Be Careful what You Wish for, You Just May Get it

The Bible teaches: "You can't change other people, you can only change yourself". Will We Ever Learn?

Are Obama and Geithner looking to start a trade war with China? Did they learn nothing from the latest skirmish between Japan and China, whereby China, producer of 95% of the world's rare earth metals, halted shipments to Japan over a fishing dispute? Don't they realize that, for now, China is holding all the cards?

The last time China's currency rose dramatically, the biggest economic crisis since the Great Depression followed! (This was then largely due to the Smooth Hawley Trade Protection Bill, which lead to retaliations and depression). This time it could be worse... After months of pressure from the U.S. Government, the Chinese Yuan is once again starting to rise versus the dollar. Perhaps the time has come to shift more cash and other assets into currencies and other investments poised to benefit from a stronger Yuan. Just like last time, not only will you protect your wealth, you could also make some real profits.


With the FED Ready to unleash QE2 on a money printing and Treasury buying binge, Gold if it does have a correction, it will be quite shallow. As with all real bull markets, Gold is climbing a wall of worry while the public remains unaware and under-invested while mainstream media commentary is sparse and skeptical. The primary trend remains up and short term pullbacks are to be expected. It's no secret that Gold has taken off like a rocket, But what some people may forget is that Gold prices are now more than five times higher than when I began urging readers to buy Gold bullion ten years ago. (And still 92% of the Investing public does not own Gold). Plus, I've been repeating this recommendation in every single letter since. Not only that, I have kept on encouraging you to view every correction as a golden opportunity to increase your positions. Nothing Has Changed nor will it, until we get a major shift in economic policy out of Washington. So, I am sticking to my projection that I made back in 2005: $6,250 by 2017. Don't fear corrections, they are Golden Buying Opportunities.


For those of you who can't stand prosperity and are having trouble sleeping, here is a downside protection strategy.

Buy the GLD Dec. 132 Put for $3.90 while simultaneously selling the $132 Call at $4.30 for total cash received of $0.40/share. You are now protected to the downside, BUT you have limited any upside potential. If you are right and we get a 10% correction down to $120, you then sell your Put for $12 and buy back your Call at $1. You pocket $11/share and you are ready for the resumption of Gold's Bull Market Rally. This is not a recommendation. It is only a sleeping pill if you need one.


We are witnessing one of the biggest disconnects ever- Once we examine the realistic economic fundamentals that I have highlighted in my last 4 or 5 missives and compare them to the performance of the stock market, they seem to be going in opposite directions. Let us now consider what we've learned:

o Consumer confidence plunged in September to 48.5 from 53.2 in August. That was far below the 53 reading economists were expecting, and the worst in seven months. o The Richmond Fed's manufacturing index plunged from 11 in August to NEGATIVE -2 in September. Economists were looking for a reading of 6. That was the worst since January. That followed the Dallas Fed report that stated: That the region's index tanked to -17.7 from -13.5 in August. o New home sales flat-lined at 288,000 in August, the second worst month in U.S. history. Home prices fell to their lowest level since December 2003. Builder confidence held at the lowest level since early 2009. Existing home sales bounced a bit, but they recouped less than a third of their 27% July swan dive.

Simply put, the situations in the real world are getting worse! But on Wall Street it's Bull Market time and Investors, according to the latest Sentiment figures, are essentially the most bullish they've ever been even though volume continues to shrink. These are usually very Bearish signs and yet September's performance has been the best of any September in over 70 years.


Is the Promise of a November Republican Landslide and More Free Money (QE2) Distorting Markets?

It used to be that asset class performance closely tracked the underlying fundamentals. If oil supplies rose, oil prices fell. If income, jobs, production, and corporate profits gained, so did stocks. If the economy improved, bond prices fell and interest rates rose.

Today stocks, bonds, commodities, and other assets are trading in virtual lock step thanks to the Fed's most dramatic intervention and interference in the markets of all time. All it takes is a whisper of "quantitative easing" and stocks and bonds and of course GOLD and all commodities take off.

Is it possible that this time around it really is different? I think not!

Stated another way, the fundamentals mostly haven't mattered lately. Stocks are reacting to the prospect of the Fed debasing our currency. That debasement is driving up all asset classes, especially Gold and Silver as well as contra-dollar investments.

But the Disconnect Simply Cannot Last

Stock market bulls would have you believe this will last to infinity and beyond. "Don't fight the Fed," they say.


