This from Taipan Daily:

The most important thing for you to take away from the tail end of 2008 – indeed most all of 2008 – isn’t the real estate collapse, or the bank collapse, or the Wall Street collapse or the automakers collapse.

I’ll grant that this is one awfully big bunch of awfully big collapses. But in the end, they are all mere phenomena – not causes but effects, stemming of a fundamental battle.

I am speaking of the whole inflation/deflation thing. As we have pointed out repeatedly in this column, this interplay is one of the single binding actors in the market.

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Four Clues to Our Future

Right now, for instance, I have on my desk four articles from the feed services, and one chart. One bemoans the fate of retail stores who have been doling out 75% discounts since Black Friday in a desperate attempt to clear out rotting inventory and maintain at least a modicum of cash flow.

Now it appears that they are hoist with their own petard (the Shakespearean equivalent of shooting off your own foot), as shoppers seem unwilling to purchase a damn thing at retail anymore. (I can confirm this trend from personal experience: My wife actually made me wait till the 27th for my gifts so that she could get even better price breaks.

The second item is on the price battle brewing in airfares. The airlines have been cutting flights willy-nilly in an attempt to reduce excess capacity, and they still can’t seem to put bottoms in every seat. So now they will try cutting prices so low it will entice even the most reticent stay-at-homes back into the friendly skies.

Here too, I can confirm this trend from personal experience that our clan abandoned its usual holiday confab in NYC in favor of a long, long (really too long) retreat at Chez Lass. I must say that I did consider FedExing the children somewhere.

Anywhere really. Fairbanks, Alaska, came to mind.

The third item also confirms our reticence to spend or travel. It is from a data conglomerator, and notes that between November 2007 and October 2008, Americans drove 100 billion fewer miles than they did in the prior 12-month period. The report lays that drop at the feet of $140 oil.

Like a Snake Eating Its Tail…

This brings to mind the cyclic nature of these inflation/deflation trends. Allow me to demonstrate…

For the better part of a decade, I have warned that loose dollars would lead to spiking inflation, which in turn would stymie the very growth that those dollars were intended to stimulate.

And indeed this is exactly what came to pass. The price of most everything (other than lead-covered Chinese toys) shot to the moon, breaking the back of the American consumer and engendering the global recession we are now “enjoying.”

Inflation Begets Deflation…

But now that this recession has finally come to pass, the wags in Washington claim that deflation is now the number-one threat. And they point to those very items that I mentioned earlier: falling prices for oil, retail items and services over the past eight to twelve weeks or so.

As this trend continues, manufacturing falls off (and indeed it is at decadal lows now), and excess inventory begins to evaporate. The service sector curtails offerings (just as we see the airlines doing). And as the folks in the oil patch stop pumping expensive steam into old wells, or even stop searching out new ones, gradually we see all that excess oil disappearing off the market.

And in point of fact, most all of my wire service feed today is obsessed with the big fight between Russia and its former satellites. Seems that the demand for natural gas had fallen a tad, and now the Russians can’t get their asking price anymore. With the Russian stock market tanking, Putin and his puppets decided to cut the entire flow of gas to most all of Europe. “Don’t want our gas at our price, eh? Well, let’s seem ’em do without it, then.”

Everyone is calling this a political power play, and perhaps it is. But in the end, the Russians are simply doing exactly what the American airlines are doing: withdrawing excess supply.

… And Deflation Returns the Favor

Some look at this whole operation like a scale: Diminishing demand is balanced by diminished supply. But that would suppose that economies are simple systems that seek balance.

This is nonsense, and it’s a good thing too. In a genuinely balanced system, all information is uniformly distributed and understood, and all goods, services – and stock shares – are perfectly priced.

Real life, however, is a chaotic system in which a moron flapping his arms at a Starbucks on the New Jersey Turnpike can eventually raise the price of sugar in Brazil.

This system may seek balance, but it will never attain it. Rather, each cycle sows the seeds of the next imbalance. Again let’s look to oil: Already this reticence to look for new supplies has New York futures traders salivating like maddened dogs. Over the past few weeks, oil futures have risen some 43% off their December lows.

This brings me the final feed item on my desk today: It is from one of those speculators, noting that he anticipates that the demand will cross over available supply sometime in the next six to 18 months.

I’ll grant that this is an absurdly vague window. But it is his conclusion that is intriguing: He anticipates another whole round of massive oil price shocks. Except this time, it won’t stop at $140/barrel. He is figuring more like $240.

