Since 2008 I have been forecasting an "L" shaped economy. Last year's "Looking Forward" article was sub-titled, "Another Year of L", and once again GDP will come in close to 2% this year. Year after year, I've looked at the current economic and fiscal policies of the government, the condition of the financial system, the regulatory environment, taxes, and the Fed's monetary policy. And year after year I've been forced to conclude that we were in for more of the same. And indeed, every year we have stayed in the 2% range, never achieving a typical economic recovery. For six years we have had sub-par growth and persistently high unemployment.

I think that is finally about to change.

The year 2014 should bring an improvement across the board, but with a joker in the deck. Although I think we have a good chance of seeing increased growth in the year, I think the 1st quarter of the year will be challenging. I’m concerned that dislocations can disrupt a natural recovery in the making.

Directly ahead we have the implementation of Obamacare. If the health system, let alone the insurance industry, begins to break down to any meaningful degree or if we see "bottlenecks" to any discernable extent, it will affect one-sixth of the economy, which will certainly affect consumer and business sentiment and decisions for the worse. The prospect of businesses cutting hours for employees, lay-offs, or even the specter of businesses actually closings their doors, are all possible next year. This will affect consumer sentiment and GDP if allowed to happen.  

The continued uncertainty caused by Obamacare will be augmented by the implementation of Dodd-Frank. This huge piece of legislation will add to confusion and uncertainty in 2014, again causing financial institutions, businesses, and individuals to hold back on spending, lending, and expansion plans more than they would otherwise. The new “Volker Rule” scheduled to go into effect this next year is over a thousand pages alone! Regulations stunt growth and end up as taxation since they cost money to comply with. The result in my judgment will be a poor start of the year as the nation reduces normal activity and struggles to adjust and cope. 

We have probably just peaked at 4.1% GDP in the third quarter and chances are good that the next two quarters will be trending lower than the pace today. I think we’ll fall to under 3%, then under 2% in the next two quarterly GDP reports.  Conversely, at a .09% inflation rate year-over-year, the odds of a continued fall in inflation are low from here. After all, how much lower can the Fed allow the rate to fall?  Bernanke at his news conference said that they are more than a bit concerned with the falling inflation rate and will do whatever is necessary to combat it if it should continue. So the tendency will be to fight any trend toward lower growth and lower inflation.

My view is that the Fed will be confronted with both during the first quarter of the year and that they will be forced to change their tapering policy to a policy of reflation, or at the very least, put their tapering plans on hold. I wouldn’t be surprised to see them eliminate or reduce the interest rate charged to banks on excess reserves to try and get the economy moving. This assumes that the 1st quarter will be worse than they expect, and inflation remains anemic. 

But let’s assume that lower growth and falling inflation is not an issue in the 1st quarter and that we continue to move higher from here. That case, the bullish case, is actually very persuasive.

Recently we have seen the development of a new energy boom, perhaps the most important boom in a generation. We are actually on our way to energy independence and making such cartels as OPEC, irrelevant.  IHS, an energy group, is estimating by the end of next year rail capacity could be enough to handle 700,000 barrels of crude, compared to 150,000 today. We are about to become net exporters of oil and gas to the world. This one industry will be instrumental in raising exports and increasing the GDP in 2014 and into the future.

Add to that a very robust housing recovery that looks to have legs, and good car sales continuing in an industry that will add to our exports next year, especially if world growth kicks in. All of these robust industries will buoy the economy in 2014.

The rising stock market, along with rising home prices, have led to a rise in individual net worth which just hit all-time highs this month. Corporate profits are at historic highs as a percentage of GDP, and disinflation has helped consumers make ends meet in a tight money and tight credit environment. Over the last five years, consumers have paid down debt and are in better shape than in decades. If it weren’t for the confusion and uncertainty this nation faces due to counter-productive government policies, we would be experiencing robust growth today and probably for years to come.

So, if I'm wrong in the short term and no meaningful deceleration occurs in the first quarter, I think I will be right in the long term where the economy moves higher from here with inflation also moving higher.  If so, it will probably be due to postponements, adjustments and waivers to present legislation; and to increased world growth as nations emerge from recession creating higher demand for commodities and consumer goods in general. After all, most of the world has been in a recession or declining growth for over two years now. This has led to unusually low demand. It can't last forever.

Either way, with or without a slowdown and some possible nasty problems in the first quarter, I think the days of disinflation and actual deflation are numbered. Whether sooner or later, I see growth higher from here after years of stagnation, gaining momentum in the second half of the year, and building momentum from there.  

It's for this reason that I am predicting a turn in gold, silver, and most commodity prices in 2014.

Where gold has been discounting disinflation and possible deflation since October of 2011 and has been falling, I think it will begin to discount 2-4% inflation rates over the next year or two. Whether through capitulation, a return to easier money by the Fed, or just plain higher world growth and demand for commodities, I think 2014 will be a year of higher commodity prices. Once inflation stops falling, the discounting process of falling commodities will also end. Instead of commodities discounting weakening world demand they will begin discounting strengthening world demand, and higher prices will result.

The CRB which fell from 370 in 2011 to a recent low of near 270 should bounce above the 300 level at the minimum and run higher. Gold and silver should put in a similar performance. If both GDP and inflation rise or even firm from here, regardless of the headwinds we face, then interest rates and gold should move up together. In either case, we should see higher demand for resources and resource stocks in general. And that I think will be the trade of the year.

It will be in this environment that we could see the beginning of the normalization of long term interest rates, money supply growth, increased velocity of money, and a rise in commodity prices in general. By the end of the year I expect things to be much different than the first part of the year, with inflation trending higher along with higher long term interest rates as the markets discount 2, 3, and 4% inflation rates and higher world growth rates to come.

The prospect of higher interest rates, higher inflation rates, and higher gold prices, will be distinctly different from the previous period of lower interest rates, lower inflation rates, and lower gold prices. The former signals reflationary growth while the latter signals a deflation recessionary bias in the system. The year 2014 I believe will mark the beginning of this multi-year reversal in trend. The process of returning to normalization, however, will be slow at best.

The most profitable scenario for those that are invested in gold, silver, and resource companies, is not the doom and gloom scenario of implosion and collapse, but the world growth scenario where a growing world middle class accumulates wealth and demands more resources. If America can increase its growth rate, along with China and Japan, and if Europe can pull itself out of recession, 2014 will begin the long process of healing, growing, and creating wealth again. With that process comes demand for goods, demand for commodities, and demand for diversification of investment and savings.

In light of the possibility of such a scenario, good resource companies that have been crushed and sell today for fire sale prices, may be a good investment for those looking out over the new era we hopefully are about to enter. 

For more of my market views and specific stock recommendations see my Market Update.

Paul Nathan