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Stop me if you’ve heard this one before….  The dollar and financial stocks fall, while gold and oil rise.  Damn, you already heard that one somewhere else? 

It’s a familiar refrain that seems to keep repeating, just like an obnoxious Barry Manilow song or that annoying dog commercial that goes “there might be bugs on some of you mugs but there ain’t no bugs on me”.  (Ha - now you’ve got it stuck in your head too!)

The reason that oil and gold continue to trend higher while the dollar and financial stocks continue to trend lower is one and the same - the Federal Reserve. 

The Fed continues to flood the system with cheap and/or free money.  It’s simple supply and demand.  There are more and more dollars but there hasn’t been a corresponding increase in the demand for those dollars.  So the amount of stuff a dollar will purchase continues to fall.

It’s called inflation, and it’s always CAUSED by the same thing - too much money chasing too few goods.  The classic way to explain inflation is that inflation “is always and everywhere a monetary phenomenon” (Milton Friedman) but it’s saying the same thing.

Even though this is nothing new, I’ve found that damn few people actually understand it.  And the more involved they are in the stock market, the less likely they are to understand it.  They blame inflation on rising wages, or rising oil prices, or the rising cost of (insert commodity here). 

They don’t understand that rising prices are CAUSED by too much money.  When the Fed injects billions of dollars into the money supply (without a real demand for the money) prices HAVE to go up. 

Pretend I have a blog that lots of people read (we’re pretending!) and visit everyday.  Now I take the blog posts that I write and post them on 7 other sites as well.  Assuming more people don’t want to read what I have to say, the number of people visiting each site would go down - even though the total number may stay the same.

Ok, maybe that isn’t the best analogy…. Try this one.  8 people are standing around a barrel of oil.  They all need that barrel of oil, and they’ve all got about $5 to use to purchase it.  Guess what the price of that barrel of oil will be?  Yup, about $5.

Now imagine that Uncle Sam gives (or lets them borrow cheaply) each one of them another $5.  There’s still only one barrel of oil, and all of them still need it.  How much will that barrel cost now?

Does that help?  That’s what the Fed is doing with dollars.  Helicopter Ben is doing everything he can to keep the over-leveraged financial institutions afloat, but he’s simply buying time.  Borrowing money to pay off debt never works - it simply delays the inevitable.

As the dollar loses value (because there are more of them in circulation) the amount of “stuff” each dollar can buy MUST go down.  So things like oil and gold go up BECAUSE the dollar is worth less. 

This sometimes isn’t obvious because with commodities like oil and gold (and corn and soybeans and wheat and rice and pork bellies) demand can also fluctuate and cause price movements, but the underlying cause is the same.  Too many dollars in the system.

Anyhoo, the major financial institutions all owe waaay more than they own.  And they’re finding out that as the value of their assets (and the payments they receive from those assets) fall, they suddenly can’t make the payments on their debt anymore.  But then the Fed comes riding in and lets them borrow more money (using the same assets which are falling in value as collateral) and suddenly everything is supposed to be ok…. Brilliant! (Not!)

There was a report by Reuters today saying “Federal Reserve Chairman Ben Bernanke told Freddie Mac chief Richard Syron that his company and Fannie Mae could take advantage of the emergency discount window, according to a source familiar with the conversation.” 

Since it’s pretty obvious to everyone that Fannie Mae and Freddie Mac are insolvent and going under unless someone steps in, this report was a catalyst for a huge rebound in the market today.  Investors were grasping at straws looking for something, anything to save the sinking financial ship.  They grabbed onto this report and stocks reversed course over 200 points and were even briefly into positive territory today.

Then they realized that even if the report was true, it didn’t change a damn thing.  So the market sold off again into the close. After the markets closed, the Fed denied the story - but I won’t be surprised if the Fed takes action over the weekend like they did with Bear Stearns. 

They know the companies are technically bankrupt, and they’ve got to act at some point.  I don’t know what they’ll do, but they won’t stand by while the ship sinks.  They’ll continue to bail water, only to eventually figure out that the water is coming in much faster than they can bail it out.  The ship will still sink, but they can drag out this soap opera for months. 

