We all know it is going to happen, so why bother discussing it. Right?

There is no doubt the world’s currency of choice has more pressure stacked against it than ever before. But even with $12 trillion in debt and nearly a trillion of annual interest payments due within the next decade, the greenback is still stronger than it was just sixteen months ago.

While so many of us are betting against the dollar and calling for its demise, plenty more investors are using it as a security net, buying American treasuries to protect themselves in case the bottom really falls out.

With the sun someday going to fade, I could sit in my basement and wait for the big day to come, or I could live my life without worry.

It’s the same thing with the dollar. We could bet against the greenback and profit as it drops, or we could forget about the minimal return potential and keep our eyes looking forward, where the real money is at.

No more Chicken Little

Here’s the scoop. The dollar is likely to fade, at most, six percent below today’s value against the Euro. That’s major erosion for such a massively distributed currency, but six percent over a few years doesn’t stack up to a hill of beans in the grand scheme of things.

I can list a couple of dozen stocks that are up by twice that figure today alone.

No doubt, you should pay attention to the dollar, as a six-percent decay in the value of the world’s most important currency will change all sorts of valuations. But don’t invest in the cause, invest in the effect.

The devaluing of the dollar is no surprise. Even a fifth grader can see what’s ahead over the next decade. That’s why there is so little investment potential directly in the currency. Yet, our stubbornness and human greed will not let our eyes focus on anything but taking advantage of the move.

Let that stuff up to the emotional investors.

While they are focusing on gold and the dollar, investments that will provide double-digit returns at best over the next few years, rational investors need to focus on the many other powerful market forces are at work.

The domestic equities market is a wonderful place to be right now, especially if the dollar is collapsing as fast as we believe it to be.

First, anybody exporting goods will see strong top-line growth as the dollar drops. A six percent fall from our currency equals an automatic six percent surge in revenue growth, without the need for any company to do a thing.

Next, if you are a follower of the green-energy craze, you had better be hoping for a weak dollar. The only thing that will ever wean this country from its dangerous addiction to oil is if crude becomes too expensive relative to our alternatives.

With a dollar that is still in demand across the world, dollar-denominated currencies like crude remain fairly inexpensive. But as Uncle Sam’s reserves dwindle in value, crude prices will move inversely. That is good news for all you folks that took Obama’s advice and invested in the “green” sector.

Finally, the markets run on a risk/reward relationship. The higher the risk, the higher the reward. The lower the risk, the lower the reward. Simple stuff.

If we all know the dollar should weaken, where’s the reward potential? But don’t even begin to think there is no risk in the play.

With Washington in charge, especially the current group of legislators, anything is bound to happen. And now that Obama has is political eye set on “saving the dollar,” the road that lies ahead could be very foggy.

My advice? Watch the dollar. Take note of its moves. But invest in anything but the currency. There is better return potential, with much less risk, elsewhere.

The distortions from reality are mind-boggling, yet all of us depend on the status of the simple fiat for our financial wellbeing.

The person with the most skin in the dollar game is, no doubt, President Obama. The nation’s economy hinges on the fate of the greenback and the White House knows it. That is why it is doing anything it can to slow the slide.

Even if it is entirely psychological.

Today, reports are flowing from Washington that show Obama may have plans to use up to $210 billion in TARP money to lower the nation’s ever-increasing deficit.

It is creative accounting at best and a $210 billion bribe at worst.

While the average Oprah-watching, Crocs-wearing American won’t take a second out of their do-nothing day to read below the feel-good headline, there is a handful of us that are actually paying attention.

With this idea of “paying down our debts,” it is vital to remember the Treasury didn’t pull the $700 billion in TARP funds out of some cavernous account.

We borrowed that cash. And now Obama wants to use the borrowed money to pay back our debts, minus a year’s worth of interest of course. It’s like taking out a loan to pay off your mortgage.

The timing of these rumors is more than suspicious.

Just yesterday, China slapped the currency markets in the rear by once again raising the notion of dumping the dollar and making a sudden change in its exchange-rate policy.

Ironically enough, less than 24 hours later, Obama has a $210 billion check in his hand ready to “repay” our debt.

It is money from one hand, around the back, and into the other.

But it gets better.

Obama is not the only one trying to mask Uncle Sam’s debt problems. Just about every exporting country in the world is desperate to keep the dollar strong.

They have to. Their economies depend on it.

Rumor has it countries like Russia and South Korea have been buying dollars on the open market over the past few weeks, in an effort to keep the greenback’s slide from gaining even more momentum.

The governments would rather risk devaluing their reserves than allow their economies to suffer from the effects of a weak dollar.

Looking forward, the question is how long can the manipulation last? How long can the dollar remain artificially inflated? And how long until the markets naturally take care of the situation?

While we may not know the exact answer to any of those questions, it does not take an economics scholar to realize the outcome will be horrific, at least for those of us with dollars in our pockets.

*** The solution? Buy gold. According to the top dog at Canada’s behemoth gold miner, Barrick, we have every reason to believe we surpassed “peak gold.”