I have learned the hard way that Reality Always Wins Out In the End. "If everybody knows something, then it is not worth knowing," not as far as making money is concerned UNLESS you are prepared to go against the CROWD.

"Fighting the Fed" may sting a bit in the SHORT TERM, but it has been an incredibly successful strategy over the LONGER TERM.

For instance …

You could've "fought the Fed" by shorting the heck out of housing and mortgage stocks even as Fed officials (Bernanke) assured us that the problems in those sectors were "contained." Doing so would have made you a fortune!

You could've "fought the Fed" by selling stocks into every single interest rate cut between 2007 and 2009. The Fed first lowered interest rates from 5.25% in September 2007. The Dow traded near 14,000 then. It proceeded to plunge to 6,470 over the ensuing interest rate cuts.

The list of Fed policy failures and economic forecasting blunders goes on and on and on. So to answer the question I've been hearing lately, "Is it Time to Start Buying Stocks?" The answer is NO; I wouldn't be buying stocks because of the Fed. I'd be selling into the rally and/or positioning for downside gains in vulnerable sectors using options and inverse ETFs.

And unless and until the real economy takes a turn for the better, the FED's QE2 program will ultimately fail and this rally will probably end with the election results. (within 2 weeks, then watch out below)


The inflation/deflation debate is now the 'topic du jour' and although I have discussed this issue many times in the past, I think that it is time to re-examine the conundrum. Today, many prominent economists (Nouriel Roubini, David Rosenberg and Paul Krugman) and fund managers (Bill Gross and Jeremy Grantham) are forecasting deflation and according to these folks, a deflationary contraction is now 'baked in the cake'. In fact, these deflationists are extremely worried about the ongoing private sector debt deleveraging in the developed world and they are also concerned about the lack of aggregate demand. Bear in mind that these factions are Keynesians and thus believe that deflation is now almost guaranteed and inflation is out of the question.

On the other end of the spectrum, and in stark contrast to the deflationist camp, are many prominent market participants (Paul Tudor Jones, John Paulson, Jim Rogers, Marc Faber and Peter Schiff) including me, who are now warning about high inflation or even hyperinflation. According to these people, the large fiscal deficits and massive debt overhang almost guarantee runaway inflation.

It goes without saying that such conflicting views are extremely strange when you consider that all these highly experienced and successful people are reviewing the same economic data! Well, everyone is entitled to their opinion, but as far as I am concerned, deflation is an urban myth and the global economy will have to contend with very high inflation. More importantly, when you are in doubt as to who to listen to check their individual track records. If they did not foresee the problems that we are now in, what makes you think they suddenly found G-D and discovered the solutions? I always believed that doing more of the same as what got us into trouble is the first place while expecting a different outcome this time around is the definition of INSANITY. The first thing I do when I get a headache from banging my head against the wall is I stop banging.

It has always been my contention that inflation is a monetary phenomenon and short sighted policymakers always have the ability to create inflation. Now, before I go any further, I want to make it clear that inflation is an increase in the supply of money and credit (debt). Conversely, deflation is a decrease in the supply of money and (credit) debt. Furthermore, it is critical to understand that an increase in the general price level is a consequence of rapidly increasing money-stock and credit and a decrease in the general price level is a consequence of a falling money supply and credit. Most importantly, despite what you may hear elsewhere, you should keep in mind that a booming economy (operating at near full capacity) is not a pre-requisite for or a cause of inflation.

If you reside in the deflation camp and believe that inflation cannot occur in a weak economic environment, you need to visit Zimbabwe and meet Mr. Mugabe who will explain how you can create hyperinflation at a time when a nation is in an economic depression! Whether you like it or not, Zimbabwe's hyperinflation clearly shows that despite a huge drop in GDP, surging unemployment and a bankrupt economy, reckless policymakers can succeed in creating hyperinflation.

So, while the economies of the developed world are struggling and will be operating below trend for several years and aggregate demand will stay well below their available capacity, contrary to the deflation camp, the money creation abilities of the central banks will be operating FULL BLAST. In order to avoid sovereign defaults in the near-term, the Federal Reserve and the European Central Bank will create unprecedented amounts of new "out of thin air" money.

Short-term interest rates in both the US and Europe are at extremely low levels and real short-term interest rates are negative. If such a loose monetary policy fails to create inflation, you can bet your bottom dollar that these central banks will unleash even more rounds of 'Quantitative Easing'. Needless to say, such reckless monetary inflation will INFLATE (dilute) the existing money-stock even further and reduce the purchasing power of money.

