A Chinese newspaper reported that Chinese officials are calling for Beijing to sell U.S. Treasuries… Whoa! This is completely different than people outside of China giving them their 2-cents worth of opinions on how they should run their economy (read, Schumer, Graham, Bernanke, Paulson, and now Geithner a.k.a “the cheater”)… Let’s go to the story…

“BEIJING (Nikkei)–Calls are growing in China for the government to reduce its holdings of U.S. Treasury securities, as some observers expect their prices to decline amid heavy issuance to fund U.S. economic stimulus plans.

Such sentiment — in part motivated by indignation over recent American assertions that China is partially responsible for the global financial crisis — threatens to cast a cloud over relations between Beijing and the new U.S.
administration.

“China should sell some of its U.S. government bonds and increase its euro and yen assets,” Yu Yongding, a former member of the People’s Bank of China’s policy board, wrote in a Chinese newspaper earlier this month. Yu warned that the supply of Treasuries may far exceed demand in the future.

Such remarks by Yu, who currently serves as director-general of the Chinese Academy of Social Sciences’ Institute of World Economics and Politics, has sparked discussion within the government on how to manage its foreign reserves, according to a source familiar with the matter.”

I told the boys and girls on the desk about the story, and Ty noted that the markets weren’t really picking up on it… But by noon, you could tell something was going on, as the euro traded to 1.30 (+2 figures), Gold was up $40, and the Long Bond in Treasuries was down 2 whole points!

Now, I’m not saying that “this is finally the last shoe to drop” You see, just because a Chinese official calls for Beijing to sell their Treasuries, doesn’t mean Beijing does. However, look at the damage done to the dollar, and Treasuries when we have a single individual within China calling for this!

So… Judging from the currency reaction overnight… There’s been no follow up to the NIKKEI story… But what a performance from Gold! WOW! The shiny metal traded over $900 for a short time on Friday… I do see the Gold futures on the internet, and they are showing Gold will be over $900 today…

Pound sterling has bounced off its lows from last week, after Barclays announced they did NOT need Capital from the Government… This is the first “good” news from the U.K. in weeks, but I suspect it won’t last too long, as this is just one Bank… There are plenty others in the U.K. that won’t be able to make a statement like that!

And speaking of Banks… I see where BNP Paribas posted a huge loss in the 4th QTR on their investment banking woes… So, it’s not just U.S. , and U.K. Investment Banks with losses… The key here is “investment” banks… The ones that got deep into the subprime bonds, credit default swaps, and didn’t manage the “risks” correctly… Any way, this news from BNP Paribas is probably weighing heavily on the euro this morning, and one of the reasons the single unit has given up it’s gains from Friday…

So… As I said above, the Trading Theme for the dollar is in place, which means… The euro gets sold along with the other alternative euro currencies like Norway, Sweden, Denmark, and Switzerland… But the High yielders, like Aussie, kiwi, Brazil, and South Africa, really take shots to the chin… On the other side of the coin, the Japanese yen rallies like there’s no tomorrow…

The U.S. data cupboard is chock-full-o-data this week, and the Fed’s FOMC meets tomorrow, but won’t announce their rate decision until Wednesday. I’ve always wondered just what these Fed Heads do during these two-day meetings… I’ve always contended that they most likely played board games… Or Battleship! I can hear Kohn, telling, Bernanke, “Ben, by Joe, you’ve sunk my battleship!” (if you do it in an English accent it’s funny)…

We begin the week with Existing Home Sales and Leading Indicators… I keep saying over and over again that if the markets had 1. read the Pfennig… Or more likely 2. paid attention to the Leading Indicators they would have not been blind sided by this recession! Leading Indicators have told us for months now that things were not going to be all seashells and balloons for the economy… And voila! Well… I think Leading Indicators will continue to tell us there are more problems ahead, as they are forecast to be negative -.3%… And Existing Home Sales? The rot on that vine has been exposed for over a year 1/2 now…

Tomorrow we get the Case-Shiller Home Price Index, and Consumer Confidence… Wednesday, we’ll get the Fed’s rate decision, which I told you last week, to forget about any more rate cuts, they are so close to zero, they are at zero… Thursday brings us the Weekly Initial Jobless Claims, which last week, got very close to 600K, Durable Goods Orders, and New Home Sales… And then finally on Friday, we get 4th QTR GDP… Which I told you, and a Huge crowd at the Wealth Masters Conference in November, that 4th QTR GDP would be a negative -5.0%…