That means all the easy gold has already been stripped from the ground and supplies are only going to shrink from here.

According to the CEO, Aaron Regent, global gold production peaked in 2000 and is expected to continue declining into the foreseeable future. So far, mine production is down by nearly 10%.

The news of increasing supply constraints comes at a time when demand is already surging. For those of you that were under the bleachers during Econ 101, it means prices will continue to rise.

There has been a lot of discussion about a sudden collapse in gold prices as many investors believe the current boom is merely a fear-induced bubble. Two or three months ago, I would have bought the story. But not now.

The dollar is simply too weak and foreign reserves are accumulating gold too quickly for prices to fall sharply.

China’s immense buying alone is enough to limit near-term fallout. The country has already doubled its gold reserves and Beijing continues to be a major buyer.

Just one more reason for bulls to send prices higher.

*** Just so you can’t say I don’t let you in on anything for free, I’m going to toss a freebie your way.

With gold prices reaching into record territory, it is a perfect week for Van Eck to release its Market Vectors Junior Gold Miners ETF (NYSE:GDXJ). The freshly created fund gives investors a stake in 38 small- to mid-sized gold miners.

For investors looking for a simple way to take advantage of the gold bull with some additional leverage, this is the ETF to do it.

Thanks to the speculative nature of junior miners, expect shares to beat the market when gold prices are surging and underperform when the bears return. For now, there is plenty of upside potential.

The Dow rose 155 points on Friday. And today, stocks are rising in Asia. Oil is over $74. Gold rose $13 on Friday… to close at $954. And the dollar is killing us softly… sinking to $1.43 per euro on Friday.

Stocks and oil are at their highest levels so far this year. With such profits at hand people figure they don’t need the dollar. Investors run to the safety of the greenback when financial storms approach. But now… they think it will be clear sailing.

“Worlds bankers suggest rebound may be under way,” says a headline at the New York Times.

Is the world economy really recovering? Should you buy stocks now to take advantage of this new bull market?

You already know the answer, don’t you, dear reader.

After a fall comes a bounce. And along with the bounce come a lot of silly ideas. You see how it works? “Markets make opinions,” say the old timers on Wall Street. When stocks are going up investors find reasons why they are going up. Pretty soon, they’ve convinced themselves that they’ll go up forever.

But bounces do not last forever. They aren’t giant turtles… they’re moths. After a few months of flitting around bright lights, they dry up. When exactly this summer of winged love will end, we don’t know. September or October is our guess. But we have little doubt it will come to an end soon.

Ultimately, stock prices depend on earnings. People compare the rate of return they can get from stocks to what they can get from other investments. Rising earnings signal higher rates of return, so investors pay more.

During the great credit expansion of 1945-2007, businesses could anticipate, generally, rising earnings. People were buying more and more things on credit. In a national economy, businesses pay wages and then the employees use the wages to buy products. The wages are a ‘cost’ to the business… but they are also the source of business revenue. When sales come from credit, on the other hand, businesses have the revenue but no wage cost. Profits go up.

Now, the cycle has turned. Businesses still have the wage cost. But instead of using the money to buy things, the employee uses it to repay loans for purchases made last year or the year before. Now the business has the cost but not the revenue.

As they say in the economic textbooks: bummer.

The process of de-leveraging will be slow. Maybe 5 years. Maybe 15. Maybe 25. It will up and down… with high unemployment (businesses will cut their wage costs as sales fail to recover)… low prices (at least in real terms)… low profits… and slow growth, or none at all.

Is that bad? No, not at all. It’s good. Economies need to adjust to the new realities of the post-credit bubble world. It will take time. And with the world’s financial authorities fighting it every step of the way… it could take a LONG time. As we’ve explained in these Daily Reckonings, government is a profoundly conservative, parasite-protecting enterprise. It cannot draw forth the future – it has no idea what the future will be. Instead, all it can do is to try to recover the past. That’s the idea of the ‘recovery’… to try to coddle, protect and pay-off yesterday’s success stories. From Wall Street to welfare… governments attempt to prevent correction.

And more thoughts:

*** The Obama administration announced that it expects $9 trillion in deficits over the next 10 years. One of the great mysteries of our time is: where will the money come from? As we pointed out last week, even if every dollar of US savings is applied to the task, the feds will still be short. And if they make up the difference with funny money – from their quantitative easing scam – the Chinese vigilantes are likely to get cheesed off and dump their US Treasury bonds.

The evidence shows that the Chinese…and other Asians…are already trying to lighten up on their US debt holdings. This from the New York Times:

“Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.

Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month’s data. In May, China increased its holdings by $38 billion, according to the Treasury figures.

“Nonetheless, the decline highlighted a fact… Asia’s appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits… In the first half of 2009, China and Hong Kong acquired only 9 percent of the more than $800 billion worth of Treasuries that were sold.

