Last week Drew/Jack used the phrase “financial obesity”.  Now of course this was viewed in a humorous manner, but it sent me down a different path.

The term financial obesity may sound like fun, if you are the one fat with cash.  But I kept thinking about obesity in another form.  The obese budget deficit we are looking at in this country is extremely daunting.  Democrats can blame the Bush administration for the deficit that President Obama inherited and Republicans can blame the various stimulus packages of the Obama administration, but pointing fingers isn’t going to solve the problem.

When I was thinking about this article I shared my thoughts with my colleagues and I pointed out how if a person is overweight, they didn’t gain 100 pounds overnight and they aren’t going to shed the extra weight overnight either.  My colleague Jon Herring pointed out that you aren’t going to lose the extra weight by eating more ice cream either.

Not only are we eating more ice cream, we are eating the cake as well and then we are washing it down with chocolate milk.

I could care less who you want to blame when it comes to the budget.  The only two things I want to know are how are we going to fix it and how can I profit from it?

As for now, inflation is being kept in check.  But you can guarantee that inflation will rear its ugly head at some point in the future.  There is simply too much money being printed and eventually all those dollars floating around in the economy will be chasing a supply of goods that simply isn’t large enough.

So how do you invest for inflation that isn’t here yet?

First, you want to wait until you see the Consumer Price Index and the Producer Price Index creeping up a little bit.  Don’t wait until it is a concern and then react, when it starts increasing slightly you want to take action.

The actions you will want to take are as follows: diversify your portfolio with appropriate allocations to bonds, precious metals and stocks.  How much do you allocate to each?  That is really up to you, but you will want to factor in things like your age, your comfort level with risk and how many years you have until you retire.  There are other factors, but my point is you want to diversify with a balance of investment vehicles, not just diversify within the stock market or bond market, you have to diversify among asset classes as well.

And if you think you can diversify with foreign investments, you are only partially right.  I was reading some data from Dimensional Fund Advisers, a mutual fund company that applies extreme levels of academics to their investing practices, Thursday evening.  Included in that material was a table showing the performance of various global equity markets over the last 24 years.  There were two things that jumped out at me from that table.  First, the only equity market that was positive in the bear market of 2001 was the Australian market (+1.68%).  This list doesn’t include all equity markets, but it includes all the countries I would consider developed markets.  The second thing that jumped out at me was the fact that over the last 24 years, the U.S. equity market has never been the top performing market.  Among the other markets that have not been the leading market over the last 24 years are France and Germany.

These two pieces of information tell me two things: one, diversification among different countries only gets you so far and secondly, the thought of seeking safety in the most developed markets leads to underperformance in most instances.  This should all tie back in to your comfort level.

As far as my plan, I will probably leave approximately 50% of my portfolio in equities (diversified among various markets and sectors of course), and then put approximately 25% each in bonds and precious metals.  And when I talk about my portfolio, I am talking about the 80% I view as long-term.  The 20% that I trade on a short-term basis changes from day to day.

Make a plan for when the U.S. is forced to go on a diet, and don’t expect to shed these extra pounds in a few weeks.  It is going to take time to shed the extra weight we have put on in the last nine years or so.

Source: Financial Obesity

The Fed extended the lives of recently initiated programs (lending facilities for investment firms, for instance) and is exploring additional moves (like Treasury purchases) aimed at reviving the credit markets.  Bernanke believes more needs to be done to slow the pace of foreclosures, especially since they jumped another 10% in September.

Meanwhile, the U.S. Treasury Department is working on a plan to rejuvenate the housing market by slashing mortgage rates to 4.5% on new purchases.  Experts say that at some point these stimuli must take hold, but that’s not necessarily true.

This week’s economic calendar is highlighted by two late-week releases that are sure to garner much analysis.  The producer price index (PPI) brings another look into the inflation picture, though the dramatic decline in energy prices may renew “premature” talks of deflation.  And November retail sales should offer few positive surprises for the holiday season.

Are there any 12-step programs for overcoming “gloom and doom?”

