Inflation to Unleash a Financial Tsunami

By: Mark_OByrne

Gold closed at $888.80 in New York  yesterday and was up $4.40 and silver closed at $16.61, down 16 cents.  Gold fell initially in Asia, then rose in early European trading prior to falling again in recent trade.

With oil prices remaining near record highs, near $137 a barrel  this morning and the dollar slightly weaker (it breached and remains close to 1.56 against the euro again this morning), gold should remain well bid at these levels but in the short term anything can happen and support is at $880 and $860. With the Federal Reserve likely to leave interest rates on hold at 2%, markets will look to the accompanying statement for indications as to future interest rate direction.

Oil and gasoline prices are at record highs, food prices rising significantly and inflation surging internationally, the Federal Reserve may in the coming weeks be forced to increase interest rates despite consumer confidence reaching all time record lows, house prices suffering their record annual drop and global economic slowing sharply.

With inflation far higher than interest rates and continuing negative real interest rates ( interest rates at 2% while inflation is at 4%+  ) continuing cheap money could lead to an even worse inflationary spiral and will likely lead to sharply increased investment demand for gold to hedge against this inflation.

Inflation to Unleash a Financial Tsunami
The inflation genie is now well and truly out of the bottle and now poses significant risks to the global economy.

Just yesterday there was a huge 96.5% increase in iron ore prices (despite iron ore prices having already surged in recent years). Inflation is out of control and even by wildly understated official measures, prices are climbing at two - or more - times government targets. And with central banks printing money and flooding the financial markets with cash, inflation is going to get a whole lot worse before it gets better.

The FT reports today that the “spectre of inflation returned to haunt the global economy”.

“Companies ranging from Dow Chemical of the United States to South Korea's Posco unveiled sharp price rises to combat the soaring cost of energy and raw materials.

The moves by Dow, the biggest chemical group in the US, and Posco, the world's fourth largest steelmaker, came as Charles Holliday, chief executive of the chemical giant DuPont, warned of rising inflationary pressures in the corporate sector.

"Inflation is here big-time," Mr Holliday told the Financial Times, adding that companies such as DuPont faced "tremendous cost pressures" and had the "obligation" to raise their prices to offset higher costs.

The general price pressure was exacerbated when BHP Billiton, the mining company, said the 96.5 per cent record increase in iron ore cost announced by Rio Tinto on Monday was not enough, signalling it could ask for a rise above 100 per cent with its steelmaker customers.”

Bloomberg similarly reported that “rising consumer prices will leave more U.S. consumers unable to pay their debts and may lead to a ``financial tsunami,'' according to Bennet Sedacca, president of money manager Atlantic Advisors LLC in Winter Park, Florida.

``Whether it is anecdotal or statistical evidence, I see inflation everywhere, and this is where the financial tsunami cometh,'' Sedacca wrote in a report published yesterday. ``A battered, over-indebted consumer, if forced to retrench, could create even more problems for the banking system as loan delinquencies would begin to rise even further. All sorts of delinquencies are rising. This is now a systemic issue.''

The four-part chart of the day shows how U.S. householders are struggling to pay their home loans. The top white chart shows the surge in delinquencies on all mortgages, while the yellow one measures foreclosures. The green chart tracks delinquencies on subprime adjustable-rate mortgages, and the purple one shows subprime mortgages that are 60 days behind on their payments.

Sedacca wrote that current financial-market conditions remind him of ``someone standing on a lonely beach, armed with only a small bucket, trying to stop a rare tsunami that hits the shores. It is how I feel about our markets and the tools being utilized by the Federal Reserve, the European Central Bank and other regulatory bodies. They are overmatched for what they are facing and, worse yet, they helped create the mess in the first place by being far too easy with money and debt creation.''

Today's Data and Influences
With no significant data out of the eurozone or the UK today the market will turn to ECB president Trichet who is speaking at a conference in Brussels. The market will hope that he takes the opportunity to clarify the ECB's stance with regard to monetary policy ahead of next weeks interest rate meeting.

US data through the course of the day include home sales, mortgage data and durable goods orders.

The world economic calendar is dominated by the Federal Reserve interest rate decision for June which is announced this evening at (14:15 EST; 19.15 GMT). The Fed is widely expected to hold interest rates at 2% as they continue to monitor the effect of recent rate cuts. The statement that accompanies the announcement will be closely scrutinized and may give a guide to future interest rate moves.

The tone of the FOMC statement is likely to reflect the Fed's growing concern about the outlook for inflation and markets will be looking for any indication of a move to increase official rates over the coming months.

Silver
Silver is trading at $16.69/16.75 per ounce (1200 GMT).

PGMs
Platinum is trading at $1999/2005 per ounce (1200 GMT).
Palladium is trading at $460/464 per ounce (1200 GMT). 

By Mark O'Byrne, Executive Director

Gold and Silver Investments Ltd. have been awarded the MoneyMate and Investor Magazine Financial Analyst of 2006.

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