This from Taipan Daily:

The euro is fast approaching an inflection point.

On Jan. 15th – Thursday of this week – the ECB (European Central Bank) will meet to decide how much to cut interest rates. The general consensus is that the cut will be big.

I wonder if the euro will “pull a sterling” and go up instead of down on the news. The chart certainly leaves room for that possibility.

As you can see, the euro’s move higher in December was sharp and swift. The ensuing downdraft has been more of a sideways lurch, creating something of a wedge formation. A sharp move back above $1.35 (and above the 50-day MA) could thus see some real upside follow-through.

While it’s generally true that anything can happen, it feels even more true in forex these days.

“Currencies Trading All Over The Map,” the Washington Post reports. “Over the past several months, global exchange rates have taken some of their wildest swings in years, with a fresh bout of zigzags hitting an array of currencies in both rich and poor countries in the past few weeks.”

Much of this uncertainty is tied to the prospects for U.S. recovery and the $64 trillion inflation versus deflation question. The theme song for the period could be “Should I Stay Or Should I Go” by The Clash: If I go there will be trouble… if I stay it will be double.The good news is currencies historically have a very strong tendency to trend. That means an “all over the map” currency period that began in 2008 could revert into a new stretch of powerful (and profitable) trending behavior in 2009.

And speaking of The Clash (and whether “to stay or go”), the powers that be threw a little more light on the subject of treasuries this week. In a speech to the London School of Economics on Tuesday, Ben Bernanke reminded his audience of the Fed’s willingness to buy long bonds.

“In determining whether to proceed with such purchases,” Bernanke said, “the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Brother, Can You Spare Some Inflation

What does that mean? It means the Fed wants inflation, ladies and gentlemen, and will do what it takes to get it.

A small helping of inflation would do nicely, but they’ll take a godzilla-sized helping too, if need be. Beggars can’t be choosers.

The logic is straightforward here. If deflation continues to grip markets, then credit conditions will clearly need “improving,” which, as Bernanke spelled out in London, would mean the Fed buying up treasuries with freshly printed dollars.

If, on the other hand, private credit markets start to “improve” on their own – without the Fed’s help – that means a flood of TARP cash, currently idle in bank vaults, is trickling its way back to work.

Either way, the end result is more dollars circulating through the system – and a jolt of reflation (maybe a BIG one) to go alongside.

Here’s a TIP

The “all roads lead to inflation scenario” is one reason Bill Gross is so high on TIPS, or Treasury Inflation Protected Securities.

Gross, the manager of the $128.4 billion PIMCO total return fund, managed to outperform 99% of his peers in 2008. He and a few others consider TIPS an amazing deal right now, in large part because the bond markets are still priced for heavy deflation. (TIPS outperform normal bonds in times of inflation, but underperform in periods of deflation.)

This presents another interesting way to think about the short treasuries trade – in the context of a TIP/TLT spread. (TIP is the iShares TIPS ETF; TLT is the 20+ Year Treasury ETF.)

As you can see from the chart, TIP dramatically underperformed relative to TLT all through the second half of 2008. This was due to the deflationary impact of the “great unwind” as credit flows collapsed.

You can also note from the chart that, as of late December, TIP started gaining ground again. Inflation-linked securities have grown more popular in recent weeks, as some look around and see the money-printing handwriting on the wall.

Source: Another Way to Play Inflation? Pssst, Here’s a Tip

This from Whiskey & Gunpowder:

This is the “other shoe” that a lot of people are waiting to drop. Right now we are caught up in a compressive debt deflation as mortgages stop “performing” and loans of all kinds are welshed on. Since money is loaned into existence, and a great many loans are not being repaid, then a lot of money is going out of existence. That’s what I mean when I say that capital is leaving the system.

At the same time, the Federal Reserve has made good on its promise to drop money from helicopters if necessary to prevent an implosion of the banking system (as all that older money goes out of existence), and so it’s now a question as to when the amount of new money will exceed the disappeared old money. (Of course when I say money, I mean “money,” because we are dealing here in a shadow realm of assumed value.) In any case, there is bound to be a lag period between the time that the Fed’s money is dropped from the choppers and the time it actually filters through the banks and other recipients to the so-called “real economy” of people who buy and sell real things. The credible estimates I hear run between six and 18 months.

I’ll only venture to guess that we could see the start of serious inflation sometime in 2009. To some extent, all currencies are now free-falling together, some at slightly faster rates than others, but the situation of the US dollar is so grotesquely dire, and our structural imbalances so monumental, that it is hard to imagine that our currency will not win the international race to the bottom. Gold resumed its movement upward against the dollar a week before Christmas, and that may be an early sign. The government — and anyone badly in debt — benefits much more from inflation than deflation, so every effort will be made to avert the latter. The trouble lies in the government’s dumb incapacity to control dangerous things that it sets in motion, so that an inflationary campaign to avoid compressive deflation can so easily lead to a fiasco of super or hyper inflation — the kind that kills governments and turns societies into murderous monsters. I’ll forecast that the US dollar is worth 40 percent of its current value by next Christmas.

Geopolitics

Well, now, who the hell knows what’s in store. Aside from a few bombs here and there, and pirates skulking around the horn of Africa, the world scene was miraculously free of major incidents in 2008 — perhaps the worst being a toss up between the September Mumbai bombings and the fiasco in Georgia, where the US prompted Georgia President Mikheil Saakashvili to send troops into the South Ossetia region and the move was answered by overwhelming force from neighboring Russia, leaving the US looking feckless and retarded for our troubles. But otherwise, there wasn’t a whole lot of action out there.

Until the last few days of the year, that is. I’m sure the ever-growing cohort of American anti-Semites who send me emails will be tickled when I assert that the Hamas rocket attacks against Israel of recent days guaranteed a sharp response from Israel — and now, of course, Hamas is playing the crybaby card: “… what’d we do to deserve this…?” Well, you ******* fired a bunch of rockets into Israel. Did you ever hear of cause-and-effect? This matter requires no further elucidation, except that it seems to suggest a ramping back up of hostilities.