“ Japan, which was replaced by China as the largest foreign holder of Treasuries last year, has been a larger buyer this year, taking up 11 percent of the new supply of Treasuries.

“Ownership of US Treasuries by China, Hong Kong, Japan, South Korea, Singapore, Taiwan and Thailand — since 1994 — rose to 25 percent, from less than 8 percent. Since then, as budget deficits in the United States grew, the share has fluctuated within a narrow range. In June, it was 24.7 percent.”

If Asians don’t finance US debts, who will? We don’t know… But the fewer bonds Asians buy… the more they are bought with funny money by the Fed. And the more the Fed buys with funny money the fewer Asians want to buy with real money.

How will this end? Badly…we keep saying. There is no way out. Either the feds cease spending more than they can raise honestly, by taxation and reasonable borrowing. Or, the system runs into chronic, mega deficits…like the chronic deficits in the private sector during the bubble years. Then, it blows up.

That is why we caution readers against the dollar and against Treasuries. Most likely, they will both go up this autumn…as investors flee to safety from the next market downturn. But the chances of them blowing up completely are too great. That’s why we stick with gold – even though we would not at all be surprised by a period of weakness in the gold market.

*** On Friday night, we went to a ‘dinner in white’ at a nearby chateau. It was a jolly affair, at an ancient chateau entirely surrounded by a moat.

We set up our table, alongside the others. We gathered for drinks. We saw old friends. And then we prepared for dinner.

Why “white?” The dinner marks the occasion of the Assumption of the Virgin. It’s held each year in this rural area of France. Everyone brings a full dinner service – table, chairs, candles, etc. etc. Then, after setting up outside, under the stars… there’s a twist. Couples switch around so that your editor ends up having dinner with a woman to whom he is not married.

Having dinner with someone else’s wife can be a delight. At least, you have nothing to argue about. But how much of a delight it is depends entirely – or perhaps mostly – on chance.

In our case, we were trebly lucky. In front of us was a charming woman who turned out to be a relative of many people we already knew. So we kept up a lively conversation about cousins, uncles, aunts… family tragedies… and upcoming marriages. On our right, was a cute woman with a bright smile and a friendly manner. On our left, was another charming woman with a shrewd, fast wit.

Time passed quickly. We crossed swords with the woman on our left – over education policies. We chatted with the woman in front of us – about family, the weather, local trends, food and whatever. We flirted with the woman on our right:

“Do you come to these dinners often,” we asked.

“About as often as you do,” came the reply, “once a year.”

“Well, the dinners suit you. You look very nice in white.”

“Thanks… but I really don’t have any choice. It’s a ‘dinner in white,’ after all. If I had a choice, I’d wear black.”

“Why… because you have a black, cruel heart? Or is it because you are in a sad mood? I hope not. And if so, perhaps I can cheer you up by telling you joke. How many Belgians does it take to change a lightbulb?”

“I’ve heard that one.”

“Then why does the guy from Belgium go to sleep with one full glass of water next to his bed and one empty glass?”

“I don’t know… why?”

“Because he never knows if he’ll be thirsty or not when he wakes up in the night.”

“Oh…”

Source: The Future Will Come

Solid U.S. and euro zone data and an upbeat assessment on the economy from Federal Reserve Chairman Ben Bernanke over the weekend earlier pushed investors to take on riskier investments at the expense of the the low-yielding yen and dollar.

“Conventional wisdom suggests that major currencies should trade within their recent ranges until liquidity improves after the Labor Day holiday,” said Wells Fargo currency strategist Vassili Serebriakov. “However, there is plenty of data in the U.S. and elsewhere to change that this week, with consumer-related numbers likely to be watched closely.”

Investors are looking ahead to upcoming U.S. and European data to confirm hopes that the world economy is improving.

The dollar was last up 0.1 percent at 94.49 yen while the euro slipped 0.1 percent to $1.4304 . Against the yen, the euro was unchanged at 135.20 yen .

The euro trimmed losses against the greenback after data showing much higher-than-expected euro zone industrial orders in June.

Sterling fell 0.6 percent on the day at $1.6405 .

The euro , meanwhile, hit an 11-week high against sterling at 87.27 pence, according to Reuters data.

Traders said the euro was pushed past a key options barrier at 87 pence, setting up further gains in the pair, while analysts said expectations for persistently low UK interest rates were weighing on the British currency.

The Federal Reserve’s Jackson Hole meeting over the weekend offered a variety of opinions about the global economy, with Fed Chairman Ben Bernanke acting as the cheerleader for growth.

But traders are keen to see how the euro zone economy fares, especially after higher-than-forecast purchasing managers’ index readings last week. Germany’s Ifo survey of business sentiment will be key this week, analysts said.

The U.S. Conference Board will release its August consumer confidence index on Tuesday, followed by the Reuters/University of Michigan consumer sentiment snapshot on Friday.

Nouriel Roubini, professor at New York University’s Stern School of Business and one of the few economists who accurately predicted the magnitude of the current crisis, wrote in The Financial Times on Monday that there’s still a “big risk” of a double-dip recession.

