February 7 , 2007

Geopolitical Tensions, Inflation & The Markets

Courtesy of www.adenforecast.com

Gold is poised to rise further. The same is true of interest rates. Bonds have turned bearish and the dollar is vulnerable to a renewed decline.

What could intensify these trends? At this point, we don’t know but it’s not unreasonable to assume that geopolitics will likely play a role, as it so often does. But inflation is picking up too.

INFLATION:  Off the back burner

In fact, inflation has been rising for the past couple of years but it’s now gaining steam (see Chart). In the past two months, producer prices have risen by an average of 17.4% annualized. The bond market is confirming that inflation is the dominant trend because it turned bearish this month. This means interest rates are headed higher and bond prices are going lower, which makes sense because rising inflation is negative for bonds and the bond market is very sensitive to inflation.

As you know, too much money is the direct cause of inflation and money has been flowing like water. With housing slowing last year, the Fed kept the money faucets on in its attempts to ensure a soft landing. And so far, it seems to be working. The economy is looking better than it did a few months ago and deflationary pressures have moved to the back burner.

Military expenses alone have been astronomical at well over $500 billion for just this year. This too is inflationary and if the war in the Middle East escalates, it’ll be even more inflationary due to the greater demand for money, which would intensify these market trends.

BACK TO THE 1960s

This is essentially what happened in the 1960s during the guns and butter era. As more and more money was needed to fight the war in Vietnam, as well as spending on social programs, it eventually fueled a huge inflation that became most apparent in the 1970s.

This in turn sent gold sharply higher and the oil price surged, along with other commodities. The U.S. dollar plunged, currencies soared and so did interest rates as bond prices dropped sharply. The stock market was volatile but it basically went sideways.

Could history repeat? It could. Things are never the same but the situation today, while more complex, is similar and the markets are in synch for an inflationary outcome.

GO WITH THE TRENDS

At this point, any number of developments could trigger these markets. It may be a geopolitical event or it may not. The point is, the ingredients are in the pot, both economically and market wise, and as the old commercial goes, it would be foolish not to listen. Arrange your finances so you won’t be hurt by what’s currently happening, but instead set yourself up, or maintain a strategy enabling you to protect your assets and profit.

The best way to do that is by owning gold and silver. Since the metals are stronger than most of the gold and silver shares, keep a larger percentage of your metals’ portfolio in the metals themselves and a smaller portion in the shares.

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Mary Anne & Pamela Aden are well known analysts and editors of The Aden Forecast, a market newsletter providing specific forecasts and recommendations on gold, stocks, interest rates and the other major markets. For more information, go to www.adenforecast.com