Is he nuts?

The Inflationary Power of $1.75 Trillion New Dollars

For that to happen we would need billions of dollars chasing relatively few gallons of oil. We already know how the oil supply is being reduced. Now where would we come up with, oh, say, $1.75 trillion dollars…

Oh my: That’s exactly the amount of money Washington has already put out there or is proposing to print.

And what happens when too much money chases too few goods? That would be called looming inflation, folks. Which is exactly why both Justice and I have been advising that you short the dollars any way you can now, while they are still big enough to short.

Specifically, I have and will continue to recommend both shares of PowerShares DB US Dollar Index Bearish (NYSE:UDN) for investors, and call contracts against the same for traders. The former ought to gain a minimum of 20% per quarter over the next twelve months, while the latter could earn deft operators 100% or more over the next 90 days.

Deflation or Inflation? Get It Right, and You’re Rich. Get It Wrong…

This from Taipan Daily:

Japan’s absurd 0.2% rate cut is offering American “Dollar Shorts” a second chance at doubling their money.

Welcome to the World Banking Limbo competition, wherein central bankers around the world try to calculate that fine line between a stimulated economy and a destroyed currency.

Last Tuesday, U.S. Fed Chairman “Helicopter Ben” Bernanke re-earned that moniker when he announced that the U.S. central bank would move rates below 1% for the first time in history. What’s more, he promised that if that didn’t work, he would just have to imagineer trillions of new dollars to buy up U.S. Treasury notes.

Currency traders reacted almost instantly, ditching dollars for euros and yen as fast as the market would allow. Suddenly, the dollar was trading at a 13-year low to the yen and damn near par with the euro’s launch price back in 2002.

Gold bugs were also driven into a frenzy, and over the next day or so, futures for the stuff popped up some 5.42%.

The Race for the Bottom

Problem is, this whole “recession thing” is an international phenomenon. So when the dollar drops, stuff overseas gets a good bit more expensive for American consumers.

Now, let’s say you work in the corner office at Toyota’s headquarters. It’s been hard enough selling into the US market, what with American consumers all down in the dumps. Last thing in the world you want to hear is that your uphill climb selling into our market just got a good bit steeper.

Think Japanese sports cars are fast? The hand that dialed the phone between Toyota and the Bank of Japan was a heck of a lot faster.

By Friday, the BOJ announced that it, too, would cut rates. So there, Mister fancy pants Fed Chairman!

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How Low Can They Go?

“Wait a minute,” you might very well ask. “Haven’t BOJ interbank rates already been sub 1% for ages now?” You betcha! In fact, before the BOJ acted, they were already down to 0.3%.

So how low can they go now? The new BOJ rate is a whopping 0.1%. That’s right: one tenth of one percent. Oh, and Governor Masaaki Shirakawa and his board cohorts also claim that they, too, will create new yen with which they can buy up corporate and financial sector debt.

Some of the folks who watch these gyrations for a living have described the new mood in Tokyo as “aggressive.” Others have described it as “desperate.”

One thing I can tell you: They will hit dead zero before we do. I don’t know if that’s anything to be proud of… In the short run (we are talking a day or two), this has driven the dollar back up off its knees.

The Yen Will “Win” in the End

I have to figure that Japan will lose this limbo contest in the end. There are simply too many Japanese housewives banking yen every chance they get… whereas our government has told us outright that we simply must begin shopping again as soon as possible, and it is quite willing to put all of “its” (and by that I mean “your”) dollars behind that notion.

To my mind, this is a buying opportunity for the various short dollar/long gold positions I have mentioned recently, including shares of PowerShares DB US Dollar Index Bearish (NYSE:UDN) and SPDR Gold Shares (NYSE:GLD).

Either position stands to gain some 20%-30% over the next few months. Traders who are looking for additional leverage (or a shorter time span) should consider at-the-money mid-term call options. Properly done, these options could easily triple your gains on these ETFs.

Source: How Low Can They Bend Before Their Backbones Break?