Market Matters

Black Friday has passed. And so has Cyber Monday (the Monday after Thanksgiving when online shopping begins in earnest).  So let the analysis begin.

While retailers continued to cry “gloom and doom,” the so-called experts did not appear to be quite as pessimistic.  According to National Retail Federation, holiday sales will climb by 2.2% from last year’s levels.  Research firm ShopperTrak claimed that sales on Black Friday rose by 3%, and ComScore Inc. (SCOR) said Monday’s online activity soared by 15% from 2007. Toys “R” Us Inc. execs “were definitely pleased with sales” during the initial holiday shopping weekend, and Internet data collector, Hitwise, revealed that web traffic increased by 21% at Amazon.com Inc. (AMZN).

While November sales remained bleak (see below), analysts point out Thanksgiving came late in the month (Nov. 27) and Cyber Monday actually fell in December.  The optimists (rare as they are) are hopeful holiday activity may be skewed with December faring far better than November.

Automakers returned to Capitol Hill. But for “Begging for a Bailout II,” the “Big Three” CEOs were smart enough leave their corporate jets at home and arrive in hybrid sedans.  Maybe next time they can carpool. But there’s a problem: Combined, the Big Three are this time are requesting $34 billion in loans, which is $9 billion more than they’d been lobbying for all along. Ford Motor Co. (F) implied its situation may be less dire and a mere $9 billion standby line of credit would suffice (assuming the others don’t fail).  The execs also expressed a willingness to operate under a federal oversight board, and even the unions offered concessions regarding health plans and the jobs bank.  While some politicos used scare tactics to predict even greater economic hardships should relief not be granted, others remained skeptical of the unlimited bailouts.  Mostly, they chose to grandstand and politicize the tragic times to win support at home (as if their constituents even watch C-SPAN).  Stay tuned…

In other corporate news, Goldman Sachs Group Inc. (GS) may be forging more into the banking world as it considers launching an Internet operation to increase its deposit base.  Meanwhile, analysts predict its fourth quarter loss could skyrocket to $2 billion.  Beezer Homes USA Inc. (BZH) and Blackberry-maker Research in Motion Inc. (RIMM) both lowered their quarterly outlooks and AT&T Inc. (T) became the latest domestic giant to announce layoffs.  While General Electric Co. (GE) believes its earnings will be weaker than initially expected, the company plans to maintain its dividend and solid commitment to shareholders.  Merrill Lynch & Co. Inc. (MER) shareholders approved its sale to Bank of America Corp. (BAC), though total valuation plunged to $20 billion (from $50 billion at announcement) as a result of the stock market decline.

Oil continued its never-ending decline below the $41 a barrel level, a point not seen in four years, while gas fell below $1.80 a gallon nationally. While winter weather generally means higher energy prices, the economic doldrums have more than offset the traditional trend.

Treasury yields plunged to historic lows on speculation that the Fed may purchase government securities to support the credit markets (as well as the ongoing “flight-to-quality” moves).  Stocks resumed their overall bearish ways on dramatic volatility, as investors grew more fearful about the economy before totally disregarding the awful unemployment data (see below) and staging a late-week “illogical” rally.  Then again, since when have markets been considered logical?

Economically Speaking

In what could one of the worst kept secrets of the year, the National Bureau of Economic Research (NBER) revealed the domestic economy has been in a recession since December 2007.  In the post-World War II era, the average length of recession has been 11 months, with the downturns of 1973-74 and 1980-81 lasting 16 months.

And the current recession will likely surpass the norm.  As the data gets weaker with each passing release, most economists expect this recession to last beyond the next four months and to set a new duration record in post-World War II times.

Then again, each new month means we are getting closer to the end; additionally, equity markets typically serve as leading indicators and begin to rebound months before a recovery starts – meaning we’ll see a bull market get under way while the economy is still in the depths of recession.

The weekly releases revealed that any pending rebound should remain on the back burner for some time.  In November, the unemployment rate jumped to 6.7% as the U.S. economy lost more than 500,000 jobs, the largest monthly decline in 34 years.  In the last three months alone, more than 1.2 million individuals have moved into the ranks of the unemployed.

