Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Bonds and Gold Strange Bedfellows in 2010

Montreal, Canada

Can deflation and inflation assets co-exist? Can both assets rally in unison, despite harboring completely divergent asset class outcomes in wildly different economic environments?

Since the onset of the credit crisis three years ago, more often than not, gold prices and Treasury bonds have rallied simultaneously; brief periods showed negative correlations, including July 2008 through November 2008 and throughout most of 2009, which followed a crash in bond yields after hitting their lowest levels since the Eisenhower administration in December of 2008.

After seven months of trading in 2010, gold prices and U.S. benchmark ten-year Treasury bonds have exhibited a higher correlation than historical behavior would suggest. That's bizarre market action because gold acts as a traditional inflation hedge while bonds are regarded as primary winners amid accelerated disinflation (e.g. 1990s) and deflation (e.g. 2008, 1930s). It's almost like cats and dogs enjoying each other's company when we all know they don't get along.

Through July, gold and bonds have rallied together in five out of seven months with January and July the only disconnect. Both asset classes also rank as one of the few investments to rise in a tough market this year; Treasury bonds have gained 6% this year as measured by the Vanguard Total Bond Fund and gold prices are up about 7%.

Perhaps a greater explanation for this largely positive correlation in 2010 lies in the growing fear that we're entering outright deflation again. Gold is a store of value in uncertain economic times – including price deflation. It's simply not true that gold must decline as nominal and real prices fall in value.

Consumer prices remain in positive territory in the United States but just barely with June CPI up 1.1% year-over-year. But in Europe, a few countries are now experiencing negative inflation or deflation, including Ireland and Spain. This is consistent with the resultant effects of housing deflation in these countries and, increasingly, it appears to be spreading to the United States.

Bubbles in housing, however, remain in Canada, Australia and parts of China.

Gold, which now commands the attention as a surrogate currency in the age of rapidly rising government deficits and weakening fiat currencies, is showing its metal (no pun intended) as a store of value as governments flood the system with debt obligations. It's also noteworthy to mention that broader monetary aggregates in the West and Japan have literally fallen off a cliff this year – again, a deflationary event suggesting central banks are losing the war on credit growth and rising inflation.

Gold, contrary to popular wisdom, is rising in a deflationary environment just as it did in 2008.

High quality bonds and gold are the new anomaly this year. Both assets should harbor a strong negative correlation but, instead, appear to be running together. I suspect this odd relationship will continue until the bond vigilantes attack Treasury, at which time I expect gold prices to head off to the next solar system or, what I would term, the "meteoric phase." That'll mark the endgame of the "flight-to-safety" trade in T-bonds and the nadir of the secular bull market in gold.

Gold Pullback Underway, Correction in FX Terms

Montreal, Canada

The summer is typically a bad time to ride most commodities – including gold. Some of the most violent declines in world markets have occurred from May to August combined with massive market dislocations ranging from the Asian credit crisis, Russian GKO default, the NASDAQ blow-up, Enron scandal and, most recently, the global credit crisis.

When markets are thinly traded, bad things usually happen. This is one of the reasons why I remain cautious on stocks even though the Dow Industrials and the Dow Transports surpassed important near-term resistance levels yesterday; the move was accompanied by a meager 4.1 billion shares – a pathetically weak showing in a rising market. All along, stocks have attracted low trading volumes, also a bearish sign.

Back to the point about gold: Since hitting an all-time high in June at $1,266 an ounce, the August contract has declined a cumulative 6.2% as of this morning. That's not a big pullback by any means; but when expressed in foreign currency terms, this ranks as a correction. The EUR, which has rallied from 1.22 on June 30 (low of 1.1875 in late June) to 1.30 now, has risen a cumulative 15% against gold this month after hitting new lows for months.

The U.S. dollar and gold, however, are now buddies since the emergence of the Greek sovereign debt crisis because traders have flocked into gold as a means to hedge against the EUR – until this month. The dollar has also been a safe-haven recipient from nervous money. Yet we now see a major divergence in the relationship between gold and the EUR whereby on any given day the European single currency rallies, gold prices usually decline. I fear the EUR is now heading higher as it strives for 1.325 and possibly, beyond.