Allan Meltzer, a political economy professor at Carnegie Mellon University, also told Reuters that the flood of money the Fed and Treasury have injected into the banking sector and economy since the crisis began will soon threaten the dollar.

“Will the Chinese continue to buy the trillions of dollars worth of debt that the Treasury intends to put out every year? We don’t know, but if not, the pressure will be on the Fed to keep buying it, and my guess is that’s going to be inflationary over the next couple of years, and the dollar will suffer,” he said.

Aug 24 (Reuters)

The buck fell to its lowest level vs. the euro since December, as the flight to the greenback continues to wane.

“We’ve turned to a more dollar-bearish environment,” said Nic Pifer, of RiverSource Investments. “As markets start to loosen up again and risk appetite comes back into vogue — in high-yield debt, emerging markets and equities — that safe-haven demand for the dollar has dissipated.”

The dollar may be stuck between a rock and a hard place. “In the near term, the stars are aligned against the U.S. dollar,” wrote foreign exchange strategists at Brown Brothers Harriman.

“If the news stream is good,” they wrote, “we are told investors are less risk averse and do not need the dollar’s security. If the news stream is poor, we are told the U.S. is in horrific shape and the budget deficit and Fed’s balance sheet will swell even more … It is difficult to see what will break this psychology in the coming weeks.”

Some analysts have expressed concern that the U.S. might not maintain its AAA credit rating, after the U.K.’s top-tier rating was given a negative outlook by Standard & Poor’s on Thursday.

However, “I don’t think institutional investors are all that concerned over what S&P may do in the future,” said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union.

“We would have to see a continuing onslaught of real deterioration in the U.S. financial situation for its rating to come under threat,” Sullivan added. “The dollar’s issues are mostly related to quantitative easing and how inflationary that might be. Also, risk aversion has lessened considerably” recently.

Source: Dollar in Freefall Against Euro

So… The euro reached a new record high overnight of 1.6038! WOW! This was reached based on the fears that credit problems in the U.S. are going to put the kyboshes on what little economic growth we now have. But the shine on the euro was rubbed out by a very weak ZEW… German Investor Confidence as measured by the think tank, ZEW, fell to a record low this month on the surging inflation problems, and rising interest rates. So for now, the euro is back below 1.60, but hear me now and listen to me later… This ZEW will soon be in the rear view mirror, and the euro won’t have that albatross around its neck as it revisits its overnight high…

And don’t look now, but the Aussie dollar is up to 98-cents! WOW! I’ve said for about 8 months that I wouldn’t be surprised to see the A$ at parity to the green/peachback… It certainly has that parity look about it does it not? The last time the A$ was 98-cents was 1983… 25-years ago… 1/4 of a century, and all that!

The U.K. pound sterling is back to $2, which seems totally unlikely an event as possible, but it has happened, so, go on and crow if you thought I was wrong to say the pound was going to have problems once the Bank of England (BOE) started its rate cut cycle…

And the Canadian dollar / loonie has crept back to parity! It’s been a long, time coming… It’s going to be a long, time gone… (a little CSNY)…

And, the poor, downtrodden, Japanese yen, is at the bottom of the 105 handle, and looking like it wants to trade with a 104 next to it! I had to laugh at a story I saw flash across the screen… The title was… “Yen may gain as Bank of Japan (BOJ) is more likely to raise rates than the Fed”. Now that’s funny! Ok, stay with me on this… A month ago, the dollar was getting bought like Pet Rocks because Fed Chairman, Big Ben Bernanke hinted that he was going to be an inflation fighter, thus interest rates would go higher… But here we are a month later, there’s been no sign of Big Ben the inflation fighter, and now it’s deemed that the BOJ could raise rates before the Fed!

And the dollar bulls wonder why their currency is getting sold like funnel cakes at a state fair? Why don’t the dollar bulls give Big Ben a call on the telly, and see if he can’t help them out? Oh… That’s right, Big Ben doesn’t take calls from just anyone… According to our friend, Jim Rogers, on his Bloomberg TV interview yesterday morning… “Ben Bernanke and Paulson only take calls from their Wall Street Buddies”… HA!

Speaking of Jim Rogers… He was full of you know what and vinegar yesterday morning… He didn’t pull any punches and said what was on his mind… You should have seen me here at the trading desk, Jim Rogers would say something, and I would clap and hoot and holler! At one point, Rogers said that the Gov’t’s plan to rescue Freddie and Fannie was “an unmitigated disaster”…

So… Remember early in the year when I kept telling you that there would be another “risk event” this year, and then we had the Bear Stearns meltdown, but that wasn’t it for the “risk events” , and I kept harping that there would be more? Well… It’s not like I was wishing, and hoping and thinkin’ and praying for these things to happen… I was simply pointing out that the world today has too many “risk events” all over, and with the credit woes in the U.S. and the housing and mortgage meltdowns, I just figure it would touch here a few times.