I wonder if it is the beginning of a new coordinated offensive by Islamic extremism aimed at taking advantage of the West’s current economic plight (and the West’s probable aversion to anything that will complicate its desired recovery). We’ll know in a month or so, I think, since any coordinated campaign (if such a thing were possible) might well be aimed at confounding the new American president.

The other hot corner of the world right now is the India-Pakistan border where the 60-year-old rivalry, which has already produced three wars, looks to be gearing up for yet another round. I’m not the first one to say that Pakistan is an extremely dangerous regional player, being an economic basket case, possessing a score or so of nuclear bombs, harboring more Islamic fundamentalist maniacs than any other place in the world, and having a government held together with duct tape and twine. The caper in Mumbai last September could well have been construed as an act of war, but somehow India kept its head. Who knows where this is going…

So far I have only described what is already obviously going on. Add to this the likelihood that Iran is closer to achieving membership in the atomic weapon club. They’ve been spinning their centrifuges all year and nobody has done anything about it. My guess is that neither the US nor Israel will attempt to take out their facilities in the year ahead. If Iran used a nuclear device against Israel, or anybody else, they would be asking to become, in turn, the world’s largest ashtray. End of story. A different story, though, is how Iran might behave if and when the US Military presence in Iraq is reduced. I can imagine Iran doing anything possible surreptitiously to gain control over Iraq’s southern oil regions around Basra, but even the Iraqi Shia don’t like the Iranian Shia that much. Anyway, Iran’s economy has suffered hugely from the fall in oil prices. That nation may be in for more internal trouble than they have seen in thirty years since the Shah was tossed out by the minions of Ayatollah Khomeini.

There’s been a lot of sentiment the past year that as the US and the Europe fall into economic disarray, China would emerge as the great new hegemonic superpower. While it’s come a long way in a quarter-century, China’s internal problems are still enormous and worsening. They’re in trouble with water, food imports, mass unemployment, and energy. They have locked in some oil contracts around the world, but they are still susceptible to vagaries in the oil markets and Black Swan events. As the US consumer economy falls into a coma, and the shipping containers from China to WalMart get sparser, the Chinese government will face the wrath of millions of unemployed workers. I believe they will struggle through 2009, perhaps growing more surly as the US dollar inflates and their holdings of treasury bills begins to look more like a swindle.

Russia may be suffering economically for the moment due to the crash of oil prices, but they are energy resource-rich — at least for the next couple of decades — and if they don’t like the current price, they can keep more of their oil in the ground until the price looks more attractive. I think Mr. Putin has the confidence of the Russian people and will survive the current malaise.

Japan remains a riddle wrapped in toasted nori. They’re beggaring their own factory workers to stay solvent. Their banking sector has been zombified for a generation. They import 95 percent of the energy they use. Do they have a plan? One can imagine them sliding in resignation back to something like the sixteenth century, giving up the whole industrial circus as more trouble than it’s worth, just as they once gave up on firearms.

The over-arching geopolitical theme of 2009 will be the end of robust globalism as we’ve known it for some time. Reduced trade, competition for energy resources, sore feelings over debts and currencies will drive the nations inward or, at least, direct their energies toward their own regions. Note to Tom Friedman: the world turned out to be round after all.

Conclusion

The big theme for 2009 economically will be contraction. The end of the cheap energy era will announce itself as the end of conventional “growth” and the shrinking back of activity, wealth, and populations. Contraction will come as a great shock to a world of conventionally programmed economists. They will toil and sweat to account for it, and they will probably be wrong. Unfortunately, this contraction will do its work in unpleasant ways, driving down standards of living, shearing away hopes and expectations for a particular life of comfort, and introducing disorder to so many of the systems we have depended on for so long. People will starve, lose their homes, lose incomes and status, and lose the security of living in peaceful societies. It will become clear that the Long Emergency is underway.

My hope for the year, at least for my own society, is that we will transition away from being a nation of complacent, distracted, over-fed clowns, to become a purposeful and responsible people willing to put their shoulders to the wheel to get some things done. My motto for the new year: “no more crybabies!”

Source: The Specter of Inflation: Forecasts 2009, Part III

This from Today’s Financial News:

The old saying that cash is king is not as true as it used to be. With so many investors fleeing the turbulent markets, billions of dollars in cash are sitting on the sidelines, with investors looking to stash their stockpiles in any safe place they can find.

The American government has been the go-to repository. As the safest of them all, Treasury bonds are seeing huge demand. But with demand comes increased prices, and with increased prices comes dwindling interest rates.

The privilege of loaning your cash to Uncle Sam is no longer a profitable one. Give the government a few thousand bucks for the next few years and it will hand you a couple of nickels to rub together. As the value of the dollar declines because of these low interest rates, the situation only promises to get worse.

That is why hordes of investors are turning away from the bond market and once again tossing some money into the gold market. Gold prices made significant moves last week and are on the rise once again this week. As I write, gold is trading for close to $840. That means the precious metal has tacked on roughly $100 since its November lows.

Hurricanes are tough to predict

If you want to know which way gold prices are headed, it depends on who you ask. Some analysts say, $1,000, $1,500 or even $2,000 an ounce is just around the corner. Others say the fundamental value in gold is waning fast and bearish investors should watch for $600 or even $500 per ounce.

As the world’s economy strengthens, the bears will be right. But in the meantime, the declining dollar, the high-risk equities market and fears of government supported inflation are going to propel gold’s prices dramatically higher.