More from Money Morning:

The reality is that these bailout programs remain with us, meaning we must factor them into our efforts to scout out profit opportunities. And on that point, we see six primary areas of change and opportunity:

• The U.S. Dollar: By pumping an estimated $3 trillion into the global financial system, the U.S. government is setting the stage for the mother of inflationary conflagrations. According to classic economic theory, the greenback should be in an actual freefall right now – especially in the current low-interest-rate environment, where there’s the potential for still more rate cuts and for additional capital outlays by the U.S. government. And that’s just with the current administration. President-elect Barack Obama has made it clear that if an additional stimulus isn’t announced before he takes office, he’ll make that one of his first official acts. What’s saving the dollar, at least for now, is that there’s so much global uncertainty that the dollar is retaining its reputation as a “safe-haven” currency. And, for now, at least, a safe U.S. dollar trumps inflationary concerns. However, should global investors regain confidence for whatever reason, expect the dollar to decline sharply.
• Oil: Many people are focused on declining oil prices as a function of a perceived slowdown in global demand. We think that’s an erroneous analysis for three key reasons. First, oil is still largely priced and traded in U.S. dollars. That means that as the dollar has risen, oil has become correspondingly cheaper. In other words, much of the price decline we’ve seen can simply be attributed to a rise in purchasing power associated with a stronger dollar. Second, China, India and other newly capitalist (and still-reasonably robust) economies are still increasing their oil consumption at a rate that more than offsets the decline in consumption we’re seeing here in the United States and in other developed markets. And third, Brazil aside, there hasn’t been a major new discovery capable of offset global demand on anything more than a temporary basis for more than 30 years, and most major oil fields are in decline or soon will be. Increasing demand and diminishing supply are clearly bullish influences over the longer term. More immediately, however, a stronger dollar negates this and may well keep oil under $100 a barrel for much of 2009. Obviously a terrorist attack would change the ballgame significantly, meaning we could see a spike to levels exceeding our multi-year target price of $225 a barrel. A year ago at this time, we called for oil to spike well up over $100 a barrel, and touch $150, which it essentially did. Even with recent price declines, some energy-industry insiders are starting to subscribe to our bullish outlook: The Paris-based International Energy Agency (IEA) last week projected that long-term oil prices would reach $200 a barrel (although we think that will happen much sooner than the IEA does).
• Commodities: The story is much the same for commodities, in general, and we expect that longer-term investors will be amply rewarded. More immediately, the popular – though erroneous – assumption that a global slowdown will negate demand is driving prices lower, and may continue to do so for the next six months. Gold will be the most obvious casualty in this arena, as hedge-fund-redemption requests and margin calls continue to mount, which is why we expect the price of the yellow metal to remain lower far longer than most people expect (We’ll focus specifically on gold in an upcoming installment of the “Outlook 2009” series). When it does rebound, however, the returns will be high.
• Global Markets: There’s no doubt that the global markets have taken their share of lumps along with their U.S. counterpart in recent months. But we don’t expect them to suffer forever. Countries with high cash reserves as a percentage of gross domestic product (GDP) – such as China, India and Brazil – are becoming less dependent on the fractured U.S. consumer almost daily, and the economic decoupling we’ve seen developing for several years may really take hold in the New Year. This stands in direct contrast to the situation a decade ago, when the Asian Rim and South America were economic train wrecks and the United States and Europe held all the cash. Companies with significant global exposure to the Asian Region, Latin America and Europe – in that order – remain the best bets for relative safety and growth in 2009.
• Stocks in General: Many investors are questioning the wisdom of being in stocks at all. While we certainly understand the pain that sentiment is based upon – and are hurting, too – it’s important to remember that the last time stocks really performed this badly was during the 1930s. Investors who decided to “get out” entirely then missed the investment opportunity of their lifetime. Don’t make the same mistake. Data shows, unequivocally, that investors who buy when the world is going to hell in a hand basket –think 1932, 1942, 1982 and 2003 – enjoy the largest returns. That’s even true if you’re “early,” and buy ahead of the specific market bottom. However, history also demonstrates that investors who pile in at the market’s peaks – such as 1928, 1969, 1999 and 2007 — tend to incur the worst returns.
• Global Stocks in Particular: Led by cash-rich China, we expect global blue chips to remain the best relative bets for safety, income and appreciation potential in the New Year. We are especially focused on companies involved with infrastructure projects and with firms that derive substantial portions of their revenues from Asian consumers. The first is a no-brainer. According to the latest studies from a variety of sources, planned global infrastructure expenditures in this area exceed $40 trillion by 2030. There is not a bigger, more unstoppable trend on the planet today. If you want proof, notice that a big portion of China’s just-announced half-trillion-dollar stimulus package is devoted to infrastructure projects. Infrastructure companies there will certainly benefit. So will consumer-products firms that are positioned to benefit from the rise of an increasingly Asian consumer base, which boasts significant savings and pent-up demand. Many of the best companies are beaten down to the point that they now feature single-digital Price/Earnings (P/E) ratios – lower than we’ve seen in decades. Some are actually trading for less than cash value, despite a strong history of growth. And the companies we’re studying have solid cash flow – and excellent prospects of maintaining it.

