The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, October 5th, 2010.

The debate is on. People are saying even if there is not deflation, at the same time there is no inflation, which is of course wrong. In the first place, inflation, which is defined as an increase in money supply (not prices), although growth rates are not hyperinflationary, still, they are rising. So, on the most basic level the premise these people are operating under is completely false. Prices are rising in under-owned asset groups (think precious metals and commodities) due to money supply growth, and falling in over-owned asset groups (think real estate and stocks), but all this has nothing to do with the inflation, which is a product of wrongheaded and unscrupulous government in that it's indirect wealth confiscation.

And the inflation / deflation debate has even less to do with what will happen to the gold price under either condition, as no matter which macro is dominant, eventually gold will rise anyway simply because it's under owned. So please, take all the precious metals bull top calling with a grain of salt, and the same disdain most still have for gold and silver, because there's just no way this thing is over with only a minuscule of the population involved, as it were. They're a stubborn bunch today, stubborn and stupid in more ways than one, however at some point in the not too distant future they will need will need to rediscover religion again as economies continue to collapse or perish themselves.

And even if there is another big bailout to go along with QE II, eventually the effects of all this largesse will run out, and worse, austerity will hit America. You will remember our study from last week, where both current events and historical precedents were used to paint a picture of sideways grinding in stock markets, the economy, etc. until next year, when austerity is to hit here, then kaboom. What's more, this could come sooner than we are presently anticipated, as dollar ($) sentiment (bullish QE II related sentiment) is far too negative in order to maintain the selling much longer despite the constant reminding that the Fed is being governed by bunch of out of control lunatics set against a picture of austerity in Europe.

Here, anybody who thinks this propaganda is not a product of our self-serving price managers is kidding themselves. The international brotherhood of central bankers came up with this storyline along time ago so that they could manage the $ down when need be. This is because it's better to have the illusion of austerity in Europe than the global economy collapsing. Of course we may get this anyway now with QE II fully discounted by the speculators / markets now, opening the door to a possible nasty surprise (think flash crash) at any time. So again, it appears this could be unraveling much quicker than just about anybody understands, which is why it's a good idea for the individual to be locked and loaded now in terms of desired portfolio structure, physical precious metals ownership, etc.

Does this mean we can't have a little rest in the precious metals (and general equities) rally? Answer: With positive internals still present in the precious metals market, anything can obviously happen, which is of course why maintaining strong core / physical holdings is so important. And in bringing in a shorter-term perspective on the markets, last Friday was the first day of the month and for that reason was subject to systematic monthly inflows that needed to be invested. And from a price management / momentum perspective, it would not have looked good to see stocks falling on the first day of a new month / quarter. Come Monday or Tuesday this will not be the case however, given the bureaucracy's price managers will be releasing the September Employment Report this coming Friday in order to continue the excitement in stocks this week, so who knows, with that and speculation concerning a surprise announcement associated with the Bush tax cuts prior to the November Mid-Term Election, it's possible the dull squeeze continues on until the bearish speculators finally puke.

What's more, this possibility is strengthened by still stubbornly high US index open interest put / call ratios (updated charts attached here), however once October is over, justification for betting negative on the markets will become increasing difficult for speculators from a seasonality perspective, possibly ushering in a material change in this regard. In terms of the attached charts, we can see that the public is already on this bus with the ratios for the SPY, DIA, and QQQQ series collapsing of late. And just look at the Commitment of Traders (COT) profile for the NASDAQ. It's a picture of bullish nirvana on the part of small speculators (the dumb money), which is of course bearish, and capable of turning the NASDAQ / Dow Ratio lower on a meaningful (and possibly lasting) basis. Now, all we need is for the pros to back off their protective put buying as we enter the seasonably strong months of the year, with November being the strongest, and we could have a seasonal inversion in the trading pattern this year, even if any weakness experienced here proved to be temporal.

In taking a closer look at the trade from yesterday in attempting to continue painting the picture, we in fact had a meaningful turn lower in the NASDAQ / Dow Ratio to define general weakness likely due to COT related considerations, so possibilities for something more profound later on might be diffused ahead of time. What's more, both financials (think XLF) and energy shares (think XLE) may have reversed lower short-term aided by the open interest put / call ratios profiles, seen in the attached above, although with POMO operations scheduled today and tomorrow, a lasting element to any such trend might have to wait. This is especially true if gold can remain invigorated, which is also a good possibility all things considered. (i.e. both POMO and rising open interest put / call ratios on GLD.) Naturally gold and silver will need to correct at some point, so if the Employment Report this Friday proves to be disappointing, perhaps a lack of money printing (note POMO's are done as of tomorrow), which is a constant and growing need these days, will facilitate such a sell-off.

Furthermore, it should be remembered from our study last week that not only do the North American (Western) stock markets have a post crash divergence to the Nikki, shown here in Figure 2, but in terms of gold, it should be pointed out it's running a divergence with just about everything else of late (the past three months), not too mention the economy, which can be seen in Figure 1 below when put against the Baltic Dry Index (BDI), which has stalled out. (See Figure 1)

Figure 1

Of course if gold (and silver eventually) is to reclaim its role as the world's reserve currency, this divergence might not be closed easily, if at all, unlike that of the stock market discussed above. This realization becomes more apparent when stocks, as represented by the S&P 500 (SPX), is also overlaid on top of the BDI, showing that a close relationship here make them more vulnerable to the larger degree downturn in credit markets, the economy, etc. (See Figure 2)

Figure 2

Further to this, it should be pointed out that even the mighty crude oil has not been able to shake a tight correlation to the economy like gold (and silver) has been able to do, which does reinforce the currency / store of wealth aspect of the yellow metal, supporting the view it has the potential to maintain it's increasing appeal amongst the investing population. Again, it should be remembered that gold is still less than .5% of investable wealth worldwide, leaving it with nothing but increasing participation rates moving forward as increasing numbers exit our deteriorating fiat currency economy. (See Figure 3)

Figure 3

And why wouldn't gold continue to do well with the race to zero in our fiat currency economies well underway. This is natural and to be expected despite what the banking cartel would like you to believe, especially when their policies / antics no longer work. Japan is the poster child in this regard, where sure enough they were at it again overnight lowering rates to zero, and like the Fed, promising fresh quantitative easing. Of course the only problem with all this is such programs have no staying power, which has been proved by Japan in that they have been doing this sort of thing aggressively since the 90's to no avail.

Be that as it may, such considerations will not stop the Fed from it's next round of bailouts in all probability, although it should be pointed out that at present all they are doing is a whole lot of jawboning, where they are likely waiting for bigger shoes to drop before stepping in on this basis again. Some speculators in the stock market are counting on them to announce at least another $500 billion at their next Committee Meeting however, which is a two-day affair on November 2nd and 3rd, right at election time.

This is likely no coincidence; giving them the flexibility to announce such measures if need be at the time if the markets were acting up. If however stocks are well behaved into next month, the Fed will likely sit pat in this regard, setting up the possibility of a seasonal inversion in the stock market trading pattern depending on sentiment, technicals, etc. We will of course be watching all this closely at the time.

For now, the consolidation in stocks over the past few days actually appears constructive for the bulls given prices have only been going sideways and not down. And although more consolidation might be in the cards, at this point, again, we cannot suggest any shorting activities, with the sentiment picture still mixed, and for this reason, downside likely limited.

No, the course of action remains the same. Hold strong core positions in precious metals and their related equities looking to add on pullbacks.

Good investing all.

Special Note: All charts provided courtesy of investmentools.com.