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

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.

Inflation on “Sale” as Deflation Dominates Global Markets

The time to start building fresh positions in oil, gold, silver and TIPs has arrived. Even distressed real estate should be accumulated if credit can be secured.

Over the next 6-12 months the United States, Europeans, Japanese and Chinese will eventually arrest deflation. And, long before that materializes, hard assets will begin a major reversal following months of crippling losses.

Since peaking in July, the entire gamut of inflation assets has collapsed amid a growing threat of deflation, or an environment of accelerated price declines. The last deflation in the United States occurred in the 1930s, purging household balance sheets, corporations, states, municipalities and even the government following two New Deals.

Thus far, U.S. CPI, or the consumer price index, has not turned negative year-over-year. Yet as oil prices continue to lose altitude and other commodities have been crushed, input costs and price pressures continue to decline dramatically since October. The only major component of CPI that continues to post modest year-over-year gains is wages. With unemployment now rising aggressively this quarter, it’s highly likely wage demands will also come to a screeching halt.

Plunging Bond Yields Discount Danger

In the span of just six months, foreign currencies (except the yen), commodities, stocks, non-Treasury debt, real estate and art have all declined sharply in value in the worst panic-related sell off in decades. More than $10 trillion dollars’ worth of assets has been lost worldwide in 2008.

What’s working since July? U.S. Treasury bonds and the U.S. dollar as investors scramble for safety and liquidity.

On December 5, 30-day and 60-day T-bills yielded just 0.01% -- the lowest since the 1930s while the benchmark 10-year T-bond traded below 2.55% -- its lowest yield since Eisenhower was president in 1955. Even 30-year bonds have surged as the yield recently dropped below 3% for the first time in more than four decades.

The market is now pricing a severe recession and, possibly, another Great Depression. Despite a series of formidable regular market interventions by central banks since August 2007, the credit crisis is still alive and kicking. The authorities have not won the battle – at least not yet.

Heightened inter-bank lending rates, soaring credit default swaps for sovereign government debt and plunging Treasury yields all confirm the primary trend is still deflation.

To be sure, credit markets worldwide have improved markedly since the dark days of early October. Investment grade corporate debt is rallying, commercial paper is flowing again and companies are starting to issue debt once more – but only the highest and most liquid of companies. For the most part, banks are still hoarding cash and borrowers can’t obtain credit.

The real economy is now feeling the bite as consumption falls off a cliff, foreclosures soar and the unemployment rate surges higher. These primary trends are deflationary as broad consumption is severely curtailed, with consumers preparing for the worst economy since 1981 and rebuilding devastated household balance sheets.

But at some point over the next 12 months, the market might transition from outright deflation or negative consumer prices to some sort of disinflation or at least an environment of stable prices. That’s when inflation assets should start rallying again.

Inflate or Die in 2009

The battle now facing global central banks, including the Federal Reserve, is an outright attack on deflation. Through the massive expansion of credit, the Fed and her overseas colleagues are on course to print money like there’s no tomorrow to finance bulging fiscal spending plans, bailouts, tax cuts and anything else that helps to alleviate economic stress.

Earlier in November, the Fed announced it would target “quantitative easing” and “monetization,” unorthodox monetary policy tools rarely or never used in the post-WW II era.

Without getting too technical, the term “quantitative easing” implies the Fed will act as the buyer of last resort to monetize Treasury debt and other government agency paper in an attempt to bring interest rates down. Quantitative easing, however, aims to flood the financial system with liquidity and absorbs excess cash through monetization or purchasing government securities.

Through monetary policy, the Fed controls short-term lending rates but cannot influence long-term rates that are largely set by the markets; the Fed now hopes it can influence long-term rates through quantitative easing and since its announcement two weeks ago long-term fixed mortgage rates have declined sharply.

These and other open market operations directed by the Fed and Treasury will eventually arrest the broad based deflation engulfing asset prices. It will take time. Inflation is the desired goal and is the preferred evil compared to deflation, a monetary phenomenon that threatens to destroy or seriously compromise the financial system. Policy makers have studied the Great Depression, including Fed Chairman Bernanke, and the consequences of failed central bank and government intervention in times of severe economic duress are unthinkable.

According to Federal Reserve Board data, the Fed is now embarking on a spectacular expansion of credit unseen in the history of modern financial markets.

The total amount of Federal Reserve bank credit has increased from $800 billion dollars to $2.2 trillion dollars (or from 6% to 15% of gross domestic product) as the central bank expands its various liquidity facilities in an attempt to preserve normal functioning of the financial system.

The Fed’s ongoing operations to arrest falling prices are targeted namely at housing – the epicentre of this financial crisis. It is highly unlikely that the United States economy will bottom until housing prices find a floor. Quantitative easing hopes to stabilize this market.

Buy Gold Now

Relative to other assets in 2008, gold prices have declined far less. The ongoing liquidity squeeze has forced investors to dump assets, including gold to raise dollars. I suspect this short-term phenomenon to end in 2009 once the ongoing panic subsides and credit markets become largely functional again.

