by John Browne, Senior Market Strategist, Euro Pacific Capital

Over the past two years, the federal government and the Federal Reserve have dispersed trillions of public dollars, run up enormous deficits, and kept interest rates at zero. In just about any economic textbook, this combination of policies would be described as the perfect recipe for inflation. Yet, with the exception of the usual increases in health care and education, prices by and large are not rising. Many have concluded that our economic leadership has simply outsmarted the textbooks.

The benign CPI figures are serving as a rallying point behind which the financial talking-heads are forming a parade of optimism. The low CPI is their ‘proof’ that inflation is not a pressing concern. This view is two dimensional.

Inflation is classically described simply as an increase in the money supply. Although these changes will impact price levels, it doesn’t necessarily follow that prices will rise when inflation is high. Instead, inflation may merely result in stable prices at a time when prices would otherwise be falling.

In the popular mentality, however, inflation is simply defined as prices rising. After decades of steadily rising prices, people seem to have forgotten that prices sometimes fall. In light of the bursting of a number of record-breaking, government-fueled asset bubbles, prices should be declining across the board (as they did in the Great Depression). The fact that prices are stable, or have even rallied in some sectors, indicates that inflation is already spreading across the economy.

After falling to just 6,547 in the months after the crash, the Dow has rallied past the 10,000 mark. This should strike even novice investors as unjustified. Jobs are still being lost, a massive healthcare entitlement and carbon tax are winding through Congress, and no one with at least one foot in the real world has a palpable sense of imminent recovery. Corporate earnings have fallen far behind the rally in shares prices, stretching valuation multiples to pre-crash levels.

While not quite as frothy, home prices are now moving up for all the wrong reasons. The seminal Case-Shiller Index of home prices is now up for the fourth month in a row. The index’s designer, Professor Robert Shiller, has stated recently that the current upward trajectory is unsustainable. In fact, the levels are still above the 50 and 100 year trend lines.

In the worst economic climate since the Great Depression, and after the largest housing bust on memory, single-family home prices should be falling well below the trend lines. But with a doubling of the monetary base and special interest programs like the homebuyers’ tax credit, home prices have stabilized and even increased in some markets. That’s the work of inflation.

With GDP growth now returning to positive territory, many inflation hawks ask why inflation has yet to truly manifest. The explanation can be found in the difference between monetary base and money supply.

The latest $1.9 trillion injection of government money was composed of some $900 billion of stimulus, of which only about 20 percent has been distributed. However, in its attempts to stabilize the financial system, the government has already spent some $1 trillion of TARP-type funds.

The TARP money, financed by an increase in the monetary base, has been provided to the banks at zero cost. And for the first time ever, the Fed is paying interest on bank reserves. Therefore, the banks can loan money to the Fed and to the government, via Treasury securities, at an interest rate spread of some 3 to 4 percent without risk. Given these incentives, it makes no sense to loan to anybody else. So, despite a massive increase in the monetary base, credit remains tight and price levels flat.

However, if the Fed stops paying interest on bank reserves or otherwise ‘persuades’ the banks to lend, the $1 trillion will be leveraged up by the banks and spewed out into the economy. Fractional reserve banking will transform a $1 trillion monetary base injection into a $9 trillion increase in money supply. When that happens, prices for everything will go through the roof.

So for now, inflation is like a ninja stalking our economy. It’s lurking in the shadows but can’t easily be seen. But once its strikes, it will be fast and deadly.

Copyright © 2009 John Browne
Editorial Archive

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc. Mr. Brown is a distinguished former member of Britain’s Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher’s government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown’s advocacy, Thatcher famously pronounced that Gorbachev was a man the West “could do business with.” A graduate of the Royal Military Academy Sandhurst, Britain’s version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military, John has a significant background, spanning some 37 years, in finance and business. After graduating from the Harvard Business School, John joined the New York firm of Morgan Stanley & Co as an investment banker. He has also worked with such firms as Barclays Bank and Citigroup. During his career he has served on the boards of numerous banks and international corporations, with a special interest in venture capital. He is a frequent guest on CNBC’s Kudlow & Co. and the former editor of NewsMax Media’s Financial Intelligence Report and Moneynews.com. He holds FINRA series 7 & 63 licenses.

