave runs while the PM stocks are lagging a bit.  You can clearly see that phenomenon if you look at the chart, below, since you can clearly see the abrupt change in the slope of the Gold chart while you cannot see it in the chart of the HUI………yet.

I do apologize for reviewing the above, and for using two charts that I have previously posted, but I think it is very important for us to keep things in perspective, overall.  That concept includes all possibilities, and I am suggesting that after the recent sell-off there appears to be very little risk in PM positions in general for investors with long-term or intermediate-term perspectives.

Very early this morning I was looking for a different way to create a chart that might give us some further evidence of what we might expect to see for the PM stocks in the immediate future.  In the last two editorials I have shown why I expect the charts of the PM stocks, Gold, and Silver to resolve to the upside much like they did in late 2005.  At the time the words of Pittrader came to mind.  He suggested that a rising Silver:Gold ratio was very bullish.  Since I think we are still missing a 5th wave advance in the current rise, and since Silver also tends to outperform Gold in late stages, I put the following chart, together.  The following chart is a bit “busy”, but it shows the chart of “Silver divided by Gold” with the HUI chart plotted behind it.  I have highlighted the current period in yellow, along with the late 2005 period that I expect to resolve in a similar fashion.  We can see in the chart of “Silver:Gold” the very similar structures on the chart in both time-frames while the 20 week moving average formed a cup.  We can also see similar moves up in the MACD indicator with similar rises in the ADX line confirming them.  Like in late 2005, the Silver:Gold price is currently correcting back to support at the nexus of moving averages.  In late 2005 the similar situation resolved higher with the PM stocks moving aggressively higher along with Gold and with Silver.  As two reference points to the above, I have also plotted charts of two dissimilar stocks that are not Precious Metals stocks at all.  The first is a chart of BQI which is an oil sands stock, but a more speculative issue since it currently has no earnings.  The second chart illustrated, above, is the chart of AUA.TO- a speculative Molybdenum mining company that like BQI has a tremendous resource base, but is currently moving toward production. The reason I included these two charts is because both started large moves up back in late 2005 at almost precisely the same time that the PM sector started its large run.  Let’s just say that those two charts look interesting at this time, and that fact might relate to a change in the psychology of investors toward the more speculative shares, along with a changing psychology toward reserve revaluations in general.  That is what we would expect to see if the PM sector is going to resolve to the upside at this time.

In my opinion, the above chart suggests that a sharp move higher in the PM stocks, Gold, and Silver are at our door step as soon as this correction has run its course.  If so, it would portend a change in the psychology of investors from one of the most recent deflation scare to one of inflation.  We should soon see how it plays out over the coming days.

As we have noted we will be moving our work to a subscription site, though there has been a delay with the site, itself.  I apologize for the delay, but do not have control over creating the site.  I would again like to thank readers for the many kind comments that I have received.  We are compiling an e-mail list to contact those who wish to be notified when our new site is up.        [email protected]

For the moment…………Goldrunner.

Below, is a link to the Goldrunner Index which includes links to the recent series of editorials we have posted.

https://www.gold-eagle.com/research/goldrunnerndx.html

Again, I’d like to thank all of the posters at the Gold-Eagle Forum for their daily input.  This thank you is especially extended to TQ and to Grininbarrett who have positively affected my growth over the years, along with posters  Pittrader, Trader_Vic, and Mr. Aholbroke.  Special thanks go to Dr. Vronsky and Westerman for creating the Gold-Eagle site and for editing my work.  A very special “Congratulations” go out to Dr. Vronsky and Westerman after Gold-Eagle saw its hit counter ring up to 286  million this last week. 

Here is the link to a site I use to research the warrants of Precious Metals stocks.  I will be discussing some aspects of the leveraged use of warrants later in this editorial series.

http://preciousmetalswarrants.com/

Another very good site that is dedicated to investments in Silver belongs to David Morgan, and his site can be found here……………. http://www.silver-investor.com/

India and the U.S. trump Italy as top gold jewelry exporters.

Gold Eagle twitter                Like Gold Eagle on Facebook