Gold should be accumulated now ahead of market stabilization. As the financial system gradually comes back to life over the next several months or sooner, the dollar should commence another period of weakness; there will be little incentive to hold dollars with short-term rates at or close to zero percent. The Fed will be in no hurry to raise lending rates.

Still, the Japanese experience in the 1990s warns investors of the travails of long-term deflation.

The Japanese, unlike the United States, only started to seriously attack falling prices in the economy in 1998 through massive fiscal spending. In contrast, the U.S. is already throwing everything at the crisis after just 17 months.

I expect the United States to print its way out of misery and, over time, conquer deflation. But the cost will be humungous and at the expense of the dollar, U.S. financial hegemony and calls for a new monetary system anchored by gold.

It’s literally “inflate or die” for global central banks. Inflation will win.

Fed Launches New Assault with $800 Billion to Unclog Credit

The Federal Reserve this morning announced new plans to unclog credit markets as the economic recession continues to deepen across the country, stifling bank lending and resulting in widespread hoarding of cash.

The Fed announced two new efforts to unfreeze credit for homebuyers, consumers and small businesses, committing up to $800 billion dollars. The move is timely as LIBOR rates ratchet higher again after a period of tightening since mid-October. Corporate bond spreads are also widening while mortgage rates remain elevated.

The Fed will purchase up to $600 billion dollars of debt issued or backed by government chartered housing finance companies. The central bank will also establish a $200 billion dollar program to support consumer and small business loans, the Fed said in a statement prior to the market’s opening.

Thus far, unprecedented efforts by the Fed and other central banks since August 2007 have failed to calm investors. Credit spreads remain historically high and three-month interbank lending rates as defined by LIBOR at 2.19% are well above the Federal Funds target rate of 1%. Though that’s much lower than 4.85% earlier in October at the height of the crash, it’s still high and testifies to a lack of counter-party confidence among lenders.

The Fed is clearly throwing everything it’s got at deflation. Bernanke is rapidly becoming “Helicopter Ben,” referring to his speech a few years ago where he warned that if deflation surfaced under his tenure as FOMC boss he would print money like crazy. That’s now happening.

The Fed’s balance sheet is expanding like a massive balloon since August with over $1 trillion dollars in assets swapped or arranged through all sorts of fancy bridge loans, collateralized loans, interbank SWAP facilities even to the emerging markets and goodness knows what else that isn’t reported in the financial press. In short, the Fed is out of control.

In Washington, the government is now guaranteeing about 30% of total U.S. GDP through backstops in financial services (Citigroup the latest bailout), insurance (AIG) and probably extending to the auto sector and, possibly, homebuilders. Pretty soon, half of GDP might be guaranteed by the U.S. government.

Throw in the cost of financing protracted conflicts in Iraq, Afghanistan and another huge stimulus package by President-elect Obama in January are we’re already in the hole for trillions of dollars.

Credit markets are still badly fractured, stocks have collapsed and housing remains in a freefall. The government’s backtrack on TARP is also confusing as investors debate whether a slush fund will be created to harbor toxic mortgage-backed securities. Or, as evidenced by Citigroup’s effective bailout on Monday, the government is sitting on residual TARP funds to attack the next disaster instead of throwing everything it’s got all at once at the crisis.

It’s no wonder gold is starting to look attractive again, even amid deflation. Investors forget their history when alluding to gold as only an inflation hedge; true, gold is primarily an inflation hedge as prices rise, but it is also emerging as a surrogate currency as the dollar, still the reserve currency of the world, heads into the abyss drowned by bailout after bailout and a seemingly never ending expansion of credit and money supply.

Gold was not freely traded post-1934 when FDR confiscated the metal. It’s therefore impossible to predict how gold will perform now in the first credit deflation since the 1930s. But I’ve got a feeling its moment has yet to arrive ahead of the next dollar sell off.

I’ll bet on gold.

Deflation Fears Hit Gold, Massacre Gold Stocks

While most investors remain fixated on the spectacular damage done to financial shares this year, another sector of the market is suffering from major heartburn – gold mining stocks.

Amid a violent transition from inflation to outright deflation since July, investors have trashed natural resource stocks, including gold mining stocks. Many of these shares now sit about 50-75% off their all-time highs as the destruction of credit chokes off the biggest bull market for raw materials in history. China, the world’s largest consumer of commodities, saw its economy slow to 2002 levels in Q3, expanding at 9%. That compares to a 10% expansion in Q2.

Gold stocks as measured by the Philadelphia Gold & Silver Index or XAU Index, has collapsed since hitting an all-time high of 206.37 in April.

From its best levels, the XAU Index of major mining stocks has plunged 58%. Since July 1, the XAU Index has tanked 56%.

Compared to gold, the gold stocks have been a poor proxy over the last 12 months.

Gold prices have gained a cumulative 1% since October 2007 versus a crushing 51% loss for the XAU Index. Over the last 12 months, the Reuters-CRB Index of commodities has declined 17%.

