Tuesday, September 22, 2009

Why Lyle Gramley Is Indirectly Recommending You Buy Gold

More and more bloggers are "sort of" calling the top in the U. S. stock market. I say "sort of" because the momentum upwards scares off rationalists. One could not predict the top in 1999 either, and in fact it went into March the next year.

Certainly there is blow-off-type activity in speculative names, yet other stronger names could move up a lot and still have reasonable P/E's; sometimes the averages conceal more than they mean. Warning signs abound, most powerfully the failure of lenders to take advantage of the immense spread between Fed funds and market interest rates; or perhaps more truthfully, the lack of interest of credit-worthy businesses or individuals to do a lot of borrowing. In that vein, Bloomberg.com reports in Fed Effort to Stoke Growth May Be Undermined by ‘Tight’ Credit that:

Federal Reserve Chairman Ben S. Bernanke’s efforts to stoke a U.S. economic recovery may be undermined by the central bank’s other goal of restoring the banking system to health.

The Federal Open Market Committee, at the conclusion tomorrow of a two-day meeting, will probably maintain its assessment that “tight” bank credit is impeding growth. Lending contracted for five straight weeks through Sept. 9, a drop that in part reflects Fed orders to banks to raise more capital and toughen lending standards, analysts say.
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Here's the "money" part:

“They would be absolutely delighted if banks went out and raised a lot more private capital and then began to lend more,” said former Fed Governor Lyle Gramley, now senior economic adviser with New York-based Soleil Securities Corp. “Until that happens, the Fed has to continue to try to encourage economic growth through easy money.”

Econblog Review differs. The Fed does NOT have to continue to try to encourage economic growth through easy money. The Fed needs to ensure that the banking system is safe and sound. Congress and the White House are doing more than plenty to encourage economic . . . GOSH-- I'm not sure they are encouraging that much growth, but they certainly are encouraging activity. (Think cash for clunkers or encouraging buying and selling of houses, all of which are being "encouraged" with money from the public at large, meaning that almost zero percentage of the population is benefitting from these activities.)

There is simply too much debt at all levels. The more the U. S. puts banking back where it was in the 1950s, which is to enable sensible investments but as a modest part of a dynamic economy in which saving rather than borrowing is applauded, the better we will all be.

The more the Fed heads past and present present this sophistry that easy money is good for the economy, the more those who allocate capital will increase their holdings of gold. The public at large is wildly underinvested in gold relative to governments and the IMF. One might consider platinum and even that very speculative metal, silver after a dip and only for a trade.

All precious metals have had quite a run recently and "deserve" a rest. Of the three mentioned above, gold has the best long-term chart, but platinum is currently historically undervalued relative to gold and if some real growth is returning for a while to global economies, platinum could outperform gold in view of its much greater sensitivity to economic conditions.

Strangely, as the Japanese experience demonstrates, excess credit creation by the sovereign is consistent with low interest rates. The lower the interest rate, the lower the cost to borrow and thus there need be no end to the borrowing, so who is to say where rates go from here? (Forget free market theory in this world of manipulated financial instruments.) In the meantime, the Baltic Dry Index went to another low yesterday at 2318, and thus its downtrend that began June 3 at over 4000 continues, now having definitively broken the August 25 low of 2388; click HERE (and scroll up) to see the chart. So there remain important deflationary parts of the national and global economies which are being met by unprecedented money-printing. Thus, weirdly, gold and bonds/money exist as prudent asset classes in which to invest. But we know which of those opposite types of commodities can and if necessary will have its supply increased substantially in short order if the authorities so desire.

That in a nutshell is the fundamental case for gold.

Copyright (C) Long Lake LLC 2009

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