What if you actually could make gold from other metals? Gold would be worth about the same as those other metals. Basically worthless. It wouldn’t be rare any more. It wouldn’t be precious.

Yet today we have an economic system founded on this fallacy. Paper money is ‘wealth’ backed by the government. The government employs alchemists like Glenn Stevens and Ben Bernanke to create more money. And that means the whole stock of money is worth less.

Meanwhile, no-one’s printing gold yet. We’ve tried every combination and permutation of every ingredient in our cupboard. None of it makes gold, although with a hybrid of vegemite and honey we think we’ve invented a grand new condiment. No new gold supply though.

Meanwhile, Bloomberg says South African gold production dropped 10% last year. Energy production over there is unreliable. And when it comes down to it, the lack of new gold supply makes it a better wealth-holder than cash. We’d take scarcity over abundance any day. Gold is scarce. Fiat money is abundant.

That’ll become very obvious soon. The failure of Fannie Mae and Freddie Mac is pushing Bernanke and the US Fed closer to a wholesale dollar-printing scenario. But you might not have to wait that long for gold to react.

Demand from the Indian jewellery market hits its stride around this time of year. Or, at least, that’s been the case every year for the last 6 years. Since 2002 gold investors have gotten a 10% Christmas present. Ten percent, on average.

Deck the halls with bullion. But for goodness sake, do it in September.

Last year the September-December surge was 24%. Following that Indian jewelers and worried investors helped take gold to its highest peak ever. The fundamentals of the gold market haven’t changed much in a year. And the price is where we left it at the end of last year, US$800.

The gold companies, however, are a completely different story.

You’d expect big gold producers to track with the gold price. They have, sort of. But in the last month they’ve gone off the rails. With the exception of Newcrest (ASK:NCM), most of Australia’s larger gold producers have lost two years of share price gains. They’re trading at 2006 prices. Back then gold was US$600.

A lot of commodities are cheap now (like our favourite metal for the energy boom). But gold producers have taken the most serious of whackings. They’ve been the scape-goats and whipping-boys for commodity bears.

If you go further down in the gold food chain, things are even cheaper. Smaller gold producers are about as fashionable as a pink mohawk at the Melbourne Cup. Take our favourite Diggers and Drillers gold pick. It’s on sale at 2005 levels. That price implies something even more dire than a US$600 gold price. There’s nothing wrong with the company. It’s selling lots of gold. But it’s at a huge discount.

There’s a point for discussion. When the market for gold equities turns around, what’ll lead it up? Chronically oversold juniors? Or producers with more leverage to gold itself?

We don’t know to be honest. We probably lean towards producers. To ride the gold express you’ll need a ticket. To benefit from a rising gold price, you need some gold. Some explorers ‘might’ have gold. But a lot of them only have patches of spinifex-ridden desert. And even if there’s gold in the ground, it might not be mine-worthy.

Considering that this sell-off hasn’t been completely rational, it’s difficult to tell exactly when it’ll turn around. You can’t predict what a crazy man will do next. He might just keep acting crazy. But we do know that these things turn around eventually. Nothing’s as cyclical as the commodities sector. And gold firms have taken a bigger haircut than most.

Source: Gold is the Oldest Form of Wealth

Chuck Butler says only one more rate cut is likely this year. Charles Delvalle, meanwhile, expects dividends on Austrialian companies BHP Billiton (NYSE:BHP) and Rio Tinto (ASX:RIO) to fall as the Aussie dollar weakens against the greenback.

Al Robinson at The Daily Reckoning Australia says the RBA is caught between fighting higher prices and a stagnating economy. But he says local mining stocks still a good bet…

If you witnessed complete strangers linking arms and breaking into song in the street this morning, it was either a long-lost chorus line or a collection of relieved homeowners. Yesterday the Reserve Bank cut base interest rates for the first time in seven years. If you’re an average Australian, you’re now $44 better off each month. Or $528 each year.

What of all that hoo-ha about Big Banks keeping the cut to themselves? It turned out to be just that. A monumental load of hoo-ha. Within nine minutes of the RBA’s announcement, all four had passed on the savings. Pretty eager. Who said there wasn’t enough competition in the banking sector?

Don’t think the credit ‘crunch’ is over though. This is the downleg of a cycle, not a blip in a glorious, perpetual uptrend as some people seem to think. Kris Sayce at Money Morning spies a dissenter in the market. Wizard Home Loans didn’t lower interest rates. It raised them. Check out today’s MM for the full story, and all your other important market news.

Meanwhile, the economy is blowing a cloud of fog into investor’s windshields.

The first thick layer of mist becomes apparent in Glenn Stevens’ official statement. Here are the two paragraphs to take note of:

The rise in Australia’s terms of trade that has occurred is working in the opposite direction [to slowing growth], adding substantially to national income and ability to spend. Fixed investment spending by businesses continues to be very strong. At the same time, high prices of oil and a range of other commodities have added to global inflationary risks. They are also dampening growth in a number of countries.

Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that household demand will remain subdued and overall economic growth slow over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices.

In plain English, there are opposing forces. The rising Australian terms of trade is bringing money into the economy, fueling it. A higher oil price is adding helium to the price balloon too.