Greg Hunter

There is an old saying in the markets,”nothing goes straight up or straight down.” If the economy has a lot more to fall, as I think it does, then it will not fall straight down. I think we are on a proverbial plateau in this downturn. Yesterday, Treasury Secretary Tim Geithner said, “The financial sector story is in a much stronger position than it was but it’s a mixed picture,” and “The price of credit has come down dramatically.” The economic picture has improved because of massive amounts of money printing for things such as “Cash for Clunkers” and the “$8,000 home buyers tax credit.” There has also been hundreds of billions spent buying toxic assets and our own treasuries to suppress interest rates. Yes, pump hundreds of billions of dollars into the credit markets and economy and things will look better… for awhile. John Williams of shadowstats.com says in his latest alert, “Fed Pushes Monetary Base to Record High.” That certainly makes sense because of what the Fed has been doing. Williams is not alone in tracking high money growth by the Fed. Terry Coxon of The Casey Report said, “As of July, the M1 money supply (currency held by the public plus checking deposits) had grown 17.5% in a year’s time. That’s not just unusually rapid, it’s extraordinarily rapid.”

Yes, the economy is appearing to look better. However, even with all the money creation, it is not great. Secretary Geithner said as much with his “mixed picture” comment. Economist John Williams concurs and takes it one step further by saying, “Recession Not Over Despite a Positive GDP Quarter.” Williams thinks the government will continue to print money at or near record amounts and thinks the downturn has farther to go. Williams is expecting the economy will not look very good in the 4th quarter. I think that means brace yourselves for another leg down.

New York University Professor Nouriel Roubini is once again sending up warning flares about a different problem, the Fed’s zero interest rate policy. We’re talking free money, folks. You might remember that he was one of the few that predicted the current financial crisis. For that, he earned the nickname “Doctor Doom.” Now you can call him “Doctor Right on the Money.” Roubini sees the economy a little different than Williams. In some ways, Roubini sees things more positive and in some ways not so much, as told in the excerpt below.

Reuters reports: … “Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis….”Roubini said he sees a bubble in emerging-market equities and that gains in some developing-nation currencies are becoming “excessive.” The rally in oil “is not justified by the fundamentals,” he said. An asset “bust” may not occur for another year or two as a “wall of liquidity” pushes prices higher … In a carry trade, investors borrow in countries with low interest rates to invest in higher-yielding assets. Roubini said the U.S. recession seems to be over, though the economic recovery in advanced nations will be “anemic.”…
(The complete Reuters story)

Money printing will make things look better, but will it last? What will happen if the Fed stops printing? What will happen if the Fed keeps on printing? Don’t be fooled by the crooked path the economy is taking. Stay defensive. One thing is for sure, when Professor Roubini gets nervous, you should too.

###

Greg Hunter

email: greghunter1@att.net
website: http://usawatchdog.com

By: Trace Mayer, J.D.

The recent gold bull upleg is in the midst of a predictable slight correction and consolidation.  When that finishes it is highly probable, based on seasonality and technicals, that the next part of the upleg will commence.  The Federal Reserve and Washington are only making matters worse through their extremely damaging policies.

GOLD PARTY BARELY STARTED

Back on 9 September 2009 I wrote:

200 day relative price of gold is at 1.08x … Based on seasonal trends gold and silver will be strengthening, with the strongest months in September and November

This upleg in gold and silver will have significant strength because of the long period of consolidation just like in 2004 and 2006 which provided the foundation for the uplegs in 2005 and 2007 that took gold from $400 to $700 and $650 to $1,000, respectively.  If the current upleg is similar to the previous two then the 200 day relative prices for gold and silver at the top of this upleg would be about 1.5x and 1.7x, respectively.

