Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Gold is King

Montreal, Canada.

With Eric in transit today, I will take the opportunity to write about one of my favourite topics in his place: gold. It's no secret that he and I consider ourselves very much as gold bugs. And why not? In a world where fiat currencies are supported by countries burdened by incredible debt, it only seems natural to want to own a "real" currency.

It always astonishes me when I check the number of the U.S. national debt. The current total is now $11,601,859,998,598.50 and is increasing at an average rate of roughly $3,900,000,000.00 per day! The number is so astronomically large that it is hard to get one's head around. To get it down to a more fathomable number, the amount of debt per U.S. citizen would be $37,839.65. The scariest part is that under the current monetary system, the sky is the limit with regards to how much the government can raise that debt number. And so it does, issuing debt that will, inevitably, put incredible inflationary pressures on its currency.

Facing the possibility that inflation could lead to hyperinflation which can easily destroy a country's economy, governments of the world could be easily looking at debt default as viable alternative. With this in mind, I would much rather be holding gold than currency or bonds backed only by government "best efforts".

The fundamental reasons for owning gold as a permanent part of one's portfolio are clear. Eric has always suggested a minimum 10% one's portfolio be allocated to owning gold. But we also like to trade gold on occasion, be it physical gold or gold stocks. In performing a simple technical analysis on gold's price movement this year, now might be one of those times.

Since the end of January, prices have managed to stay firmly above the 200 day moving average even after coming down to test the moving average line on several occasions in early spring . What's more, 2009 has brought about a symmetrical triangle consolidation pattern on the gold charts. We should be watching carefully to see if prices break out above the trend line, at approximately $980. A breach to the upside could see an easy $100 dollar increase in the price of gold and, therefore, a worthwhile trade.

- Dugald Malcolm

New Canadian Gold Fund Offers a Twist

Montreal, Canada.

A new and unique closed-end gold fund hit the Canadian market last Friday with more than $366 million (C$400 million) raised from institutions and investors. Although introduced as a closed-end fund, if in six months the fund trades below its NAV, it will automatically convert into an ETF. The much anticipated offering also offers more unique twists compared to other globally-traded gold fund for two important reasons.

The Claymore Gold Bullion Trust (Toronto-CGL.UN) is the first Canadian dollar denominated gold fund to hedge its U.S. dollar exposure back into Canadian dollars. That’s a major shift away from other gold ETFs and closed-end funds in Canada, which don’t hedge out the U.S. dollars’ exposure. Since gold prices are quoted in U.S. dollars, investors in Canada have assumed adverse currency consequences since 2003 when the loonie began its ascent north of 1.60 versus the American dollar. The loonie opens this morning at 1.09.

Basically, Canadian investors (and foreigners) wary of holding U.S. dollar denominated gold funds can now maintain their constant purchasing power in local currency while participating in the gold bull market.

Over the last four weeks, for example, the loonie has surged 8% vis-à-vis the American dollar while gold prices have gained about 10%. A hedged gold bullion portfolio in Canadian dollars would have captured most of that total return; but in the absence of this hedge Canadian investors have barely benefited from gold’s recent upturn. The same goes for EUR, Norwegian kroner, Brazilian real and a host of other foreign currencies – all robbed by gold’s decline in dollar terms.

The second unique feature about Claymore’s new gold fund is the tax treatment of capital gains.

U.S. institutions were heavily involved in Friday’s offering because the deal offered a tax arbitrage strategy for gold bulls. Investing in the Claymore structure attracted a lower rate of tax than if the same investor made a similar investment in a U.S. product. If a U.S. investor holds physical gold in an ETF the capital gains attract a luxury tax at 28%; but holding the same investment in an offshore corporation or a trust – the structure that applies for U.S. institutions buying the Claymore Gold Bullion Fund -- attracts a lower 15% tax rate.

For U.S. investors the Claymore Gold Bullion Fund serves as an ideal investment tool to hedge against the long-term decline of the U.S. dollar. And unlike a regular gold ETF based in American dollars this one offers the chance to profit from currency appreciation and rising gold prices.

As for timing, now is not the ideal moment to place this trade. Commodity currencies have skyrocketed since last month and gold along with other commodities have surged as the American dollar has tanked.

Commodities and most foreign currencies are severely overbought. The Canadian dollar, which raced above par value against the U.S. dollar earlier in 2008, posted its biggest monthly gain in more than 16 years in May. Don’t chase prices. A correction lies ahead this summer.