Meanwhile, the credit crunch has smashed investments and caused money markets to flare up. The upshot: higher market interest rates, lower asset values and less spending by John Citizen. Poor Johnny C.

That’s pulling the economy down.

We have consumer price inflation plus a stagnant economy. Stagflation. The two-headed ogre of despair. With its dual maws, it attacks wealth from two directions at once. Rising prices mean Johnny C pays more. A slower economy means he has less wealth to spend in the first place.

Central banks are only equipped with one sword: manipulating cash rates. ‘Sword’ might be a generous term. Maybe butter-knife is better. Anyway, it can’t take out both the ogre’s heads at the same time whether it’s slashing or buttering. So what’s the economic solution?

There isn’t one. Not based on Keynesian, business cycle-smoothing economic policy. Or any other economics for that matter. An economy is a self-correcting system. It’s correcting the low prices and high growth we’ve had for years…with high prices and low growth.

So there’s that first layer of mist. Economists are faced with a scenario they’re not used to. Economic ‘uncertainty’, as Glenn Stevens put it. Hence the fog. How do you invest when the future is invisible?

(If you answered the housing market, go sit in the corner. If you can even afford the rent of sitting in the corner. Investing in unaffordable assets is not advisable. And we see Money Morning has a nice graph of what unaffordable housing looks like today too.)

We’ll get to a real investing solution shortly.

First, we spy a second layer of wisping, foggy uncertainty. A cheaper Aussie dollar. The interest rate cut has slashed over US13c of value from our little gold kangaroos. They’re trading at US83.5 cents today.

Other currencies are giving our dollar the hop too. That’ll only serve to import higher prices from overseas. Australians paying more for things, in other words. The left head of the ogre just grew a little. Which problem should the RBA deal with? Slower growth or higher prices?

Again, this isn’t the kind of thing a central bank is equipped to deal with. An article in The Age down here in Melbourne hinted we might see the RBA switch back to raising rates. Just to keep the dollar up. That’s getting fancy. A cut here, a snip there. A deft dodge, a subtle weave. Now we have a ballet dancer taking on a two-headed ogre with a butter-knife. Eeep.

It’s an absurd suggestion. But it’s evidence that this is a serious dilemma. Absurd suggestions start appearing when there are few good ones. We have rising prices from higher incomes…higher prices from a lower currency…and slower economic growth from high market interest rates. It doesn’t bode well for individuals or businesses.

About that solution. Quickly.

It’s no barnstorming, revolutionary idea. It’s just picking an industry that has the best of this world.

Raw materials companies are Australia’s breadwinner. Undeniably. The RBA’s still worried about ballooning prices. Mainly because mining exporters are still pulling in cash from Asia. Those rising terms of trade are concentrated in a few industries; coal, iron ore, energy, wheat. If the Australian economy is a water balloon that expands and contracts, there’s only one thin straw drawing real, liquid wealth inside. That straw is Western Australia, Queensland, and their natural resource advantage.

It’s the precursor to the inflation that keeps the RBA up at night. Mining earnings. Inflation’s first stop-over in Australia is BHP’s income statement. Unlike John C Citizen, and most other businesses, miners are still making money. Most coal companies locked in double digit earnings growth last month with contracts.

The lower Aussie dollar doesn’t hurt every industry either. China’s basically pegged to the US dollar. As far as Beijing is concerned, Australian coal is US13 cents cheaper than it used to be. So are the coal companies themselves.

And those falling asset values? That’s the key. That’s what makes investing in resource firms timely. Without a broken stock market, miners might still be trading at P/Es double those of today. Buy low.

So Diggers and Drillers will be stocking up on miners this month and next. More than usual.

Source: Reserve Bank’s First Interest Rate Cut in Seven Years

Al says that once the dust has settled on the financial crisis, the industrialization of Asia will return as a key driver of the global economy. This, of course, will be led by China, which could experience a post-Olympic jump as it switches the factories back on after the Games. Al says Australia’s resource sector is a great place to profit from China’s rapid development…

The ASX chases the Dow wherever it goes. Last night Captain America’s stock market lost 242 points. Leading the charge toward oblivion were US financials. Banker Lehmann Brothers (NYSE:LEH) and insurer AIG (NYSE:AIG) took a whacking.

And what ho…this morning BHP (ASX:BHP) and Rio Tinto (ASX:RIO) are down 1.5% apiece.

Australia is a two-sector market: financials and resources. But in a bear market, they cease to be two different sectors. They become the same thing. ‘Stocks’.

The same was true for the US market in the early 1920s. More so. There was no index for the overall market. One each for the two different sectors: railroads and industrials. You could have chocolate or vanilla. No strawberry.

Industrials pulled the whole market up during WWI. Analysts were worried pre-war that Europe would sell US dollars for gold to help finance their war efforts. The opposite happened. Liquidity flowed in. To murder each other more efficiently, European nations needed to tap into the new, American industrial machine. They bought everything America could make.

At the turn of the century, US industrial stocks were worth about 25% of the market. By the end of the war that was closer to 80%. During that time, the railroad-dominated transport index had been up and down. Then the bear of 1919-1921 struck.