This puts $1,300 gold and $25 silver within range without greatly exceeding previous trading norms

Back then the price of gold was $996 and the 200dma was about $920.  Today gold’s price is about $1,030 with a 200dma of about $950.  While the probability for a profitable trade is not nearly as high as it would be should the price relative to the 200dma be significantly below the 200dma there is still room for the price to run as we enter winter.  The October intermission is likely coming to a close.

OCTOBER INTERMISSION

Dr. Greenspan testified in 1998 that, ”Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.”

One of the key reasons to keep the price of gold suppressed through central bank gold leasing is to keep interest rates low.  This will be particularly helpful for the $182,000,000,000 of certificates of confiscation that will be sold during the week of 26-29 October 2009.  Another reason is that NYMEX November options expired 27 October 2009.

PHYSICAL PREMIUMS RAISED

The physical coin dealers are fairly wise to the machinations of Wall Street.  When the paper price of bullion falls precipitously then the dealers often raise the premiums.

For example, a reader asked me a few weeks ago when would be a good time to buy gold American Eagles.  I suggested after the next drop and if lucky then he may be able to acquire them around $1,025 spot but the premium would likely increase.  He reported his shopping to me a couple days ago after the recent drop in price and informed me the premium had been raised from $37.95 to $41.95 per coin.

SILVER BACKWARDATION

On 12 September 2009 I observed that “the London SIFO, the Silver Forward Mid Rates, have been trending towards backwardation.”  It is interesting to observe the continuing trend and brief entry of silver in backwardation in the LBMA on 9 October 2009.  It seems like the physical silver market is getting a little tight.

QUANTITATIVE EASING

The big issue is whether the Federal Reserve will be able to, as Ben Bernanke said on 8 October 2009 in The Federal Reserve’s Balance Sheet:  An Update, ‘tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration?’  Back in March 2009 when Bernanke started this lunacy I asserted that The Federal Reserve Will Fail With Quantitative Easing.

Bernanke asserts:

Although the Federal Reserve’s approach also entails substantial increases in bank liquidity, it is motivated less by the desire to increase the liabilities of the Federal Reserve than by the need to address dysfunction in specific credit markets through the types of programs I have discussed. For lack of a better term, I have called this approach “credit easing.

What Bernanke is trying to do is get capital to take on additional risk by moving up the liquidity pyramid.  But The Great Credit Contraction has begun.  While there may be differences in the velocity at which capital moves down the liquidity pyramid the overall direction has not changed.  Washington and the Federal Reserve are tiny actors compared to the total size of the market.

Their policies are aimed and designed to grant special privilege to banks like JP Morgan and Goldman Sachs.  Through government assistance the banks are able to move their capital down the liquidity pyramid.  In effect, they have privatized the gains and socialized the losses.  While there may be a case for a rise in the FRN$ in the short term the ultimate destiny is known:  the fiat currency graveyard.

Buy “The Great Credit Contraction” eBook

EXACERBATING THE GREATER DEPRESSION

As Murray Rothbard observed on page 18 of his 1963 America’s Great Depression:

It is true that credit contraction may overcompensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market.  But since contraction causes no positive malinvestments, it will not lead to any painful period of depression and adjustment.

Mr. Rothbard continues the observation that government policy can hobble the adjustment process by: “(1) Prevent or delay liquidation, (2) Inflate further, (3) Keep wage rates up, (4) Keep prices up, (5) Stimulate consumption and discourage saving and (6) Subsidize unemployment.”

In the present case, mark-to-market rules, like FAS 157, are not implemented, delayed, ignored or willfully violated.  The financial markets are now undergirded by fair-value lying standards. For example, Section 132 of the Emergency Economic Stabilization Act of 2008 is titled “Authority to Suspend Mark-To-Market Accounting” and restates the SEC’s authority to suspend the application of FAS 157.

The Austrian definition of inflation is an increase in the money supply.  The Adjusted Monetary Base, the very lowest layer of power money, shows a tremendous increase over the past year.  The effects are most likely masked by the tremendous slowing in the velocity of money.