But after August, I expect the European debt crisis to re-emerge and show its ugly head. It's inconsistent to have a strong EUR accompanied by rising austerity measures in most eurozone countries coupled by rising unemployment and softening GDP growth. The EUR is still not out of the woods.

The European bank stress tests were a total joke and smart investors know this. European banks need capital. Amazing how most Greek banks even passed this stupid stress test – the whole system is rigged. Gold knows this. We know this. Use any intermittent weakness in the gold price to buy or accumulate more bullion this summer and fall.

Gold Stocks Still Undervalued

Montreal, Canada

I've been bullish on gold and the mining stocks since 2002. Personally, I hold far more physical gold than mining stocks because when push comes to shove, I like the metal more and believe it provides far superior financial insurance benefits than a gold mining company. On a risk-adjusted and total return basis since 1996, gold has severely outpaced mining companies.

Before this rally is over we'll witness some mind-blowing currency crashes, global exchange rate mechanism reforms and a new unit of value that will encourage price stability. The U.S. dollar will play a role in this new regime but by no means will it remain the world's reserve currency indefinitely. Emerging market giants like China and Brazil along with core European and natural resource-producing countries will all play an important role in this new currency. Gold and crude oil are also likely to participate.

Anyone that doubts we're on the cusp of a new exchange rate system isn't doing their homework.

The post-1971 system of free-floating currencies is a disaster; currencies are devalued or revalued constantly, businesses continue to spend a fortune trying to hedge their key markets from adverse currency fluctuations while currency volatility hurts world trade and individuals' purchasing power as fiat paper money is debased.

Currency unions, as evidenced by the EUR, are certainly no panacea for stability; we all know that Europe has historically failed to merge their economies into a currency mechanism that functions properly. Bismarck tried and failed. The ERM, or Exchange Rate Mechanism (ERM), ultimately failed and the EUR, though probably likely to survive this credit crisis, won't be as strong as originally forecast because of sovereign deadbeats in the Mediterranean and possibly elsewhere.

Gold senses big troubles. This, in part, explains why we've been in a secular bull market for gold since it bottomed almost ten years ago. But most recently the acceleration of deflation and the ongoing destruction of credit has boosted the metal's appeal because there isn't a single currency that represents true price stability; and in an environment when more investors distrust sovereign credit risk gold has gained more followers because it is an asset outside of the confines of the battered credit system.

Over the last eight years my Commodity Trend Alert (CTA) service has been riding this historical bull market with periodic defensive strategies ahead of major corrections for gold, silver and the mining stocks. Corrections are a normal process in a bull market and allow patient investors to accumulate assets at lower prices. Our model Gold-Bugs Portfolio, however, doesn't hold just gold stocks; we're also heavily weighted towards physical gold and silver, which tend to outpace the mining stocks sometimes.

Gold mining stocks have indeed lagged gold over the past 14 years. Yet, I think we might be on the cusp of a massive advance as the gold mining industry makes shrewd acquisitions and mergers, reduces operational costs and boosts profit margins in a big way. The major gold mining companies now operate with an average cost of $450 per ounce – leaving a fat margin as gold prices continue to climb year after year. The next phase of this bull market might be dominated by the laggards or the gold mining shares. I believe gold stocks do not truly reflect current gold prices.

Ahead of this secular shift in performance, however, we might be approaching a short-term correction for the asset class.

Gold stocks do tend to break away from gold prices amid severe market declines and this one might not be any different as stocks worldwide struggle since May. Use any intermittent price declines as another opportunity to accumulate the large-cap, mid-cap mining stocks and the juniors gold miners. The next phase should be quite rewarding as the miners finally catch up with gold prices.

Silver and Gold Tied in 2010

Montreal, Canada

In a world marked by compressing asset values since the "Flash Crash" on May 6th and the subsequent top of the stock market on May 20th, the precious metals stand out as some of the best performing assets in 2010. That trend is likely to continue provided that real or inflation-adjusted interest rates remain historically low amid sovereign debt contagion, accelerating currency debasement and the reluctance of major market central banks to hike interest rates in an unstable macroeconomic environment. This is still the "Perfect Storm" as it pertains for gold and silver.