In my opinion, they should let it sink now so we can start building the new ship.

gk

Back in January, I posted a short article basically saying that it was way too early to call a bottom in financial stocks.  I had been reading an article on TheStreet.com by Doug Kass where he made the case that it was time to buy the financial sector, via XLF.  

While I agreed with much of his analysis, I didn’t think the financials were anywhere near a bottom - most banks and brokerages simply hadn’t taken into account the full impact of the sub-prime mortgage debacle.  Those relatively few bad mortgages were so highly leveraged that just a few percent failure rate is enough to make the whole house come tumbling down.

Despite the best efforts of the Fed, Bear Stearns has disappeared.  It took a $30 billion taxpayer backed guarantee to do it, and I think the buyout simply swept the underlying problems under the rug and out of sight - for a few months.

The last few months are looking more and more like a rehash of the Internet bubble and the resulting bear market from 2001 through 2003.  during that time, I lost count of how many times I heard things like “buy and hold”, “stay the course”, “this is a great buying opportunity”, etc. 

The people who listened “to the experts” back then STILL aren’t back to even on their investments, while those who got out and waited for the smoke to clear are way ahead.  Those of us who are conservative investors, who follow broad trends and don’t move in and out of the market very often know that this isn’t the time to buy back in.

Could this be the bottom?  Sure - but I don’t think so.   I move in and out of the market in my 401K based on the crossover of the 75 day EMA and the 200 day EMA.  I usually go with an S&P 500 index fund, and here’s what the chart looks like today.

The 75 and 200 day EMA’s are nowhere near signaling the start of another bull market, so my retirement money is 80% in cash and 20% in overseas funds.  I’m down about 4% for the year - how’s your 401K YTD? 

If you’re still fully invested (like the “pro’s” tell you to be) you’re down over 12% YTD, and you’re right back where you where in July of 2006.  If you’re retired and you’ve been fully invested for the last decade, you’re right back where you were in March of 1999. 

9 plus years and zero return - how’s that “buy and hold” strategy working for you?

Anyway, it’s time for a check on Mr. Kass’s buy call on XLF.  I normally don’t make a big deal about stuff like this - after all, analysts make bad calls everyday - but he titled his original analysis “Buy the Financials. Yes, Buy” to emphasize what a great opportunity it was.  So, let’s see how XLF is doing since Jan 14th.

XLF closed at $27.88 on Jan 14th.  It closed today at $20.57.  That’s down $7.31 - or about 26% in about 6 months. 

Great timing on the “Buy the Financials.  Yes, Buy” call Mr. Kass!  I hope you haven’t screwed over too many investors with your advice.

In my original post, I made this prediction: “In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.”

Since I recomended investing in commodities instead of stocks, let’s see how my pick (gold) is doing.  Gold closed at $903.40 on Jan 14th, and it closed today at $931.30.  That’s up $27.90 - or about 3% in 6 months.

Yup, gold is up just a tad, and it’s actually off the highs of a few months ago.  It’s also just come back up over $900 after being stuck in the $860 to $890 range for a while - I mention that because it just came back up this week, and I don’t want to appear to be trying to hide that it’s been lower.

But as long as the Fed keeps printing extra money (inflating the supply) the dollar will keep falling, so gold will continue to hold its’ value for now. 

Only if Bernanke gets serious about fighting inflation and ensuring a stable dollar (which is the Fed’s primary purpose - read the Fed website if you don’t believe me) will the dollar rebound and gold fall.  And “Helicopter Ben” isn’t Paul Volker, so it ain’t gonna happen anytime soon.

For you too young to remember the late 70’s, inflation was high and the economy was stagnant - the term “stagflation” was coined to describe it.   We’re in the early stages of it now, and unless we get the Fed to grow a pair of brass balls, it’ll be 1980 all over again.

Raising rates and restricting money supply killed the stagflation, but it also caused a deep recession.  But that recession led to one of the greatest bursts of prosperity this country has ever seen.   We can do it again - if the Fed would administer the medicine.