In an effort to stimulate consumption and discourage savings that will result in keeping prices and wages high the Obama administration has unveiled a $1 trillion stimulus package.  The Geithner toxic asset plan will only serve to hasten the destruction of wealth from the economy as the system evaporates.

The Federal minimum wage rose in July 2009.  Unemployment will be subsidized by extending benefits for 13 weeks and delaying the income tax payments.  Legacy industries, like the auto industry, are receiving bailout money to keep wage rates up and people employed doing nothing all day long because of the huge over capacity of automobiles.  With Cash-For-Clunkers automobiles which have value are destroyed to reduce supply of alternative goods to new cars made by Government Motors.  This is a prime example of what Washington DC is:  A giant wealth destruction machine.

Therefore, like heroin to cure a hangover the quantitative easing from the Federal Reserve and the lunatic policies from Washington are not improving the situation for average people but instead exacerbating the greater depression.  Now is the time to Raze The Fed and while doing the spring cleaning who needs Washington?

CONCLUSION

The current correction and consolidation of gold appears to be within trend and expected based on the seasonality.  November is the strongest month and this recent correction on low volume is laying a strong foundation for a large move upwards.

The Federal Reserve’s quantitative easing programs have not been helping the situation but instead exacerbating the greater depression.  All in an effort to save the inefficient, barbarous and archaic relics of a fiat currency and fractional reserve banking system that is destined for extinction and replacement.  The Crash of 2008 was just the start of The Great Credit Contraction and it will last for decades.

Disclosures:  Long physical gold and silver and no position the problematic SLV or GLD ETFs.

Trace Mayer, J.D.

–

http://www.RunToGold.com

By: David Morgan, Silver Investor, Silver-Investor.com

A well-known truism is that every investor needs to start with savings. But what if that “savings” gave the investor too much exposure to risk? What investors or people in general need in this financial environment is savings that don’t deteriorate. We are in an environment now where the idea of making money, which is kind of the preamble to being American, is going away. In other words, today’s environment is, he who loses the least, wins, and the way that you do that is to hold a currency that doesn’t devalue over time.

There really are only two currencies, and they are gold and silver.

I remember starting my quest in this silver journey that has been ongoing for several decades, beginning in the mid 1960s. Silver was the coin of the realm here in America, through 1964. In 1965, coins were minted but they did not contain silver. (Just to be accurate about this, there were some exceptions with the 50-cent piece.)

The futures market back in the late ’60s and early ’70s had two silver markets, actually. There was the bullion market that we still have, and there was also a coin bag market. The bag market consisted of “junk silver” as it was referred to, which is U.S. coinage that is 90 percent silver. I remember people asking questions such as, how can you make money by buying money?

In other words, the link between the dollar and silver had been cut but people didn’t even understand it, because it hadn’t drifted that far—they didn’t get it. Paper money, silver money, what the heck is the difference?

In fact, in years hence, many people my age or older tell me it never dawned on them to obtain the silver coinage that was available for the taking and hold on to it. Of course some people saw right away what was happening, and silver coinage in general circulation disappeared very quickly.

What you need now is real money and that means silver and gold. I advocate silver “junk bags”—quarters or dimes or even half dollars that are 90 percent silver and placed in bags of $1,000.00 face value or some fraction thereof, such as a ½ bag, which is $500.00 face, etc.

Today that full bag of junk silver $1,000.00 face value is going to cost you probably 12,000 in Federal Reserve Notes. So they both say a dollar on them but one’s a little different than the other—one is real, and the other is a promise, but not much of one.

Once an investor has accomplished a physical metal holding in both silver and gold, he or she might want to speculate. Personally, I favor top-tier, cash-rich, unhedged mining companies for serious money.

The next level of risk to reward is a very high-risk sector but very high reward at times, and that is the junior mining sector. Let me be clear: I don’t sell bullion but do advocate that everyone buy coins and bars of both gold and silver. I think that’s your best savior in this kind of an environment.

