Inflation Is the Real Enemy

10/28/2008 11:00 am EST

Focus: FUNDS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, says the Fed’s creation of a ton of money will boost inflation and commodities in the future.

There is a pervasive, and admittedly seductive, argument that the US is headed for a dire bout with deflation. These folks point to the recent decline in commodity prices as solid evidence.

There was certainly some froth in the commodity market as we entered the summer months, but any excesses have been thoroughly washed out of the system at this point.

The decline we have seen in commodities has been a consequence of the self-feeding process of liquidation brought on by highly leveraged institutions finding themselves at the door of bankruptcy, selling everything and anything to raise needed cash. The result has been to see asset prices—both paper and tangible—decline.

As to the question of deflation versus inflation, the inflationary evidence is compelling. All in all, the Fed has created an amazing amount of money of late. Ed Bugos, an expert follower of Federal Reserve releases (and a gold bug—Editor), calculates that “this is about 20% of the cumulative amount of reserves the Fed has directly injected into the banking system since its inception in 1913.”

The Fed has approached the current crisis by first lowering interest rates—but more recently, by aggressively creating a lot of money. Furthermore, this appears to be an important and permanent change in Fed policy. Mr. Bugos summed this up recently: “When the Fed inflates, the banking system does soon after. The Fed has never inflated in one month as much as it did in September. The odds are against deflation.”

There is another consequence to this summer’s commodity price decline. Future production is going to suffer as projects are stalled or are permanently halted. The bottom line, however, is that the global supply of raw materials is going to decline. [But] global demand is not likely to decline at all.

The International Energy Agency (IEA) cut its global crude demand forecast for 2008 to 86.5 million barrels a day—down some 240,000 barrels. This reduced projection, though, is still ½% higher than oil demand was in 2007.

Demand for oil will continue to climb in the economies of China, India, Brazil, Russia, the Middle East, and the rest of Asia. Couple this with an assured decline in production from older oil fields and mines, the sudden turn away from future investment in exploration and development due to the current credit crisis, as well as the current ridiculously low prices that are discounting the end of the world, and you have the stage set for the next commodity megaboom.

The Canadian energy trusts have been beaten back hard. It is time to start looking through the rubble, and I am recommending Enerplus Resources Fund (NYSE: ERF) again. We originally bought this in 2001 for $18 and sold it for a 136% profit in 2007. In the meantime, we enjoyed some very nice dividends. It is time to try and buy it back. (It closed below $21 Monday—Editor.)

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