Rick,
I don't trade in commodities (except for that which I need for my job). I am nowhere near informed enough to do so, and not nearly smart enough. I would be the sucker everybody else makes their money off. As far as gold, I can't challenge any of your statements, because I really don't know much about it, certainly not from a technical trading perspective.
Overall though Rick we agree about far more than you think.
I do agree with you about gold being driven by inflation. It is seen as a safe haven, and a good hedge against further price increases in oil, or any other base commodity. America has experianced significant monetory inflation over the past few years, and that has been the "cause" of the sharp run up in gold, no doubt about it. I think it is important to understand and remember that, the vast majority of the run up in commodities has been a result of monetary inflation, and not because of increasing costs to extract, or grow a base commodity, or because of radically increasing demand, or rapidly decreasing supply. There have been supply interruptions, but they have been temporary and not permanent. Inventories were low when these disruptions occured, which exacerbated the supply issues, which lead to increasing prices.
Now just to repond to your most salient points
The demand for commodities isn't going down. The US economy may be rolling over but India and China are growing very rapidly and their demand for energy, and metals is only going to go up.
Understand that governments which print money, hate seeing commodity prices rise. Their power and control stems from the ability to create money, and commodities like Gold tell you that their printing too damn much and creating inflation.
The past few months have seen a huge drain of liquidity from the market- engineered by the Central Banks, who paniced after seeing Oil and Gold run up to multi-decade highs. China and India were both concerned about internal inflation and put on the breaks and so did Japan.
This is what drove oil and gold down, NOT THE SUPPPY AND DEMAND relationship.
Here's the key: Commodities like oil and gold are expensive to get out of the ground and process. No one in that business will stay in business if they can't sell their commodity for more than it cost them to bring it to market. That's why these things are more honest. You have to work to produce them and they are traded on open markets.
I agree that the demand for commodities isn't going to go down, but that doesn't mean that the supply of them will also go down, in the near term future. We have seen a very sharp increase in prices across the board in VIRTUALLY ALL COMMODITIES over the past 2-4 years. This follows the late 90's through early 2001, when commodity prices were incredibly low.
Did the demand equation change radically upward, while supply decreased AT THE SAME TIME FOR ALL THESE COMMODITIES?
No, which confirms your point, and my point Rick, that the rapid increase in base commodities has been driven my monetory inflation and not because of changing supply/demand relationships. Based upon the fact that governments have "drained liquidity" confirms my basic premise. The big question is "will the governments return quickly to an inflationary monetory policy once commodity prices fall?" If so, then buying gold, or any other base commodity makes sense, because it will be a good hedge. If we are entering a period of tighter monetary policy, then buying commodities as a hedge doesn't make as much sense.
I am not yet sure I really understand what Bernanke is looking to do, and how aggressive he will be in managing monetary inflation. I do believe that the Fed makes the mistake of attempting to manage money supply and monetary inflation only through the open market fed funds rate. While it is a reasonably effective tool, there are other tools that can accomplish the same thing, and give you the ability to manage multiple variables, thereby creating less of a boom and bust cycle in our economy.
They should manage reserve requirements more aggressively, as well as the buying and selling of bonds, to not allow one tool to dominate monetory policy decisons. The decision by Greenspan to drop interest rates to 1% was too much. They should have never gone so deep, and they should have managed reserve requirements and bonds more aggressively, so as to not create a "low interest rate" driven economic boom.
I do believe that what the Fed has done with interest rates the last year has been reasonable. It has pulled a lot of money out of the market, thereby limiting money supply, thus reducing pressure on base commodities. While they have paused, I think they have done so only temporarily. The main concern of the Fed right now, is much less about inflation, but more about severe deflation on the housing market. There is already a significant slow down in housing (believe me, being in the wood products business, I deal with it every day), and they want to make sure we have a soft landing in housing. A large number of the Adjustable Rate Mortgages (ARM's) from the housing boom, are coming due in the next 3-4 months, as well as some acceleration in balloon payments due from interest only mortgages. When these come due, there will be a large amount of disposable income pulled from the economy, and moved to mortgage market. This will have a huge impact on money supply, and will reduce monetary inflation pressures on base commodities. After we are through the worst of this, then I think the Fed will probably start raising rates agin, up towards 6%.
With regards to you key point, "Commodities like oil and gold are expensive to get out of the ground and process". Expensive is a relative term, not an absolute term. If it costs $20 a barrel to extract oil, it is expensive if you can only sell it for $22 or $25. If you can sell it for $65 or $70, then extracting oil at $20 is very cheap. Based upon the level of profits of the worlds major oil companies, extractions cost for oil are very cheap right now. Even at $45 oil extraction costs are cheap today. If extraction costs are high relative to return, then supply will not grow. If demand is high, and supply is low, the only option is for prices to go up, and when they do extraction costs become less and less important, and supply increases.
But extraction costs are related to supply and demand and not about monetary supply. If the price run up has been due to monetary inflation then this is really not relevant. If the price increase has been due to rapidly increasing demand accompaning declining supply, then extraction costs will determine how low prices will go.