Often the question arises, what percentage of someone’s assets do you recommend in the precious metals sector? Let us understand that we’re talking in a very generic sense here without any kind of suitability or special circumstances or things like that. But what range or percentage is recommended that people allocate through real money?

In The Ten Rules of Silver Investing, I was asked that question. At that time I said 10 percent; however, after that was published, my inclination was to move it up to 20 percent, because the financial system was becoming much more unstable.

The best investment you could ever make is in yourself. If you have a going business, put money in your business, make it stronger, make it better, and market it better, whatever. Or get an education for yourself so you can get a better job or a promotion and so forth. Having said that, you do need some exposure to the metals, and 10 percent as a minimum is a good place to start.

The next question of course is how much gold or silver? This is subject to the individual. The older you are, the less time you have to recover from a mistake. Thus, the older you are, the more gold you should have—so you should probably favor the gold market. The younger or more aggressive you are and the more risk you can take, the more you might consider the silver market. Then there are those who watch the market carefully (such as I do) and trade the gold/silver ratio when it seems favorable. If this is done properly, an investor can actually end up with more metal, with very little effort.

You could look at it this way: if you’re 50 years old, you’re 50 percent gold, 50 percent silver; if you’re 60 years old, you’re 60 percent gold, 40 percent silver, that type of thing. Several people I know who are in their fifties, sixties, and seventies believe silver will outperform gold, but it’s a rougher ride.

I think you definitely should have both, a metals portfolio; it’s not a metal portfolio. And while there aren’t very many silver-only bugs out there, there are more gold-centric people who really don’t want any silver exposure. And I’m not against them; I think that they’re going to really see something that’s going to take their breath away in a couple years. I think once silver rises above the $25.00 level, there will be an acceleration up in price that will absolutely astound people. But we’re not there yet. That’s sort of the end of the story, and we’ve still got several innings left in this ballgame.

A couple of weeks ago in my weekly posting I stated,

“I would be much more comfortable saying this is the final blast-off if silver were hitting $21.00 right now as gold is trading over $1,000—that would be confirmation in my book, and I’d be very, very bullish. Unfortunately, silver isn’t leading the charge at this time and that is acceptable. It’s certainly shown some good strength this whole year, but not quite the amount of strength I would expect if we were to see all this inflation pouring into the financial markets. Again, I still suspect that there’s probably some more recessionary, deflationary, depression type of news coming.”

Looks like the markets are responding to the downside—how far and how long is tough to state at this time.

It is an honor to be.

Sincerely,

David Morgan

Mr. Morgan has followed the silver market for more than 30 years. He wrote the book Get the Skinny on Silver Investing. Much of his Web site, Silver-Investor.com, is devoted to education about the precious metals; it is both a free site and does have a members-only section. Mr. Morgan has just written a free report titled, Silver Fundamentals, Fundamentally Flawed, which can be accessed here: Free Silver Report. To receive full access to The Morgan Report, click the hyperlink.

Website: Silver-Investor.com
Email: david@silver-investor.com

Gold IS the best game in town — and when the music stops it may be the ONLY game in town that can yield any sort of return. The music I refer to here is the sound of spin given some measure of credibility (only to the un-initiated) by massive stimulus spending which has kept this farce of an economy on its last legs through various stages for 9 years.

Why do I claim that gold is the best game in town? Gold has outpaced all investment classes over recent years - meaning that it IS the leading investment class of this decade. Gold IS at record highs and has broken above resistance in USD but you have heard all that already. Gold IS real money and vital to the monetary system at the highest levels, it IS real wealth and it IS a real store of wealth.

Gold IS the only substance on earth that is convertible to gold - “money” (currencies - bank notes and coins) are not. Even today many people do not realize that the currencies they are forced to use for transacting goods and services are backed by nothing except confidence and more paper. Gold bullion cannot be forged or printed, it cannot be won from the earth without honest effort and hard work so it IS rare - make no mistake gold just IS.

