Monday, November 17, 2008

Inflation or Deflation? YOU DECIDE!

I have been making the case for inflation and have gotten some very good arguments for deflation. I am not changing my stance---we are headed for inflation. The argument for deflation starts with the thought that the money supply is decreasing. How can the money supply be decreasing with a government that has decided to be the ultimate backstop? The money may be stalled at the current time, but be rest assured that all of this government money will make it through the system eventually. For those expecting it to show up immediately---it just won't work that way. That is why this situation is going to catch many by surprise.

The strong dollar argument always surfaces in the deflation camp---again a very short term phenomenon. Fortunately we have been in a short but meaningful cycle of the strengthening dollar pushing down the price of oil. I ask one simple question. Can the dollar stay strong over the next 2 years given the rate at which the government has been printing money? No it can't! Can oil prices decline if the dollar starts to decline? No! So we can interpret that we are most certainly headed for a weaker dollar and rising commodity prices.

Finally there are those that will argue that we have lost so much money with the recent declines in the stock market. Again based on what is about to happen in Washington, this decline will be short lived in terms of what we see with money supply. Those that take the tax hit will save and invest less and their money will be given to the lower income brackets who will spend it. Remember tax and spend always seems to work over the short run because it will kick start the economy. It will help to reduce unemployment as new dollars in effect are not saved but are spent. I don't buy the argument that the credit card defaults are going to cause deflation. This society is addicted to credit and most people will spend again as soon as they get a little room on their credit line.

Granted it may take 2 years for my scenario to develop , but it most certainly will!!

I do believe that we may test the lows tomorrow. I can't find any compelling reason to buy stocks. Given my inflation thesis, I think XTO is a gift under $30 and it may drop below it tomorrow. FLR is a gift right here. I think everyone selling this stock below $40 is just plain stupid. Not only are these guys blowing out earnings and revenue estimates---they should benefit from the incoming administration. UNG may well drop again tomorrow and will be another gift if you are willing to hold it for a while. If we drop below 7950 on the Dow tomorrow it could be on of the worst days in years--and years. If we bounce we could see a very nice rally---but if we don't expect bloodshed. I am watching and waiting and have no plans to commit much new capital. If we drop below the October lows I will play the SDS and DXD with tight stops. Those are the short ETF's on the S&P and the DOW.