Anyway… What I’m trying to get at here is simply that these are the things I kept telling people to protect themselves from by diversifying into currencies and precious metals… I also, recall, the wink, wink, I gave you when Gold was trading below $900 about a month ago… Today, Gold is $983!

OK, enough with all the “I told you so” talk! Let’s talk about today… Well, today has “risk” written all over it! Big Ben goes to the “hill” to talk to lawmakers about the economy and Fed direction… You have to think that before the Meltdown last week of Freddie and Fannie (see more talk about them, I just can’t leave them on the side of the road!), that Big Ben would go to the “hill” and talk the inflation fighter talk… But now… Not now… Not with the financial sector in meltdown mode… So this is a double-edged sword… If he doesn’t go and sound hawkish, then the markets will take that as no rate hike is coming and take the dollar to the woodshed again… (you would think by now that the dollar would have gotten used to these beatings!)

Besides Big Ben, we get a ton-o-data today… PPI for June… Retail Sales for June… And Business Inventories for May… Retail Sales is the Big Kahuna of data today… And I would think that given the tax rebate checks that were still being mailed in June, Retail Sales would remain somewhat robust… Wait till July’s number, I saw all the shopping bags from my beautiful bride’s trip to Chicago this morning! But that’s for next month! For now, PPI poses a treat to future Consumer inflation, so this one plays big too…

If any of this stuff comes in worse than expected, we could see the dollar not only get taken to the woodshed, but told to go pick the switch that it will get beaten with.

Source: Credit Woes Sink The Dollar!

For the day, July crude oil soared $10.75, or 8.4%, to close at an all-time high of $138.54. For the week, the contract climbed 8.8% on the NYMEX.

The still-weak greenback today fell more than 1% to $1.5674 per in late-afternoon trading – its lowest point since May 28 – after employment data from the U.S. government detailed a bigger-than-expected 0.5% decline in non-farm payrolls.

U.S. stocks were pounded. The Dow Jones Industrial Average plunged 394.64 points – or 3.13% – to close at 12,209.81. The tech-laden Nasdaq Composite Index skidded 75.38 points, or 2.96%, to end the day at 2,474.56. And the broader Standard & Poor’s 500 Index plummeted 43.37 points, or 3.09%, to finish the week at 1,360.68.

Troubling Trends

The U.S. payroll numbers really spooked investors. The unemployment rate jumped to a higher-than-expected 5.5% in May, up from 5% in April, as employers put 49,000 Americans out of work.

Employers have now cut payrolls for five straight months, leaving the jobless rate at its highest level since October 2004. The 0.5% rise was biggest monthly jump since 1986. The total number of unemployed has reached about 8.5 million people, up from 6.9 million a year ago when the unemployment rate was 4.5%, the Bureau of Labor Statistics reported.

The unemployment rate is expected to reach at least 6% by early next year.

The dollar’s decline Friday followed an equally dramatic tumble Thursday, when the greenback fell 1% on news that the European Central Bank (ECB) hinted at an increase in the European Union’s main financing rate.

“It is not excluded that, after having carefully examined the situation, that we could decide to move our rates a small amount in our next meeting in order to secure the solid anchoring of inflation expectations,” ECB President Jean-Claude Trichet said at a news conference.

The ECB has remained hawkish on inflation, holding its key lending rate steady, even as the U.S. Federal Reserve cut its benchmark Federal Funds rate seven times in a desperate bid to revive the U.S. financial-services sector while also averting a recession.

Between Sept. 4 and April 22, the dollar plummeted 14% against its European counterpart as a result of the divergence, and the $1.6019 it reached on April 22 was an all-time low.

The Greenback “Head Fake”

After reaching that nadir, the greenback posted a slight 3% rebound, hitting a five-week high on May 2 after Fed Chairman Ben S. Bernanke signaled a pause in the U.S. central bank’s rate reductions.

In a May 8 financial commentary, however, Money Morning Investment Director Keith Fitz-Gerald warned investors that the dollar rally was “a head fake of legendary proportions.”

Recent events have derailed the greenback’s rally – and validated Fitz-Gerald’s warning.

Friday’s employment figures compounded the negative effect of Trichet’s comments by fueling speculation that the U.S. Federal Reserve would be unable to reverse course and start raising rates as most analysts have been predicting without pulling the rug out from under the U.S. economy. Should the ECB raise its rate in July, the results could be devastating for the dollar, which could slip into an out-of-control spiral.

“The big shock was the rise in the unemployment number,” Samarjit Shankar, a foreign exchange analyst at The Bank of New York Mellon (BK), told Bloomberg. “It damps the outlook for a tightening in U.S. rates and strengthens the case for $1.60 [against the euro].”

Oil and Gold Soar

Commodities, priced in dollars, soared on the greenback’s freshly exposed vulnerability.

“Many investors used the latest sell-off in the dollar as an excise to get back into the [oil] market,” Andrey Kryuchenkov, an analyst at Sucden (U.K.) Ltd. told Bloomberg. “Concerns that demand is flattening in the near term have been overshadowed by persistent inflationary worries.”

