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Commodities Play Coal Mine's Canaries

Editor's note: This column by Doug Kass is a special bonus for and RealMoney readers. It first appeared on Street Insight on May 1 at 8:12 a.m. EDT. To sign up for Street Insight , where you can read Kass' commentary in real time, please click here .

Some of my closest friends have recently remarked about how bearish my musings sound lately. They say that I should lighten up a bit, especially on a Monday morning after such a pleasurable weekend down here in southern Florida. Some readers have also chimed in with the same criticism over the past several months.

My initial response was this: Because there is near bullish unanimity on Wall Street most of the time, am I being criticized because I'm a member of a vocal minority? After all, Jim "El Capitan" Cramer can identify a bull market in just about any environment. So why can't I, the anti-Cramer, have as my charge to find a bear market in any environment?

After all, shouldn't a contrary voice provide added value?

Here's my thinking on the markets:

Last week, the markets soared on Bernanke's testimony to the Joint Economic Committee. Investors believe that he signaled without ambiguity that a pause in tightening could be expected in June. His precise words were: "... At some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook."

As testimony to the market's conviction that a pause is almost baked in, the futures market odds fell from a near two-thirds likelihood of a June increase in interest rates earlier in the week to only about a 20% chance by Friday. So I believe the optimism as recorded by the equity markets was misplaced as the Fed falls behind the curve.

I have disagreed strenuously with the government's assessment of inflation over the last 24 months, so the risks associated with a pause are profoundly negative.

In that piece I noted that we will face a combination of accelerating inflation and rapidly slowing economic growth, commonly known as stagflation. As such, the market's leaps of faith and willingness to take risk seem in jeopardy. I believe that a combination of rising wages, higher commodity prices, stubbornly higher energy costs and a likely sharp increase in the housing component of core CPI will produce an unpleasant surprise to a complacent worldwide investor base.

The nascent rise in inflation will likely accelerate further with a June pause as the Fed gets further behind the inflation curve. If I am correct, further and more substantial tightening will be needed later in the year as an outbreak of inflation will occur unless the Fed dishes out its medicine now.

While the equity markets seem undeterred regarding this threat, the gold and silver markets smell blood, and rose dramatically during the latter part of last week. I suspect the equity markets will shortly follow suit and recognize the inflation threat. The bearish consequences for stocks are clear.

Doug Kass is general partner for two investment partnerships, Seabreeze Partners L.P. and Seabreeze Partners Short L.P. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box." Kass appreciates your feedback; click here to send him an email.

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