As is stands, Bernanke is simply trying to keep a sinking ship afloat.  He doesn’t want a deep recession (or worse) to mar his tenure.  After all, he is an “expert” on the Great Depression, and he know’s what he’s doing.  Just like the experts calling repeated bottoms in the stock market.

I didn’t come up with any of this on my own.  Read  Warren Buffett’s annual letters to shareholders.  Read Phil Town’s “Rule #1″.  Read damn near anything by anyone who isn’t a Wall Street “expert”.  Their jobs are going away as the companies they work for are revealed to be a highly leveraged house of cards.  They’re running scared and are trying anything to keep up the pretense of the 80’s and dot com years.

What about the next 6 months?  I don’t see the financials (banks and brokerage houses) coming clean with their books yet - many are still pretending that their “level 3″ securities are still worth a lot of money.  Until they ‘fess up and take the losses they’ll just be on a long slow bleedout. 

This part is simply a guess, but I think Goldman Sachs is priced way too high.   At some point I think they’ll come down to earth just like the rest of the investment banks.  This might sound “out there” but I would not be suprised to see GS lose 50% (or more) of their value over the next 2 years.   Maybe sooner.  Something is fishy in their financial statements, but I can’t put my finger on what.  Just doesn’t smell right….

Back to the “hard vs soft stuff” that started this.  Don’t take my word for it - read and look at the situation for yourself.  Decide where to put your money because YOU want to put it there - not because some so-called “expert” on TV or the Internet said “Buy the Financials.  Yes, Buy”.

gk

Read this.  Please.  It’s the annual report from the Social Security and Medicare trustees, and it has bad news for anyone who doesn’t already have one foot in the grave.

If you pay taxes, you will be paying more - a lot more - sometime soon.  The annual report contains all the numbers in black and white, and all that money has to come from somewhere. 

Medicare will pay out more than it brings in starting this year.  For 2008, Medicare is only projected to be $8 billion in the red, but that translates to a $16 billion increase in the deficit.  Why?  I’m glad you asked!

For years the government has been taking the “excess” revenues from Social Security and Medicare and “investing” them “in special non-marketable securities of the U.S. Government on which a market rate of interest is credited.” 

In other words, the government takes the money, writes an IOU (promising to pay it back with interest) to Social Security and Medicare, and spends it as part of general revenue.

That’s your trust fund.  There’s no money in a bank account drawing interest, there’s no gold in a vault, there’s no stock certificates.  There’s just a huge pile of government bonds (IOU’s) in the administration building.

Maybe that doesn’t make it clear so let me try explaining it this way….  You deposit $500 into an account (let’s call it a trust fund just for the hell of it) then - promising to pay yourself back - you transfer it to another account and spend it. 

You could even print out your IOU to yourself and stick it in a pretty box.  You do the same thing the next month.  And the next.  And the next….

After a year, how much money is in your trust fund?  Exactly nadda, nothing, zip, zilch, squat. 

You can’t take money out of one pocket, put it into the other pocket, and spend it.  Well, technically you can, but you haven’t saved anything.  And there’s no money left (you spent it on other things) to put back into the first pocket.

I hope that clears up the mystery of the Social Security and Medicare trust funds.  To put it bluntly, there’s no money in them.  Zip.

But the government stills owes that money to itself - or more accurately, they owe it to the designated recipients who have paid into the “trust fund.”  That’s you and me.

So where do they have to go to get the money they’ve promised to pay?  There are only three ways for the government to get money; taxes, borrowing, or printing more money - or a combination of these. 

Which one should they use?  Let’s take a quick look at the choices:

1) Taxes.  The government can raise taxes to cover their expenses.  Since we’ve run a deficit for years, I don’t think they’ll do this - which is actually the option which would cause the least pain for all. 

2) Borrow: This simply means they sell more bonds to foreigners.  We get to use their money and simply make payments on our national interest only loan.  Hey, it’s working out great for homeowners!  Right?

