Instant inflation-Just add velocity
One of the first things you learn in Economics is that MV=PQ. M=Money supply, V=velocity, P=price, and Q=output. There is some dispute as to how M is calculated. Some include bank reserves and some do not. Some include private bank deposits while others do not. But the point here is not to discuss the equation but rather ponder the implications if V picks up as I believe it will in the coming years.
Now lets assume that during a recession the velocity slows. Doesn't take a great imagination to do this since people typically spend less and save more during tough times. Now let's assume that M is increased inversely to the decrease in V. Wouldn't this offset a possible deflationary trend in the short run? Possibly. But in the long run it's all too clear that when V returns that P or Q must increase and it's typically P that does just that. Or perhaps both would increase depending on the recovery. Either way, M would need to be reduced at a rate equal to the increasing velocity to offset the rise in P or Q and as we all know it's far easier to pump money into an economy than to reduce the amount. Or the Fed would have to time rate increases perfectly which is even more unlikely. I don't see this exact relationship playing out no matter how smart the Fed may be with all that brainpower.
Since I see a recovery on the horizon, as does the bond market, the VXX, mega caps, etc. then we need to prepare ourselves for the coming round of inflation. We've all been talking about inflation since 2008 but we haven't seen much of it yet in the CPI (which is skewed but that's a different article). That's because velocity is still very depressed.
How do we protect ourselves from inflation? The simple answer is gold. I know it's boring and already had quite a run. But it's ready to go higher. YTD gold prices have been flat. Gold miners over that same time are down anywhere from 15-25% and trading well below their 200 DMA. Now think about the Euro crisis ending, a European recovery, possible China easing, a US recovery (or another round of QE if that doesn't materialize), and the increasing appetite for this finite resource in other developing markets like India, Brazil, Indonesia, just to name a few billion people that would like to own this commodity.
So I plan to play this future round of inflation in the gold miners. Recently I have purchased a some gold miners on the Motley Fool Caps. But I'm also looking their way in real life. I believe that currently many miners such as ABX, GG, and AU are highly undervalued. Not just in current terms but they are heavily undervalued in future terms if my thesis plays out as I believe it will. Over the coming days and weeks I'll be looking for support to hold for these mining stocks. If the current bottom is in, as I believe it may be, then now is looking like a very attractive time to purchase these miners for a long term hold.