Well, it looks as though it probably will be an even greater negative than I forecast back then…

OK… Let me give you a bit of a lesson on what’s happening with the economy and this recession… You see… Every other time in the modern era that the U.S. economy has contracted more than 5% in a quarter, falling inventories have been a major reason, if not the single biggest factor. Unfortunately, the really bad recessions, like this one is going to turn out to be, get worse by the Companies getting rid of all their inventory, you know, stuff that isn’t selling! Then… Once the inventories are sold off, the economy can grow quickly again, but at the cost of inflation, as the Companies sold off their stuff, and now there’s demand for it again.

But so far in this recession, falling inventories haven’t been the problem. Of course you have to forget about housing here… NO, this recession is a direct result of the Credit Crisis that was first exposed in August of 2007… Which, I’m afraid, doesn’t bode well for a turn around in the recession, that a lot of economists are calling for in the 1st QTR of this year… The recession is deep rooted, and will be protracted until someone figures out how to get this credit crisis unlocked!

I’m still holding out hope that by summer, we see an unlocked Credit market… Then it would take a couple of months before the economy could get some “legs”… Then… We could see this spiral of demand again, and inflation rising, like in previous recoveries from recessions… And this is why I believe that in the 2nd half of 2009, we’ll see a return to the fundamentals, and all this awful debt creation that was done to “stop” the correction, will be on display again, and a dollar sell off, along with U.S. Treasuries should be in store…

But, if the Chinese jump the gun, and begin selling ahead of that time, then the dollar sell off could obviously move forward on the calendar!

I think what the markets are looking for these days, and especially after the NIKKEI story on Friday, is some sort of hedge against Treasuries… All that safe haven buying, that I’ve been talking about for months now, has created what I call the last balloon / bubble in this cycle…

And then finally before we head to the Big Finish… There’s this… A story that Ty found the other day, and sent to me… When I went to read it, I saw that the writer is a young man, that used to swim against and play water polo against my oldest son, Andrew! The lad’s name is Jamie Saettele, and he’s now the Senior Currency Stategist for DailyFX.com…

Jamie is a stategist, so he works with charts… And he believes that the euro is forming a base for a Large Rally… He points out that each time the euro rallies, and then drops, the drop is less than the previous drop… You may recall that I pointed this type of information on Gold a couple of weeks ago, and said that it looked like it would rebound to $900, and voila! Here it is… So… Let’s see if the charts work for the euro, the same way, eh?

Currencies today 1/26/09: A$ .6570, kiwi .5290, C$ .8190, euro 1.2970, sterling 1.3870, Swiss .8625, rand 10.1820, krone 6.8750, SEK 8.1750, forint 222, zloty 3.3815, koruna 21.5920, yen
89.30, sing 1.4980, HKD 7.7580, INR 48.90, China 6.8465, pesos 13.93, BRL 2.3140, dollar index 85.69, Oil $45.90, Silver $12, and Gold… $898.30

Source: Chock-Full-O-Data Week!

As a result, gold has started to shine again as a stable source of value at a time when the dollar and other commodities – like oil and copper – have fallen hard. The spot price of gold has climbed above $870 an ounce on the New York Mercantile Exchange, up about 20% from its October lows.

Gold has been on roller coaster ride in 2008, moving from its all time high of $1035 in March, to as low as $681 an ounce. Some of that decline occurred during the recent stock market plunge. Many investors were forced to liquidate profitable gold positions in order to raise money to cover their paper losses.

Its decline was then accelerated by the recent onslaught of financial bailouts, as many investors held a preference for liquidity and safety in the form of cash holdings guaranteed by the U.S. government.  That was reflected in the skyrocketing prices of government bonds and investments in government-backed banks, which also lowered yields.

But with the Fed’s recent decision to cut its target interest rate to a range of 0% to 0.25%, the dollar has suffered a significant decline. Suddenly, foreign investors who were scooping up dollars have cut back on their flight to safety, knocking the dollar index (NYBOT: DX) down 10% in the last month.  The index reflects the dollar’s value against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc.