Gold and silver have rallied 10% this year compared to a 7% loss for the MSCI World Index and -8.6% for the MSCI Emerging Markets Index. The S&P 500 Index is down 1%.

Silver is still cheap compared to gold as the chart below depicts. And with silver production now trailing demand I also think that silver will outpace gold on a total return basis over the next 12-24 months as inventories tighten and investment demand from ETFs continues to boom. I'm buying silver for my managed accounts this week at roughly $18 an ounce.

As the second half of the year quickly approaches, I suspect gold and silver will surprise most investors, especially the bears who still lack a clear understanding of why a bull market remains in place for the metals. That failure to understand the relationship between hard money, the destruction of credit and the fiat paper in which it is denominated has eluded those who believe we're in a "bubble." As I've commented before, the only investors that proclaim gold's in a "bubble" are those who've missed this rally since it started ten years ago.

Silver's high in this rally was $20.78 an ounce in March 2008. We should hit that level and violate resistance before the year is over. Silver's inflation-adjusted price since 1980 is $128 an ounce; it's quite possible that we'll reach half of that threshold before this rally is done.

Will IMF Sell Gold?

Montreal, Canada

The International Monetary Fund (IMF) is likely to rain on the gold parade as it seeks to unload almost 200 tons of the metal to raise capital for this week's eurozone bailout. Investors should use the upcoming correction – which should be quite sharp but short-lived – as another opportunity to accumulate gold.

Gold opens this morning at $1,240 an ounce – an all-time high. Earlier this week, the June contract broke into record territory easily taking out the early December nominal high of $1,216 an ounce. In 2010, gold prices have gained 13% in dollar terms, 26% in EUR and 12.7% in yen.

What's even more impressive about this latest phase of the rally is that it's occurring at the same time the U.S. dollar is appreciating against most European currencies in 2010. Gold and the dollar can run together; the pair also rallied in unison in 2004. But this year, gold and the dollar are deemed to be safe-havens amid a currency and debt crisis in Europe.

Gold is in a secular long-term bull market. Those investors that fail to recognize or appreciate the primary trend also fail to understand gold's role in a post-credit crisis environment of escalating government deficits, central bank debt monetization and the adverse long-term implications of these policies on paper money's purchasing power.

Nowhere is Joe Public's psychological perspective more apparent than on CNBC. I rarely watch this network because it represents Mainstream America and almost serves no purpose for investors – the programs exudes hype and, for the most part, offers no concrete long-term building blocks to global asset allocation or how to protect investor capital. Gosh, in the midst of the credit crisis and stock market crash in late 2008 these guys were consistently plugging stocks!

After I returned from work yesterday I spent fifteen minutes listening to some supposedly savvy hedge fund guy explaining why gold is in a bubble and how it serves no purpose as an investment. Obviously, this gent has missed the bull market. He also misses the point.

The European Central Bank's (ECB) admission on Monday to bailout weaker peripheral countries at all costs in order to preserve the EUR adds another lid on the coffin as it pertains to government money printing.

Most people on the street – and the majority of individual investors for that matter – still don't understand what's happening to their paper money vis-à-vis gold and the future implications of rapid debt monetization and the high inflation these policies are likely to bring over the next several years once central banks finally defeat deflation.

But as gold continues to break important resistance levels this week and marches higher, the odds favour a significant correction as central banks in the West look to temper the rally.

The IMF, or International Monetary Fund, a conduit of U.S. foreign economic policy, isn't finding any buyers for its remaining 191.3 tons it wants to sell – equal to about 5% of annual global demand. So although this suggests that central banks aren't looking to build gold reserves at $1,240 an ounce for now, I think that will change ahead of the next currency crisis – probably in Europe or the United States.

China, of course, is the one to watch. The government last May revised sharply higher its official gold reserves, shocking many investors. China, however, doesn't have to necessarily go to the IMF to buy gold. Instead, it can purchase what it needs directly from domestic producers; China became the single largest gold producing nation in 2008. Truth is we really don't know how much gold China holds. Yet it would seem logical and prudent that China is on a long-term gold accumulation plan to supplement its hoard of decaying U.S. dollars and now, EUR.

