Graham Summers' Weekly Market Forecast

November 7, 2010

We are officially in an inflation trade melt-up.

Everything that is an inflation hedge has exploded since late August. Gold is up 15%. Silver is up 48% (courtesy of the manipulators finally getting taken to court). Agricultural commodities are up 25%. Oil is up 20%.

Against this backdrop, stocks' 17% rally becomes slightly less insane. That's right, stocks are up 17% since late August. What happened in late August?

The Fed announced QE lite and promised QE 2 was coming. Almost to the day of this announcement, the US Dollar rolled over and dropped some 8% (it's down nearly 15% since June).

In plain terms, we are entering an environment in which a US Dollar collapse has fueled inflation trade mania. By launching additional QE measures at a time other central banks have renounced additional easing measures (the ECB and Bank of England) or are actively raising interest rates (China and Australia), Fed Chairman Ben Bernanke has made it clear he is willing to trash the US currency.

Consequently, money is pulling out of Dollars and flowing into hard assets and other inflation hedges. The below chart plots the US Dollar (green) against Gold (yellow), stocks (black), and commodities in general (blue). This picture, details in stark terms the overall trend for markets today.

The most concerning thing is that there doesn't appear to be any sign of this stopping. Emerging markets, which have lead the S&P500 ever since the Financial Crisis began (during this recent rally, they bottomed in May while the S&P500 didn't bottom until July) are not only back to pre-Crisis levels but are a mere 8% off from their 2007 highs. It's almost as though 2008 never happened.

Part of this is better fundamentals, but a lot of it is money flowing out of US equities and piling abroad. This is causing many emerging markets like China and Brazil to impose capital controls and other efforts meant to slow the inflows of funds.

Will this trend continue? It's very hard to tell. I cannot believe China is going to let Bernanke get away with QE 2. However, until China issues a response in the form of policy, we'll have to go by the US Dollar for signs of what's to come.

The below chart shows the greenback's multi-year uptrend line (black) and support lines (green).

As you can see, the US Dollar is literally sitting on its multi-year trend-line. If we break below this, then we have support at 74. If we break below that, we have FINAL support at 72. Below that… well, we've NEVER been below that before. So PRAY we don't go there now.

Indeed, if QE2 succeeds in devaluing the Dollar below 72, then this triggers a MASSIVE Head & Shoulders pattern that forecasts a 50% devaluation in the greenback over the coming years.

If this neckline is violated, we're in uncharted waters for the greenback and the US is in for a very, VERY rough time (think Argentina or even Weimar Germany). As I write the US Dollar is at 76. Going from 76 to 71 won't take much so keep your eyes here for signs of what's to come.

In the meantime, the inflation trades dominates everything. So the best place for money is in commodities, especially precious metals (make sure it's bullion, NOT ETFs) and agricultural commodities, as well as emerging markets.

On that note, if you have not already taken steps to prepare yourself for the inflationary storm that is coming, PLEASE DO SO NOW.

Good Investing!


Graham Summers

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Graham Summers is Chief Market Strategist for Phoenix Capital Research, an independent investment research firm based in the Washington DC-metro area with clients in 56 countries around the world.

Graham’s clients include over 20,000 retail investors as well as strategists at some of the largest financial institutions in the world (Morgan Stanley, Merrill Lynch, Royal Bank of Scotland, UBS, and Raymond James to name a few). His views on business and investing has been featured in RollingStone magazine, The New York Post, CNN Money, Crain’s New York Business, the National Review, Thomson Reuters, the Glenn Beck Show and more.

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