China and the Future of Gold Purchases

With the International Monetary Fund, or IMF, poised to sell some of its gold this year, gold bug investors are on edge. That imminent sale will probably put some pressure on gold this summer but don’t let it depress you; the big picture remains unchanged as it pertains to the next dollar crisis, skyrocketing U.S. debt levels and the drive to create inflation by deflation-battered and wounded central banks.

In addition to the above reasons, I’m a gold bug because of the obvious accelerated decay of the global exchange rate mechanism. And it’s not just a volatile dollar that’s the primary actor destabilizing the financial system; many other currencies fluctuate violently from one year to the next causing disruptions in business activity, financial projections and cash-flow.

Currencies shouldn’t devalue or revalue by 20% or more in a short period of time. But that’s been the case since the demise of the Bretton-Woods gold standard in the early 1970s. Crashing currencies don’t evoke confidence among investors or businesses and ultimately lead to higher inflation and a lower standard of living.

About three weeks ago, China began to publicly express its concerns over exploding U.S. Treasury debt issuance. The Chinese hold about 40% of all outstanding American Treasury debt and, since 2001, have seen their dollar holdings decline vis-à-vis other currencies despite gains in T-bonds over the last decade. Basically, the Chinese appear to be growing frustrated with this quid pro quo arrangement whereby the United States consumes a fifth of her exports while Beijing supports the Treasury market by recycling part of its trade surplus into dollar-denominated Treasury debt.

According to the World Gold Council, China holds 600 tons of gold, or 0.9% of its foreign exchange reserves in physical gold. This compares to more than 8,000 tons for the United States and over 3,000 tons for the International Monetary Fund.

I find it truly hard to believe that with China sitting on almost 40% of all U.S. Treasury issuance and almost $2 trillion dollars of Uncle Sam’s paper in her foreign exchange reserve coffers that she’s not aggressively buying more gold. I’ve got to believe some of these numbers are not accurate; is China really reporting its true gold holdings to the World Gold Council? If the Chinese are so shrewd and pragmatic why haven’t they amassed more gold over the last several years?

I think it’s fair to assume that many government statistics worldwide are not accurately reported.

We already know that governments fabricate the consumer price index (CPI) because this component of price measurement really doesn’t depict the real rate of inflation occurring. I think it’s the same with China. We can’t trust government data in China any more than we can rely on government data elsewhere. If you subscribe to this view – and I certainly do – then I would find it hard to believe the Chinese have been sitting back watching their dollar reserves shrink vis-à-vis gold and other currencies since 2002.

I reckon the Chinese are aggressively accumulating gold as they gasp for air watching the United States print money like crazy to finance fiscal spending, bank bailouts and two military conflicts overseas. This rate of spending is simply not sustainable, even for a reserve currency.

Gold prices, which currently trade 13.5% off their all-time high of $1,033 an ounce, will recover swiftly before the end of the year and should close north of $1,150 before Christmas.

Though jewelry (fabrication) demand has indeed collapsed since $750 an ounce, especially in India, investors elsewhere are accumulating gold to hedge their paper money portfolios at a time when global government spending is totally out of control. Central banks will not be able to drain all of this incredible liquidity from the financial system once the markets stabilize; history does not bode well for fiat paper and this round will probably witness the worst destruction to our purchasing power since the early 1970s and possibly Weimar Germany in the 1920s.

Volatility Crashes but for How Long?

The big action in global markets since early March remains largely confined to trends in equities. As fears of an extended global market meltdown have receded since March, the VIX, or CBOE Volatility Index, or fear gauge, has collapsed a cumulative 28% since March 2.

Outside of stocks, barely anything is really moving at all, including government bonds, most corporate bonds, commodities and even currencies.

The lack of volatility in currency markets has been especially mysterious considering the relationship between the dollar and risk adversity since the onset of the credit crisis almost 20 months ago. As markets bled, investors dumped risky assets and piled into the dollar amid a wholesale liquidation of risk; the dollar has been rising only because institutions have been flooded with investor redemptions, which generated aggressive dollar accumulation.

The worst performing major currency, however, belongs to the Japanese yen, down over 14% since hitting an 11-year high earlier in March. The Japanese economy certainly doesn’t deserve a strong currency considering a whole range of economic data has literally crashed since January.

If risk is re-entering global markets then the U.S. dollar should be next on the firing line as investors move out of low-yielding Treasury bonds and sell dollars in the process. This should benefit hard assets, including oil and gold as investors once again seek to hedge their dollar assets from fears of rising inflation over the next 36 months.

Yet the U.S. Dollar Index (see below) is still hanging in there and remains above its important 200-day moving average but below its 50-day moving average. If the U.S. Dollar Index breaks below 81.70 then it’s quite probable the dollar will have peaked in the post-2007 credit crash.



