The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, July 29th, 2008.

Talk of failures and bank holidays is becoming increasing wide spread as each day passes, with good reason. Combine this with the fact it appears both price managers and the market itself are out of touch about the possibilities, and this increases potential for a 'self-fulfilling prophecy' in this respect. In terms of being out of touch, and much like the situation prior to the stock market crash that commenced in 1929, money supply growth rates are presently insufficient to stimulate growth in the larger economy because price managers are still dealing with the effects of previous accelerations in inflation. So, they are limiting their response to increasing stress in the banking system to bailout style monetizations that do nothing to put more purchasing power in the public's pocket. (i.e. this is why M3 remains buoyant while M2 flounders.) It's the potential for a collapse in the dollar ($) that has them backed into a corner in this regard. If it were perceived they had embarked on another accelerated currency debasement episode, the $ would collapse like that of a banana republic.

And the public - they are out of touch about the severity of what is occurring at present as well - at least as far as a reaction in the market place is concerned. To what do we refer? While it's true stocks are going down, which makes it appear the public must be selling their portfolios out, in actuality this is not the case. No - the stock market is declining because of complacency, as measured by low and stable open interest put / call ratios on the major US indexes, indicating they too are out of touch with reality. And if there's anybody who should be very concerned about future prospects of the stock market, it's the public. Why? Well, one reason I can think of is because the stock market has become the primary means by which American's save for their retirement. But perhaps more important, and in fact on a related note, how about because of what is alluded to in our open comments above, that the stock market has been turned into a liquidity addict right along with the economy. This of course implies that how the stock market goes, so goes the economy.

So what you say. If the stock market goes down, the Fed will lower interest rates and stocks will go back up. This has occurred in every past instance within most people's memories currently in stocks, which explains general complacency. The only problem is if the US economy (Western economies) slow, this time it will cause a slowing of highly dependent foreign economies like never before due to a slowing in consumption that will finally be the bond market's undoing. For example, if growth in foreign currency reserves slow in China (and other emerging markets) due to a lack of consumption of manufactured goods globally, they will have less money to buy US debt, and the bond market will suffer unless it is monetized further. So you see, the fix might not be so easy this time. And if it does not happen sooner, it will later, as this time around there will be no end to the problems because the larger credit cycle has made a secular turn into contraction. This is a very important understanding to have moving forward - this and how 'peak oil' will interplay with the human experience.

In a nutshell, it's important to understand that peak oil will place pressure on population growth, which will in turn decrease the demand for money supply growth eventually. Less people will cause less demand for money you see - it's that simple. In an effort to counter this however, our economists will first endeavor to thwart such a development by increasing the easy money supply (monetization) by simply printing more fiat currency as opposed to having it borrowed into existence through credit related mechanisms, which is a tell-tale sign an end to the larger fiat currency cycle is fast approaching. This of course ends in hyperinflation of some degree, which is increasingly being felt in the weaker extremities of the global economy, but will also be taking hold of 'core economies' (Western economies) as process unfolds. These are hard truths to face up to for most people, which is why denial of the situation is commonplace. (i.e. think of the buffoons on CNBC.)

This will change however, where we are now getting close to the point of acceptance that something fundamental is changing, although most people will not understand what is happening until it's too late for them to do anything about it. They know something is wrong because prices are rising, and it's getting harder to make ends meet. But again, and as alluded to above, in the past central planners have always found a way to smooth things out in the public's eyes, which is another reason the current threat of accelerating inflation is not being taken seriously. So perhaps because of this it's not fare to talk of denial about the abovementioned truths, but instead to talk more in terms of sheer ignorance. (i.e. they are out of touch.) Either way of course, the end will be the same, with increasing bank failures finally waking people up about the possibility that this time may be different, which would shake their belief system in government, their security, and the future.

And believe it or not, there's actually a way to measure all this. Or should I say there is a measure that will show us when the lights will be expected to come on for increasing numbers of the public in this regard. When will this be? Answer: When the Yen turns higher from it's present consolidation, indicating contraction in the Carry Trade. Here, as increasing bank failures and / or associated credit related stress begins to shake the public's confidence in a more profound manner, the Yen should turn higher out of the divergence to declining stocks its been exhibiting these past months, which in terms causal factors we will attribute to denial (within the larger recognition / acceptance process) in remaining in sync with the above discussion. Of course if one had a more suspicious mind, it would not be difficult attributing the Yen's recent weakness in the face of declining equities as market manipulation in an effort to keep people borrowing / spending. You see the bureaucracy's price managers are getting to the point of ridiculous desperation in this regard now, expecting us to believe that a tapped out consumer is chomping at the bit to dig themselves into even bigger debt traps as the economy is imploding around them. (See Figure 1)

Figure 1

At some point in coming weeks this condition / ploy will blow up in our collective faces in my opinion however, sending the Yen higher in rapid fashion if the above observations have any merit, which will in turn have a positive effect on precious metals, and hopefully producers. Explorers and developers (juniors) may continue to suffer with the economy due to the need for capital in bringing new deposits into production (the credit cycle is tight even for good projects at present), however based on the tight correlation between the Yen, gold, and the Amex Gold Bugs Index (HUI) displayed above, apparently even a falling stock market will not prevent good things for the precious metals complex forever. So in terms of the juniors, this will be true at some point as well, at the outside when in the absence of readily available credit, high commodity prices enrich producers to the extent they become cash rich and endeavor to replace diminishing reserves through acquisitions. In general however, don't expect the juniors to act like bullion or senior producers until it becomes apparent mergers and acquisitions are viable once again, which means they could remain under pressure for some time yet. (i.e. until Christmas like in the year 2000, with parallels [think the election and contracting credit] similar in the present sequence.) (See Figure 2)

Figure 2

This is why it's important to have diversified portfolios, because process will dictate which elements of the precious metals sector will perform at a particular time, and which ones won't. In fact, and as pointed out in our last discussion on portfolio planning, it could be that the market needs to be cleansed of the multitude of start-ups that hit the scene over the past few years - companies with little to no chance of ever finding economic deposits while detracting from those that are either in development or will find such a deposit. And if we get the prolonged and dramatic downturn in the stock market / credit cycle that is suggested above in Figure 2, then we may see just that, with many juniors decimated this Fall due to failing liquidity / credit related conditions, which is why one must remain on guard with respect to this risk. What's more, this is why holding only the highest quality juniors (like San Gold, Nova Gold, etc.) at this time is exceptionally important, because if stocks and commodities decline together this Fall for a period, the resulting deflation scare could do terminal damage to the weaker members of the group. These are companies with high cash burn rates and no means of raising capital in any market.

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