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June 06, 2006

Will the Fed Kill Gold?
by T. Stein / S. McIntyre

So Bernanke got appointed and gold bulls cheered. After all, this was the guy who threatened to fight deflation by running the printing press while dropping money out of helicopters. Gold going to four digits and never looking back was a slam dunk, right?

Not so fast.

Central bankers are, above all else, politicians. And shrewd politicians will do whatever is politically more popular at the time. The moment Bernanke took office, the talking heads in the media kept referring to Bernanke as needing to prove his "inflation fighting credentials" before the rate hikes could end. So whether speaking on Capitol Hill or elsewhere, the spin from Bernanke was something like, "The economy is wonderful, but we just need to make sure inflation doesn't get out of control."

As winter turned into spring, Wall Street liked Bernanke's tone and the stock market marched higher. Bernanke even went as far as to give clues that the rate hikes would be ending soon. Wall Street really liked this and the Dow nearly rallied to an all-time high. But in April, the new Fed Chairman started to mess up when he told a CNBC reporter at a dinner party that the public had been misreading him. A few weeks (and several hundred lost Dow points) later, Bernanke admitted to Congress that he should've been more careful when talking about monetary policy off the record. He called it a "lapse of judgment" on his part.

At the same time the stock market was topping in early May, the commodity markets were zooming out of control. Jumps of 5% in one day in the prices of gold and silver reminded us of 1979. All of the sudden, inflation became the talk of the town in Washington and on Wall Street. Ah, what a difference four years make!

So where are we now? Stocks, real estate and commodities have cooled off over the last several weeks yet most people still expect Bernanke to hike rates again this summer. A hike in late June would indeed solidify Bernanke's inflation fighting credentials - or at least that is what the media wants you to think.

We like to take a much longer term view of things at the Texas Hedge Report. Yes, the short term politics of the day call for Bernanke to stop inflation. But in the long run of history, the public cares more about full employment and rising financial asset prices than they do about rising commodity prices. High food and energy prices mean protests against oil companies accompanied by dog & pony shows in Congress. High unemployment means low approval ratings, revolution and upheaval. The Fed will hike until something in the economy breaks - maybe we are starting to see that today in the form of the equity and housing markets. Bernanke says he watches the gold price everyday, so as long as he is trying to be a tough guy, we may see gold continue to take a pause. But eventually the employment situation will worsen and public fears about rising commodity prices will be replaced by fears of being laid off.

While we are not in the business of predicting monetary policy, we wouldn't be surprised if Bernanke hikes once more and then says he's done. We also wouldn't be surprised if the stock market celebrated this news with a huge rally. That said, an end to the rate hikes coupled with the Dollar-bearish macro fundamentals mean that good things are in store for the precious metals. The Fed may win this round against gold, but gold will eventually win the fight.

Todd Stein & Steven McIntyre
Texas Hedge Report

Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets. For more information, go to http://www.texashedge.com