Other assets, including crude oil – the largest single constituent in commodities indices – has also been confined to a trading range over the last few weeks. Crude oil has been unable to decisively break above $55 a barrel on this rally following a low of $33.87 earlier this year.

One of the most interesting market anomalies exist in the government bond market. Volatility has been markedly low even though investors have been selling Treasury bonds to buy stocks.

The United States, along with several other countries, is now heavily engaged in quantitative easing, which is basically a fancy term that equates to long-term inflation creation through debt monetization. Even though the Fed has been aggressively buying back Treasury debt over the last few weeks, yields on the entire range of Treasury debt has actually climbed, not declined.

If the Fed was not buying back Treasury debt over the last few weeks it’s highly probable that the entire Treasury yield curve would have steepened much further; hopes for an economic recovery – confirmed by the ongoing equity market rally since March 9 – should be accompanied by rising, not declining Treasury yields and therefore much higher volatility.

Volatility is now approaching an attractive level for speculators. The VIX can now be traded as an exchange-traded-note, or ETN, in the United States (symbols VXX and VXZ) while providing an easy route for investors to hedge their portfolio risk from the next correction. From its all-time high of 80.86 last fall, the VIX is now down 53%.

With the economy likely to be mired in a sluggish state over the next few years amid a deep credit deflation, investors would be wise to build some portfolio protection following a 30% gain for stocks since March.

Fed Out of Control, Follows Bank of England in 2009

Following The Bank of England is not a good thing. No other central bank in the OECD faces a more daunting task to revive credit. The United Kingdom, for all intents and purposes, is effectively broke. Its financial system is largely insolvent, the pound has crashed and the government already owns two of the largest banks. Unemployment in February hit its highest levels since 1971.

Deflation is attacking the United Kingdom and the central bank is throwing everything, including the kitchen sink, at credit markets. Yet London is not alone in this desperate anti-deflation battle.

The Federal Reserve surprised the markets late yesterday afternoon announcing it will purchase up to $1 trillion dollars’ worth of Treasury debt and mortgage-backed securities. Treasury bond yields immediately crashed more than 50 basis points in less than 20 minutes – the biggest such compression in yields since 1987 following the October stock market crash. Gold skyrocketed in after-hours trading and the dollar tanked against most foreign currencies.

The United States and other central banks want to grow inflation – now.

The Fed is clearly out of control as it expands its balance sheet by another quarter to roughly $4 trillion dollars and effectively goes down the destructive path of creating money or expanding credit like never before. The resultant endgame will be much higher inflation, probably 1970s-type inflation and possibly worse, if the central bank fails to rapidly drain excess liquidity from the financial system once credit markets finally stabilize.



This is a dangerous monetary precedent for the Fed. Like The Bank of England, which announced similar quantitative easing measures earlier this month, the Fed joins The Bank of Japan and the Swiss National Bank in their efforts to ease credit stress and keep interest rates low. The majority of OECD governments are now aggressively engaging deflation with all sorts of creative measures to boost the money-supply and, ultimately, inflation.

After months of relentless declines following their peak last July, inflation assets are surging this morning, including gold, silver, oil and most other commodities. Inflation-bugs are in good company following reports that Paulson & Co. – the best hedge fund in the world since 2006 – purchased a stake in South Africa’s Anglo-Gold Ashanti while boosting its gold position in GLD, or the exchange-traded gold fund.

The Fed will now purchase Treasury debt up to ten years on the maturity scale in order to keep interest rates down amid the worst recession in 27 years. The Fed will also boost its purchases of Fannie and Freddie debt where it has already spent more than $90 billion dollars since November. It also plans on buying TIPS, or Treasury Inflation-Protected Securities.

It’s obvious to me – more than ever – that the U.S. dollar and other fiat currencies are heading into the dustbin as this credit crisis drains central banks while forcing the expansion of the money supply. I’m not sure about you, but I’d have serious trouble sleeping at night in the absence of holding gold. The Fed’s announcement yesterday is just mind-boggling. Gold and other inflation hedges should start to form a new base and climb higher over the next several months in anticipation of renewed inflation starting in late 2010 or 2011.

Stock Values Hit 1966 Levels Adjusted for Inflation

An incredible market development occurred recently as the Dow Jones Industrials (Dow) broke below 6,700 – its lowest level since 1997.

Stocks are now at the same level adjusted for inflation since 1966. Stocks have done absolutely nothing for your portfolio over the last 43 years and have badly lagged bonds and even T-bills.

