Home > Main > Will the Rout in Gold Kick-Start a Rout in Commodities?

Will the Rout in Gold Kick-Start a Rout in Commodities?

January 28, 2011

Something very, very strange is going on in the markets.  The falloff in gold is a big deal – far bigger than most people want to admit.  The “Massive Inflation Soon Scenario”, or “MISS”, has been supported by Gold’s march higher.

While we’ve been short the Barbaric relic since 1,400, others have remained wildly bullish.

When you point out to these people that we don’t have any real inflation in the U.S. or in Europe, then people rightly point out that gold is climbing higher.  Higher gold means that people fear inflation- at least that is the reason they are giving now.  Since markets are forward looking, higher gold means people think we’re going to have inflation sometime soon. The high price of Gold gives credence to the fears of inflation –

It is sound reasoning, really – but it requires either:

  1. inflation to materialize at some point to justify the price of Gold today; or
  2. gold to stay near its highs to justify the MISS scenario

What happens to the case for inflation if gold takes a 30% hit?  A major supporting wall gets knocked out of the house of “MISS”.  Without any current inflation, and inflation expectations remaining low, AND Gold losing 30% of its value, how can inflation trades in other markets be justified?

I consider the rest of the Commodities to be “me toos” in this case.  Corn, Soybeans, Wheat – all of these commodities are in bull markets.  These bull markets partly depend on the inflation scenario – which has been strongly supported by the run up in the price of Gold.  Those markets are small.  But we spend nearly 7% of GDP on oil and energy products.

A Rout in Yellow Gold could start a rout in Black Gold.

The dominant meme over the last few years has been “We’re on the edge of a crisis.”  Gold’s rally has been the “proof” that people need to “justify” that a horrible scenario was just about to happen.

First,  the complete meltdown of the financial world that propelled gold much higher. The reaction to get long gold was justified here. Next, the world experienced an ongoing fingertip wall climb out of the debt crisis abyss.  Again, a strong case can be made for gold in that environment.

The reasons given for going long gold have changed in the last 6 months.  The reason people are giving for going long gold now is “MISS”.  Of course, we’re still at risk of melting down in Europe.  It seems like both the “out of control inflation” idea and the “all Euro sovereign debts are bad” idea have run out of gas – at least for the next few months.

The meme would need to change if Gold falls from its highs.  It would have to be something like: “All Clear, smooth sailing ahead”.  This kicks the ladder out from under the grains complex, and makes some of the softs awful suspect as well.

But most importantly, oil has been rallying with a significant component of inflation fears as the fuel for the rally

If gold continues to fall, I look for a washout in some of the commodities, and oil in particular.  And if we get oil back down to $70 a barrel, the entire economy will be in a boom.

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