Gold IS a major part of the cultures that are in the process of inheriting some of the power that the USA is losing at present. With vast pools of monetary reserves, manufacturing capacity, cheap labor and or oil reserves at their disposal - countries like China, India, Russia and those in the Middle East are in a unique position in this new emerging era. They love gold and we now have to face an era with a more powerful Islamic Banking system that loves gold too. Gold IS their favorite commodity and money.

The only way out for US citizens IS to get capital out of the USA and or to get their USD’s away from the US banking system. This is best done by buying gold - gold IS the answer.

Gold IS won from the earth by mining companies who are in a unique position in the economy at this time in history. They will become in essence, like a form of central bank churning out real money to be used to stabilize economies and currencies used for international trade.

International trading partners of the mighty USA have had to suffer an imbalance of power since 1944 when the Bretton Woods Agreement came into force. The USA was handed this privilege and responsibility because it held the most significant proportion of the global gold reserves at the end of WW2. USD’s were originally convertible into gold on request however that all ended in 1971 when Nixon withdrew this function.

They all said “gold IS NOT” but they were wrong and all history and common sense said so. Inflation of the money supply and the “great” modern monetary / banking experiment was here in full force.

This was managed more covertly and expertly than any similar deeply flawed and dishonest monetary experiment in history. That is to say it lasted longer than any similar experiment to such a degree that the modern economic mantra became a new “truth” that even infiltrated education and common beliefs.

As for the so called fantastic era of growth and prosperity, there have been many advances but also many disadvantages too. There is no doubt it was great while it lasted if you were the one with the food and a good job and nice car / house / holidays etc. But have we really had any meaningful growth in GDP in the Western economies? What about culture, human rights and other higher values revered by civilizations at their heights through history?

Gold bugs adjust the current price of gold in inflation adjusted terms and quite rightly so. The peak of gold at US$850 per ounce in 1980 dollars can be conservatively shown to be equivalent to $3,000 in 2009 dollars. But how about adjusting GDP growth to reflect true inflation? Let’s face it 3% growth rates that have been considered strong and viewed in awe by some as unsustainable can be inflation adjusted to show a continuous depression for the last 20 years in the Western world. That is right - no real growth at all and this is absolutely sustainable. Read More…

The bullish Dow theory trend change that occurred in association with the advance out of the March 2009 low still remains intact. Cyclically, the advance out of the March low also still remains intact. Intermediate-term, equities are overbought and I do see weakness on the horizon. The key to this materializing will be the downturn of my intermediate-term Cycle Turn Indicator.

Longer-term, my research continues to tell me that this is still a bear market rally within the context of a much longer-term secular bear market. Robert Rhea, the great Dow theorist of the 1930’s wrote: “Bear markets seem to be divided into three phases: the first being the abandonment of hopes upon which the final uprush of the preceding bull market was predicted; the second, the reflection of decreased earnings power and reduction of dividends, and the third representing distressed liquidation of securities which must be sold to meet living expenses. Each of these phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market.”

From a Dow theory perspective, I continue to view this as the rally separating Phase I from Phase II of what should ultimately prove to be a very long and very ugly secular bear market. I totally realize that this may be a difficult concept to grasp, but this comes as no surprise to me. In 1929 the Phase I decline carried the market down into the November 1929 low. From that low the market rallied into April 1930. As I read the writings of that period it is obvious that they too found it hard to believe and the politicians of the day tried desperately to convince the masses, and probably themselves, that the bear market was over. But, in spite of the efforts to hold things together and in spite of the propaganda spread by the politicians of the day, the bear market resumed and ultimately found its low after an additional 86% decline into the Phase III low in 1932.

During the secular bear market of 1966 to 1974 the Dow theory warned that the rallies into the 1968 and 1973 highs were bear market rallies. Yet, few believed this and again the politicians and media tried to convince the world that the decline was over. Ultimately, the secular bear had his way and the final Phase III low came in December 1974 after a 46.58% decline from a new recovery high in January 1973. It was at the December 1974 low that Richard Russell announced in his December 20, 1974 Special Report that “We are finally in the zone of Great Value.” It was then in Mr. Russell’s January 24, 1975 letter that he gave the hurdles that had to be bettered in order for Dow theory to confirm a primary trend change. The benchmarks were then bettered on January 27, 1975 and in Mr. Russell’s February 5, 1975 issue he made the official call of the Dow theory bullish primary trend change.