Should stocks crash another 50% from current levels – an unlikely event – that will put the Dow at the same inflation-adjusted level as 1929.



Amazingly, common stocks have gone nowhere since 1966 after including the consumer price index in the total return equation. The last time equities were in similar dire straits was back in 1982 when the same matrix saw stocks return a loss adjusted for inflation from 1966 to 1982.

No Reagan in 2009

Yet in 1982 the United States was at the cusp of the Reagan Revolution, the nadir of the Volcker high interest rate era and the commencement of the biggest bull market in history. That’s certainly not the case today as tax rates increase, deficits skyrocket to the moon and the banking system continues to deflate.

Spectacular Loss of Wealth

U.S. stocks have now lost $11 trillion dollars in market value since their 2007 peak, based on the Wilshire 5000 Index, which includes large-cap, mid-cap and small-cap stocks. Global stocks have seen more than $25 trillion dollars wiped-out over the last 17 months.

Incredibly, nearly half of all U.S. stocks in the Wilshire 5000 Index are now trading at less than $5 and 37% are under $3 a share. In the 18 years in this business I have never witnessed such a depression of values, which, under normal bear market circumstances, would warrant a second and third mortgage to buy depressed stocks. History does strongly suggest this is an incredible buying opportunity.

Don’t Underestimate Deflation

The problem with adopting a bullish stance now in the midst of the first credit deflation in 75 years is the unusual nature of this bear market; deflation, unlike inflation, is an investors’ worst nightmare as asset values plummet and the cost of debt financing grows stifling. History doesn’t recall any precedent for such a sharp economic contraction – both in the United States and overseas – combined with a breakdown of financial intermediation. Indeed, we’re in a deep financial hole and, thus far, we’ve been unable to break the shackles of deflation.

Since late 2007, the Federal Reserve and other major central banks have attempted to counter falling asset prices but only with limited success. The only solution at this point after 19 months of creative monetary stimulus and unprecedented bank bailouts is to inflate the national debt. It’s literally “inflate or die” for the world’s central banks.

Gold as a Store of Value

Meanwhile, investors have a limited choice of assets to protect their purchasing power. My favorite remains gold, even though it was not freely traded in the last two economic depressions (1930s & 1890s).

From its closing price on July 31, 2007, just ahead of the subprime explosion in August, gold prices have rallied from $666.90 an ounce to $935 now – a cumulative 40% return. This compares to almost 36% for benchmark 10-year Treasury bonds, which recently saw yields collapse to their lowest levels since the 1950s in December.

The only assets to “officially” appreciate in the 1930s deflation were government bonds and the dollar – the same duo leading the performance brigade since late 2007. Gold, of course, is also in the spot-light since 2007 as it continues to trade freely; I have serious doubts gold will remain a publicly-traded asset for much longer because the way the United States is expanding credit and printing money is alarming. At some point I do believe gold nationalization is inevitable and not just in the United States.

Will the Dow and Gold Cross Paths?

The upcoming buying opportunity of a generation lies upon us as common stocks eventually hit a floor in this dangerous economic cycle.

It is possible that both stocks and gold can rally together as the dollar is compromised to finance renewed risk in equities. Also, any significant bear market rally for stocks should support gold prices because of the perception that inflation is making a comeback, which is consistent with accelerated corporate earnings and rising pricing power.

There’s also the possibility the Dow and gold will cross paths like they did ahead of the last bear market low in 1982. If that happens, I’ll liquidate almost every asset I own, possibly even selling some gold to finance my purchase of stocks.

History doesn’t necessarily repeat itself but it comes darn close.

Last Chance to Buy Gold under $1,000 an Ounce

Last night, I dined with an old friend of mine who runs his own manufacturing company. Of all my buddies, he’s by far the most investment savvy. In 2008, he suffered his first portfolio loss, losing 15% compared to 42% for the MSCI World Index.

My good friend, Maurice, a Lebanese-born entrepreneur, still refuses to buy gold, despite my constant warnings about the dollar, long-term inflation and the debt super-cycle possibly imploding.

Since 2003 when gold was trading around $350 an ounce I’ve been urging him to buy gold; he admits to making a mistake not owning gold but refuses to buy the metal at these lofty levels. He thinks gold will eventually implode and drop 50% of more very quickly once stocks form a bottom. Obviously, I completely disagree.



For one reason or another, I think there’s many more sophisticated investors like Maurice who have yet to pounce on the gold bandwagon. And smaller investors are still out of the market for the large part. Increasingly, net supplies are running thin as gold coins sales skyrocket; imagine what can happen when everyone climbs aboard this gold train?