3)  Print more money:  Sounds, good - after all, the government makes a profit on each dollar they print.  It costs less than a cent to print a dollar bill, and it’s worth $1 - before inflation anyway.

See, there’s this little thing called supply and demand that refuses to go away.   When you make more of something without a corresponding rise in demand, each one of them is worth less.  Make too many, and each one is worthless.

That’s why we have inflation - we print dollars with nothing standing behind them.  The money supply (the supply part) rises faster than the economy grows - the demand side.   Rising prices for “real” stuff like oil, gold, wheat, and milk don’t cause inflation - they’re caused by inflation.

Read that paragraph again, it’s important.  Most people (even bankers and some of the fed board) don’t “get” this basic fact of life.

Anyway, the government will need to get the money to pay Social Security and Medicare benefits from somewhere, so my bet is that taxes, deficits, and inflation will all be a big part of the years to come. 

And if you think the deficit is big now, you ain’t seen nothing yet.  You can ignore those “pull the numbers out my ass” deficit projections from the government - because they actually assume that the money from the Social Security and Medicare trust funds are there!

I don’t know what “real” stuff will be worth in a week or a month, but gold, oil and silver will be a lot higher 10 years from now.  That’s where my money is.

gk

As regular readers know, I think that the price of “stuff” will go up long term as the dollar continues to fall - and the dollar will continue to fall long term, as our governemnt prints more pretty green pieces of paper.   So why have commodities (gold, silver, oil, wheat, etc.) dropped so much over the past 2 days?

The short answer is that I don’t know.  How’s that for sticking my neck out? 

From what I’ve read and heard, it’s a combination of two distinct factors:

1) The market had priced in a 1% drop in interest rates, and the Fed only dropped 3/4%.  So traders think that the Fed is now hawkish on inflation.  (Yup, I think it’s weird too.)

2) The US is definitely going into a recession.  That means that demand for commodities will drop as consumers spend less. 

Of the two reason given for the drop, I’m inclined to think that #2 has more validity than #1.   Not that I think that’s a bad thing!  The US needs to spend less.  The average US consumer is in over their head with debt.  Collectively we need to stop spending more than we earn - and the same goes for the US Government.  If the dollar is to rise long term, we need to stop spending more than we make.

We need to pay off old debt and stop taking on new debt for awhile.  We need to accumulate capital so that our banks don’t have to drop their trousers and bend over for money from Sovereign Wealth Funds in order to stay in business.  A little actual capital would have prevented Bear Stearns from being bought out for $2/share.  Of course, that was us (the US) doing the “buying”, but now we’re all on the hook for $30 billion of Bear Stearns’ over-valued mortgages.

I don’t know what the next shoe to drop will be - or how the markets will react to it.  In spite of the fact that CIT Group (not to be confused with CitiGroup as I did at first!) today announced that they didn’t have any money on hand and needed to borrow $7.3 billion to stay afloat, the US stock markets all went up today.  And the commodities all dropped. 

Side note:  I like the headline on the CNN article I linked to - “CIT Borrows $7.3 Billion to Repay Debt“  I’m still trying to figure out how borrowing money to repay debt works….

Anyway, despite the news of yet another financial company having problems, the stock market shrugged it off and the DJIA soared 261 points.  XLF (an ETF that tracks all the financial stocks in the S&P 500) was up an astounding 6%!  But I think that we’ll see this sector plumet at some point as this mortgage inspired credit crisis unfolds.

Remember that very few of the ARM’s and Option ARM’s that were handed out at the peak of the housing bubble (2005 through 2007) have reset to higher rates yet.  A lot of those mortgage holders are making minimum payments on their interest only loans.  This is far from over, and I’m hanging on to my gold ETF.  I’m also buying silver when I find it cheap on eBay.

In other words, I’m using this drop in commodities as a buying opportunity.  I don’t know about oil, wheat, or corn (they depend too much on the economy) but I expect to see a big rebound in precious metals sometime soon.  And when that happens, I’m betting that the rebound in precious metals will coincide with a drop in the financials.

gk

From the 400 point rally today in the stock market, you’d think that the bulls are running rampant in Pamplona.  And you may be right, however….