There are multiple ways to take advantage of the price hikes. The simplest would be to buy a gold-based ETF like SPDR Gold Shares (NYSE:GLD).  But if you want to magnify the potential gains, use the leverage created by investing in a gold miners like Goldcorp (NYSE:GG) or Barrick Gold (NYSE:ABX). Their current valuations look quite cheap if gold starts to soar.

But with so much uncertainty in the economy and the government ready to re-write the economic textbooks, investors must be aware of the increasing risks. In an ill-informed attempt to “jolt” the American economy back into high gear, the government could easily force gold prices off their track and into a canyon of deep declines.

Source: The Gold Debate Heats Up

This from Money Morning:

The plethora of bank and corporate bailouts, stimulus plans and interest-rate cuts that the U.S. government has produced over the last three months can only lead to one outcome: The U.S. dollar has to decline.

During the crisis so far, the dollar in general, and U.S. Treasury bonds in particular, have been regarded as a “safe haven,” making the dollar strong and pushing long-term U.S. Treasury rates downward. In the New Year, however, this is likely to change – the weight of the added supply of dollars in circulation will be too great for the greenback to shrug off.

Back in November 2007, when I wrote about the U.S. dollar becoming the “Bernanke peso,” I suggested that the dollar – then trading at $1.50 to the euro – would get weaker. Alas, I was wrong: It is currently trading at $1.29 to the euro, although it did reach $1.60 in May. However, I recommended buying not euros, but yen. The chaos of 2008 has reversed the decline in the dollar against the euro, but not against the yen, which has reached Yen 92.8 = $1 compared to a rate of Yen 114.8 = $1 when I wrote the piece. A gain of 24% against the dollar is not bad, and indeed I defy you to find a stock market that has done as well over that period.

The fundamentals tending to weaken the dollar remain. The U.S. trade deficit was $57.2 billion in October, which annualizes to $700.3 billion – down but a little from the 2006 peak of $758 billion. Although the recession and recent sharp decline in the value of U.S. oil imports will reduce the U.S. trade deficit further – perhaps to $500 billion annually – there is still no reason why foreigners should continue to so highly rate the currency of a country that is running a $500 billion balance-of-payments deficit, and a $1 trillion budget deficit.

After a pause during the summer, the U.S. money supply has begun rising again rapidly. The excess money has flowed into Treasury bonds, sending the yield on the 10-year bond down to a recent 2.71%. The distortion in the market can be shown by the yield on the 10-year Treasury Inflated Protected Securities (TIPS), which was 2.44%; that combination of prices said that investors expect U.S. inflation to average a mere 0.27% annually over the next 10 years.

Clearly that’s nonsense; the explanation is that yields on long-term Treasury bonds have been driven far below their economically appropriate level. In other words, U.S. Treasury bonds are currently benefiting from a bubble, and like the bubbles that we’ve seen in Japanese stocks, real estate, U.S. tech stocks, the American housing market and global commodities, this bubble, too, will ultimately burst.

The budget deficit in the 12 months through to September was $455 billion, but that’s expected to expand to close to $1 trillion in the year to September 2009 – and that’s even before President-elect Barack Obama’s stimulus plan, which is expected to cost at least $500 billion, and could possibly cost that much a year over several years.

If that’s surprising, consider this: The U.S. budget deficit was $237.2 billion in October 2008, a record monthly figure. That puts a huge strain on the U.S. Treasury Department’s financing capacity, and will probably result in the U.S. Federal Reserve printing yet more money, since the alternative would be for the huge amounts going into Treasuries to choke off demand for private investment – not the desired objective. With more money being printed, inflation is likely to soar and the dollar to weaken.

Net foreign purchases of long-term U.S. securities declined to $793 billion in the 12 months to September 2008, from $1.03 trillion in the previous year. Of those purchases, Treasury bonds and notes represented $385 billion, up from $192 billion in the previous year, while purchased corporate bonds shrank from $447 billion to $168 billion.  Thus, the “flight to quality” has so far been enormously helpful in enabling the U.S. Treasury to finance its growing budget deficit; in October and November it will doubtless have been even more so.

Once the inflow into U.S. Treasuries slows, or the huge volume of Treasuries issued simply overwhelms it, the dollar will weaken and Treasury yields will rise. At that point, there is likely to be a stampede for the exits from the Treasury bond market, which will be self-reinforcing. As a wise investor, you could prepare for this stampede in four ways:

• First, you could have a modest holding of the Rydex Juno Fund (MUTF:RYJCX), the price of which is inversely linked to T-bond prices (the fund shorts Treasury bond futures.). The fund has had a poor record since its inception in 2001, and it probably makes little sense to put too much money in it. However, given the scenario we’ve sketched out here, the fund will do a lot better in 2009.

• Second, you should have bond, cash and stock holdings in foreign currencies, particularly the euro and the yen (but not British pounds sterling; with a housing bubble and a bloated financial sector, Britain has many of the same problems as the United States). Aside from foreign-currency-denominated stocks and bonds, you may want to consider a foreign-currency-deposit account through EverBank, which offers foreign-currency certificates of deposit (CDs), albeit at low interest rates, at present – only 1% on a 12-month Euro CD for example. [Editor’s Note: EverBank also offers a product called the EverBank Asian Currency Portfolio. Readers can find out about all the bank’s products by contacting the folks at EverBank’s World Currency desk at (800) 926-4922. Be sure to mention product ID #12534. We should also mention that Money Morning has a marketing relationship with Everbank, but that’s only because we believe in its products.]

• Third, you should hold some gold, which is likely to profit from a dollar collapse – for example through the SPDR Gold Trust fund ETF (NYSE:GLD), which has ample liquidity, with $17.6 billion outstanding, and which tracks the gold price directly.