Crude oil for July delivery jumped $5.49 a barrel, or 4.5%, Thursday before extending its gain to a record high above $137 Friday.

Money Morning’s Fitz-Gerald – one of the first investment gurus to predict triple-digit oil prices – recently boosted his target price for crude oil from the $187 level he projected back in December to a new level of $225 a barrel.

Gold climbed 2.7%, returning to the $900 an ounce mark as the dollar stumbled.

“Gold rallied in line with moves down in the dollar.” David Thurtell, analyst at BNP Paribas SA (OTC: BNPQY) told Reuters. “The worry is if unemployment is climbing, then mortgage defaults and subprime losses rise.”

Money Morning today (Friday) published a research report reiterating its earlier prediction that gold prices could reach $1,500 – or even $2,000 – an ounce, thanks to the powerful global trends that are forcing many commodity prices to new record highs.

Gold is traditionally used as a hedge against financial uncertainty. It also makes commodities priced in the U.S. currency cheaper for holders of other currencies.

Source: Oil ‘Bulls’ its Way Above $139 on its Way to a New Record as the U.S. Dollar Resumes its Descent

But don’t despair. Because a trend that has long been talked about – economic decoupling – is finally starting to manifest itself as other world economies, particularly the so-called “BRIC” markets of Brazil, Russia, China and India, have continued to grow even as the U.S. economy has slowed. That means profit opportunities abound for U.S. investors, despite myriad messes on the home front that include a collapsed housing market, a mortgage crisis that turned into a five-alarm credit conflagration, and a plunging greenback that seems to have left its parachute on the airplane that it jumped from.

Some of the profit pathways to play:

• Investors can eschew the U.S. market completely, and pursue profits abroad.
• They can latch onto the U.S.-based members of the “Global Titans” club, companies with their headquarters in America that derive a hefty chunk of their profits from overseas markets.
• Or investors can ferret out U.S. investments that are either immune to some of this country’s current economic afflictions, or that are problem-plagued now, but a good bet for a turnaround later.

A Year to Forget?

Like a Dickens’ novel, 2007 was a definite “Best of Times/Worst of Times” combination for the U.S. economy. Volatility and crisis were the watchwords for much of the year. After key stock indices reached record highs in the middle of the year, the explosive emergence of the subprime mortgage debacle and related credit crunch pushed share prices into a nosedive that steepened as the year progressed.

With a 0.6% increase in gross domestic product (GDP) for the fourth quarter of 2007 and a first quarter that’s supposed to be flat at best, it’s clear that we’re not out of the woods, yet. Many fear that 2008 will find the United States in a recession. Other investors believe we have already experienced the first elements of a recessionary contraction.

“If I had to be bold, I’d say we began a recession in December,” Bill Gross, manager of the PIMCO Total Return Fund (PTTAX), told the Financial Times in a recent interview.

The Homeowner Blues

As 2007 progressed, many Americans experienced a growing despair as they watched their largest asset – the family home – experience a significant value decline. The United States is experiencing its worst housing recession in more than 15 years. And that domicile downturn is far from over. Consumers are being forced to watch as the housing slump siphons off the equity they’ve built up, even as it shaves the market value of their homes. Consumers with marginal credit who’d signed up for adjustable-rate loans have seen their mortgage rates “reset,” and then had to watch as their monthly mortgage payment ballooned to the point that they could no longer afford those payments.

For many, unfortunately, refinancing hasn’t been an option. The vanishing homeowners’ equity made such deals unfavorable to lenders. And with the burgeoning credit crisis that quickly became global in nature, banks and mortgage firms have slashed the available amount of refinancing loans that homeowners needed to escape their soaring mortgage payments.

Soon, the banks that had made the questionable calls on subprime loans were in trouble, too. With the housing market cooling, the homeowners who couldn’t refinance also discovered that they couldn’t sell. Homeowner defaults – loans that are 30 days or more past due – soared and started a firestorm that has swept through the global financial-services sector, singing such stalwarts as Citigroup Inc. (C), Fannie Mae (FNM), UBS AG (UBS), and others.

“It will take most of the year to work out of the housing slowdown. Currently, the inventory of unsold homes is at an eight to nine-month level. We have to get this down to a more normal level of four to five months. In order to get to this level, housing starts will remain low,” Dr. Robert Sweet, an economist at MTB Investment Advisors, the investment-advisory subsidiary of M&T Bank Corp. (MTB), said in an interview with Money Morning.

And we might be getting closer to the bottom. In fact, existing home sales rose in February, the first such increase in the past seven months. But it’s probably too soon to get excited about a full housing recovery.

“It looks like this may be a temporary pause,” Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Mass., told Bloomberg News after the existing homes sales report was released. “The price declines have helped, and people are still getting financing, though not on the good terms they could before.”

“We’re still a long way from a recovery in housing,” Gault said.

The Fed to the Rescue?