Stocks are still down over 10% for the year.  The highly leveraged banks and Wall Street firms are still highly leveraged.  Massive amounts of mortgage backed securities - and their higher default rates coming this year and next - are looming.  When a CDO takes a 10% loss because the home owners can’t make the payments, that translates to a 300% loss on a 30 to 1 leveraged portfolio such as Bear Stearns and Lehman Brothers.  (Citigroup is also highly leveraged.)  The $2/share Fed ”take it or leave it” financed JPM buyout of Bear Stearns still needs to be approved by shareholders.  Hmmm…. How would you vote if you owned BSC?

As I’ve written before, this unwinding of the leverage in the financial markets will take quite awhile.  The longer the Fed props up failing companies, the longer it will take to hit bottom.   JP Morgan is getting a deal only because the Fed is guaranteeing $30 billion of BSC’s “assets.”  They’re not really worth $30 billion, but the Fed took that much risk away from JP Morgan.   That’s $30 billion that US taxpayers will end up spending to finance this bailout - because the underlying securities are “riskier assets.”

 A couple of weeks ago, I thought we were headed for a repeat of the Carter years and stagflation, but it’s beginning to look more and more like we’re repeating Japan’s mistakes of the 1990’s.  Low interest rates, keeping bad debt on the books (instead of recognizing the loss and getting it over with) propping up banks with fake assets on their books, etc. 

Japan still hasn’t fully recovered from the 1990’s.  I sincerely hope that we don’t continue making the same mistakes, but today’s 3/4% drop in both the discount and Fed funds rates isn’t helping.  That only serves to drive up long term inflation, and that (rather than deflation that I’m reading about) is my long term worry.

As regular readers know, I don’t try to predict short term market swings, I simply try to stay on the right side of the market during long term trends.  I don’t know if today’s action signals a turnaround or not; my gut says no - because of the reasons listed above - but my gut doesn’t make the market move.

Regardless, I don’t see any fundamental change in the long term trends of the dollar going down, commodities (especially gold, silver, corn, and oil) going up, and the broad market (especially financials) going lower.

My feeling is that the majority on the street think that the worst news is behind us; that most people are looking for a reason to buy.  They’ve discounted all the bad news and they’re ready for another bull market.  I don’t think they’ll get it just yet.

Too many firms have too much debt.  Too many firms are leveraged enough so that a small change in the base assets (mortgages in most cases) results in a huge change to their balance sheets.  One little piece of unexpected bad news will be enough to cause a dramatic sell off.  I’m talking about a sell off big enough to trigger a halt to trading. 

I think the coming upswing in the foreclosure rate (because of all the ARM’s taken out in 2005 through 2007) hasn’t been fully factored in to the stock prices of the companies that are using these mortgages as collateral on their loans. 

When people realize how little capital is propping up these companies, share prices will drop.  The dollar will drop, and commodities will rise.  Again, I have no clue what the market will be at in a week or a month.  I don’t know if commodities will be higher a month from now or not.  But I’m betting that 10 years from now, you’ll be glad you bought gold at $1000/oz, silver at $20/oz, oil at $105/barrel, etc. 

If we really are following the deflationary path Japan took in the 90’s, the Dow may well be at 7000 10 years from now.  As it stands, buy and hold investors are down from where they were 8 years ago….  How much longer do we need to prolong the agony? Take the losses now, write off the sub prime and alt-a loans, get it over with!

Of course that’s just my opinion, I could be wrong.  :-) 

gk

Given the posts I made earlier tonight, I’ve been thinking that instead of just outlining the problems of today (and how much worse it’s going to get) I should talk a bit about what to do with your money to allow you to keep more if it during this downturn - or worse - of the economy.  So shooting from the hip, here are my thoughts.

1) Pay down debt.  If you’re one of the idiots who bought more house than you could afford, or who took out HELOC’s and second mortgages to “access your home equity” this doesn’t apply to you.  You’re toast.  You’re the problem.  For anyone who has a reasonable amount of debt - which I’ll arbitrarily define as totaling no more than 50% of your gross annual pay - I suggest paying it down as fast as possible.