• Fourth, you may make a modest (no more than 1% to 2% of your portfolio) speculation in currency options, which are traded on the Philadelphia Stock Exchange. Since the yen has already enjoyed a considerable run against the dollar, the best speculation might be to purchase out-of-the-money euro call options, which will rise in price once the dollar starts falling against the euro. Personally, I prefer to buy the longest possible options available, to give the market time to move in my direction. So, I would go for the September 140s (PHLX: XDEIH), giving nine months to maturity at a strike price about 8% out of the money (the euro being currently at $1.29). Currently these are trading at $4.55 offered, so you would have to pay $455 for each 10,000 euros on which you purchased an option.  Your break-even would thus be $1.4450. If the euro is trading above that level next September, you would gain, so if it matched its May peak of $1.60, you would make $2,000 per contract. If it was below $1.40, you would lose your investment of $455 per contract.

Source: With Billions in Bailout Funds Flowing, the “Peso-fication” of the Dollar Continues

This from Money Morning:

In November 2002, Federal Reserve Chairman Ben Bernanke cracked wise in his now infamous ‘Helicopter Theory’ speech. When it came time to pay our debts back, he said, we could simply fire up the printing press. The world would be forced to accept our paper in lieu of those debts. If need be, the Fed “could drop dollars from helicopters” in order to get the money into circulation.

Unfortunately, traders around the globe didn’t react kindly to his comments: Since his speech, the dollar has declined over 40% against a basket of world currencies.

It’s likely we’ll continue to see a steady downward trend in the dollar, occasionally punctuate by rallies as traders take profits. And it’s unlikely our government will be able to do anything soon to stop it.

Here’s why…

The Fed’s in a box

There are a number of factors weighing on or bouying the dollar. But Bernanke is the 300-pound gorilla in the current chess game – and his latest moves seem destined to keep the dollar in the doldrums.

The Federal Reserve, which rode boldly to the rescue in past economic slumps, can’t do much this time around. Cutting interest rates, as the Fed has been doing for the last year to spur economic growth, hurts the dollar. On the other hand, raising interest rates to help the dollar would probably send the economy into a tailspin.

Then there’s the economic facts of life…

The U.S. lives beyond its means, buying more than it sells. As a net debtor nation, we’re running a huge trade deficit with the rest of the world, about $700 billion annually.

That’s financed by foreign money inflows – mostly by foreign investors buying U.S. Treasury bonds. That leaves them holding an ever-ballooning number of U.S. dollars. Altogether, they now hold $3 trillion in government debts and liabilities.

The subprime crisis, a deteriorating stock market and consumer malaise has accelerated the greenback’s slide. The overall impact, is that the global market now takes a more cautious view of the relative strength of both the U.S. economy and the dollar.

The solution, according to the currency markets, is for the dollar to sink. That would cause U.S. exports to rise as U.S. goods get cheaper for overseas buyers. In turn, U.S. imports would fall as the declining greenback makes foreign goods more expensive for U.S. consumers and businesses.

However, there’s a large fly in the ointment. Having foreigners buy T-bonds inflates the money supply even as it leads to higher economic output and rising inflation.

Inflation rears its ugly head

The slowing economy has been a major concern for the Federal Reserve, prompting the central bank to make a series of interest rate cuts since last September. But the Fed has to figure out how to balance the risk of inflation against the risk of further weakness in the economy.

“Unacceptably high headline inflation has heightened the FOMC’s concerns about inflation, but continuing strains in the financial markets and evidence of spreading economic softness will force the FOMC to toe a fine line between the two risks,” David Resler, chief economist at Nomura Securities, wrote in a note to clients.

But, according to the government’s numbers, consumer inflation rose 0.8% in June, the biggest monthly increase since February 1981.

That figure is artificially low because drastic changes have been made in how it’s calculated. Food and energy are no longer even taken into account. In fact, using Consumer Price Index (CPI) calculations in effect during Clinton’s presidency, the CPI would be about 6% now.

A number like that sends shivers through the Fed’s bones. You see, once inflation has entrenched itself in an economy, getting it back under control is like pulling teeth.

But they really don’t want to talk about the “I” word.

The Federal Reserve stopped reporting the M3 value, the U.S. money supply, in 2006. Best guess is it’s increasing at about a 10% rate. But about $1.5 trillion of additional ‘money’ in bank bailouts and credit will be put into the financial system in 2008 alone.

When that much paper money is printed or electronically pumped into the credit markets you can bet your bottom dollar (excuse the pun) inflation will follow.

And that puts the main engine of the American economy, the consumer, on the defensive.

Consumers pull back

Make no mistake, consumer spending makes up about 70% of the U.S. economy. But with the foreclosure storm in full fury, and the credit crunch tightening the screws, the consumer is pulling in the reins.

So naturally, the feds are stepping up to the plate. Federal government spending rose at a real rate of 6.7% in the last quarter, while personal consumption rose only 1.5%.

Meanwhile, consumer spending is not even keeping up with income. The government recently handed out billions in tax rebates, which boosted incomes by 4% – more than twice the level of consumer spending increases.

So where does that leave the Fed? For now, in between a rock and hard place.

Any solution that would strengthen the dollar would probably involve sharply raising interest rates, increase the rate of savings, and curtail private consumption.

Don’t hold your breath waiting for those kinds of measures to come to your neighborhood.

No reason to panic…yet

Conventional wisdom has long held that foreigners would continue to support the dollar. After all, what could replace it?

But that argument may no longer hold water.

China with its $1.6 trillion, and other countries with huge reserves, are looking elsewhere to invest. Many governments, especially in the Middle East, have created sovereign wealth funds not limited to U.S. investments.

They’ve been plowing their winnings into foreign telecommunications companies, airlines and financial companies. China and India are spending their increasingly valuable currency on importing food, energy and other resources,

But despite the gnashing of teeth by foreign central banks, there’s scant evidence that they’re abandoning the dollar even as it tests new lows. The International Monetary Fund’s numbers show a slow shift from dollars into euros, with the dollar’s share falling to 63% of all global reserves in 2007, from 65% in 2006.

