Excerpt from fund manager John Hussman’s weekly essay on the US market:

Precious metals have enjoyed a fairly explosive advance in recent months. This may partly reflect some accumulation of precious metals as reserve assets by central banks such as China and Japan. The concurrent weakness in the U.S. dollar is consistent with some degree of "diversification" of reserve assets by these foreign central banks. That said, precious metals have advanced to the point where it would not be surprising to see some amount of normal retracement. The Strategic Total Return Fund has reduced its exposure to precious metals shares to about 8% of assets, but is likely to increase rather than decrease this exposure on weakness in this group. The broad fundamentals – particularly an enormous current account deficit and reasonable prospects for stagflation – continue to be favorable for this group.

That reference to stagflation is based on two factors. First, historically, and internationally, it's not the rate of money growth per se, but the growth of government spending as a share of GDP (particularly spending that doesn't add to the productive capacity of a nation), that drives inflation pressures. Second, the enormous current account deficit means, by definition, that a substantial portion of U.S. gross domestic investment is currently being financed by foreign capital inflows. There are only two ways out of this deficit – invest less domestically, or save more domestically. Given a profligate fiscal policy and a low propensity to save among U.S. households (saving more requires income growth to outpace consumption growth), “saving more” is probably not a likely source of adjustment. More likely, we'll adjust a good part of the current account deficit through weakness in U.S. gross domestic investment (mostly via a housing slowdown, in my estimation). In any event, the U.S. has virtually zero likelihood of enjoying a sustained “investment boom” anytime soon – whatever growth we observe in capital spending is likely to come from a contraction in housing investment, leaving gross domestic investment relatively flat.

So “stagflation” isn't an outside chance, but a reasonable likelihood here.

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