My view is that gold prices - regardless of central bank selling, IMF rumored sales – will soar at least $100 an ounce or more in a single day, probably this year. The scope for a huge upside crash lies in the cards as investors finally come to realize that we’re heading into double-digit inflation over the next five years, possibly sooner.

Gold prices are correcting again this morning and are set to open below $950 on the April contract. This comes as no surprise since we’ve just enjoyed a big rally over the last several weeks briefly piercing $1,000 an ounce last Friday. In this bull market, gold peaked at $1,033 intraday last March.

In a gold bull market – and this is the Mother of all gold bull markets – investors have been rewarded buying the metal on the dips or in the midst of corrections. Here’s such an opportunity right now. Gold should hold above $900 in this correction.

Of all asset classes and investments in the world there’s none I feel more confident about than gold over the next 12-24 months.

The scope and depth of unprecedented global fiscal spending and massive bank bailouts will propel inflation back to the forefront eventually. It’s “inflate or die” for global central banks.

The United States and other governments have totally lost control, bailing out banks that are insolvent and spending money like it’s water; any monetarist worth his or her salt should be alarmed by the size of Treasury and European government bond issuance in 2009 and 2010. And in all probability, the United States will spend trillions on several more New Deals before the economy finally bottoms.

Finally, as a side note, I do expect global stocks do post another big rally again. This won’t be the start of a new bull market because the structural problems affecting the global economy and U.S. domestic consumption will take at least a few years to untangle; in a counter-trend bear market rally I don’t expect gold to decline. Initially, any optimism on banking restructuring will hit gold - but only briefly. Optimism that accompanies a rally implies inflation expectations are returning and that can only be bullish for gold.

Maurice, though a successful investor and a good friend, is wrong. The macroeconomic forces driving gold prices are staggeringly bullish, even amid a brutal asset deflation. Buy gold.

Gold’s Finest Hour is Coming

Over the last 12 months the world has witnessed the greatest market volatility since the 1930s.

Banks in several industrialized countries, including the United States, are effectively bust, credit markets have frozen, unemployment has soared and real estate remains in a freefall. Domestic consumption in the United States – vital to global export growth – has collapsed amid a consumer recession while individual balance sheets have been crushed by a deflation gripping real estate, stocks, non-Treasury debt, commodities, foreign currencies (except the yen) and even fine art.



Since January 2008 gold prices have risen 8% in dollars and far more when measured in local currencies in Europe, Latin America, Asia and elsewhere. Only the Japanese yen has managed to gain over this period and due mostly to the unwinding of leverage amid economic carnage over this period.

Gold prices logged their eighth consecutive year of positive returns in 2008. I expect that to continue in 2009.

The Dollar Blip

The U.S. dollar, amazingly, has violently turned the corner since July 2008 posting huge gains versus most currencies as investors deleverage, sell foreign assets and bring their dollars home.

The dollar is the world’s reserve currency. It is also the single largest unit used for institutional accounting purposes, including the valuation of mutual funds, hedge funds and other investment products. As markets have crashed, investors have converted their foreign assets back into dollars to meet redemptions (at record highs for mutual funds and hedge funds) and to raise cash levels amid market hysteria since Lehman Brothers failed in September.

The dollar has also benefited from the demise of the infamous “carry-trade,” or borrowing low yielding Japanese yen from 2003 to 2007 to finance leveraged trades worldwide. That game is over.

Commodities have also been trashed for similar reasons.

As expected, commodities, which perform inversely to the dollar, have collapsed from their all-time highs last summer with oil prices down a spectacular 68% and a host of other raw materials down more than 50% from their highs. Only cocoa prices have rallied over the same period.

Commodity funds have not been spared by the spectacular cycle of redemptions. And, like other assets, commodities are being sold and converted back into dollars or short-term T-bills to meet liquidity needs or investor redemptions.

Deflation Now, Inflation Tomorrow

For patient investors, gold will ultimately head through the roof as unprecedented global government fiscal spending and industry bailouts inevitably invite the worst dose of inflation since the early 1970s and possibly, reminiscent of Weimar Germany in the 1920s when hyper-inflation wreaked total havoc.

The United States will print money like there’s no tomorrow to rescue the financial system and the American Way. This is already happening since late 2007 as the Fed, Treasury and the government unleash a wave of spending. The Federal Reserve’s balance sheet has already exceeded $2 trillion dollars in January 2009 and continues to soar.

If the Federal Reserve fails to quickly drain the excess liquidity when this crisis stabilizes, then gold prices will literally skyrocket as paper money becomes near worthless. This is a distinct possibility, a scenario that might unfold as we head into the great economic unknown in 2009.