That doesn’t add up to a willy-nilly stampede out of dollars. Instead, look for a gradual decline in the dollar to continue as developing markets rake in more of the world’s cash.

What to do now…

Hedge with real assets: The inflationary nature of this environment means you should look to own the stocks of companies that produce goods, not services. Companies that own gold, ferrous metals and iron mines, for instance.

Gold isn’t reliant on a government promise to maintain the value of any currency. And while gold is up over 150% in the last 18 months alone, we think it still has room to run.

Martin Hutchinson, an analyst here at Money Morning, thinks you might want to consider

streetTRACKS Gold Trust (NYSE:GLD), an exchange traded fund (ETF). You might also look at Market Vectors Gold Miners (NYSE:GDX), which tracks the major players in the field.

Go Global: The current meltdown in the U.S. credit markets couldn’t have come at a worse time. Huge blowouts in dollar-denominated vehicles severely eroded the competitive edge U.S. dollar investments had over developing markets. That means foreign central banks will look to developing markets for the returns they used to get from U.S. assets.

Four places in particular stand to benefit. The BRICs (Brazil, Russia, India and China) all have burgeoning economies and significant natural resources.

Horacio Marquez, another of our analysts, likes Petroleo Brasileiro SA (NYSE:PBR), Brazil’s state-owned oil exploration company recently discovered the Tupi oil field, the second-largest discovery in 20 years. It also boasts top-notch management and leads the world in deep-water drilling technology.

If you’re looking for more safety and diversification, Rio Tinto PLC (NYSE:RTP) could fill the bill. It’s the largest iron ore supplier in the world and just signed lucrative new contracts to feed China’s voracious steel mills.

That gives you a starting place to look for relief from a weakening dollar. But the dollar probably won’t implode in a sudden burst of volatility. There’s simply too much riding on it for that to happen.

Here’s the bottom line – the value of the dollar is largely determined by the confidence investors around the world foresee in the future success of the U.S. economy.

For right now that confidence is flagging and is likely to continue to slowly let the air out of the dollar in the future.

Source: Why the Federal Reserve Can’t Save the Dollar

This from Money Morning:

“Gold’s universal role as a store of value has shone through during this quarter helping attract investors and consumers to all forms of gold ownership,” James E. Burton, chief executive officer of the World Gold Council.

However, if you’d just looked at gold’s performance alone, you’d never be able to tell demand was so strong. Indeed, in the third quarter alone, gold prices tumbled almost 6% – and were actually down as much as 20%, until a mid-September rebound narrowed that loss.

Then came “Black October.”

The worldwide financial crisis continued to punish stocks, slashing the Dow Jones Industrial Average by 14%. At the same time, however, in a disconcerting surprise for gold investors, yellow-metal prices plummeted 17%.

Why? The financial crisis is apparently once again taking long-held market truisms – and forcing investors to question the validity of their beliefs, namely:

• That gold should act as a safe haven against the global recession most economists believe has just begun.

• And that when demand for gold moves up, prices should do the same.

“Gold is not a safe haven against recession,” said Money Morning’s Martin Hutchinson, an investment banker with more than 25 years’ experience on Wall Street and a leading expert on the international financial markets. “It’s a safe haven against inflation.”

And it just so happens that, in October, consumer prices dropped at the fastest rate in the 61 years that the Labor Department has been keeping records.

And as far as gold prices go, demand for gold isn’t as widespread as the World Gold Council would have you think.

Overall demand was a record; that’s no fluke. And most of that came from the retail side. But like common tradable stocks, institutional demand exerts much more influence on the market than consumer-led retail demand.

As markets collapsed, institutions and hedge funds were forced to liquidate assets across the board. This so-called “de-leveraging” is taking place for a number of reasons, but one is due simply to asset allocation issues.

Simply put, institutional investors typically employ an asset-allocation model that’s designed to manage risk and maximize returns by setting a percentage for each category of assets. Those ratios can change over time as some assets surge in value, while others hold steady or even decline. Thus, assets that performed well while others tanked could now comprise 20% of the portfolio’s value, instead of once accounting for 15%.

And these multi-billion-dollar portfolios are often controlled by precise asset allocation guidelines that set strict maximums and minimums for each asset category.

For example, Harvard’s endowment aims to have 13% of its portfolio to be composed of “private equity” investments. But private equity now accounts for more than its assigned allocation. So, to get back to that 13% target, it’s selling $1.5 billion in private equity assets, according to Fortune.

One purpose of such asset-allocation models is to prevent a massive loss in case one class of assets takes a big hit.

But in this case, institutions are selling gold because, in the third quarter, it only fell 6%, while the rest of the stock market skidded 14%.

The logic is confounding, but the bottom line gold’s value is incredibly suppressed considering demand has moved at an all-time high.

Two Catalysts For Gold’s 2009 Climb

The U.S. Department of Agriculture’s Oct. 10 Crop Production Report said acreage for a handful of staple food commodities has shrunk:

• Corn acreage fell 1.2%.
• Soybean acreage dropped 1.4%.
• Canola acreage dropped 1.9%.
• Sunflower acreage shrank 0.8%.
• And acreage of dry edible beans fell 0.7%.

That naturally translates into higher prices because it squeezes the supply of the particular commodity. And it does so at a time when demand continues to escalate from populations in China, India and Latin America.

And higher prices equal inflation.

But Hutchinson – who correctly predicted this last run-up in gold prices – says there’s another catalyst that’s right now inherent in the U.S. economy that could help vault gold prices to $1,500 an ounce by the end of 2009. And it has to do with the much-ballyhooed $700 billion rescue plan.

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

The philosophy behind the rescue plan is elegantly simple: By providing a portion of the $700 billion to foundering U.S banks, the Treasury Department believed it could provide banks with badly needed capital, and get them to start lending money once again – jump-starting the economy in the process.