As far as the private sector is concerned, the credit bubble burst two years ago. Commercial bank credit in the US started to contract and debt repayment by the private sector was a logical response to the crisis and for 17 months, commercial bank credit declined by roughly US $700 billion. In fact, it was this private sector debt contraction that prompted many economists and investor to enter the deflation camp.

While it is true that the private sector in the US did experience deflation (contraction in debt) for a brief period of time, it is notable that this 'austerity' did not last very long! US commercial bank credit bottomed out earlier this year and since then, it has risen by roughly US $400 billion. So, it should be clear to all observers that the private sector in the US is no longer de- leveraging but is it inflationary? It also seems that a "Take Over" craze is also beginning.

Furthermore, I would like to point out that even though commercial bank credit in the US contracted between October 2008 and March 2010, during that period, America's federal debt went through the roof! Ironically, during the time frame when American households and corporations were tightening their belts, the US Treasury borrowed US $2 trillion thereby stopping deflation in its tracks. The truth is that at no point during the Recession did total debt (private sector plus Federal) in the US contract, so deflation did not occur. Now, it is conceivable that the private sector in the US may abruptly start repaying its debt again. However, if such a debt contraction occurs, Mr. Bernanke will create money like there was no tomorrow.

Today, America's total liabilities (including Social Security, Medicare and Medicaid) are around 800% of GDP and federal debt has climbed above 90% of GDP. Given the fact that deflation will increase the real value of this debt, you do not have to be a genius to figure out that before the US Government declares bankruptcy, it will desperately try and inflate its way out of trouble by unleashing another 'stimulus'. The current administration will try and maintain nominal GDP growth, so that nominal incomes and tax receipts are sufficient to service the outstanding debt.

QE2 should begin any day now in a last ditch effort by the government to save the election for the party in power.

It is interesting to observe that in order to fund its spending binge, so far the US Administration has succeeded in borrowing huge amounts of money at low or zero interest rates. It is notable that up until now demand for US Treasuries has been strong and the US Administration has not had much trouble raising money. Perversely, in today's volatile economic environment, US Government debt is still viewed as a safe haven. However, all good things must come to an end and investors' perception could and will change virtually over night. When that happens and the bond market starts to focus on America's ballooning deficits, demand for government debt will dive. At that point, the Federal Reserve will have no option but to create new money so that it can lend it to the US Treasury. In fact, the Federal Reserve has already announced that it will use the proceeds from the sale of its mortgage-backed securities to buy US Treasuries. It's my view, that this is only the beginning of outright debt-monetization which will intensify over the coming years.

Throughout history, periods of massive money creation have always been inflationary and this time should be no different. Over the following months, if the economies of the developed world take a turn for the worse, you can be sure that the respective policymakers will respond by creating copious amounts of paper money. That is their only option OR so they think.

Given the inflationary environment we find ourselves in, I do not like cash or fixed-income securities. In my view, both cash and bonds will lose considerable real value and the ongoing strength in the government bond market (the world's BIGGEST Ponzi scheme) will also turn out to be the history's BIGGEST BEAR MARKET. Conversely, I maintain that precious metals will provide stellar returns in this inflationary environment. I am not so sure about energy and the stock markets of the fast growing developing markets. They may initially crash as well, but then present stellar buying opportunities.


The US Dollar has collapsed 13% in the last four months alone... while Gold has skyrocketed from $1,170 per ounce to a new all time high of $1,370+ per ounce... in just TWO MONTHS! A 13% drop in a currency in just four months is a HUGE deal. While brain dead guys like Geithner and Schumer blather on about how China is manipulating its currency, the US Federal Reserve makes China look like pikers and is literally TRASHING the Dollar... setting the stage for a full-scale currency collapse in the US Dollar as China and the rest of the Worlds' large holders of Treasuries are gradually unloading their holdings making the US the largest owner of US debt. We're actually PRINTING money just to buy our own debt until eventually we will own it all and what do you think the value of the dollar will be then?


Continue to buy GOLD and Silver and their respective stocks. Take some initial positions in Uranium and Rare Earth Stock But most of all keep your powder dry for Now. We are about to be presented by the best shorting opportunity of our life time: Which will probably occur about the time of my next Missive. (Nov. 1st)




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Aubie Baltin CFA, CTA, CFP, PhD.
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The Incas thought gold represented the glory of their sun god and referred to the precious metal as “Tears of the Sun.”

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