November represented the 11th straight month of labor contraction.  Both the manufacturing and services sectors continued to struggle according to Institute for Supply Management and factory orders plummeted by the largest amount in eight years.  Retailers reported weak same-store sales numbers, with only Wal-Mart benefiting from the dire times.  Even Costco Wholesale Corp. (COST) experienced a steeper than expected decline.   And of course, dismal auto sales brought more ammunition to those Congressional hearings as General Motors Corp. (GM) (-41%) and Ford (-31%) were joined by Honda Motor Corp. (ADR: HMC) (-32%) and Toyota Motor Corp. (ADR: TM) (-34%) in the “if misery loves company” category.  Meanwhile, Bernanke and friends are hard at work dreaming up creative ways to shore up the economy, particularly after the Beige Book reported softer activity across the country.

Weekly Economic Calendar

Source: Fed Looking at Another Rate Cut, While Treasury Has New Plan for Housing

Such concerns may be warranted in the short-term. But in the long run, deflation won’t be the challenge we face.

Thanks to an overly aggressive central bank, and more than $1.5 trillion in U.S. Treasury Department bailout programs – as well as other factors related to the ongoing global financial crisis – inflation will be the problem that ultimately bedevils us.

As long as oil and commodity prices drop, the PPI and CPI indices, which include oil and commodity prices, also will fall. Such a decline, however, does not constitute deflation; it is simply a one-time price adjustment. This is particularly true if most of the commodity-price declines are simply a reversal of excessive increases that had occurred over the previous year. That’s essentially what we’ve been seeing here.

However, the deflation believers currently have an additional argument: With output in the United States plunging, and the stock market down around 50% from its October 2007 peak, there are very few pressures pushing prices upward. For instance:

• Manufacturers, facing sudden sales declines, cut prices in an attempt to clear inventories or engage in foreign sales drives, intensifying price competition in all markets.
• Nobody is pushing for wage increases – folks are all too pleased to keep their jobs, and their employers know this.
• So while the U.S. economy is declining sharply, prices will not increase significantly and may even decline.

But even this will not turn into deflation, unless the recession is exceptionally prolonged. Currently, output and employment are dropping very sharply, as is the stock market. This cannot continue for more than a few months – the latest being perhaps late spring of the New Year. As output declines, forces pushing it towards recovery will become stronger and equilibrium will appear.
Provided world trade remains open healthy – and doesn’t plunge by 60%, as it did during the horrid stretch from 1929 to 1932 – we will avoid a second Great Depression, so the bottom in output cannot be all that far down, and will be reached relatively quickly.

Since inflation was running at more than 5.0% when output began its steep descent, it is unlikely to have turned significantly negative by the time the economy reaches bottom. After all, the so-called “core” PPI rose at a rapid clip of 0.4% (equivalent to 5.0% per annum) even in October, while the Cleveland Fed’s “median” CPI, which smoothes out fluctuations, rose by 0.1% in October and 3.2% over the past year.

Once the bottom has been reached, the excess liquidity that has been created over the last few months through the various bailouts – such the Treasury Department’s $700 billion Troubled Assets Relief Program (TARP), which is fueling bank takeovers, and not expansionary lending, and the follow-on $800 billion credit-market stimulus unveiled late last month – will combine with the huge federal budget deficit to spur inflation. By that time, discounting will have become much less prevalent, as the most aggressive discounters will have gone out of business and inventory excesses will have been worked off. Costs will have increased, since many producers will be operating well below capacity.  And the excess money supply will push up inflation.

This time, there will be no surges of foreign competition restraining price increases – Chinese producers are currently suffering high inflation in both wages and prices, so their sales prices are increasing fast.

To estimate the inflation rate we might see, you can look at money supply growth over the past year. The St. Louis Fed’s M2 money stock, the broadest money supply growth now reported by the U.S. Federal Reserve, has increased by 10% over the past year, while the St. Louis Fed’s Money of Zero Maturity (MZM), the nearest we can get to the old M3, has increased by 7.4%.

