The Fed Wants Inflation

Yesterday, the Fed said it was prepared to move on new
stimulus if the economy weakens further. What’s more, the Fed’s statement
that inflation is below levels it wants to see suggests that further easing
is coming. That’s a clear indication that the Fed is still worried about
deflation.

I suppose it’s a good sign that the Fed held off on new
easing action. But the Fed also failed to sound a confident tone about the
economic recovery, which I think is mistake.

Of course, we know the economy isn’t great. But most
economic data has improved over the last month or so. And it should be
understood that there is no magic bullet that puts millions of Americans back
to work. It’s going to take time, re-training and probably some government
incentives.

Still, the Fed seems to be simply reacting to data, instead
of getting ahead of the economy providing some leadership. That may not be
part of the Fed’s mandate, but it should be clear that the economy needs some
leadership.

One unmistakable consequence of the Fed’s statement is the continued rally for gold. Gold
is the ultimate safe-haven right now. Investors buy it on deflation concerns
and inflation concerns. And with the Fed essentially saying it wants more
inflation, gold is off to the races. The yellow metal could take out $1300 an
ounce today.

I’m sure the rally in gold prices hasn’t escaped your
notice. I hope it hasn’t escaped you investment dollars. Because another
10%-20% move for gold prices is by no means out of the question.

One aspect to gold’s rally that may have escaped your notice
is the gold miners. One might think that higher gold prices would
automatically translate to higher profits, and stock prices, for the gold
miners.

Prices are essentially fixed for gold miners. Labor costs
don’t rise 2% overnight just because gold prices do. And while gold companies
can’t take advantage of every price swing, the sustained rally for gold
prices means that miners are getting ever higher sale prices for the gold
they pull out of the ground. And that’s going to lead to higher
profits.

So farthis year,
gold mining stocks have more or less moved in lockstep with gold prices. That
may seem logical, but really, miners should outperform gold prices because
their profits can grow at a much faster rate as gold prices move
higher.

Part of the reason that gold mining stocks haven’t moved
significantly higher as gold prices launch is that investors have been unsure
whether gold can sustain its lofty levels and even move higher.

But the recent open-ended statement by the Fed is a pretty
clear signal that gold prices can, and almost certainly will, continue to
move higher.

Gold mining stocks have just started to outpace gold prices
as of the last week of August. And when you see that some of the top gold
mining stocks carry forward P/Es of 14, 18 and 20, it’s easy to see how these
stock can move much higher.

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As always, let me know what you’re thinking: [email protected].