QE2 and inflation good for oil and commodities

Give me that old time inflation. Give me that old time inflation. Give me that old time inflation, it's good enough for me.

The Federal Reserve has changed sides! Can you believe that the Federal Reserve is rooting for inflation! I mean that is like Superman rooting for the communists. The Feds' mission has always been to fight inflation, not create it. Yet that is exactly what they are doing. Of course the truth is, regular readers of my reports have known for years that the Fed joined the inflationary dark side of the force. The Fed wants commodity prices higher to inspire economic activity as business start to fear that use it or lose it in relation to the spending power of their devalued dollars. The Fed wants inflation and they know how to create it and you cannot get in the Feds way.

It is as I wrote the day after Quantitative Easing 1 March, 2009 when I said, "I fought the Fed and the Fed won. I fought the Fed and the Fed won. Needed money so they printed some, I fought the Fed and the Fed won." I went on to say, "do not underestimate the way this Fed can change the marketplace.” The Fed's timing of this move to quantitative easing still has the market coming to grips with the shorter and longer term effects on the economy and the markets. The one thing that is for sure is that the rules of the game have changed. And when it comes to a knife fight and Fed power, there are no rules. Someone say one, two, three, gold! In a blink of an eye the Fed, with its unlimited power to print money, can change the dollar value of a commodity or its long term trend in an instant. By creating inflation and money out of thin air they can change the entire commodity trend as we know it and drive away the deflation demons of that particular moment. Being short commodities has become a more dangerous proposition and the Fed has put us on notice. At anytime they can run the printing press and change the fate of a commodity.

They do this not because they created a global shortage of a commodity or because of sky rocketing demand. It is because the Fed has the ammunition to make it so. At the same time the Fed's policy of quantitative easing is as simulative to the economy as a good old fashion interest rate cut, yet at the same time it has the potential to be much more inflationary (especially for commodities). And now that the Fed has opened Pandora's box, the markets now from this point forward have a more complex element to them. Not only that the market seemed a little shocked at the Fed's timing of this historic and dramatic move. It's not that the market was on guard for the possibility, but after Ben Bernanke's Emmy winning caliber performance on 60 Minutes, the thought was that this silver easing bullet would be saved for another time. Is there a best actor award for a Fed Chairman and a cheery disposition in a continuing role?

I asked at that time Why Quantitative easing? There are two possibilities. One is that the economy is much worse than it appears. The other is that the Fed thinks things are getting better and wanted to give some to shock and awe stimulation to this feeble recovery with the hope it will turn into a full-fledged spurt of unbridled economic growth. Inflation can be ok as long as it comes with economic growth. The Fed's gamble is that this will stimulate the economy by removing the deflationary risk and drive down yields to get businesses and mortgages moving again.

The problem is that if we don't get the growth to overcome the inflation risk, you get the dreaded stagflation. The fear is that the Fed move might not be simulative enough or will not have the desired effect. For commodities and oil, if this is just an inflation play, this is no good. If oil is driven higher just because the Fed is printing more money as opposed to improving demand, the Fed move may actually damage the economic recovery. If the dollar continues to plunge against other major global currencies, the Fed is in the same weak dollar position that they lamented about earlier on in this crisis. In other words, if the inflationary effect on oil outweighs the economic stimulus effect of lower long term rates, the oil drag on the US economy is headed towards the dreaded stagflation scenario.

Stagflation is a real danger for the Fed and its unending arsenal of money. This is the Feds biggest gamble. It is like their version of the surge in Iraq. It is make it or break it time. If the printing of money cannot change the direction of this economy, then get out the wheel barrels to fill up with cash and try to pave your portfolio with gold. If it works and the economy starts to grow, the Fed will have to put on the breaks and commodities will fall. If commodities stay strong and the recovery doesn't keep pace, then prices will start to fall again. That is until the fed starts printing again. Now the Fed is getting ready to print again and QE2 may be around the corner!

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com.

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.


Futures and options trading involves substantial risk of loss and may not be suitable for everyone. The information presented by The PRICE Futures Group is from sources believed to be reliable and all information reported is subject to change without notice.

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