The Fed’s interest rate cut may also have given gold a comparative boost in the eyes of investors. Gold, which never pays interest, suddenly doesn’t look so bad when compared to T-bills, which also are paying zero interest lately.

Volatility has risen this year compared to previous years, and the last few months have been the most volatile of all – an indication of investor ambivalence. But any uncertainty about the increasing price of gold may have been waylaid by the Fed’s recent rate cut and its dampening effect on the dollar and Treasuries.

Consequently, don’t expect this rally to be short-lived. As we pointed out in our 2009 Outlook Report on Gold, the fundamentals in the market hold the promise of more gains ahead.

It appears unlikely central bankers around the world will stop stimulating economies, printing money and doing whatever it takes until growth and confidence are restored – even if the cost is rampant inflation.

Consider these wild card inflation indicators that Money Morning Contributing Editor Martin Hutchinson believes will carry gold prices to $1,500 an ounce by the end of 2009:

• Over $7 trillion of freshly minted U.S. dollars are now in circulation with the aim of saving the global financial system.
• The incoming Obama administration has promised another $1 trillion or so stimulus package is on the way.
• It’s likely the Fed’s interest rate cuts will soon be followed by central banks around the world.

These economic stimuli are designed to do one thing – get the consumer spending again.

The bailout of the banks was the first step, but the banks are still keeping a tight rein on credit. Now the government is trying to get easily available, cheap money back into the hands of the consumer by running the printing presses around the clock.

“The government is pumping money in so many banks, and that money has to come out somewhere,” said Hutchinson.

Some of that money will “come out” into the economy in the form of higher stock prices. That will make consumers wealthier, and could give them more confidence in the economy. More confidence means more spending. As that happens, prices for goods should begin ticking upward, giving another booster shot to gold prices.

For instance some of that money is already going into gold bars and coins. In fact, the U.S. Mint was forced to suspend sales of the popular American Eagle and Buffalo gold coins for extended periods twice in the last year. The mint was unable to secure enough gold blanks from suppliers to match demand.

“I’ve never seen a case where demand was so high and supply was so short,” Chicago coin dealer Harlan Berk told the Associated Press.

With massive amounts of capital floating around, the time it takes to re-inflate the global economy will be far shorter than most analysts expect. Governments fear deflation more than anything.  It appears they will only fight inflation when they are assured they have won the first battle, which is growth at any cost.

When inflation kicks in, the dollar’s buying power will suffer long-term.  In fact, we expect a decline in all the world’s paper money, over time.  Historically, investors in gold have prospered during periods of weakening fiat currencies.

That leaves gold as a bright light in the investment world, making it an odds-on favorite to open a new leg of a long-term uptrend

Gold Bugs Have Fed to Thank for Recent Rally

With everything in the world of finance, people get scared. Last month, gold broke the $1,000 threshold and silver broke the $20 one. So of course, weak investors got anxious. They pulled back and sold off some of those gains.

As I write, it would cost you $880 for an ounce of the yellow stuff, while silver is going for $16.90 per ounce. That’s 20% cheaper than it was a few weeks ago. Great. But, why should you care?

Money…and lots of it…

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First, let’s take a look at the last gold rally, back in the late 1970s.

As you can see in the chart below, gold underwent an eerily similar correction at the end of 1978. It lasted exactly one month before it righted itself again.

Does This Correction Look Familiar?

On October 30, 1979, the spot price for gold was $242.75. Exactly 31 days later, it had shed $50. That’s a hair over 20% off its high.

See the similarities?

So, the next question you may be asking is: “What happened after the last time this happened?” Oh, just the largest bull market we’ve ever seen in the precious metals world.

In 1979, and then again in the first month of 1980, gold went from this puny little sub-$200 metal to an $850 investment. It ended up being a 340% jump from the bottom of the correction to the top in January 1980. That’s nearly four and a half times your money in 14 months!

Now, I’m not saying we are bound to repeat that this time around. But, others are:

“Market ructions, the sub-prime conflagration and a collapse of the dollar could send gold prices to more than $3,400 an ounce within the next three years.”

