In my article "Why the Price of Gold is Falling", posted at Seeking Alpha March 1 2013, I stated, "While all the talk is how and when the Fed will tighten, I am sure that in a very short time the conversation will turn to how and when the Fed will ease to prevent a deflationary recession from taking hold." See full article at: http://seekingalpha.com/article/1239211-why-the-price-of-gold-is-falling

On Friday we awoke to the following headlines:

Retail sales fall in March most in 9 months.

Consumer sentiment drops in April to 9 month low.

Producer prices fall an unexpected .06%, largest since last May.

The commodity markets fell hard led by gold which fell over 70 dollars. As the gold market opened the following Monday, gold fell another 150 dollars and the stock market caved 265 points. A whiff of deflation and recession is in the air. I have been contending for some time that we are in a stagnant disinflationary/deflationary economy and that gold has been signaling this. Money supply has been stagnant since,and in spite of QE3.

According to the M2 money supply figures supplied by the St. Louis Fed, money in circulation on 12/24/12 was 10432.1. On 3/18/13 it was 10429.0. Obviously, the 85 billion dollars per month the Fed is creating is not getting into the money supply. And credit is still tight to non-existent exasperating the situation. Then you have the fact of the velocity of money being dead in the water with GDP growing last quarter at .04%. This is a picture of a stagnant economy with disinflation and the threat of deflation and recession developing.

No one is looking for a deflationary recession, but from my vantage point, there is absolutely no reason in the world why we can't have exactly that. In spite of all the views to the contrary, the Fed is tight..too tight. Disinflation is turning into deflation. And the GDP has fallen to about zero over the last quarter. Even though we may get a bounce in the next GDP quarterly release of about 3%, that could be the last of it. We could deteriorate fast from here.

Consider: the sequester will continue to cut jobs and spending, each and every month until October when a new round of even bigger cuts kick in. Then we have the negotiations on the budget where any new budget agreement will include even more cuts and/or higher taxes. What will this do to an already weak economy?

Then we have more regulations on the way with the further implementation of Obamacare. And Dodd-Frank will be implemented soon with its thousands of pages of new rules and regulations to contend with. All of these new regulations will raise costs and reduce productivity. And of course, then we have the debt ceiling to deal with. And in the midst of all of this, we have the Fed talking about tightening as the year progresses -- the exact opposite of what they should be doing.

As an investor and a trader, this is not a market I am eager to invest in. Gold, commodities, bonds, and common stocks, are all risky as far as I'm concerned. Trying to short these markets make more sense to me than trying to make money on the long side.

I think we are in a similar place today as we were back in 2010 where commodity deflation started to become a grave concern. It's not that the Fed isn't creating enough money; it's that the money is being directed into the wrong places. Buying bonds in order to lower interest rates when everyone around the world is clamoring for them doesn't make much sense. The market is already lowering interest rates for the Fed. And buying mortgages during a speculative housing boom makes even less sense. Once again, the Fed doesn't need to stimulate the real estate market when multiple bids on properties are bidding up prices at a record pace and real estate prices are rising 11% year over year. Yet still the money supply stagnates and velocity is dead in its tracks. It's this that the Fed needs to direct its attention to.

A change in emphasis and direction of monetary policy should be the Fed's next move.

If the Fed is mandated to prevent deflation as well as inflation they must fight what is becoming an obvious trend. The fiscal drag of sequester together with a stagnant money supply is pulling prices and the economy down.

This is a time to be very cautious, and very defensive. It should not come as a surprise to anyone if gold and the stock market both go into prolonged bear markets, if in fact we are headed toward a deflationary recession. The irony is that as we spiral downward, all of the talk is still about when the Fed will tighten! I seriously believe that only about 1 out of ten people in the economic and investment business understand monetary policy. What scares me is we may be about to prove it.

Unless the Fed moves quickly to increase the money in circulation we may see an acceleration of disinflation and then deflation. The Fed has been pretty good at heading off deflation in the past but with the developing new opposition, both publicly and internally within the Fed, they may not be able to this time. If they get behind the curve they may never be able to get in front of it again.

Gold is signaling deflation and even possible recession ahead. If this is the case the stock market cannot be far behind. The last thing we need is to see is stock prices implode like commodity prices are beginning to.

Watch the price of gold for clues to how the Fed is doing. A falling gold price along with most other commodities indicates money is too tight. The mere suggestion by the Fed that they are considering an "adjustment" to their monetary policy that will address the developing deflationary/recessionary threat, would be enough to nip this commodity deflation in the bud.

We need price stability, not runaway rising prices, and certainly not runaway falling prices.

Paul Nathan
Paulnathan.biz