Investors will pay an awful price for the ongoing credit crisis and its resultant consequences – the destruction of the dollar, the end of Pan-American military domination and the end of U.S. capitalism. If you subscribe to this view then gold’s finest hour has yet to arrive.

Gold Tied to Liquidity Cycle

But in the meantime, deflation remains short-term dollar bullish.

The global unwinding of leverage and the flight to safety will continue to support the dollar at a time when other economies are behind the U.S. economic cycle and likely to deteriorate further. This includes monetary chaos now underway in Europe, Scandinavia, Russia and a host of other countries in the industrialized and emerging economies.

Many institutions, namely hedge funds, have been forced to sell gold over the last several months to meet redemptions; gold is highly liquid and among the only asset to have appreciated over the last eight years.

Aside from hedge funds, the rest of the world is taking refuge in dollars and gold.

Where individuals can afford the metal, gold sales (excluding fabrication demand) have surged over the last six months; the U.S. Mint has stopped selling Eagles since last summer while in Europe private banks require up to three weeks to fill orders to purchase physical gold (coins, bars and wafers).

In poorer countries, however, the dollar is still viewed as a “safe haven,” a frightening contradiction considering its unlimited supply and gargantuan liabilities. Gold, however, is the only asset that is completely outside of the credit system and the only asset that has no liability.

In a world whereby currencies are literally a “bunch of drunks” competitively devaluing against each other, the dollar is currently viewed as the most sober unit. But don’t be duped into thinking the American dollar is at the cusp of a secular bull market similar to 1994 when it last bottomed.

Deficits out of Control

The U.S. government recently announced a record fiscal first quarter deficit of $485 billion dollars – a staggering amount of debt that’s likely to top $1 trillion dollars, if not more, in 2009. On top of fiscal spending, bank rescues, auto bailouts and probably other spending to boost a rapidly deflating economy, the U.S. will pile on another $2 trillion dollars of debt in fiscal 2009 and 2010. Again, this is a conservative estimate.

Gold is a Deflation Hedge

As an investor, short-term swings in gold prices are meaningless. We all know the United States and other governments worldwide will spend tremendous sums of money to inflate the financial system in 2009 and if they’re unsuccessful, will spend even more money in 2010.

It’s “inflate or die” for the global economy.

Previous periods of deflation saw official gold prices frozen by the government and in some cases, confiscated with the exception of numismatic gold coins. We really don’t know if gold will appreciate in this environment; thus far, inflation rates remain slightly positive but as the year progresses the odds are growing that U.S. CPI (consumer price index) will turn negative.

Judging by the rapid destruction of asset values across a wide spectrum of investments last year, gold prices fared impressively well. I imagine the same will be true in 2009.

Regardless, I suspect the war against gold is now in earnest as governments strive to protect the financial system and safeguard paper money. Ultimately, they should succeed in arresting deflation but at an enormous cost that will invite future inflation and more monetary debasement.

Deflation Rules, Avoid most Commodities

With deflation or an environment of falling asset prices gripping global markets since last July, the whole gamut of inflation-based assets are now “On Sale” for the first time since late 2001. Many commodities and resource stocks have crashed more than 50% over the last six months.

Though there’s no hurry to lunge after depressed commodities now – except gold and silver – the time to aggressively buy these assets is approaching.

In 2008 commodities posted their first calendar year loss since 2001. Only a handful of raw materials posted a gain in last year’s market massacre, including cocoa and gold.



The CRB Index, the most widely followed commodity benchmark, remains 52% below its all-time high in July 2008. The biggest constituent of the CRB and all commodity indices is crude oil, down 70% from its all-time high last summer.

In addition to commodities, other inflation hedges are also in the bargain bin. These include TIPS, or Treasury Protected Inflation Securities, REITs or Real Estate Investment Trusts and most natural resource companies, including gold stocks. Some inflation hedges – namely TIPs and gold stocks probably bottomed in November.

But in order for these and other inflation assets to start a meaningful rally we need to see signs of waning deflation – and that’s not likely until the upcoming U.S. spending package hits the real economy.

President Obama has earmarked $825 billion dollars’ worth of spending, including tax breaks and massive infrastructure spending to boost jobs.

Over the next 12-18 months it’s highly probable that the American economy will react positively to this spending spree. Whatever the final number, it’s bound to lift GDP for at least a few quarters, similar to FDRs first New Deal in 1933.

Starting in mid-1932 the Dow began a historical bear market rally of unparalleled proportions, bottoming in June 1932 at 41.22 and then skyrocketing more than 300% until it started crashing again in 1937.

