Gold News

Inflationary Fireball

The Fed's opened the propane tank, waiting for someone to light a "green shoots" cigarette...

THIS WEEK the president of the European Central Bank said the worst of the recession is behind us and we can look forward to improved growth from here, notes Tom Dyson in Daily Wealth.

Oil made a new six-month high this week. The Pound Sterling is hitting four-month highs today. And Citigroup just announced it has loaned almost every Dollar of TARP money given to it by the US government.

"If I hear the expression 'GREEN SHOOTS' one more time, I'm going to throw up," complained a trader at investment bank CLSA.

The feeling of relief is palpable, even in my small town. Everywhere I go, people are acting as if the worst is over and it's back to "business as usual" in America.

This optimism could spark a fireball...

One of my favorite writers, Richard Maybury, likens the current situation to a fire bomb at a garden party. It's like Bernanke left the propane tank open and he's just waiting for the first person to light a cigarette...

Bernanke created this bomb by dropping interest rates to zero and pumping over a trillion freshly printed dollars into the economy. Bernanke wants inflation...and he's made it clear he'll do anything to get it.

"This is the first time in human history the global reserve currency has been created in hyperinflationary amounts," Maybury writes in his newsletter, Early Warning Report.

This is money supply. It's the fuel for the fireball. But fuel alone can't start a fire. You need someone to light up a cigarette. A massive drop in demand for money is the spark.

When people increase their demand for money, it means they're scared and they'd rather cling to their cash than spend it. Because they stuff this cash under their mattresses, it can't circulate in the economy, and the banking system can't build loans on top of it. Hoarding money is extremely deflationary.

Two months ago, at the peak of the crisis, people were so scared and demand for money was so high, it smothered Bernanke's gasoline vapors and kept the bonfire from igniting.

But if sentiment suddenly improves, that might change. Instead of hoarding their cash, people would spend it. All this new money and cheap credit circulating through the economy, combined with Bernanke's money supply inflation, would lead to a massive surplus in the money supply and send a fireball of inflation through the market.

In the last nine weeks, the S&P 500 has rallied 37% and optimism has returned to the market. Some small commodity and emerging-markets stocks – which are very sensitive to inflation – have soared more than 500% in two months...

Are we seeing the spark that detonates the Fed's bomb?

If it is, this "green shoots" optimism could soon turn into a massive crowd stampede out of the Dollar and into commodities, Gold Bullion, real estate, stocks, and foreign currencies.

"The world will be awestruck at the rise of non-dollar assets," writes Maybury, "and we will look back on the present as the greatest bargain-hunting opportunity in history."

My favorite way of betting on an inflationary fireball is by buying small-cap stocks in sectors like mining, gambling, emerging markets, and construction. Some of these stocks fell 90% or more in the bust and will rise hundreds of percent in the rebound if an inflationary fireball materializes.

Contributing editor to Steve Sjuggerud's widely-read DailyWealth email, British-born Tom Dyson is a proven contrarian investor, qualified to the Chartered Institute of Management Accountants (the UK equivalent of CMA in the US). After working on the bond desk at Salomon brothers in London, and writing for The Daily Reckoning newsletter, Tom launched the 12% Letter for US retirement savers looking to extend and defend their income and wealth.

See the full archive of Tom Dyson articles.

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