The key to Mr. Russell properly calling this low, from my eyes, was that in spite of the propaganda and erroneous media reports throughout that period, Mr. Russell understood the Dow theory and more importantly the phasing and value aspects of Dow theory. As a result, he was able to navigate that great bear market and to recognize the bear market bottom when it appeared. The same disciplined approach was used by George Schaefer during the 1950’s and 60’s to navigate that great bull market. Before that, Robert Rhea used the Dow theory to call the 1932 bear market bottom and William Peter Hamilton before that to call the 1929 top in his famous editorial in the Wall Street Journal titled “A Turn In The Tide. My point here is that Dow theory can guide us this time around as well if we have the ears to listen to what it’s telling us.

I have discussed the phasing of this bear market with Mr. Russell. I explained to him that based on my read of the Dow theory that the March 2009 low appears to have only marked the Phase I low and that the ongoing rally should ultimately prove to separate the Phase I from Phase II of the ongoing secular bear market. Mr. Russell agreed with my assessment at that time and to date I’m not aware of anything that has changed this assessment.

From a value perspective, history shows that the dividend yield and the P/E will be roughly at par at true bear market bottoms. As an example, I show that the yield on the S&P at the 1932 low was 10.5 with a P/E just under 10. At the 1942 low the yield was 8.71 with a P/E of 7.3. At the 1974 bear market bottom I show the yield on the S&P to have been at 5.9 with a P/E of 7.24. Even at the 1982 low the yield was 6.2 with a P/E of 6.9. At the March 2009 low I show the yield on the S&P to have been at 3.58 with a P/E of 24, which has historically been considered overvalued. At present, I show the yield on the S&P to be 1.99 with a P/E of 144.83. Yes, that is right. The current P/E, based on Generally Accepted Accounting Principle, is one hundred forty four. The historical P/E ratios at the previous lows were also calculated using Generally Accepted Accounting Principles, so these numbers are consistent. If you are seeing any other number showing much lower P/E’s it is because it is a George Orwellian phony bologna calculation. If the S&P were to trade with a GAAP P/E of 20, which has historically been considered overvalued, it would be at 150. If the S&P were to trade with a P/E of 15, which has historically been considered to be fair value, it would trade at 113. My point here is that at the March low the P/E and the yield were no where near par and thus the market did not reach levels in which true secular bear market bottoms are made. Plus, with the spread between the current P/E and the yield at an historic 142, the market is grossly overvalued. This will ultimately be corrected with the Phase II and Phase III declines. If you have not read my article on Bull and Bear market phasing I urge you to go to www.cyclesman.info/BullBearRelationships.htm and do so.

As for gold, I reported here in my last post in early October that gold was in uncharted waters and that I believed that the 9-year cycle was stretching. In light of the recent advance above the March 2008 high, which marked the 9-year cycle top, current developments suggest that perhaps the 9-year cycle is not stretching and that perhaps it did bottom in October 2008. If so, we truly are in uncharted waters, but this comes as a double-edged sword and I will be discussing the developments in great detail in my research letters and short-term updates. As of this writing, gold remains positive as the bear market rally separating Phasing I from Phase II of the ongoing secular bear market continues.

By Terry Coxon, Editor, The Casey Report

Most of us are gathered at the station, watching for the Inflation Express to come rumbling in. But we’ve been waiting for a while now. Just when should we expect the big locomotive to arrive and start pushing the prices of most things uphill?

We’d all like to know the exact date, of course, but no one can know for sure. Not even a careful reading of the Mayan calendar will help. What we can do is estimate a time range for price inflation to show up, and that alone should have some important implications for investment decisions.

