The Big Question for 2016: Commodity Inflation or Credit Market Deflation?

IDW-2017-01-13As you can see from my IDW on the left, this measure of credit expansion and credit contraction is for the moment at least in the expansion or inflation mode. After moving over the three-year moving average it fell back to test it. It passed the test and, so far this year, it seems to be “onward and upward.”

I wrote a bit about this issue on the front page of my January 2017 monthly letter that was sent out this past Friday morning. I passed along the fundamental views of Daniel Oliver that we could very well be in a deflationary environment much like that of the 1930s and if we are, rising interest rates could well result in a lower nominal price for gold but a higher price in real terms, which is bullish for gold mining stocks. For reasons I don’t have time or room to discuss now, that argument rings true from my fundamental reasoning. We have without a doubt reached “peak debt.” However, what I have also learned over many years is that I’m not omniscient. Neither is Mr. Market omniscient. Only God is. But Mr. Market comes a lot closer than I or even the gods of our humanist and arrogant institutions like the Fed, Harvard, Princeton, Yale, Oxford, Cambridge, and the Council on Foreign Relations.

That said, as mere mortals we do need to try to use the best tools possible to make our investment decisions. With regard to that I have come to respect technical analysis because the collective wisdom of markets is much superior to my own judgment, especially when a great technical analyst like Michael Oliver is at the helm. His work is nearly impeccable if not completely so. His latest great call has been to stick with gold when most componentstechnical analysts were throwing in the towel. And his major plate tectonic calls continue to position him and his clients to stay long precious metals and commodities and to get ready for long-term bear markets in stocks, bonds, and the dollar. Of course the bears won’t all growl at the same time for stocks, bonds, and the dollar. For example, Michael sees the bond market and gold both rallying for a while as money flows out of stocks. However, at some point in time as the dollar tanks and confidence is lost in equities, he sees the U.S. Treasury markets taking a bath as well.

Now getting back to the direction of these markets for this year, I would like you to take a look at the charts above. The chart on the left shows the move of individual components in my IDW from the peak of the commodity market in April 2011 to December 31, 2015. The chart on your right shows the moves of those same sectors during 2016! This suggests to me that, at least for now, we are seeing a tectonic shift upward in the price of precious metals and commodities, while financial assets (which I consider cars and housing a part of, given their sensitivity to artificially low interest rates) are getting ready for a reversal, much like a ball heaved into the air reaches its zenith and has no direction to go but down. As long as stocks and bonds remain suspended, the IDW may remain elevated. But if/when those instruments begin to deflate, as I believe they inevitably must, we could indeed again see a massive waterfall decline of my IDW as artificially high prices caused by a massive debt pyramid plunge to earth in compliance with the natural laws of market physics. If/when the massive debt induced air escapes this unprecedented global financial bubble, there will be massive gnashing of teeth across the American spectrum. But one oasis will be gold mining shares that perform best in a credit deflation. Given my confidence in the work of Michael Oliver as well as the guidance of Dan Oliver and many other analysts both fundamental and technical, I remain bearish on stocks and bonds. Thus I have held on to my bearish positions in my Model Portfolio. See my Model Portfolio summary as well as my personal portfolio allocation toward the end of this weekly letter.

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.