When the shit hits the fan, you need to be able to live as long as possible on your savings.  Just imagine how much money you’d have each month if you didn’t have any payments!  If you’ve got a car payment, sell the freaking car to get rid of the debt and payments.  Buy a cheap car that runs good. Build up a small emergency fund by making minimum payments on everything and saving every dime you can.  You need at least one month’s worth of expenses saved up. 

Then (as Dave Ramsey would say) “act your wage”.  Live on less than you make so you can start paying off the debts.  Stop eating out, stop renting movies, get rid of your cable or satellite service, collect coupons, etc.  Cut your bills to a minimum and get out of debt.

2) Pile up cash.  Continue your frugal budget and save at least 6 months worth of expenses.  This money needs to be in your local FDIC insured bank in a simple savings account.  I don’t care about the interest rate - the object here is to save money, not grow it.  It needs to be easily accessible, so that means no CD’s or other investments.  This is your cushion for the dismal day when you don’t have a job.

That 6 months of expenses you save gives you time to plan, to look for a better job, to avoid despair, if and when you don’t have an income.

3) Fund your retirement.  Save at least 10% (and you’re much better off if you can save 15 or 20%) of your gross pay in an IRA.  Use your 401k at work if you have one.  Most employers have some sort of matching program, so be sure to contribute enough to get the full employer match.  Put the rest into a self funded IRA - you can open an account online with for as little as $50.  I use Scottrade and TD Ameritrade, but there are dozens of others.  Just do it!

I think a Roth IRA is best - taxes WILL be going up over the coming decades.  A Roth IRA is funded with after tax dollars, and the earnings are tax free.  That might not be much difference right now, but it will when tax rates hit 50 and 60%.  (If that seems extreme and alarmist to you, just wait.  I’ll have more to say later!)

If you’re putting in a big pile of money, be sure to spread it out among various large funds.  Be sure to include international funds (to take advantage of the tanking dollar) and I don’t think you can go wrong in the long run by putting a decent chunk (say 10%) into a gold or silver fund.  10 years from now you’ll be glad you did. 

Personally, I’d stay away from Asia, as the tightly regulated economy (and zero transparency in the numbers the governments provide) will eventually drag them down.  The China bubble may be popping now - although most “experts” say that the Chinese government will keep things propped up through the Olympic games later this year.

If you’re just starting out, pick a few good index funds and contribute each month.  You’ll be automatically dollar cost averaging, which in effect allows you to buy at a lower average price.

4)  Invest in staples.  No, not the office supply company (I don’t have an opinion on them) I mean consumer staples - the things everyone needs regardless of the economy or job situation.  This is stuff like food and clothing.  As times get tougher, people will spend as little as possible on everything - but they have to eat. 

Where’s the cheapest place to buy food and clothing?  Wal Mart.  As sales go down at the Gap, Dillards, Kroger, etc, look for them to go up at Wal Mart.  Target might be ok as well, but I think Wal Mart sales will grow faster - so the stock price should rise more over time.  McDonalds and other cheap fast food should also do better than average.

5)  Stuff.  I don’t have time to get into this in the detail it deserves right now, but “stuff” will become more valuable as the dollar is inflated away.  By stuff I mean things like farm land, apartment buildings, and rental property.  We’re nowhere near the bottom yet in the real estate market, so there’s no hurry on this one.  But in a year or two you should be able (if you’ve saved and invested) to pick up valuable property for 50 to 60% off today’s prices.

Look for property in retirement areas, such as Florida, southern California, and Arizona.  Look for farm land in Nebraska and Kansas - possibly areas of Texas and Oklahoma that receive adequate rain.  If it’s in a windy area, so much the better, as you may be able to lease small sections to energy companies for wind turbines.  It may sound crazy right now, but there will be fortunes made in wind energy over the next 20 years.  There’s too much to go into here, but Google “peak oil” sometime.  We’ll need energy, and wind is relatively cheap.

