Gold's price action in the past week was an especially interesting one and it defines the current environment for just about all commodity markets. Why are commodities increasing in price? There is no shortage of gold, crude oil or natural gas. However, there are a lot of newly created U.S. dollars floating around relative to commodities. The influx of dollars into the monetary system, as a result of an entire year of stimulus, is one of the main reasons why commodities are more costly.
The crux of the future price action will therefore be how long that stimulus is available at full throttle and when does it get pared back. A case can be made that there is no other fundamental that counts right now.
Remember back in September the Federal Reserve declared fed funds rate will remain exceptionally low for an extended period. The ECB is in same boat, and Jean-Claude Trichet spoke of great uncertainties facing world economy. He is of course hemmed in by not wanting Euro to soar against dollar adding to headwinds for European exporters. Is it any wonder most asset prices are higher? Risk takers, this is opportunity knocking for any good trader. 
So rather than the supply of individual commodities, it’s the supply of dollars that will trump all other considerations. Markets might have short term pullbacks, but breaks should prove to be an opportunity for long positions as long as the fed continues to target short term rates at lowest levels in post-war history. For some hard evidence, Barclays Capital, which keeps track of commodity assets under management, just reported a $15 billion increase for the 3rd quarter.
Of course there will be head fakes from the news tape to be on guard for. Just last Thursday night Bernanke said the Fed will be ready to tighten when economy improves and may have to do so quickly. However, the Fed has never in the past raised rates as quickly as it has dropped them, especially when we’re in an economic slump. There are no real details or timetable about starting to withdrawal stimulus, just vague talk. President Obama's economic advisor, Larry Summers, was also on news shows last week talking about the administration's commitment to a strong dollar in the future, but it doesn't sound like any monetary tightening is imminent.
No wonder the dollar hasn't been very strong and in fact it's only in dollar terms that gold has punched thru into all time highs. Talks cheap and reality is that government extremely unlikely to do anything with unemployment level so high. In their minds battle with deflation is paramount. New avenues to ease such as quantitative easing are still in play and will support commodity prices as they suppress long-term rates.
The gold market obviously doesn’t fear any change in the Fed's policy. There are doubts whether there is any political will there to take petal off the metal. I believe there is a chance that markets will force the issue and continue to trend, or even accelerate bullish trends. A game of chicken could ensue with markets pushing until the Fed actually does reverse course and sticks to the political jaw- boning. Back in the late 1970s, that is how events unfolded, but of course the events also included a change in administration, which is not in the cards for now.
Exact circumstances today are also very different because there’s an element of deflation in industrial goods due to the industrialization of China and other countries such as Brazil and India. Ironically, these countries also add to the raw material inflation because of their increasing demand. At the same time, their output puts pressure on manufacturers in the U.S. who continue to lose market share, which in turn leads to unemployment and political reasons to keep interest rates low.
Clearly, bullish action not limited to gold and silver, and not a result of supply shortages. Crude, copper and soybeans exploded to the upside in the past week with the breakout of gold. Grains and soybeans received an extra boost from short-term factors after a crop report that was less bearish than feared. Very wet weather impeding the harvest was also a factor. Wheat is joining in the party and one would be hard pressed to find a commodity that isn't buoyant.
Evidence shows that investors worldwide are looking for exposure to commodities as an asset class . Most markets are now trading above consolidation patterns and above intermediate-term moving averages. They are likely to find support on breaks.
Commodities will remain volatile and trading opportunities continue to set up for those paying close attention. This doesn't mean there won't be breaks, but those breaks are unlikely to morph into any actual bear market. There can be short-term volatility that makes it hard to hold onto positions, so be sure to have a trading plan that always includes risk management.
Jim Barrett is a Senior Market Strategist with Lind Plus. He can be reached at 866-419-7698 or via email at jbarrett@lind-waldock.com.
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