Beijing is the sixth largest bullion holder in the world at 1,054 tons — if you believe that number.

The World Gold Council recently reported that net gold sales by central banks are now at their lowest levels in 20 years. Selling by European central banks slowed to a crawl following the renewal last September of the Central Bank Gold Agreement, which regulates the sales. Only two tons have been sold since September 2009.

Whereas central banks dumped bullion en masse in the 1990s, many are now either holding on to their bullion stash or, in many cases, as it pertains to the emerging markets, accumulating gold. India was the largest central bank buyer in 2009 following a late October purchase of 200 tons from the IMF at roughly $1,050 an ounce. Sri Lanka and Mauritius quickly did the same but at far lower numbers.

The IMF doesn't have to sell gold. The United States is its largest shareholder and can simply transfer the money it needs for bailouts electronically. But it would seem like an opportune moment for the IMF to sell gold now in order to depress this rally, which compromises paper money and its legitimacy.

Use any short-term pullback as another opportunity to buy gold. This will probably mark the last time investors will get a chance to buy bullion before the final phase of this bull market takes prices to at least the 1980 inflation-adjusted high of $2,309 an ounce.

Trichet “Bluff” Called as ECB Joins Quantitative Easing, Bails Out Eurozone Banks

Montreal, Canada

The European Central Bank (ECB) is now part of the "quantitative easing" cycle joining other major central banks since late 2008. The ECB will start printing money en masse to essentially bail out eurozone banks saddled by the threat of default in Greece and elsewhere in Europe's monetary periphery. Indeed, the printing presses at the world's largest central banks are now working overtime as officials continue to battle the forces of credit deflation, weak housing markets and tepid employment growth in the advanced economies.

The ECB will now head into secondary market in the eurozone to purchase government bonds – an exercise the Fed, The Bank of England and the Swiss National Bank have conducted over the last 12-18 months. Markets, including Greece, posted huge rallies on Monday coupled with plunging bond yields in Athens (rising prices) as relief spread across European capital markets.

 

But the answer to fix Europe's structural deficits won't be cured by throwing another $1 trillion dollars at the problem; Greece and other profligate spenders will have to head down the path of austerity, which implies hard economic decisions, accelerated deflation across most regional economies and a long period of economic stagnation. That's not a bullish picture for the EUR, now officially in a bear market versus all things paper and tangible.

Basically, the EUR is heading down the same path as the U.S. dollar and the majority of fiat currencies as central banks increase the ante to bail out respective financial systems, domestic banks and flush out speculators.

The EUR, unfortunately, barely climbed to 1.30 versus the dollar on Monday's almost $1 trillion dollar European spending blitz to bail out troubled eurozone members and to create a slush fund to protect the EUR from massive shorts; open interest shows a continued acceleration of short-sellers or institutions betting against the EUR since March. The EUR opens this morning at 1.27 – a sad level after a barrage of financial support announced just 36 hours earlier.

For investors, two of the world's largest reserve currencies are now heading down Banana Row. The dollar and the EUR are debt-infested units that will continue to struggle over the next several years and beyond and eventually, will be replaced by some sort of global currency unit backed by the largest emerging market nations, the majors and some commodities, including gold and possibly, crude oil.

The EUR is now down more than 20% against gold this year and I suspect this trend will accelerate as more investors dump the single currency and run to the yellow metal to protect their purchasing power. The ECB has shamed the Bundesbank. It's a dark day for hard-money Austrian economists and a great time to be a gold-bug. Next stop: gold $1,300.

Sovereign Challenges and Gold’s Finest Hour

Montreal, Canada

Increasingly, the domino-effect of highly indebted sovereign borrowers struggling to secure financing amid a deflationary noose will trigger the next financial panic. Greece and Dubai are small examples of what lies ahead if governments fail to reduce spending and control their finances. And gold smells trouble.

The next global financial crisis is likely to be in the sphere of government financing. Since this is where the most financial leverage is accumulating, it would seem plausible that some sort of major dislocation will rattle major market government bonds in the years ahead.

