GOLD THOUGHTS
by Ned W. Schmidt, CFA, CEBS
Schmidt Management Company
November 2, 2008

In the past few weeks, U.S. Federal Reserve has joined with U.S. Treasury in an attempt to remedy the financial fiasco. In that effort, the Federal Reserve's balance sheet has ballooned by more than 50%. Never in peace time history has the central bank for the world's reserve currency so intentionally implement policies that will destroy the value of that reserve currency. As a consequence of that massive monetary ease, the U.S. money supply, M-2, is now growing at a double digit digit rate. That monetary growth is readily evident in the first graph. The deflationists can now quite worrying, the quantity of U.S. dollars is rising and the value of those dollars will therefore fall.

As the second chart below shows, that renewed monetary growth is likely to benefit Gold investors. Green line is six month rate of change of the value of $Gold. It uses the left axis. Red line is six month rate of change for inflationary component of U.S. money supply growth, using the right axis. Calculation for that measure is annualized six month rate of change minus 3%, a long term estimate of productivity growth.

Buy signals on Gold have been created with that monetary inflation measure. When that measure is negative and then turns up into a positive reading, a buy signal is given. Those signals are marked with black triangles. As is apparent, those signals are associate with rising returns on Gold. This most recent explosion of U.S. monetary growth is signaling that the return on Gold should begin rising dramatically. That would be as expected as the Federal Reserve is doing all possible to inflate, and reduce the value of the dollar. At the same time a massive short, real and psychological, position has been built such that a classic short squeeze in $Gold is extremely likely. Investors not mired in the thoughts of 1930 should be buying Gold at these prices, while they exist.