Obama might inherit a similar rally as hundreds of billions of dollars feed through the economy by 2010. If the economy starts growing again in 2010 then stocks will lead a recovery, probably sometime in 2009.

Still, major structural challenges face the United States with residential housing the most important variable in this recovery process; until real estate prices begin to stabilize the economy won’t find a solid footing – even if accompanied by waves of government spending. The source of deflation lies in real estate, including the piles of junk created by Wall Street called synthetic mortgage-backed securities.

How do you know if deflation is phasing out and it’s time to buy inflation assets?

I’m watching several indicators for direction. These include:

• Housing Prices • TIPs • Treasury bond prices • Gold • Oil • The CRB Index • A Weaker Dollar

For now only gold is heading higher as it approaches important technical resistance levels north of $900 an ounce.

Gold is rising for a combination of reasons and not just because of future inflation fears fanned by a monster spending spree in Washington in 2009-2010; it’s also rising because the global exchange-rate system is faltering as most industrialized and emerging market governments pile large swaths of debt to finance economic growth in a severe recession.

Gold is the only asset outside of the credit system that is no one else’s liability. Along with supply deficits in South Africa and flat-to-declining production in most countries accompanied by booming investor demand, gold prices should top $1,250 in 2009.

I suspect it’s probably too early to buy most natural resources even at these low prices. That’s because deflation is still accelerating, growing stronger lately as credit destruction continues and bank equity evaporates. Real estate prices are still in a freefall. The stock market has not bottomed and, until it does, commodities remain hostage to dollar strength and global deleveraging.

But if you believe the global financial system will survive then it’s inevitable that inflation will be the endgame. For now, gold should be at the core of every investor’s portfolio regardless of age or risk.

My 2009 Mini Q&A

Over the last several weeks I’ve received numerous questions from Sovereign Society subscribers, including individuals who frequent this daily blog.

As we start 2009, I thought this would be an ideal forum to collect some of these important questions and attempt to give you my best conclusions. I can’t reprint all of these inquiries; yet I’ve compiled several I think are excellent questions from our members.

Overall, I don’t like forecasting. I generally believe it’s a total waste of time and most consensus estimates ahead of 2008 ended in the basement with the majority of analysts dead wrong about the economy, the market and just about everything else.

I have to admit that I never expected the markets to crash, the banking system to go bust or the dollar to skyrocket in the midst of the worst financial crisis in 75 years. To be fair, I think most pros failed to make accurate predictions.

Question: I’m a retired investor living on income. Prior to the big rally in Treasury bonds, I held most of my savings in short-term Treasury’s and bank term deposits. But with short-term rates under 1% and government bonds yielding a pittance, I’m nervous. What should I do to supplement my income?

Comment: This is perhaps the most challenging environment for retirees in more than a generation. With money-market funds yielding almost nothing, Treasury bonds yielding around 2% and bank CDs paying under 1%, retirees must supplement their income.

My advice is to take a small portion of your savings, say 20%, and scatter that sum across a dozen or more investment grade corporate bonds. I emphasize “investment grade” and not junk debt. Investment grade debt includes anything rated BBB or better in my book and, to make it easier, I would stick to issues rated A- or higher.

The Dow Jones Corporate Bond Index now yields 6.90% -- down from its post-crash high yield of 8.87% in early October. Still, investors can tap into non-financial bonds like IBM, Johnson & Johnson, Wal-Mart and Kraft Foods – all paying 5.5% or more. Or, look at corporate bonds issued by America’s largest banks, including JP Morgan Chase, Goldman Sachs, Well Fargo and US Bancorp. These banks won’t default.

A good strategy to keep things simple is to buy a laddered portfolio of corporate bonds ranging from two years all the way to seven years. This should at least give your nest-egg a boost and if you feel comfortable with this formula, then increase your position to say 35% of your portfolio. But remember, don’t go whole-hog; at some point over the next 12 months, perhaps later, Treasury bond prices will get smashed and long-term rates will head higher as the government expands credit to the Moon. Keep your powder dry.

Question: Do you think we’ll avoid another Great Depression? Despite all the money thrown at the markets since late 2007 we’re still in the midst of a severe credit contraction and the global economy has literally fallen off a cliff since October.

Comment: I think we’ll avoid another Great Depression but only because government will nationalize or partially nationalize key industries. Without government intervention, the free market would have resulted in massive failures and a total collapse of the banking system and the broader global economy. There’s no doubt in my mind that the government made a big mistake not rescuing Lehman Brothers last September. Once you’re bailing out major banks, then do it right. But in all honesty, we don’t know what transpires behind the Fed’s walls or the Treasury’s. There’s some crazy buddy system in progress with special interests influencing government policy. The government doesn’t give a damn about you or me. What they care about is protecting their interests. That’s why we must protect our assets and, in the end, I believe gold will triumph above all paper money, especially against the dollar.

