The January 2nd edition of Notes From the Rabbit Hole, NFTRH117 opened the new year with a review of a successful 2010 and a look ahead to 2011. We reviewed the precious metals, commodities and broad markets. Risk is quite high in the broad markets now, even as they pump higher this morning, as I write this intro.

Stock market sponsorship is represented by the absolute dumbest money on the planet as measured by several metrics (AAII out front). This is money that wants in on the party and wants to repair the indignities of first being fleeced in 2008, and then sitting in Treasury bonds watching the party from the outside.

While I expect a significant correction before too long, the analysis in the 'Wrap Up' segment of #117 left me feeling a bit less bearish for the entirety of 2011. Let's see how things develop. Manage risk (which means manage bear instincts as well as bull ones), keep perspective, and you will do fine in 2011.

NFTRH117 Wrap Up (Bank Loans Bottoming?)

Upon finishing the report, I find myself feeling a bit more bullish on the immediate term than I was before I started writing. If I had to take a guess, I would lean toward continued bullish activity in most everything outside of the USD, which sports a chart that does not look very good. But at some point there should be a strong reversal and with any luck at all, we will be able to find some negative divergence somewhere to indicate its impending arrival.

Of course, a strong candidate will be the Gold-Silver Ratio, which remains pinned in a nose dive despite some positive MACD and RSI divergence. Junk bond to relative quality bond ratios may provide a clue. Gold in relation to industrial metals maybe. Or perhaps the thing will just reverse one day when most people least expect it.

Well, NFTRH will expect it no matter how high our gains go in the interim, because NFTRH is in high risk mode and will remain so until the risk parameters clear. Meanwhile, I guess it's party on Wayne, party on Garth.

If Wayne and Garth are going to party well into or through 2011 however, the inflationary policy must translate to the economy. Below is a graph from the St. Louis Fed (updated 12/30/10) showing what could well be a bottoming out in bank loans to businesses.

Deflationists promote the 'velocity of money' argument as they predict economic implosion. While current events indicate speculative momentum and froth subject to reversal, bank loans look to be gently bottoming into a pattern I would normally buy. We must consider that this could be one of the diminishing returns (in relation to huge commodity and precious metals upside) of intense inflationary policy, post-2007.

This would argue for inflation effects (price increases) to become more prominent in 2011 and for treasury yields to continue to rise, which would of course put major pressure on the economy. An unwinding of non-governmental credit brought on the most recent deflationary crash in 2008. The next crash might well be brought on by revulsion toward Treasury credit.

But if the graph below is indeed bottoming, an argument could be made that any coming near term correction of frothy markets could be a healthy resetting of excess on the way to a more extended - albeit inflationary - recovery. As with the cycle from 2003-2007, I would expect the real gains in said recovery to be in the most productive economies and valuable resources.

Then again, maybe I am reading too much into a fledgling bottoming pattern on a graph. Best to let events unfold and monitor weekly, and not impose bias on the proceedings.

Here is a long-term view of business loans. Deflationists argue that they are right in the big picture, but as we have noted previously, they will only be right in the final deflation. All others, since the last monetary system ties to gold were severed have just been deflation 'events' along an inflationary continuum. The trend as they say, is up. So will the tiny hitch below turn into a real bottom, signaling that money is indeed getting out into the economy now that banks have fed at the trough of pigs for two years? If so, do not be a deflationist.

Best wishes for a prosperous 2011 to all readers.