Both those rates are far higher than the increase in nominal Gross Domestic Product (GDP). In fact, money supply has been increasing about 65% faster than GDP since 1995, which is when former U.S. Federal Reserve Chairman Alan Greenspan began to overly relax monetary policy. In the most recent two months, MZM has risen only modestly, at a 3.1% annual rate, but M2 has risen much more rapidly, at a 20.6% annual rate. (The difference between the two figures reflects quirks produced by the various bankruptcies and bailouts – for example Washington Mutual Inc. (OTC: WAMUQ), nominally a “thrift,” has been taken over by Bank of America Corp, (BAC), a bank).

In any case, it seems likely that inflation in the 7%-10% range lies in our future once output stabilizes. The deflationists here have a huge problem: Their view of falling prices is in incompatible with swiftly rising money supply, so only a sharp fallback in money supply, which we are not seeing, would make deflation plausible.

The Fed has been blamed so widely for not expanding money supply fast enough during the Great Depression, that it is showing every sign of making the opposite error now.

If inflation does return with renewed force, we need to invest accordingly. One way of doing so would to use Treasury Inflation Protected Securities (TIPS). TIPS yields have recently risen, as investors have focused on deflation. Indeed the 10-year TIPS currently yields 3.11%, only 0.08% lower than the 10-year conventional Treasury, so the market is saying inflation will average 0.08% over the next 10 years. That’s nonsense, and such a mis-pricing makes TIPS an attractive investment, even though conventional Treasuries are vulnerable.

Another investment that benefits from inflation is gold, which has declined in price, albeit less than oil, and is currently selling around $770 per ounce. If inflation is expected to take off, gold prices will rise sharply, and a gold price of $1,500 per ounce is by no means out of the question. The most efficient way to buy gold is through the SPDR Gold Shares ETF (GLD).

Source: Why Fed Policies and Treasury Department Bailouts Will Lead to Inflation Rather Than Deflation

It is an interesting time for gold investors. On one hand, gold prices should be soaring as investors flee to the precious metal for security. On the other, gold’s value should be dropping precipitously as deflationary concerns gain momentum.

It is no wonder gold prices remain horizontal and the gold hedge I recently created is paying profits. Last week we cashed in for gains of up to 50%.

Some interesting reports released today will help illustrate why gold prices are acting the way they are.

First, let’s look at the demand side of the equation. Global orders for gold increased by over 120% during the third quarter on a year-over-year basis. Retail investors moved 232 tons of the metal, compared to 105 tons this time last year.

Exchange-traded funds (ETFs) significantly boosted their physical possession of gold over the past three months. Third-quarter holdings increased by 150 tons. During the second quarter of the year, they only added 4 tons of gold.

These figures are proof that global demand is soaring. But why are prices staying flat and showing signs of a serious collapse?

They want it, but we don’t

There are two answers.  For the first, we have to look at the situation here in the States. During the previous quarter, Americans demanded 20% less gold than the same period a year ago. Thanks to a strengthening dollar, American investors are shying away from gold as it typically moves inversely to the greenback.

Remember, gold is a vehicle used to protect against inflation. Right now, the American economy is anything but inflationary. The headline reading of the latest producer price index, released yesterday, showed a record 2.8% decline in wholesale prices last month. Today’s consumer index confirms the deflationary environment with a negative reading of one percent.

Deflating prices will be a major drag on gold’s appreciation. Enough American investors will be dumping their gold holdings in exchange for stronger assets to nearly offset the significant increase in global demand.

If a deflating economy is not enough to drag gold valuations down, the fact that institutional investors are abandoning the metal certainly will. The world’s largest funds unloaded 300 tons of gold recently. As they are forced to meet margin calls or as their investors cash out, institutional investors are unloading their gold holdings as the metal is liquid and, compared to their other holdings, has held much of its value.

By reviewing this information, it is easy to see why gold prices have made relatively little moves over the past three months. When prices get pulled in both directions, they tend to stay put.

Something’s gotta give

Eventually one of the forces will give and gold valuations will make a significant move. If the break is caused by a slowdown in global demand thanks to signs of economic recovery, gold prices will plunge. If it institutional sellers stop unloading while global demand is at record levels, prices will soar.