This marks one of the rare occasions in history where a market anomaly has occurred between the physical metal and the underlying shares. It has happened before. The most violent disconnect occurred in 1979 as gold stocks broke down while gold bullion blasted off to hit a peak of $850 an ounce by January 1980.

The accelerated threat of deflation since July has resulted in a wholesale liquidation of assets as investors raise cold hard cash. The dollar, reining supreme since hitting the basement in July, is a consequence of a flight to liquidity, not a flight to safety. Global risk-based assets are coming home to meet redemptions, margin calls and bearish portfolio manager asset allocation changes. This includes even gold – a highly liquid asset.

It is incorrect to assume that the dollar is strong because the euro is weak; the dollar and the euro are declining vis-à-vis the Japanese yen. All three major currencies are a bunch of drunks with no real value and subjected to the same poor economic fundamentals that point to an ultimate victory for gold.

I suspect this short-term rally for the dollar will end rather violently once the world finally settles down and credit markets normalize. This process has already begun with LIBOR rates down sharply since last Friday.

The dollar will resume its long-term decline because the United States is on course to expand its balance-sheet by ultimately monetizing the debt or buying back Treasury securities. The funding obligations required for this bailout are staggering and will likely run into the trillions before it’s over. The U.S. will suffocate the financial system with T-bonds. Inflation will make a comeback and the Fed will make it happen.

At some point foreign lenders will demand higher interest rate premiums, especially at the long end of the yield curve, to compensate for massive Treasury issuance or booming supply. It won’t happen overnight but long term rates will rise substantially over the next 24-36 months as an overwhelming supply of Treasury bonds saturates demand. Do you honestly believe 30-year U.S. money should be trading at 4.14% this morning?

Jim Bianco, a very astute market seer, claims the United States is flushing the financial system with too many dollars, possibly creating the seeds of hyper-inflation. I’m not sure we’ll get to that extreme but it’s certainly unbelievable that gold prices are sitting at $750 an ounce this morning when global markets are torn at the seams. Gold has been a disappointment this year – down 27% from its all-time high in March.

If a banking crisis coupled with the worst credit crisis since the 1930s won’t lift gold prices, then what will?

Inflation and a renewed monetary crisis, probably starting in Europe, will put gold back on course to $2,000 an ounce or more before this bull market is over. The United States, Europe and other countries will spend their way into oblivion in order to arrest debilitating deflation.

This is exactly the time to dive into gold and the huge values now widespread in the gold mining sector. The declines have been enormous. Judging by previous market declines of this nature over the last 20 years, gold stocks should be accumulated at these prices along with physical gold.

Market Needs Evidence Central Banks can Beat Deflation

Since July, global markets have violently transitioned from one obsessed with inflation to deflation, or an environment of falling prices. Though I have no doubt the Fed and other central banks will ultimately win the battle against falling prices through the aggressive expansion of credit, the near-term direction of asset prices remains down. This implies a very defensive investment position, including only the highest quality debt securities, limited exposure to large-cap multinational blue-chip stocks and alternative investments, including reverse indexing and gold.

Emerging markets and major markets face a different macroeconomic battle.

Though emerging markets still face the growing tribulations of rising prices this year affecting consumption, it’s deflation that has gripped Western economies, including Japan since commodities hit a peak in mid-July.

Asset prices continue to rapidly deflate everywhere with global stocks as measured by the MSCI World Index down 21% and the MSCI Emerging Markets Index off 30% in 2008. These are the worst calendar year returns so far since 2002. A few percentage points lower from these levels and we’ll have to go all the way back to 1974 to show similar percentage declines.

Inflation-based indicators now flash “green” with gold prices, TIPs (Treasury Inflation Protected Securities), Treasury bonds and the U.S. dollar confirming inflation is yesterday’s worry.

Until central banks, including the Federal Reserve, significantly boost the supply of credit and cut lending rates again, deflationary forces will continue to gather momentum. This marks the first time since the Great Depression that financial assets and real estate are declining in value simultaneously, threatening a hard economic landing in the United States and other industrialized economies. Over the last 12 months residential real estate prices in the United States have plunged 15.4% through June; the Dow is down 15% and global markets have tanked more than 20%.

Thus far, 13 months into the credit crisis, policy responses from major central banks have worked with limited success as inter-bank lending rates remain elevated and credit grows harder to secure for borrowers. These are the classic symptoms of deflation or in this case, an unwillingness of major financial institutions to lend amid a complete breakdown of inter-bank confidence.

The entire process of de-leveraging the excesses of the 2003 to 2007 bull market will take more time as banks and investment banks work through their clogged inventory of synthetic securities; a bottom in U.S. housing values would trigger a bottom for asset values and, probably, an end to the credit crisis.

Unfortunately, we’re at least six to nine months away from a housing bottom. The government’s bail-out of Fannie Mae and Freddie Mac this week has accelerated this hopeful outcome by several months as a starved mortgage market will now get a dose of liquidity and confidence, courtesy of the United States government.

Deflation is now firmly in control since July. Let’s hope it fades soon.