— Dr. Clive Roffey
Publisher, Gold Action

“If 1979 to 1980 is anything to go by, [gold] could exceed several thousand dollars per ounce.”

— Bloomberg

…And my favorite:

“Gold and silver are now early in a historic bull market that will dwarf the 500-1700% profits we made in the ‘70s. Gold will hit at least $2,172 and $100 silver is inevitable.”

— Marketwatch

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Honestly, it doesn’t make a bit of a difference if you believe any of them. At current levels there are already some huge profits to be made.

We’ve written to you about the potential juniors have right now. I’m not going to bore you with any more. If you want to, you can check it out right here.

As for what you should do now…the precious metals world is on a silver platter. (No pun intended.) Take what you like.

We will continue to let you know when the best ones come along. This is something worth following for quite some time.

Sincerely,
Jim Nelson

P.S.: If this is something you’d like to get into, Greg Guenthner and I have the perfect way for you to do it. We currently have the absolute best silver play we’ve ever seen. It is still at rock-bottom prices. To get in on it, take a gander at this report…

However I have a much different and technically far more accurate interpretation of the parable. After eating a bowl of porridge which was neither too hot nor too cold, the little clueless blonde is ultimately chased out of the house by three angry bears. Wall Street bulls will be similarly dispatched. However, upon further reflection I believe that the “Goldilocks” scenario is apt in a way that none of its adherents realize. Wall Street might actually have it half right for a change. In this case it’s the first half, “gold.”

Thus far in 2007, as all eyes have been fixed on oil’s sharp decline, few have noticed the resilience of gold. Since January 1, while oil is off by about 13% and the Dollar Index is up close to 2%, the price of gold has held steady. In fact the gold market has sold off several times in recent months, but held the line at $600 on each occasion. But while gold itself has shown strength, gold mining stocks are off about 7% thus far this year, as traders continue to discount a price decline that has yet to materialize.

To me, this action is indicative of some serious physical buying. For now the growing demand is being satisfied by nervous longs exiting the market and speculative shorts betting on a decline. However, a market that refuses to break will eventually turn and head higher. When that happens, a spectacular gold rally will likely ensue. Those who sold prematurely will rush to re-establish their long positions and those who sold short will rush to cover. With few sellers left to take the other side of the trades, the price of gold will spike higher.

On the fundamental side, gold’s outlook continues to brighten. Bond prices continue to fall, with the yield on the 10 year now up 40 basis points from its December low. Despite Wall Street’s positive spin that rates are rising based on evidence of an improving economy, the gold market indicates something far more troublesome. My hunch is that this bond sell-off will gather momentum, with ten year yields exceeding 5.5% by spring.

A continued rise in yields will dampen the hoped for springtime demand for new homes (typically the busiest home buying season) that many are hoping will help the housing market turn around. Rather than a flood of new buyers, I expect a deluge of sellers. If anyone thinks the supply of unsold homes is high now just wait until the fall. With today’s inflated prices, the process of waiting for a qualified homebuyer is becoming the real world equivalent of waiting for Godot.

As if higher interest rates weren’t bad enough, the recent re-emergence of traditional mortgage lending standards indicates that a return to traditional real estate prices may not be too far off. Of course that is a huge problem as traditional prices, which are underpinned by incomes, the ability to offer down-payments, or rental returns, are far below current levels.

During the recent real estate mania lenders assumed that down payments, fully amortized loans, documentation of income, and various ratios that traditionally measure affordability, no longer applied. Lenders became convinced that this was a new era where their sophistication and skill at assessing and managing risk meant that virtually anyone could borrow any amount. The reality of course was that it was not smart lenders, but a speculative bubble that saved the day. As home prices kept rising borrowers could re-finance or sell their way out of any problem. However, as real estate prices fall and homes become harder to sell, defaults are on the rise.

In a misguided attempt to prop up the housing market, the Fed will reluctantly cut interested rates. However, this will actually have the opposite effect on the housing market. The dollar will plunge sending long-term interest rates higher, exacerbating the recession, and making housing even less affordable. In the end Bernanke will feel he has no choice other than to rev up his helicopter engines. The recent strength in gold suggests that those engines might already be warming up.

Source: Don’t Forget the ‘Gold’ in ‘Goldilocks’