 | Investment U E-Letter: Issue # 590
Friday, October 6, 2006 The "Fight" That Knocked Out Commodities
by Mark Skousen, Chairman, Investment U
Last May, when gold was selling for more than $700 an ounce and oil was over $70 a barrel, I turned bearish on commodities. I slashed my position in natural resource stocks in my newsletter. And I grew wary that the real estate market was topping out in the U.S.
Since then, the slide in commodities has been dramatic. Take a look at gold, for instance… 
Why did I change my mind? No, I didn’t buy into the popular conspiracy theory, that Bush is manipulating the price of oil to drop right before the November elections.
At the same time, I warned investors against the “gold bug” thesis (Jim Rogers, Doug Casey, among others) that commodities must go up because commodity cycles inevitably last 15 to 30 years. Blind obedience to past cycles is a dangerous game in the financial markets.
Here’s what’s really happening… The Inflation Threat Is Subsiding
I looked at a more fundamental reason for the collapse in gold and oil prices, and the topping out of the real estate market. The price of gold, in particular, is the best forecaster of future inflation, and the decline in the yellow metal is a sign that price inflation is headed back down.
Why? The Fed is serious about fighting inflation. This has largely been ignored by the conventional wisdom, both on Wall Street and Midas City.
Under new chairman Ben Bernanke, the Fed has beat inflationary expectations in two ways: First, it created a negative yield curve by raising the Fed Funds Target Rate to 5.25%, substantially above the long-bond rate (currently 4.6%). Second, it slowed down the growth rate of the money supply. The broad-based money supply (M2) was growing at a 6%-7% clip a year ago. Now it’s down to 2%. The Adjusted Monetary Base (the Fed’s private checking account) is not growing at all. See the chart below, in billions. 
Bernanke built his academic reputation on “inflation targeting,” and every country that has adopted it (New Zealand, Great Britain and Canada) has seen its inflation rate decline sharply. Last August, Bernanke added his academic colleague Rick Mishkin to the Fed board. Mishkin is an “inflation targeting” expert who I met at Columbia University. Both Ben and Rick must be smiling right now, even as gold bugs are hurting.
What Does This Mean for Us?
As gold and oil stocks have collapsed, the bull market on Wall Street has returned. Wall Street’s greatest threat is rising inflation; a soft landing in price inflation is bullish. I think this trend will continue into the next year, although there’s a possibility that the Fed will tighten too much and a financial crisis could still develop. (The Fed is famous for overreacting in both directions, in being too tight, and being too loose.)
Investor Conclusions
Right now, I’m recommending a majority of one’s assets be invested in the following: - High-income bonds
- Dividend paying stocks
- Foreign markets, and
- Money funds earning 5%
There are plenty of opportunities for investors to make money, but you have to know the signs of the times. But I'm not selling all my oil or gold stocks any time soon. That would be foolish in an age of war and big government.
Good trading, AEIOU,
Mark
Today’s Investment U Crib Sheet - Hydrogen fuel cell technology, while still a few years away, may very well be the next best energy alternative. But can you profit from hydrogen stocks? The Investment U Research Team recently released its verdict. Check out their free investor’s report: Hydrogen Stocks: How The World's Most Abundant Element Stacks Up as an Investment
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