The United States is not immune to a global bond market panic. Just because it's a reserve currency and has the deepest and most liquid financial markets doesn't mean it can continue to write blank checks to finance its bloated spending. No nation, not even a reserve currency, can continue to spend into oblivion in the absence of domestic savings and a credible deficit reduction plan.

The CBO (Congressional Budget Office) estimates the budget deficit will hit a record $1.6 trillion dollars in the year ending September 30 and total $5.1 trillion dollars over the next five years. The $1.4 trillion dollar deficit in 2009 was equal to 9.9% of GDP – the largest share of the economy since the end of WW II. It is literally exploding and nobody cares. Keep in mind the CBO is a government body; these figures might be too conservative.

At some point, the United States, like other sovereign borrowers, will face limits on just how much they can raise from international creditors. And quantitative easing will probably return as the Fed's primary weapon to secure whatever capital Treasury can't sell to foreigners. Interest rates will rise, bond markets will crash and inflation will surge. These developments aren't inevitable but certainly in the cards if the United States doesn't change its financial doomsday flight path.

Gold, of course, senses more than just imminent inflation. As a surrogate currency it also senses the ongoing struggle among sovereign nations and weak national currencies, representing debt infested government IOUs.

All along, I've made the case for gold (and silver) because it's very clear to me that the global exchange rate system is increasingly becoming hostage to out of control fiscal deficits in the West that will be hard to reduce at a time when unemployment is high and civil strife increasing – especially in Europe. Greece will eventually be joined by Spain, Portugal and goodness knows whoever else. Europe is now suffering from its own version of subprime as economies start to fall like dominos.

The prescription by Germany and the EU (European Union) at large for Greece and other troubled eurozone members is to cut spending right away. Yet this sets the course for more social and economic discord, as austerity comes at a stiff price – deflation.

The IMF, or International Monetary Fund, isn't a distressed nation's friend; the IMF forces borrowers to dramatically cut deficits at a steep price. I suspect the IMF is already in a bull market with tentacles spread out across several European countries since 2008, including Iceland, Hungary, Ukraine and, possibly, several more in Western Europe.

I also believe that gold can rally sharply even amid a deflation IF central banks fail to rescue the financial system. The credit crisis has entered a new phase as sovereign debt markets grow increasingly unstable. There isn't a single central bank in the world that isn't attempting to inflate the money supply or trying to grow bank credit.

The problem is that both of the world's largest currency areas – the United States and Europe – are failing to grow the money supply over the last 12 months. Bank credit is still contracting for industrial and commercial loans over the last 3, 6 and 12 months. How can you have a sustainable economic expansion without bank credit?

The fact is that most investors, especially institutions, have no clue what's happening to paper money. Institutions are fixated on the S&P 500 Index and other benchmarks without understanding how fiat money is declining almost on a weekly basis vis-à-vis gold since 2005.

Investment demand for gold has clearly overwhelmed fabrication demand since gold passed $800, or so, an ounce in late 2008. This trend will only intensify as more investors climb aboard the bull market, including hedge funds and pension funds. I imagine that most investors still fail to appreciate what's happening to the global exchange rate system, their respective purchasing power and how the endgame is likely to be played out in Washington.

Gold is not in a bull market only because of inflation or fears thereof. It is rising because the big money knows that high levels of government indebtedness can't last indefinitely and that currency devaluations must accelerate if the global economy is to produce a sustainable expansion. Currency devaluations reduce purchasing power and produce long-term inflation. Also, major central banks in the United States, Europe and Japan will be slow to hike interest rates as consumption stalls and labor markets struggle to recover. Central bank policies will remain bullish for gold for the foreseeable future.

The emerging markets hold the key to the future as they harbor budget and trade surpluses while having reduced deficits since the financial crisis in 1997-1998. They will command a greater share of world output in the years ahead and deserve a premium compared to Western currencies, which are still overvalued. Some of these central banks, including China, Russia and India, have already started to accumulate gold.

The smart money is buying gold. This is likely to continue until the next financial crisis erupts, which typically occurs in the areas where leverage is growing the fastest, currently in government finances.