Now for the $64,000 question – when could we see a rebound?

We don’t know for sure. Nobody does. History demonstrates that the first and second years of any newly elected U.S. president’s term are almost always problematic. When taken in isolation, we could see a scenario where this is countermanded by President-elect Obama’s planned stimulus, but given the potent combination of flagging earnings and slowing U.S. growth, we’re leery of doing so. 

On the other hand, for a variety of reasons, history also suggests that if we are to see a rebound, however nascent, the probability is highest for a resurgence starting in the middle of next year. First, since the 1970s, the time between the first and last market lows in any given bear market is an average of seven to eight months. If historical trends hold true, this suggests we could see a bottoming out by the middle of next year. That’s consistent and plausible, especially since other data shows U.S. recessions, on average, last 14.6 months – which also points to a bottoming out in late spring or early summer.

But the biggest indicator of all that we may see a bullish rebound in late spring or early summer – however slight – is admittedly based on emotion. Literally. Small investors have fled the stock markets in droves, and so far they’ve yanked more than $175 billion from the markets, with nearly 50% of that coming out during October alone. Granted, this is a mere 3.2% of the $5.5 trillion invested in stock market funds, according to Forbes, but it’s the first year that net equity flows have been negative since … a drum roll please … 2002.

History shows that small investors may be the most telling of all Contrarian indicators. According to TrimTabs, the Investment Company Institute and our own proprietary research, individual investors have a remarkable habit of rushing in near market tops and fleeing near market bottoms.

That means that long-term investors seeking the best wealth-building opportunities should find the immediate price declines we see ahead to be some of the most compelling buying opportunities of their investing lifetimes.

Now for the caveats – and you knew this was coming – we see three wildcards in 2009, and any one of them could prove to be a joker:

• The continued de-leveraging of hedge funds and other financial institutions.
• More credit-default-swap valuation problems.
• And unknowns associated with the ongoing U.S. and global-economic-system bailouts.

There are still huge questions regarding who owes what to whom, how large the debts are, and exactly who’s going to get what help and when. History shows that the most effective bailouts are those that recapitalize institutions and that allow the weak to fail, which is why we are especially leery of the U.S. government’s plan to acquire bad debt while rewarding weaker institutions that should be put out of their misery.

What’s more, as a Money Morning investigative story demonstrated, many banks are using the government bailout money as takeover capital, and not to boost their lending, which at least would have had an expansionary benefit for the U.S. economy. With most of the bailout programs, and through no fault of their own, U.S. taxpayers and investors have been caught in the middle – or left on the sidelines altogether.

The Outlook 2009 Action Plan

For investors who want to get a head start, it’s important to bear in mind that the markets tend to begin their rebound in earnest anywhere from two months to six months before an actual economic bottom. While that doesn’t suggest going “whole hog” into stocks, it does speak to the need to take some steps now to get ready. Here are the top moves to make now:

• Rebalance Now: As markets have declined, many portfolios have done out of kilter, too – not only in terms of value, but in terms of balance. And that lack of balance can seriously dampen returns, even as we await the market recovery – and even more so once the market begins to rally. It’s far harder to catch a moving train than most investors think.
• Think Safety First: There’s no need to rush into the markets. It’s not clear we’ve hit bottom yet. Keep your powder dry for the better days and easier trades we see developing ahead, while bargain-hunting for those stocks with true upside, and that are positioned to capitalize on the strongest global trends.
• Spread your buys over several days: When you’ve found something to buy, wait for a particularly bad day, then place your order in the last half an hour of trading. Leverage the lower prices (and maximize your returns) by spreading your purchases over several days or weeks. That way you won’t get tripped up by committing your entire nest egg when the market looks cheap and will probably get cheaper.
• Go Global: China is still on track for 9.6% growth this year and may, in fact, slow to a “mere” 8.0% next year. Even that reduced growth rate will probably be about eight times the growth rate of the U.S. economy – if we’re lucky. Consider adding exposure to the Asian Rim as part of the rebalancing process, or as a primary focus once the recovery begins in earnest.
• Get Inverted: Continue to use specialized inverse funds to hedge downside risk. We’re not out of the woods by a long shot.
• Stop Your Losses – with Stop Losses: By all means include trailing stops to control small losses before they become catastrophic ones. This market could easily fall further before it gives way to the rally that history suggests is in the making.

