Supply Side Shock

So, this week we had “good inflation” with stocks and bonds rising and commodities falling. With the S&P down “only” 17.93% this year, thanks to a massive rally today, you can say that stocks have emerged from bear market territory. But the bear market is hardly over. Actually, if Friday’s rally had not taken place, stocks would have declined for a record 11 out of the last 12 weeks.

Those who would like to believe the huge rally on Friday was something very positive might like to think that this strong rally was because rate hikes are now priced in, given that a recession is looming. The problem with that thought process is that Friday’s rally was simply a major short covering episode of the most shorted names.

One factor that may be providing some optimism to the market was this week’s unexpected decline in the University of Michigan inflation expectation index from 3.3% to 3.1%. This is an index that Chairman Powell seems to consider very important. Normally when an economy is heading into a recession it may be reasonable to expect prices to fall. But what I think may be overlooked here is the fact that this inflation problem is a supply shock issue that may not be going away any time soon. In large part because of the sanctions and restrictions in using dollars, euros, and the SWIFT system, Russia is holding all the economic cards. That is not only causing prices on natural gas to rise for Americans but many other key shortages from Russia. For example, Bob Moriarty pointed out to me that urea is required to produce diesel exhaust fluid, and the U.S. doesn’t produce enough.  We are normally one of the largest importers of urea in the entire world, and Russia and China are two of the largest exporters. The Biden Administration has decided that we don’t want urea from Russia, and China has restricted exports. Obviously, the Military Industrial Complex profits are more important than the livelihood of American truckdrivers or for that matter the transport of good to markets for American consumers. I wouldn’t bet on the inflation curse being over until we start to see evidence of it in the monthly CPI numbers. Supply chain issues began with COVID, but those that have resulted from NATO’s sanctions are far greater even than those of COVID. And with America’s lack of willingness for peace in the Ukraine there is little hope that supplies will flow freely any time soon.

For those who think this week’s rise in equities means the downside risk is over, I would strongly suggest they consider that our inflation problem is a supply side problem created by oil shortages similar to that of the 1970s, except that this episode is much more of a threat to America because we are far weaker and our adversaries far stronger economically than in the 1970s.  Just as in the 1970s when Fed Chairmen were behind the inflation curve, until proven otherwise, I think there is a lot more pain ahead and that likely means more rate hikes than the market is pricing in this week. In other words, the Fed is dancing on the edge of a knife and there is no room for error. Slightly too restrictive and we head into a serious recession. Slightly too little restriction and hyperinflation beckons. What does that mean for gold? Are gold miners going down forever? See Michael Oliver’s thoughts on that topic on the next page.

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.