Eurozone Deflation Dead Ahead

Zurich, Switzerland

The talk in Europe remains about Greece. Should we or shouldn't we bailout Greece? That's what the Europeans are fiercely debating at the moment.

The Europeans are heading right into the den of a deflationary trap. If that's indeed true then high quality German government bonds, or bunds, offer the best values in the eurozone now. As for the EUR, I believe it has entered a decade of discontent and hardship as the Germans above all debate whether to remain a part of the EMU, or European Monetary Union.

At a time when most of the world is still supporting an economic recovery plan to boost growth following the darkest days of the credit crisis, the Europeans seem bent on fighting inflation.

Indeed, the recipe given to address rising fiscal deficits across the eurozone is a recipe for economic disaster.

By forcing profligate countries like Greece and many others to aggressively cut spending at a time when unemployment is rising and output declining is the wrong way to address imbalances, at least at this time.

The ECB, or European Central Bank, will eventually be compelled to launch a "quantitative easing" program, similar to the United States, England and, to a lesser extent, Switzerland in order to boost monetary aggregates and grow inflation. This will become apparent over the next few years when the ECB's efforts to drain economic growth vis-à-vis sharp spending cuts in Greece, Portugal, Spain and others results in deflation, an environment of declining prices.

The Germans are now prepared, however reluctantly, to supply Greece with 28% of the total €30 billion ($41 billion) needed to cover the country's short-term financing requirements. But for how long can the Germans continue supporting Greece and others with out of control finances?

 

The EUR faces a long road ahead. For EUR-based investors, gold remains the best defense in an uncertain monetary union

April Puts Spring in Gold's Step

-Dugald Malcolm

Montreal, Canada

It has been a while since I have had an opportunity to give an update on the status of gold. In December of last year I had mentioned that gold was taking a breather from a four week rally that had brought its price from under $1,042 an ounce to over $1,226 an ounce, an almost 18% gain. There were rumblings from critics at the time, saying that gold was way too overbought and that it might very well be in a bubble that was about to burst. There forecast proved to be overly pessimistic.

The price movement of gold did indeed pullback from those high levels. From late November to the beginning of February, the price of gold gave back almost all of its gain made in the aforementioned four week rally. On February 5th gold put in and intra-day low of $1,044.80, but managed recoup its losses and then some to end the day at $1,065.60. In so doing, it managed to successfully retest the lows made prior to the four week rally as well as forming a bullish hammer on the daily candlestick charts.

While sometimes frustrating for investors, price corrections can a play healthy part in a bull market. Pulling back 10% or more to test trend lines, moving averages or previous levels of support and, thereafter, resuming previous price directions adds validity and strength to the overall upward trend. It is something we have not seen in the major markets indices since the March 2009 lows. Although there have been price pullbacks, none of the them have resulted in a fully fledged price correction.

Gold, on the other hand, has given us a price correction and has subsequently gone on to form a triangular consolidation pattern. Investors took particular interest in this consolidation pattern, which had been in place since late last year. Since around the same time, the US dollar has shown considerable strength. Since the price of gold tends to move in the opposite direction of that of the dollar, some feared a breakdown of the consolidation pattern was imminent.

In the beginning of April, however, in the face of a stronger US dollar, the price of gold managed to break out of the triangular consolidation pattern and has been on a tear ever since. What's more, is that it does not look like it will be stopping its advance anytime soon, with the MACD showing continuing strength and the ADX line poised to cross the 20 line to confirm a rising trend is in play. Also of note is what appears to the break above a neckline of a Head-and-Shoulder Bottom Formation. The break out will be confirmed with a close above $1,174.

The next hurdle for gold after that will come at the $1,226 level, its previous high made in December. Let's see if gold can manage to maintain its new found spring shine.

Government Printing, Currency Chaos Guarantees Higher Gold Price as “Inflate or Die” Rules

Montreal, Canada

Gold's decline from a nominal high of $1,216 an ounce in early December to $1,053 this morning is drawing a rising chorus among some distinguished bears that the nine-year bull market is over. Some pundits claim gold is in a bubble.