Prior to the bear, industrials were industrials. Railroads were railroads. They went up and down for their own reasons. In 1919, they all became ’stocks’.

There was no more discrepancy. The chocolate tasted awful. Vanilla tasted just as bad. Investors spat them both out. Each lost over 40% before the market settled in 1921.

The last year has eclipsed that performance. Pretty much anything with a price tag has tumbled in value at some point, on a global scale. It all went up, bar a couple of dogs like the US dollar. Now it’s all coming down.

The common denominators? Stupidity, ignorance and speculation. Credit booms breed these things. Credit busts help eradicate them.

What we want to know is how the financial mountain-range will look after the snow of speculation has fully melted. Our guess is that the real Everest of the boom (Asian industrialisation) will stand a lot taller than the other, false peaks (banking, real estate, derivatives, stupidity).

On that point, Rio has raised an interesting possibility this week. It reports annual results later today. Expect double-digit profit growth and shameless spruiking of its businesses.

But the big miner gave us an appetiser this morning.

Your Most Honourable Chief Reckoner Dan Denning mentioned the possibility of a post-Olympics slump in China’s economy recently. Something similar to Sydney. A slow-down in the economy as all the tourists and competitors head home, taking their spending money with them.

Best of luck to any athletes travelling Qantas. The swimmers should be fine.

Beijing isn’t Sydney, though. It’s the centre of the world’s third grand industrialisation. And while the country was on show, everything had to look ship-shape. That meant a bit of spit here. A bit of polish there. Shutting down factories that otherwise would’ve spewed pollution into the path of Kenyan marathon runners.

“The Olympics have accentuated the usual summer slowdown in commodities demand,” Rio’s Chief Economist Vivek Tulpule told reporters yesterday. “When activity is allowed to start around – Beijing, there will be a post-Olympics jump.”

There’s the possibility China might have brought the slump forward. That’s food for thought. Sydney didn’t have smokestacks it could turn off prior to the 2000 Olympics. All it had was tourism spending.

But China has more internal demand that it can now bring into play. And it continues to prove that point. The greatest source of its wealth is its own people. Their spending and labour is self- contained. They have little to do with America’s shambles.

China has 1.2 billion people living on incomes of around US$5,000 per year. The average person in a developed country makes over six times that. Catch up, China.

There will be bumps, of course. You can’t grow a country at double- digits smoothly. And there’s always the risk the whole thing could come crashing down in a heap. There’s only so much oil in the ground, after all.

Until that happens we like a couple of metals plays. You’ll find them in the recent pages of Diggers and Drillers.

The first is nickel. We’ll hold off on dropping the full story here. Suffice to say, a lot of the world’s biggest nickel mines are getting a mite expensive. That’s putting a new floor under the nickel price. Want a closer look at the nickel market right now for free? Pop on over to Money Morning. Gabriel Andre has a few words for you.

But we don’t mind telling you about the other play in full. We’re out of time today. You can read the full report sometime in the next 48 hours. Keep an eye on your email inbox. And tomorrow we’ll find out exactly what Rio has been up to in the past six months.

Source: China’s Economy Could Experience a Post-Olympics Slump

Officially, producer prices rose 1.0% in the June quarter. Hmmm. Here’s 3.03 cheers for making stuff.

But it’s still a good result for the manufacturing sector. Commsec, for example, was predicting growth of 2.0% for the June quarter. The economy pulled a fast one and stopped buying.

The important thing is, if the producer price index is a prelude to a lower consumer inflation release on Wednesday, you might get that bounce in the ASX after all. The slightest prospect of an interest rate cut sent investors into bullish acrobatics yesterday. They did handstands until the close of trade. The All Ordinaries added 3%.

Note that those handstands are based partly on the assumption that the producer price index is linked to consumer prices. That the cost of production finds its way through to retail prices… so that consumers can enjoy the same inflation as manufacturers.

A lot of people are expecting consumer inflation to follow producer inflation’s lead.

That may or may not happen. But here’s an interesting point. This is the official release about the June 2008 producer price index. Take a glance at it. According to the ABS, the only items to actually fall in price were agricultural goods and electronic equipment. Everything else got more expensive. Especially fuel…refined petroleum rose in price by 8%.

If the fall in food prices filters through the economy, you get a bit of short term relief at the fruit and vegetable aisle later on in the year. And if the oil price continues dropping, there’s a good chance petrol might drop off too.

Prices, it seems, have risen enough for now. Inflation will be back, we suspect. And don’t rule out a surprise in the consumer price index release on Wednesday. But at this point, the economy could use a rest. Hopefully it’ll get one. If the CPI numbers come in at ankle-height too, shares will go up. That’s our prediction.

So that’s what shape the economy is this morning. There aren’t as many sharp corners on it as experts expected. And Energy prices haven’t moved a whole lot this week. Oil is still trading at about US$130. But there’s one other ‘E’ that we reckon is driving the sharemarket… Earnings results.

Al Robinson
The Daily Reckoning Australia

Source: June Producer Price Index Indicates Slower Inflation in Australia