A correction in oil prices is so inevitable that there is no point in even calling it, especially since I don’t have any great insights as to when it’ll start. But just when the world economy is slowing and central bankers are talking tough, the stickiness of this commodity’s price at heights that were unimaginable five years ago must be scaring the bejesus out of Bernanke. He can’t make heads or tails of it.
Ben won’t be there long, anyway, especially if he mucks this up.
Maybe the new administration will replace him. Then he could write a book debunking gold bug myths about the Federal Reserve System, such as the one about how the Fed is “the engine of inflation.”
Anyway, the markets, overall, are performing as expected.
They are treating the gold correction as though it were a healthy mistake.
Not only did it weed out the weak hands, but it gave central bankers a false sense of security in the face of escalating energy costs. With gold in the doldrums, bond yields relatively low and stock prices recovering, all looked good for a relaxing summer vacation – at least until last week.
Gold bulls are popping with enthusiasm about the post-FOMC recovery in gold prices.
They should be.
After breaking through $920, the market almost shot clean through the May high of $940, staring the reversal point at $950-960 right in the face. The chart bias has turned bullish. I would expect to see support hold above the $900-920 level if the market were to backfill over the next few days – to validate my bullish outlook. But it’s not just technical. The market is doing all the right things, fundamentally.
It has realized that the Fed didn’t really mean what it said, and if it did, it isn’t all that, anyway.
The focus of the debate is shifting to areas that make the Fed uncomfortable: The Dow failed to breach 13,200 and the inflation story is heating up, despite ongoing cracks in the economy.
These things are driving gold now.
Bull markets are notorious for going much further than their earliest prophets ever imagined.
That’s the message in oil prices. As a gold bull, I am taking heed.
What the Fed didn’t anticipate was that the oil price rise would be so sticky that it would embolden the inflationary psychology with or without gold. And it cannot afford to lose control over bond yields.
On the other hand, it cannot afford to tighten.
It can only try to talk down inflation expectations.
A whole new generation has grown up since 1979. It is not used to a tough Fed. The toughest Fed it has seen was in 1994. And putting aside the character comparisons, I’ll tell you this – it was only after several years of inflationary fallout, when people finally began to worry more about inflation than deflation, that Volcker was hired with a political mandate to attack the inflation monster head-on. At the time, CPI inflation and interest rate levels were already high, and P/E ratios were half today’s.
The Bernanke Fed is nowhere near such a mandate. It cannot have anything more in mind than Greenspan’s gradualism. Yet even that is dangerous at this time.
The Greenspan Fed was raising rates during a period of economic stability (2004-2005). Today, the Fed is talking about raising rates in response to an inflation outbreak amid a financial crisis.
C’mon! How are you gonna ’splain that to the voters?
If Bernanke wants to survive long enough to secure another term, he’s not going to challenge the status quo, and the status quo is not willing to accept the kind of austerity package necessary to contain or defeat inflation. The Fed is damned if it does and damned if it doesn’t.
This means that prices will continue to rise until outright fear of inflation exceeds all others.
That’s why gold has the potential to catch fire here.
The market is beginning to understand this, too. It has seen Bernanke flip-flop from worrying about deflation to worrying about inflation a few times already. The Fed’s hesitation to act in last week’s Federal Open Market Committee meeting was like a starting pistol for this realization.
It’s too late to fix this break in confidence, and it’s too early for the Fed to really take it to inflation.
Watch gold prices double over the next year. My forecast is for gold to reach $1,200 by year-end, and $2,000 by next summer.
This may well be your last chance to buy the metal below $1,000 per ounce.
for The Daily Reckoning Australia