Source: Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009

More from Money Morning:

A properly structured and globally diversified portfolio using the 50-40-10 allocation model (50% “base-builder” foundation investments, 40% global growth and income plays and 10% “rocket rider” speculative investments that will perform well in a recovery) we recommend in The Money Map Report – our affiliated monthly investing newsletter – will prove to be an investor’s best friend. And the reasons for that are as simple as they are compelling:

• First, a properly structured portfolio has built in safety brakes that keep us from making overly risky decisions.
• And second, while this allocation model was constructed to minimize our downside in markets such as the one we’re navigating right now, it also positions us to benefit when the rebound eventually gets under way.

During the past year, we’ve repeatedly urged our readers to make sure two other elements are part of their portfolio: Dividend-paying stocks and specialized “inverse funds” that gain when the markets decline.

While dividends are important in any market, they’re downright crucial now because they add to returns during market rallies and help offset losses during market declines. And our commitment to inverse funds was rewarded during the whipsaw month of October: During a month in which the Standard & Poor’s 500 Index lost 16.8%, the Nasdaq Composite Index shed 16.3% and the Dow Jones Industrial Average dropped 13.9%, all 10 of the best-performing exchange-traded funds (ETFs) were inverse funds, which boasted one-month returns ranging from 36.4% to 66.6%, Thestreet.com reported last week.

Now those are admittedly highly remarkable returns – and clearly aren’t the norm. But it does demonstrate the point we’ve been making: It pays to protect y our downside even as you position yourself for gains. And not only do such investments as inverse funds hedge our downside, they smooth out our overall portfolio volatility and help calm roiled waters.

Source: Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009

The PowerShares DB Crude Oil Double Short ETN led the way with 66.6% gains in October, as crude oil prices continued to slide.

Click here to read the list in full

Eric Roseman says the Fed will eventually triumph over deflation with by a massive expansion of credit.

In the meantime, he recommends a defensive portfolio weighting: 50% cash, 10% gold, and 20% in reverse ETFs, such as Short Dow30 ProShares (AMEX:DOG) or Short S&P500 ProShares (AMEX:SH).

This from The Sovereign Society:

The Fed and other major central banks, including the Chinese, cut benchmark rates by 0.50% today. The central banks are now throwing everything they’ve got at the credit crisis. This is a monetary conflict of the first degree for central banks as they fight the growing threat of accelerated asset price deflation across world markets.

Key asset values, including housing, equities and credit are all collapsing in value this year, and the rate of decline has accelerated markedly since September 1. And despite the concerted global rate cut this morning, world markets are still declining.

Global stock markets are now posting their worst calendar year loss since 1974. The Dow has now plunged more than 15% in six days. The MSCI World Index is down a mind-boggling 35% heading into this morning’s trade. And the MSCI Emerging Markets Index has crashed 47% – its worst loss in 20 years.

The Federal Reserve continues to do the right thing to alleviate credit stress. Bernanke is the right guy for this job. The Fed has an enormous array of policy response tools at its disposal. So combined with other central banks, the Fed will eventually arrest deflation through an unprecedented expansion of bank credit. If not, we’re in serious trouble because this gun is quickly running out of bullets.

Last night, for the first time since the Great Depression, the Fed became the lender of “only” resort to the massive commercial paper market.

The Fed will now directly loan to the biggest companies, including General Electric (NYSE:GE), which require commercial loans to pay for inventory, salaries and account payables to suppliers. Again, the Fed is doing the right thing because banks are not lending – not even to AA and A credits like GE.

I know this is an extremely difficult time for investors. We’re all witnessing a massive purge on our assets over the last 12 months and the latest bout of panic-selling has everyone on edge. But please keep a cool head.

By now your portfolio should have at least 50% in cash with equities representing an under-weighting. You should also have reverse-index funds, like the Short Dow30 ProShares (AMEX:DOG) or Short S&P500 ProShares (AMEX:SH) representing about 20% of your assets. Gold should be at least 10%.

If you don’t have the above allocation or something that looks similar, then you’re bleeding heavily. Wait for a big rebound, which is coming, to sell any unwanted stocks. The last thing you should be doing is selling amid a panic. Be cool and sell on intermittent strength. It’s coming.

Stay strong and keep your head on your shoulders.

Source: We’re Running Out of Bullets to Stop this Monster