Since September 2007, U.S. Federal Reserve policymakers have cut the benchmark Federal Funds target rate nine times – from 5.25% down to the current 1.0% rate – to increase bank-to-bank lending and bank-to-consumer lending.

Right now, banks aren’t boosting lending. Instead, as a Money Morning investigative article demonstrated, they are using the cash – essentially taxpayer-provided money – to finance buyouts of other banks.

Even so, that money will “come out” into the economy in the form of higher stock prices for banks. That will make consumer/investors wealthier, and could make them more confident in the economy. If they’re more confident, they will spend. As that happens, food prices should begin ticking upward, adding another set of thrusters to gold prices.

“Everybody thinks that because we’re having a horrible recession, we’re not to going have inflation. I think that’s probably wrong,” Hutchinson said. “I think gold has quite good hidden-store value.”

As gold prices increase, count on more investors leaving the sidelines to invest, too, causing the surge in gold prices to accelerate and then steepen.

“As gold goes up, it gets more popular and investors start piling into it,” Hutchinson said.

And if gold gets anywhere near the $1,500 mark, it will probably be smart to sell. At that level, the price of gold could likely stall and remain in place for a long stretch. Or, in an even more likely scenario, the yellow metal could see its price careen downward – once the economy starts to show some life, forcing the central bank to boost interest rates, an act that should also cause the dollar to rise in value.

Source: Gold is Experiencing Record Demand: So Why Have Prices Fallen?

First, let’s take a closer look at those producer figures. Yes, gas costs to retailers went down a startling 25%. But that’s no real shock, as I think that we are all aware oil is down in the mid-$50s per barrel.

Unfortunately for those folks who eat, food costs were only down 0.2%, after nigh doubling over the past few months. And that’s the good news!

Strip away these two drops, and you are left with a truly dismaying conclusion: Core prices actually went up 0.4%. That’s right: despite the headlines, costs to industry are still rising.

It’s an Expensive World After All

Dig into consumer prices and you get a mixed picture here as well.

As mentioned earlier, the top line is down roughly 1%. However, when you compare October 2008 to October 2007, you see that the past year’s inflation still leaves us up 3.3%.

But even that 1% drop is suspect. Strip out the drop in fuel costs, and we actually see a 0.1% rise.

And in fact, not even that fuel cost-cut is an unalloyed joy. While retailers did drop gas at the pump roughly 33%, they only received a 25% cost cut. The rest is coming out of station owners’ bottom lines.

Keep in mind that big refiners like Exxon Mobil (NYSE:XOM) have for the most part sold off their local operations to “private entrepreneurs,” i.e. your neighbors and fellow PTA members, and suddenly this is less a cause of celebration and more a shot across the bow for your town’s and state’s tax base.

The Big Lie

But all this is small beer compared to the really big fib.

Over the past few days, I have seen a veritable parade of talking heads and “in pocket” scribes ranting as to how this one-month drop constitutes the threat of a “horrible deflationary juggernaut that must be stopped in its tracks before it can gain any further momentum.”

Their cure for this “looming threat?” Why printing more money of course!

Because there is, after all, such a “shortage” of dollars out there (okay, it was really hard to type that without shuddering).

Source: Deflation? I think not!

This from The Daily Reckoning:

To give you an idea of the wild measures undertaken by the feds, we look at what is happening at the world’s leading bank – the US Federal Reserve.

The short form of how the Fed operates is this: it holds a certain amount of securities in its vault; this is the cornerstone capital – or monetary base – of the whole banking structure. How does it get this capital? It buys it, creating the money to pay for it as necessary. Naturally, the Fed doesn’t want to create too much money or the inflation rate would get out of control and economists would point their fingers accusingly. But now, people fear dandruff more than inflation. So, the Fed has gone wild.

From the day of its founding in 1913 to September 24, 2008 the Fed’s assets – the aforementioned cornerstone capital for the US financial system – grew to $1 trillion. By November 14, 2008 the amount had grown to over $2 trillion. And in a speech in Texas, the head of the Dallas branch of the Fed said he expected the total to reach $3 trillion by year end.

For the moment, this explosion of monetary inflation is hardly noticed. Asset deflation has the headlines. People worry about having too few dollars, not about having too many.

Comes the news this morning that US business chiefs are asking the up-coming Obama administration for another $500 billion ‘stimulus’ program. They’ll get it. And much more. Trillions worth.

Trying to stimulate the economy with easier credit in the early 2000s, Alan Greenspan overdid it. He gave the world the credit it wanted, and created the biggest bubble in human history.

Now that bubble is collapsing and his successor – Ben Bernanke – is confronted with a new problem. Now it is cash that people want – income to pay their debts! Bernanke will give them what they want. And, most likely, he will overdo it too.

Source: Into The Wild

This from Taipan Daily:

Take a look at this long-term gold futures chart.

Stepping out to a longer-term chart is a bit like seeing the world from a higher altitude. As you head further out, the drama begins to recede. (From a far enough distance, the world is little more than a pale blue dot – as Carl Sagan liked to point out.)

So, too, with gold. There has been a lot of yellow metal angst in light of the recent credit implosion. But if we look back to the genesis of the gold bull market in 2001, we can see that the long-term uptrend is still intact. Gold would have to close below $650 to break it.

Hedge Fund Deluge

What, then, about gold stocks, which have been hammered through the floor?

As we now know, the carnage in gold stocks – as in the entire market – had a lot to do with investor panic and forced hedge fund selling.

Third quarter data on hedge fund stock sales recently came available, and the numbers are staggering. Among the larger players, fund after fund with holdings of $5 to $10 billion slashed equity exposure by 90 percent or more. At the same time, very few new positions were picked up. Almost to a man, asset managers have been bracing themselves against the threat of further investor redemption.

