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Fed's Moves Good for Gold


The stagflationary environment we're headed into will benefit gold.

T-bill yields are still near a record discount to the Fed funds target rate (see the chart of this spread below). Today's step of cutting the discount rate is just the first in a process. The Fed will still be forced to cut the fed funds rate, perhaps even as soon as next week.

Click here to enlarge.

The importance of today's news is not that the discount rate was cut but the fact that the Fed blinked. The fact that the Fed did it before the open on an option expiration makes it even more clear where the Helicopter Ben Fed's true resolve lies to anybody that was foolish enough to think this Fed was any different from the Easy Al Fed. In many ways, this Fed is even easier than Uncle Al's was.

I feel it should be plain for all to see after today that in a social democracy all roads lead to inflation. The Fed will print money, and it's shown today in no uncertain terms that it is giving up its feigned "fight" against inflation (assuming we can call sitting at 5.25% for over a year "fighting" anything) and shifting its bias to easing.

The Fed will move heaven and earth (in terms of printing money) in order to keep the financial system intact, and make no mistake, the problems emanating from the housing bust are systemic.

Printing money won't necessarily save the stock market (just as we saw from 2001-2002) or prevent this rally in stocks from eventually failing and leading to a bear market for stocks. After all, as you can already see today, the dollar and bond market don't particularly like what they are seeing. But the stagflationary environment we're headed into will benefit gold.

The gold shares have been taken out and shot over the past three days as gold bulls have had their faith in the Fed's resolve to print its way out of all problems somewhat shaken. But the shares will recover, even though it may not be immediate due to the pain that was inflicted, margin calls, etc. But the fundamentals are what they are, and the money that will be required to be printed will eventually work its way through the system and produce a dramatically higher gold price.

The XAU/Gold ratio (see below) shows us that the gold shares plunged yesterday to just shy of their deepest discount to the metal since the gold bull market began. Buying the gold shares at this discount to the metal has always paid off over the past seven years, and it should again as the Fed is forced to print its way out of the housing bust in the coming months.

Like we've been saying... we have all seen this movie before, and we know how it will end. It's just the precise makeup of the filler in between the opening credits and end of the movie that are somewhat in doubt.

Click here to enlarge.
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Position in gold shares.

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