The world's greatest hedge fund manager since 1969, George Soros, was recently quoted on Bloomberg claiming "gold is in a bubble" while renowned economist, Nouriel Roubini, believes the gold bull market is over. In the absence of inflation, the latter thinks gold should be sold.

Nothing could be further from the truth.

The Sovereign Society and my Commodity Trend Alert service have been bullish on gold since about $400 an ounce and we remain positive for many reasons, namely out-of-control U.S. deficit spending, sovereign government debt accumulation, declining global gold production, growing currency chaos and, ultimately, high inflation over the next 3-5 years as the Fed fails to drain excess liquidity from the financial system.

It's amazing to hear from some investment gurus that gold is in a bubble. How can an asset such as gold be in a bubble when its inflation-adjusted price is about $2,300 an ounce? Also, the gold price is only 24% higher than its nominal high in 1980. These are not bubble criteria by any means. The NASDAQ, U.S. and Spanish housing, Chinese equities and real estate and Brazilian bank balance sheets are or have been classic bubbles, but not gold.

My bullish stance on gold went into "maximum overdrive" starting in late 2008 when the Federal Reserve announced its plans to start "quantitative easing," the codeword for monetizing government Treasury or government agency debt (GSEs) in a bid to keep mortgage-backed securities markets liquid and to mop-up excess Treasury sales amid a flood of issuance since 2009 to finance bail-outs and fiscal spending orgies.

The Fed has informed the markets that at some stage it will begin to withdraw these and other unorthodox monetary operations as credit markets have normalized and economic growth recovers since falling off a cliff in Q4 2008. Indeed, this has already begun with the Fed exiting the commercial paper market late last year and hinting it will end its purchases of Treasury bonds in 2010.

The Fed has created a deep chain of inter-dependence since the financial crisis erupted 18 months ago whereby any hasty withdrawal from supporting mortgage-backed securities might tip the economy back into recession. Credit intermediation, particularly as it pertains to mortgage-financing, remains heavily impaired; without government support, Fannie and Freddie would collapse and mortgage financing would almost disappear.

It's also worth noting that financial sector securitization markets are only a fraction of what they were compared to two years ago. This gaping hole in credit intermediation won't be resurrected any time soon. Moreover, consumer installment debt continues to shrink, loan demand remains anemic and consumers are still reducing, not increasing, net debt levels as the savings rate rises since 2008.

The above is not the prerequisite for monetary tightening – especially in the absence of employment growth. In fact, it's probably supportive of an extended period of easy money, resulting in some sort of monetary overshoot and, of course, its consequence: inflation.

The case for gold, therefore, remains compelling in the face of a massive credit overshoot likely to emerge in the United States. I'm pretty convinced the Fed is desperate to grow inflation at any cost in order to defeat deflation in housing, domestic consumption, wages and employment. And some sort of bungled policy response is bound to occur in the near future as the Fed tries to appease bond markets should interest rates at the long end rise, threatening a recovery.

Banks have started to lend since late 2009, albeit in small doses. Commercial bank credit has declined 2.6% year-over-year (through December), a level that is moderating compared to six months prior. At some point, banks will start to lend again. As loan demand grows the odds favor a serious credit overshoot as the money-supply eventually expands aggressively – causing inflation. Hedge fund managers John Paulson and Paul Tudor Jones subscribe to this view as does financial writer extraordinaire, Rick Russell.

Withdrawing extraordinary monetary stimulus without causing a financial dislocation in the markets is a bold task confronting western central banks. I have very little confidence that central banks will drain the liquidity spigots ahead of inflation, which they are so desperate to grow.

To bet against gold is to bet that central banks will "get it right." The odds of that happening are next to nil.

My view remains that gold is now in another series of corrections since the bull market began 11 years ago at $252 an ounce. The global exchange rate mechanism is flawed, wrought with enormous uncertainties and governed by individuals that don't give a damn about our purchasing power vis-à-vis profligate spending. I have more faith in gold than the Fed, the ECB or The Bank of Japan – a bunch of drunks at the bar with no sense of monetary responsibility or financial integrity. I remain more bullish than ever on gold.