With that kind of deluge – not to mention forced margin-call selling on the part of many company execs – it’s no wonder hard asset stocks got crushed. The funny thing, though, is that this is exactly the kind of thing the old hands talk about when they chuckle over tops and bottoms. Near the top, the public can’t buy enough. Near the bottom, they refuse to buy for love or money. And so it goes.

But anyway, now let’s take a look at another chart.

Money is Getting Cheap (Again)

As you can see above, the yield on 1-year treasuries (the rate you get loaning money to Uncle Sam for 12 months) currently hovers above 1 percent. It hasn’t been down this low since 2003.

During the time when “Easy Al” Greenspan was cutting rates and keeping them low, interest rates just kept on falling. Money went from super cheap to ridiculously cheap to insanely cheap. Then, beginning in 2004, yields slowly began to rise again. (But not fast enough to wreck the party that was by then in full swing.)

Now we’re back on the old downward slope, with rates on a kamikaze path towards zero. (“Turning Japanese” as Bill Bonner likes to say.)

The upshot is that right now the Fed and the Treasury are absolutely flooding the system with money. They do this because they are desperate to jumpstart the U.S. economy.

You’ve seen it before in these pages, but it’s still hard to beat this chart for shock value:

That is a chart of the adjusted monetary base, courtesy of the Federal Reserve Bank of St. Louis. It shows how the Fed has rolled up its sleeves since September. Boy howdy, have they rolled up those sleeves.

Holy Balance Sheet Batman!

Rolled-up sleeves aside, it might even be fair to whisper that the Fed has gone nuts.

Proof of nuttiness, you say? Ask and you shall receive.

As Jim Grant of Grant’s Interest Rate Observer recently observed, it took the Fed a full 75 years – from 1914 to 1989 – to get its balance sheet up to $100 billion.

From there (under care of The Maestro) it only took another 10 years to hit $500 billion.

Eight years or so later, the Fed’s balance sheet hit the big “T” for the first time – a whopping $1 trillion – and within the space of just three weeks in late 2008 doubled that from $1 trillion to $2 trillion. (Do I hear a bid for $3 trillion?)

“So a second order effect which might not be subtle,” Grant suggests, “might be inflation.”

Illegal for Every American Investor — UNTIL NOW

This super-safe $4.50 stock is the sleeping giant of India. Most U.S. investors think they can’t buy it, but they’re wrong.

I guarantee it’ll post a triple-digit gain in 12 months… or your money back!

(Over the next five years, you could see 10 times that amount… maybe more)

Read on for details…

Enter the Gnomes

The “Gnomes of Zurich” was originally an insult term, dreamed up by a British politician named Harold Wilson to disparage Swiss Bankers.

Mr. Wilson didn’t like the fact that the “gnomes” were gunning against the British Pound in the 1960s. As it turns out, the gnomes were gunning against the U.S. dollar too – and one of the ways they did it was by buying gold.

To understand the Gnomes’ frame of mind, you have to remember that the old gold standard didn’t disappear all at once. It was progressively weakened (the first blow taking place in the 1920s) and receded in stages from there.

In the late ‘60s – when Bretton Woods was intact, the dollar was king, and LBJ was spending like a drunken sailor – the United States remained quaintly determined to defend the dollar’s virtue. That virtue was defined by convertibility into gold, for all comers, at a fixed market price of $35 per ounce.

The problem was that more and more dollars were making their way into the world. As the world’s gold supply did not see a similar rapid increase, the yellow metal’s price began to twitch. The Gnomes and their speculative friends had begun casting votes against the soundness of the dollar by purchasing gold in the London market.

In order to put the kibosh on this misbehavior, the powers that be set up the “London Gold Pool.” This gold pool – made up of eight central banks led by the United States – would sell to all comers in the London market, in order to keep the yellow metal’s price fixed firmly at $35 per ounce. “We will use our gold down to the last bar,” declared the U.S. Undersecretary of the Treasury in 1968. (Nixon proved him a liar of course.)

The tide-fighting central bankers also sought to raise interest rates, knowing gold’s achilles heel is the fact that it bears no interest. But they couldn’t raise rates too much, as that would hurt the various economies in question… and the Gnomes had a powerful edge.

Simply put, the Gnomes knew they couldn’t really lose. There were too many dollars sloshing around, and the fixed $35 per ounce of the time meant gold’s false ceiling was also a floor. So if the Gnomes failed in driving the price of gold higher, their holdings would stay at $35… no real harm done.

But if the Gnomes were successful in their gold-buying drive, the London gold pool would have to throw in the towel. The price of gold could then break free from the $35 ceiling – and rise higher from that point on.

A Skip and a Hop to 1971

To make a long story short, the Gnomes succeeded in their campaign. They bought so firmly and resolutely that the London Gold Pool gave up on trying to keep the $35 per ounce ceiling intact.

After finally letting the yellow metal rise to $40 an ounce and beyond, the authorities sent out a pooh-poohing statement suggesting they didn’t really care about the market price of gold anyway.

The monetary rules were than quietly changed (surprise, surprise) so that the U.S. government no longer had to bother with redemption requests based on the market price of gold.

After that it was all a slippery slope. From the Gnome’s London victory it was just a hop, a skip, and a jump to President Nixon’s closing of the gold window. That infamous event in 1971 gave birth to our modern-day fiat currency system – a slap in the face to Gnomes everywhere.

Falling Rates, Rising Stimulus

But regimes come and regimes go, including monetary ones… and now it feels like the balance of power is shifting once again.

The whole world continues to mop its brow with the sweat of deflation worries – but that is precisely the excuse the world’s central bankers use as they chug out fresh stimulus like mad.

As for gold’s achilles’ heel, high and rising interest rates, remember which way rates are going now (straight down). The U.S. and Europe have embarked on an aggressive “reflate at all costs” program, and it is still too early to register those costs. The piper may take his time, but he always gets paid.