6) Tin foil hat stuff.  I don’t know what the price of gold or silver will be next month or next year.  But in my opinion, we are watching an epic devaluation of the dollar.  Until we stop spending more than we make (at the personal, local, state, and federal levels) the dollar will continue to lose value.  Conversely, things priced in dollars will continue to rise long term.  Things like gold and silver and oil.  It’ll be a bumpy ride, but 20 years from now, all of these will be much higher than they are today.

1/10 oz gold coins on eBay are going for about $100, while 1 oz silver coins are about $20.  Pick one and buy a coin or two every month.  This isn’t something to turn around for a quick profit - this is your insurance against a 1930’s type depression, or (more likely IMHO) hyperinflation like 1930’s Germany, or Argentina in the 1980’s.  We’re inflating the money supply faster than ever, and the law of supply and demand hasn’t been repealed. 

Remind me to talk more about inflation, deflation, and peak oil sometime.  It involves M3 and the huge unfunded Social Security and Medicare mandates - which are the major reasons the dollar will continue down.  Deficit?  You ain’t seen nothing yet!

gk

Ok, I don’t understand how such bright and well educated people can be so stupid.  I’m referring to the Federal Reserve which released their meeting minutes today.   In case you didn’t notice, here’s what happened in the markets today:

Gold and oil hit record highs - http://www.foxbusiness.com/article/gold-prices-hit-28year-high_421594_1.html

The stock market swoons:  http://money.cnn.com/2008/01/02/markets/markets_0405/index.htm?cnn=yes

Here’s some background - basically all commodities have been going up for the past few years.   I’m not just talking about oil and gold - corn, wheat, soybeans, pork bellies (anyone ever bought a pork belly?) - basically anything material “real” thing has gone up at least 35% to 40% or more in the past 7 years.  And it’s not a coincidence that the stock market is about the same as it was 7 years ago, because the reason is the same.  Inflation.

The Fed’s dirty little secret is that they’ve been printing money like mad.  Everytime you see an article mention something like “The central bank, in conjunction with central banks in Canada and Europe, have already conducted two auctions of $20 billion apiece.” (from http://money.cnn.com/2008/01/02/news/economy/fed_minutes_analysis/index.htm) ask yourself where that $20 billion came from.  When you realize that the Fed “created” that money from absolutely nothing, you’ve understood the major issue. 

That $20 billion isn’t setting in a vault somewhere, it isn’t gold reserves that they sold and/or loaned out, it’s not even actually printed - it’s simply bookkeeping entries.  The Fed “made it up” and then loaned it out to banks - so the banks appear to have more money than they do.  It makes the books look better because - get this - the banks don’t even have to report to stockholders that they’ve borrowed the money!  That’s the key to the new “Term Auction Facility” that they’re lending the money through.

Unlike the usual overnight Fed Funds borrowing - which is required to be reported - there’s no reporting requirement for the TAF.  Since the Fed is sen as the lender of last resort, borrowing money to cover shortfalls from the Fed meant that that bank was struggling.  Now that they can do it secretly, the banks will do it even if it carries a higher interest rate, because they don’t need to disclose the fact.  And the Fed gets to “print” another $20 billion and put it into circulation.

They quit reporting on M3 a while back, but you can still find it at a site that compiles it from publicly available information.  Check it out at: http://www.nowandfutures.com/key_stats.html

Is it starting to make sense yet?  In a nutshell, it’s simple supply and demand.  We’re putting more dollars into circulation, but there’s nothing behind them - no tax revenues, no gold or silver deposits, not even the fake backing of government bonds.  What happens when you increase the supply of something but the demand doesn’t change?  That’s right, the price drops - but in this case the thing that’s dropping in price is the money itself, so real things (commodities) HAVE to go up.

Prediction:  Commodities will go up and down in 2008 (brilliant huh!) but they’ll go up a lot further than they go down.  You won’t regret putting 20% to 30% of your portfolio into some gold, oil, Euro, corn, etc, ETF’s a year from now.  And until the Fed stops printing money like madmen, the commodity boom will continue.

gk