History and basic economic principles point towards falling prices so I am naturally bearish on gold’s long-term valuation. But there are plenty of folks that tell me I am wrong. As the world economy tanks and the U.S. floods the market with its currency, they say, gold price will soar.

Never one to invest unprotected, I created a hedge play that will profit no matter which way valuations move over the next year. If I am right, the bearish leg of the hedge will win. (Last week we proved my theory by cashing in gains of over 50%). And if I am wrong, the bullish side will win. No matter what, the hedge is designed to pay out profits.

If you want to learn about this unique hedge, click here.

This is an interesting time for investors. Never before have so many unique, yet infinitely strong forces, tugged at the market.

As we slowly weigh and understand all of the variables, the economic future will become clear. But for now, it is prudent to take protection and seek shelter in the opportunities that have historically provided profitable recessionary havens.

Source: The gold dichotomy: Demand rises, prices fall

My colleagues in the Dollar Bear camp like to blame inflation on Ben Bernanke, the Fed, and the decline of the dollar against major currencies since 2001. It’s an easy sell.

Extrapolating from this, inflation in other countries — those with tight-fisted central banks — ought to be a pittance. Take the euro, for example: A symbol of the ECB’s commitment to fiscal responsibility.

But then look at the numbers:

In the United States, the annual Producer Price Index for finished goods rose 9.8% in the 12 months that ended in July. In the same period, German producer prices jumped 8.9% year-to-year — the fastest rise in nearly 27 years, based on data from the Federal Statistics Office.

Now, following the argument of the Dollar Bears, inflation in the U.S. can be blamed on that fact that the dollar buys less oil, Volkswagens, Beaujolais, and Mozart Balls than it used to. But the strong euro buys more gasoline, Hanes t-shirts, Raytheon anti-missile batteries, and pallets of Schlitz than it used to. That, after all, is the mission of the ECB.

So how come the difference in wholesale price inflation is just 0.9%?

While U.S. inflation numbers will revive the sagging chorus of the dollar doomsday sayers into predicting fresh new lows of the greenback against the euro, I wonder if they will be able to maintain the happy oblivion of economic realities in other countries.

My money, as I said last Sunday, remains on the dollar at this point.

Source: U.S. Producer prices are up 9.8% year over year… but we’re not alone

World food prices will fall from current peaks in the coming years but will remain “substantially above” average levels from the past decade.

The world’s poorest nations are most vulnerable — particularly the urban poor in food-importing countries — and will require increased humanitarian aid to stave off hunger and undernourishment, a joint agricultural outlook by the Organization for Economic Cooperation and Development and the U.N. Food and Agriculture Organization said.

High oil prices, changing diets, urbanization, expanding populations, flawed trade policies, extreme weather, growth in biofuel production and speculation have sent food prices soaring worldwide, triggering protests from Africa to Asia and raising fears that millions more will suffer malnutrition.

Meanwhile, in the US the core US inflation rate or Producer Price Index (PPI) rose 0.4% in April, double the increase forecast by economists.

This puts the core US inflation rate up 3% in the past year, the biggest year-over-year rise since late 1991.

“Since the beginning of the credit crisis last summer, Fed policy has been purely inflationary,” says Bill Bonner in The Daily Reckoning, “intended to convince people that they had more money and credit than they thought…and that they should spend it and invest it. But that policy can’t work forever. Eventually, consumer prices rise sharply. Then, the game is over…the Fed has to ‘lower inflation expectations’ before it can inflate again. The hocus pocus only has a positive effect, in other words, as long as people are misled…once they catch, the jig is up.”And on a global scale, “rising raw material prices, in particular rising food prices, are now causing real hardship and what represents a cause for shoppers in developed economies to grumble is a matter nothing short of life and death for the millions less fortunate around the world,” says Money Week editor Merryn Somerset Webb.

This puts the core US inflation rate up 3% in the past year, the biggest year-over-year rise since late 1991.