I don’t advocate government intervention; but these are not normal times and the consequences might have resulted in the death of capitalism and perhaps the emergence of a new social order, similar to what occurred in post-Weimar Germany in the 1920s. Harsh economic times usually result in a new socio-economic regime. If the Fed and Treasury fail to rescue the credit system, then we might face similar consequences. The world as we know it will come to an end.

It’s hard to know exactly what goes on behind the Federal Reserve’s closed doors and at the Treasury’s. Thus far, government efforts have been bold since the October crash, including major central banks worldwide. Major credit indicators have indeed improved since November but the housing market – the crux of the crisis – is still in a freefall. Housing must stabilize before this severe recession ends.

In my eyes, it seems that bailouts and backstops are not addressing the real problem; most TARP money is ending up in bank coffers again and, in most cases, these institutions aren’t lending. The core of this credit crisis lies with the consumer and with housing. If you’re going to fork out several trillion dollars to fix or remedy this crisis then give the money to the consumer – not the banks. The consumer is in a severe bear market with personal assets plummeting over the last 18 months, including real estate, stocks, most bonds and now, possibly his or her job might be next on the chopping block.

Give consumer households $50,000 or more and allow them to clean-up their busted balance sheets, keep their homes (service mortgages) and pay off installment debt. You might not agree with me and, in all fairness, it’s against the tenets of the Sovereign Individual; but what good will all this money do if it’s basically squandered by government and ending up in the pockets of reckless bankers again? I have serious doubts about how the government is dealing with this crisis and I don’t think Obama’s spending package will help much at all despite perhaps growing the economy for a few quarters.

Question: What about the banks? With governments now standing behind their biggest financial institutions, is the worst over?

Comment: The global banking system, for all intents and purposes, is effectively bust or bankrupt. This is especially the case in the United States, Europe and, to a lesser extent, in Japan. More than a dozen emerging market banks are totally bust, including Iceland, the Baltics, Hungary, Romania, Bolivia, Ukraine, Ecuador, Argentina, etc. Not a pretty picture.

I think we’re more than 75% through the worst at this juncture. Governments now stand behind the largest banks in each country and, in some cases, even guarantee entire deposits until 2010 (e.g. European Union). I wouldn’t worry about the largest banks failing at this point. The worst is now behind us.

Question: I know you’re a big gold bug, but isn’t the euro a strong currency and do you think it’s a better hedge against the dollar than gold? Is it too late to purchase gold coins and, if not, where would you suggest I buy coins?

Comment: I have absolutely zero faith in the U.S. dollar and other currencies, including the euro or yen. In the end, all currencies will decline vis-à-vis gold and, in fact, since 2005 the world’s currencies have been losing their relative value to gold bullion. Despite big moves by the yen and euro over the last several years, they pale against gold.

Increasingly, the average man in the street will realize that paper money is not protecting his purchasing power and will revolt against fiat money. At Sovereign Society, we’ve driven home this message since our first year of publication in 1997. Gold is the only asset in this world that isn’t someone else’s liability; with U.S. interest rates effectively at 0%, paper money now competes with gold, which also pays 0% interest. In a zero percent world, which asset would you rather own? I think the answer is obvious.

The government’s enormous spending plans to rescue the financial system and bailout almost every ailing industry assures dollar destruction because the Fed is now on course to print money like never before to quash deflation. We all better hope and prey that the Fed can drain excess bank liquidity very quickly when this credit crisis ends. If not, we’ll have some serious inflation – much worse than what we saw prior to July 2008.

I think every investor should hold at least 10% of his assets in physical gold. This means coins, wafers or bars. Getting gold coins today is difficult because the U.S. Mint has stopped selling Eagles since last summer while other dealers are complaining about tight supplies amid booming investor demand. I suggest KITCO (www.kitco.com) or First Federal Coin Corporation (www.govmint.com).

Also, I would not hold or store all of my physical gold at my home domicile. I strongly suggest parking some of your gold in Switzerland, too. Remember, you must report assets outside of the United States and Canada.

I’m convinced we’ll see some sort of government confiscation of gold again just like we did in the 1930s. Back then, FDR did allow Americans to hold a maximum of 100 ounces. I’m not so sure the next confiscation will be so generous.

I hope you found this helpful. See you tomorrow.