What’s more, the mandarins that whisper into Obama’s ear are warning him not to be conservative… not to hold anything back… to remember that FDR’s near-fatal mistake in the 30’s was doing too little rather than too much.

New York Times columnist Paul Krugman (a recent Nobel Laureate) has even said this: “My advice to the Obama people is to figure out how much help they think the economy needs, then add 50 percent.”

So we can bank on another round of jaw-dropping government stimulus being thrown into the mix. Dollars, dollars, dollars. “Don’t worry about the deficit this year or the next,” our President-elect tells us

A Gift to Wise Hands

For those who can take a Gnome’s eye view of things, the dollar’s late 2008 short-covering rally is a gift. It has given the powers that be a false sense of complacency as their printing presses run deep into the night.

We will soon wake up to a time when the world is awash in dollars it neither needs nor wants… and when interest rates drag along at rock bottom, Japan-style, in a bid to prop up the struggling U.S. economy.

When that time comes, the Gnomes will have their revenge.

Source: The Gnomes of Zurich Shall Have Their Revenge

The article starts off, “Angry Hong Kong investors, some banging gongs and others waving banners, scuffled outside a bank on Friday as frustration mounted over losses tied to investments linked to failed U.S. bank Lehman Brothers,” and “Several hundred investors, many of them elderly retirees, marched to eight banks which had sold Lehman structured products, demanding compensation for their losses” because the banks were guilty of “misleading investors on the risks involved.”

And it wasn’t just them, either, as “Investors in Singapore and Indonesia have also hit the streets in protest, expressing outrage that the failed products they bought were actually complex derivatives.”

Now, normally you would think, “What a bunch of dummies! Demanding compensation for their losses just because some slick stock and bond hustlers talked them into sinking all their hard-earned money into some now-worthless crap? Hahaha! Welcome to the real world! And now they want their losses covered by the government? Hahaha! What do they think this is, communist Russia? Hahaha!”

Apart from the fact that the English philosopher Herbert Spencer said, “The ultimate result of shielding men from the effects of folly is to fill the world with fools”, the joke is actually on me, as these Asian investors actually think that they deserve compensation for their stupidity by using the stupidity of us Americans as a model, as our stupid government and central bank are creating untold zillions of dollars to do that very thing!

And part of it is first jacking up Total Fed Credit to get the new credit into the banks, and sure enough, it was up another stunning $62 billion last week, taking the total to a staggering $1,872.948 billion, which is up an also-staggering $1,010.325 billion in the last year! My God! Total Reserve credit was up more than 117% in a year! A freaking year! Twelve months! More than doubling!

And if you are one of those people who write to me and say that I am just a stupid guy with bad breath, poor posture, and minimal social skills, I can only say “Touche!” but one of the few things I do know is that an increase in the money supply means that there will be an increase in consumer prices as all those additional dollars end up bidding for things in one marketplace or another, thus driving up their prices, and pretty soon the prices of food and energy and housing and everything else are rising so much that it is causing distress among the poor, and they are rioting in the streets, while the middle class will be drained of every penny’s worth of buying power, gold will be shooting to the moon in response to a devalued dollar, and you Earthlings will realize the True Mogambo Significance (TMS) of having gold, guns and grub, because no matter what happens, with those you can buy your way out, shoot your way out, or wait out a siege, in which case you will want to stock your bunker with tasty grub, extra ammo, and enough booze to deaden the horror of watching the outside world disintegrate under the onslaught of so much inflation.

On the other hand, one can infer the same thing from the fact that the new Gross Domestic Product Deflator is 4.2%! In other words, inflation in prices is, across the entire aggregate economy, 4.2%! Yikes!

This is so horrifying that during Halloween a few weeks ago, I made a last-minute decision to change my choice of costume. Originally, I was going to dress up as the beautiful ballerina whose heart has been broken in a tragic misunderstanding and ultimate betrayal, and who is now packing an Uzi to track down that lying bastard and make him pay, big-time.

Instead, I went as inflation; I stuck the head of a doll into my mouth so that it looked like I was eating somebody alive. When I knocked on the door, a man answered and we all said, “Trick or Treat!” and then the guy looked at me and asked, “What are you supposed to be?” I told him, “I am inflation, and I eat people alive!”

Mostly, the joke fell flat, and the rest of the conversation quickly turned to why a raving lunatic my age would be trick-or-treating among children, and wearing such a disgusting and incomprehensible costume, too.

I told him, “Because the new GDP deflator was 4.2%, you moron! And if that is not enough of a ‘trick’ for you, then you are too stupid to have candy, and so I am going to take all yours! Hahahaha!” Then I made a grab for the bowl of candy he had, and we tussled back-and-forth over it, candy flying everywhere, him yelling to his wife to “Call the cops! Call 911!” and me yelling back that he is a moron who doesn’t deserve any damned candy because inflation in prices, as a result of this insane inflation in the money supply means he won’t have any candy because nobody will be able to afford to buy candy, and the inflation is going to kill everybody, including him and all these stupid little kids, whereupon all the kids ran away, screaming and crying, and I was yelling, “If you think that this 4.2% GDP deflator is bad, you little morons, wait until the rest of the inflation in prices gets here as a result of the trillions and trillions of new dollars in various stimulus packages being concocted Around The Freaking Globe (ATFG), with more and more to come!”

By this time, I suddenly lost my grip on the candy bowl and the door was rudely slammed into my face. I kept ringing his doorbell and yelling for him to open the door and get a taste of the misery of inflation that all these trillions of new dollars are going to cause, and how he is an idiot to be cowering in there and spending his money on stupid trick-or-treat candy instead of spending it on gold and silver.

I was getting louder and louder, until I saw a police car turning the corner. Then I figured I had imparted enough wisdom, and snagged enough free chocolate candy, for one night.

It was the least I could do to help a neighbor!

Source: Shielding the World from Financial Folly