Fed’s Easing Is Good For Gold

05/05/2008 12:00 am EST

Focus: COMMODITIES

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Mark Skousen, editor of Forecasts & Strategies, warns that the Fed’s easing will lead to inflation, and that will ultimately boost gold prices.

The Federal Reserve’s aggressive bailout of the monetary system will begin paying dividends soon with a strong rally on Wall Street.

If history is any guide, when the Fed turns on the spigot, the economy eventually turns around. An early indicator is when the stock market rallies.

Last month, Wall Street seemed as if it had breathed a great sigh of relief. Stocks rallied sharply, and gold fell. How is it possible for an inflation hedge like gold to fall in the face of another rate cut by the Fed and the injection of so much more liquidity? The answer is easy.

Gold was selling at a “crisis premium.” When the crisis temporarily subsided, as evidenced by major banks getting an infusion of private capital to survive for another day, the crisis premium faded. The Fed’s artificial, short-term medicine seems to be working, as the gigantic bottles of aspirin have thinned the blood of the economy and resuscitated the heart of the global markets.

By any measure (monetary base, M2, the cut in short-term interest rates), the Fed has panicked and adopted an easy-money policy. Aspirin may save a life in the short term, but how much help can it provide to a patient with heart disease?

Once again, the Fed has lowered interest rates below the natural rate of interest, which spells another asset boom some time down the road. In real terms, after price inflation, interest rates are negative.

While inflation is at least 3% to 5% a year, the 30-year bond is yielding 4.49% and the 10-year bond yield is down to 3.7%. The federal funds target rate is now at 2.25%, and three-month Treasury bills are yielding only 1%! If M2 continues to grow rapidly, more price inflation is sure to follow.

With the Fed aggressively cutting rates and injecting new inflation into the monetary system, it won’t be long before gold is back up above $1,000. Reflecting continued strong demand from Asia, copper prices now are back up more than $4 a pound.

US Global Resources Fund (PSPFX), which invests in oil and gas, precious metals, and other asset companies around the world, roared ahead more than 16% since last month [before a recent pullback]. Global Resources is one of the world’s best managed natural resource companies and is a five-star rated fund, according to Morningstar. Keep on buying.

This recovery is artificial and inflation-driven. Do not sell your gold, silver, and oil stocks. The most recent financial crisis will not be the last, as long as the Fed continues to adopt an easy-money policy with interest rates below the natural rate.

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