U.S. Federal Reserve policymakers cut the benchmark interest rate by less-than-expected three-quarters of a percentage point at their last meeting, a move that was designed to energize a badly flagging economy without causing inflation to spike or exacerbating the greenback’s decline.

When central bank policymakers reduced the key Federal Funds rate from 3% to 2.25% on March 18, it was the sixth time in seven months the closely watched benchmark had been reduced. Many analysts had been expecting a reduction of a percentage point – or even more – as such recent events as the near-collapse and subsequent Fed-led bailout of U.S. investment bank The Bear Stearns Cos. Inc. (BSC) stoked fears that the U.S. financial system was ready to seize up.

The policymaking Federal Open Market Committee (FOMC) has now cut the Fed Funds rate six times and slashed the Discount Rate for direct loans to banks eight times since August, when the subprime mortgage market collapsed and created a global credit crisis.

While the FOMC made it clear that inflation has grown as a concern, it still says that economic worries remain the biggest problem and emphasized that it was ready to act again if need be.

“Today’s policy action, combined with those taken earlier, including measures to bolster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity,” the FOMC said in its March 18th statement. “However, downside risks to growth remain. The committee will act in a timely manner as need to promote sustainable economic growth and price stability.”

The retreat has most certainly caused “gold bugs” considerable angst. But they can relax.

This “retreat” is only temporary.

Indeed, gold could easily spike above the $1,500 level this year, says Money Morning Contributing Editor Martin Hutchinson. After all, worldwide monetary policy, global supply-and-demand, and expectations built up from past performances already have combined to ignite the earlier rally that took gold to its record levels just a few short months ago.

Many of those factors remain in place.

And now, three additional catalysts are ready to power gold prices to even greater record levels. Those new catalysts are:

• Inflation.
• Oil prices.
• Fatter wallets in emerging markets.

Inflation and Gold

Global inflation will be a key – if not the key – factor because of gold’s established reputation as an inflation hedge.

Since September, the U.S. Federal Reserve has lowered interest rates seven times – chiefly because of a subprime-mortgage mess that grew into a global financial crisis.

Many foreign central banks have either reduced interest rates in kind, or opted to stand pat, even though inflationary forces in their own markets actually dictated that a rate increase might be a wiser move.

Low worldwide interest rates – arguably an artificial situation, of sorts – has stoked global inflation and caused the greenback to plunge to record lows against other major currencies. And the weak greenback has been a key catalyst behind the escalation of oil prices.

As Money Morning’s Hutchinson has predicted, however, the Fed and other central banks will eventually be forced to start pushing interest rates higher – a stance that even Fed governors are starting to support.

“And during that period, expect speculative demand for gold to intensify and its price to increase steeply,” Hutchinson said. “The longer the period before the Fed is forced to increase interest rates, the higher gold will go.”

“Black Gold” and Gold

There is a very tight correlation between rising oil prices and rising gold prices. While the torrid oil-price advance may moderate at some point – no market goes straight up or down without interruption – the trend in the crude-oil market clearly is toward higher prices, MoneyWeek reported.

And high oil prices tend to support gold prices.

Referring to the “magic relationship” between oil and gold, Moaz Barakat, the managing director of the World Gold Council, said the fluctuations were natural and in accordance with historic price adjustments.

“If you look at the past 100 years, the gold price was always 10 or 12 times that of oil prices,” Barakat told MoneyWeek. “With oil basically around $100 a barrel, gold prices should be at $1,000 or $1,200. That’s the magic relationship between the two.”

[Editor’s Note: Gold investors have made a killing in the past few years, and gold’s meteoric rise is hardly over. Money Morning contributing editor Martin Hutchinson has predicted the precious metal could climb as high as $1,500 in the near future. For additional profit plays on gold - as well as oil, the U.S. dollar, sovereign wealth funds, emerging markets, agriculture, uranium, biotech and much more - check out Money Morning’s just-published global investing guide, The Essential Investors Playbook. It’s Money Morning’s first foray into the investment-book market, but we’re certain you’ll find it worthwhile.]

Asian Wealth

Naturally, as per capita wealth increases in such emerging markets as China, India and Latin America, demand for “American” goods will soar. That holds true both for American “brands,” as well as for so-called “lifestyle goods” – products that foreign consumers identify as being part and parcel of the “American” way of life. Jewelry, gold, gems, other precious metals all will benefit from the growing ability of the newly forming middle classes to spend on wares that aren’t just necessities.

That’s different from past bull markets for gold, which were solely inflation-driven; that is, investors who were seeking to hedge their bets against rising prices caused gold prices to skyrocket.

To be sure, inflation has been a big factor this time around. Gold prices usually move in the opposite direction of the U.S. dollar. With the dollar weak, and interest rates low, an up-tick in inflation could send gold prices higher.

But for gold prices to really zoom, consumer demand will have to act as an adjunct to inflation. And rising demand from increasingly wealthy consumers in China and India may be just the ticket.

