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Gold, Oil The Real Deal


Not your traditional asset "bubbles."


I want to address what I believe is a common misconception. How many times have we heard recently that oil, gold, and other commodities are only going up because they are a "bubble" or because it's a "trade" off the weak dollar?

In my view, both of these notions are completely false.

The reason that commodities are rising is because of inflation (i.e. - too much money and credit growth). While the Federal Reserve is at present being forced to continue to accelerate money and credit growth or risk the financial system seizing up and imploding (as it almost did back in March), the beginning of the inflation occurred long ago. It's just that it used to manifest itself in the form of asset inflation for the most part (i.e.- in stocks and real estate) during the Greenspan era, which nobody had a problem with for obvious reasons.

With the housing bubble (the last wave of asset inflation from the Greenspan era) having now burst, the inflation has nowhere left to go that will also support the U.S. economy and keep the perpetual motion machine going (plus "peak oil" is probably playing a role here too). As a result, the inflation is now manifesting itself in the form of CPI inflation and a currency collapse. And what are people calling it? A "trade" and a "bubble"? This tells us, in my opinion, that the vast majority of market participants remain in total denial and that we are very early in the inflationary trend.

What's happening today is not the mindless asset inflation that occurred in stocks and real estate previously. It's the consequence of the prior asset inflations and the fact that the system was never allowed to cleanse itself. The reckless monetary policy by the Greenspan Fed that led to the prior asset bubbles (and their busts) has culminated in a complete distrust of the fiat dollar-based monetary system, and inflation is now feeding on itself all over the world as a result. That thought may not be in the consciousness of most investors, but collectively, that is what their actions are telling us.

What are central banks doing about the inflation that has been unleashed? The Fed is "monitoring" it "closely" (and is now being "attentive" to the dollar too, apparently while it falls) and has been doing so from $70 crude to $130, while it was easing!

Meanwhile, the ECB has only now said this week that it "might" tighten a whopping 25 bps because of inflation? Unfortunately, the Fed can't even consider raising rates any time soon (even it wanted to do so) to match the ECB because the U.S. banking system is in such a mess in the wake of the housing bubble (a quick glance at the 5-year low in the BKX today makes that more than apparent in case there was any doubt). Raising rates now would cause the banking system to collapse, which in the end would require even more inflation to "fix."

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What's it all mean? In my opinion, it means the fiat dollar-based global monetary system is doomed, but more importantly, it also means that the dollar is going lower because of inflation, not that commodities are going up because the dollar is going down.

In very specific terms, the dollar is weakening because global inflation is forcing some foreign central banks to tighten (or at least not ease like the Fed has been doing) and break pegs to the dollar. The result is that those currencies are strengthening against the dollar, while gold strengthens in all these fiat currencies. That's why the dollar is dropping against the euro and other currencies where the central banks have been more concerned about inflation, and why it is falling against gold. This is also why the fiat dollar-based global monetary system that has been in place since 1980 (when Volcker restored confidence in the fiat dollar) is literally coming apart right before our eyes, just as the Bretton Woods system did in 1971 when Nixon closed the gold window.

Speaking of the global monetary system breaking down, I discussed back in October that I believed we were in the early stages of seeing the fiat dollar-based global monetary system break down right before our eyes. Interestingly, Nobel Prize-winning economist Robert Mundell, the architect of the euro, is saying the same thing (and more importantly, so apparently are the Chinese). Note the following Reuters article that came out Tuesday night:
A major dollar crisis could come within five years and China is discussing reforms to the global monetary system to protect its $1.6 trillion reserves pile, says Nobel Prize-winning economist Robert Mundell.

Mundell, who has regular contacts with Beijing officials, said they are considering proposing ways to fix major currencies including the dollar and the euro, in a system similar to the one which operated under the Bretton Woods agreement from the end of World War Two until the 1970s.

"There's no doubt about it that inside the Chinese government there's a lot of discussion going on. I'm not sure how they're doing it but I know they're going to get an input from me," Mundell told Reuters in an interview. Without reform, the global monetary system is headed for a dollar crisis within years, Mundell believes.

As I said in the October piece, we can't know what the new currency regime will be on the other side of the fiat dollar system's demise, but it's a certainty that investors will eventually flee to the safety of gold (just as they did when the Bretton Woods system broke down in the early 1970s) until they know what that new currency system is. And if the Chinese are the architects of that new system, it may even include gold.

To repeat: This is not a traditional asset "bubble." It's the beginning of an enormous wave of inflation that is the culmination of the mess that the Greenspan Fed built up over 20+ years. No amount of new regulation, talking tough about inflation, or "hope" will make it go away either. One must simply accept the stagflationary environment for what it is and plan accordingly. It's not a coincidence that those who have already been planning accordingly and chosen to hold gold, gold mining shares, and oil and gas shares since August have done quite well and continue to see their investments appreciate today.

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Position in GLD, gold and oil shares.

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