The PPI figures are unlikely to affect the markets which, according to a report by MarketWatch, “don’t seem to trust the government’s inflation figures that show falling energy prices in a world of record crude oil prices.”

The government’s data are seasonally adjusted to hide the impact of normal seasonal variations to focus on fundamental changes in prices that are not driven by the ebbs and flows of the seasons. Because energy prices typically rise more in April than they did this year, the seasonally adjusted figures showed a 0.2% decline. In unadjusted terms, energy prices rose 2.9%.

“Since the beginning of the credit crisis last summer, Fed policy has been purely inflationary,” says Bill Bonner in The Daily Reckoning, “intended to convince people that they had more money and credit than they thought…and that they should spend it and invest it. But that policy can’t work forever. Eventually, consumer prices rise sharply. Then, the game is over…the Fed has to ‘lower inflation expectations’ before it can inflate again. The hocus pocus only has a positive effect, in other words, as long as people are misled…once they catch, the jig is up.”

And on a global scale, “rising raw material prices, in particular rising food prices, are now causing real hardship and what represents a cause for shoppers in developed economies to grumble is a matter nothing short of life and death for the millions less fortunate around the world,” says Money Week editor Merryn Somerset Webb.

The Labor Department reported that the producer price index surged by 1.1% in March, far more than the 0.4% gain predicted by economists. Core PPI, excluding food and energy, rose 0.2%, in line with expectations.

John Ryding, U.S. chief economist for Bear Stearns, expects the Fed to cut the funds rate by only a quarter-point later this month. “Inflation is everywhere within this report,” Ryding wrote. “Fed policy is stuck between the rock of recession and the hard place of rising inflation pressures.”

It’ll opt for the hard place, said Mike Englund, of Action Economics. “The Fed has abandoned the luxury of addressing the inflation threat for now,” he said, “but hefty price gains will likely still be a problem, even after the problems of turmoil in the financial market are resolved.”

And the futures market is pricing in a 32% chance of a half-point rate cut when the Fed meets April 29, down from 44% on Monday. A quarter-point cut is fully priced in.

The Producer Price Index for March will be released tomorrow morning and it is expected to show a slightly larger increase over the February report. Analysts are looking for an increase of 0.4 percent after a 0.3 percent increase in February.

The Consumer Price Index report comes out on Wednesday and analysts are expecting a larger uptick in the CPI than in the PPI. In February, the CPI was flat compared to January. The March report is expected to show an increase in inflation at the consumer level of 0.3 percent.

Both the Leading Indicators report and the Philly Fed Survey will be released on Friday. The leading indicators report for March is expected to come in at 0.1 percent, which would mark the first time in six months that this report was positive.

I am not holding my breath that it will come in positive though. The Philly Fed Survey for April is expected to come in at -14.0, which isn’t as bad as the March reading of -17.4.

Date	Time (ET)	Statistic	For	Market Expects	Prior
14-Apr	8:30 AM	Retail Sales	Mar	0.10%	-0.60%
14-Apr	8:30 AM	Retail Sales ex-auto	Mar	0.20%	-0.20%
14-Apr	10:00 AM	Business Inventories	Feb	0.40%	0.80%
15-Apr	8:30 AM	PPI	Mar	0.40%	0.30%
15-Apr	8:30 AM	Core PPI	Mar	0.20%	0.50%
15-Apr	8:30 AM	NY Empire State Index	Apr	-16	-22.2
16-Apr	8:30 AM	CPI	Mar	0.30%	0.00%
16-Apr	8:30 AM	Core CPI	Mar	0.20%	0.00%
16-Apr	8:30 AM	Housing Starts	Mar	1025K	1065K
16-Apr	8:30 AM	Building Permits	Mar	970K	984K
16-Apr	9:15 AM	Industrial Production	Mar	-0.10%	-0.50%
16-Apr	9:15 AM	Capacity Utilization	Mar	80.40%	80.40%
16-Apr	2:00 PM	Fed’s Beige Book	-	-	-
17-Apr	10:00 AM	Leading Indicators	Mar	0.10%	-0.30%
17-Apr	10:00 AM	Philadelphia Fed	Apr	-14	-17.4