Now that the Internet and satellite TV have allowed these aspiring consumers to see what kinds of wares U.S. consumers regularly have, this new group of Asian consumers also want their own houses, cars, appliances, cell phones, computers and jewelry. They are willing to work to get it. And they are all-too-happy to pay the rising asking price.

The upshot: The wealthier this new group of consumers becomes, the more they’ll envy these goods – and the higher the price tags on those products will climb.

This new source of demand could potentially blunt gold’s run toward $1,500. Naturally, demand drives up prices. And, recently, steep prices are to blame for the 11% decline in gold sales during the Hindu holiday of Akshaya Tritiya, where long-term investments such as gold, silver and real estate are religiously merited as purveyors of prosperity.

Like Christmas, Hindus are constantly reminded of Akshaya Tritiya by a bevy of special sales and advertisements from jewelers and real estate companies. 

This is important to note because Hindus were curbing the religious tradition of buying gold, which sheds light on “how much is too much?”

Gas prices hit another record high. Soaring food prices ignite riots the world over. It should come as no surprise that a 71% increase in food prices since 2006 has the good citizens of South Africa, Morocco, Egypt, Ethiopia, Bangladesh and Mozambique up in arms.

And if you thought things couldn’t get any worse, the Financial Times reported on Monday that U.S. mortgage rates soared last week amid a sharp rise in Treasury market yields. Make no mistake, inflation’s back. A Volker-like response may seem alarmist, even far-fetched, to many. However, investors are bracing for the Federal Reserve to raise rates going forward.

At least those rate increases could help U.S. Treasury Secretary Paulson fulfill his recent promise to “defend the dollar.” Secretary Paulson is on the final day of a four-day trip to Saudi Arabia, Qatar and the United Arab Emirates to negotiate currency and economic issues (i.e., a supply increase) from members of the OPEC cartel.

Shall we say America’s relationship with OPEC is a bit strained? Perhaps we’ve stayed a bit too long and expected a bit too much. The greenback keeps sliding down a cliff. Oil-producing states holding their dollar currency pegs are importing more and more inflation. At some point, both parties must reconcile that M3 – the fullest measure of U.S. money supply – can’t outpace a nation’s GDP forever.

Regardless, the Fed seemed content to exchange $16 billion worth of Treasury notes for mortgage- and asset-backed securities last Thursday. In its 10th Term Securities Lending Facility (TSLF), the Fed gave desperate investment houses another chance to dump their worthless derivatives for good ol’ American IOUs. To date, brokerage firms have dumped $175 billion on the Fed’s balance sheet.

Even holders of the mighty euro are feeling the pinch. We read in The Economist last week that customs seizures of counterfeit goods rose by 17% in the EU last year. Cigarettes and clothing accounted for more than half the sham gear seized.

It seems like desperate times call for desperate measures. And the masses, desperate for answers, call on politicans for help.

And any political production worth its salt has three main characters: the hero, the martyr and the villain. Heroes (politicians) need a martyr (America’s middle class) and a villain (oil companies) – and, if they’re lucky, a super villain (foreign oil companies).

Our colleague Eric Fry sums it up best: “When share prices soar, we call it a ‘bull market.’ When home values soar, we call it ‘healthy price appreciation.’ But when oil prices soar, we call it ’speculation’ and ‘manipulation’…and then we gaze around for someone to blame.”

The members of Congress recently convened a special hearing to berate, rebuke and ridicule executives from five major oil companies. Each congressional inquisitor took a turn excoriating the oil companies for daring to earn a profit, especially when so many Americans have so little money. It just isn’t fair.

A few months earlier, you may recall, Congress invited the heads of America’s leading financial institutions to a little tête-à-tête. During that encounter, the congressional inquisitors took turns admonishing the finance CEOs for feathering their nests a bit too lavishly. But none of the execs in attendance drew much criticism for frittering away billions of dollars of shareholder wealth.

Therefore, the essential message from the nation’s top lawmakers is clear: Losing billions of dollars of shareholder wealth is a bad thing, but not nearly as bad as adding billions of dollars to shareholder wealth. In fact, earning billions for shareholders is such a bad thing that it must be legislated away or taxed into extinction.

Where were the nation’s top legislator-inquisitors when the NASDAQ bull market of 1999 and 2000 was powering higher? Where was the outrage over the “speculation” that produced obscene “windfall profits” for the Wall Street firms?”

We’re not so sure. But we continue to see that many in the West want to go through life pretending they’re still the greatest story never told.

It comes as no surprise. From Dutch tulips to dotcoms, people fool themselves into believing it’s “different” this time.

It’s never different this time.

Regards,

Christopher Hancock
for The Daily Reckoning

P.S. Our advice: Embrace the madness. We here at Free Market Investor are hard at work finding our next great way to profit in the face of this U.S. foolery. And for a very limited time, you can get Free Market Investor, along with every single newsletter and options research service Agora Financial currently publishes for as long as we publish them.

Source: Inflation´s Back: Embrace the Madness