Why It’s Expected

The reason for expecting price inflation is the recent, rapid growth in the money supply and the deficit-driven likelihood that more such growth is coming.

As of July, the M1 money supply (currency held by the public plus checking deposits) had grown 17.5% in a year’s time. That’s not just unusually rapid, it’s extraordinarily rapid. Since 1959, M1 has grown more rapidly in only one other 12-month period – and that was the one ending last June, when the M1 money supply jumped 18.4%. Even in the inflation-plagued 1970s, growth in M1 never exceeded 10% in any 12 months.

Dropping large chunks of newly created money into the economy leads to price inflation, because the recipients are likely to find themselves overprovisioned with cash. As they try to unload the excess, they bid up the prices of the things they buy, whether it be stocks, shoes, gasoline, silver coins, or granola. The sellers of those things then find themselves cash rich and start doing some buying of their own, and so the wave of excess money and the bidding it inspires propagate through the economy.

The process isn’t instantaneous. It takes time. Just as each player in the economy has a sense of how much of his wealth he wants to hold in the form of money, everyone will move at his own speed to make adjustments when his actual cash holdings seem to be off target.

And the process can seem to stall, especially when fear is growing. When people are worried or otherwise feel a heightened sense of uncertainty, they will gladly hold on to abnormally large amounts of cash – for a while. But when fear abates, as it will when the economy begins to recover from the recession, that temporary demand for extra cash will also fade, and the hot-potato process of trying to pare down cash balances will emerge to do its inflationary work.

But when?

The speed at which the public tries to unload excess cash and the timing of the effects have actually been measured, in the work of the late Milton Friedman and his monetarist colleagues. The method was indirect and roundabout, and so the results, unsurprisingly, were nothing as precise as nailing down the value of a physical constant.

What the monetarists (or the first of them to be equipped with computers) found was that when the growth rate of the money supply rises:

• The initial effect is on the prices of bonds and stocks, an effect that comes within a few months.
• The peak effect on the growth rate of economic activity comes about 18 to 30 months after the pick-up in the growth rate of the money supply.
• The peak effect on the rate of consumer price inflation comes about 12 to 18 months after that, which is to say it comes 30 to 48 months after the peak growth rate in the money supply.

As Friedman famously put it, the lags in the effects of changes in monetary policy are “long and variable.” He might have said, “It’s a big, wide blur, but we’re sure we’ve seen it.”

And even that picture exaggerates the precision that’s available to us. The emergence of money substitutes, such as NOW accounts and money market funds, has added its own muddiness to the picture of how growth in the money supply translates into growth in the level of consumer prices. It is only because the recent episode of monetary expansion has been so extreme that we can look to the results just listed for an indication of what’s to come.

If you apply the findings of the monetarists to the present situation, here’s what you get. The peak growth rate in the money supply occurred last December, so based on the general monetarist schedule:

• Some of the effect on stocks and bonds should already have been felt.
• The peak effect on economic activity should come between the middle of 2010 and the middle of 2011.
• The peak effect on consumer price inflation should come between the middle of 2011 and the end of 2012.

A More Particular Schedule

This time around, should we expect things to move more rapidly or more slowly than average? My bet is on slow, which would push the peak inflation rate out toward the end of 2012. One reason for slow is that the government’s rescue packages are delaying the process. Rescuing banks that are choking on bad loans postpones the day of reckoning for both the banks and the loan customers. It retards the pace of foreclosure sales (whether of real estate or other collateral) and puts the deleveraging that has been going on since last fall into slow motion. A wilting of the recent stock market rally would confirm this.

Investment Implications

The big plus about the Mayan calendar is that, right or wrong, it is very definite about things. Human civilization will come to an end, I’m told, on Dec. 21, 2012 – not on the 20th and not on the 22nd. There was no room for monetarists in those step-sided pyramids, but there still are few what-to-do implications from the monetarist findings.

1. When you hear would-be opinion leaders cite the current absence of rising prices at the supermarket as proof that all the new money isn’t a source of inflation, don’t believe them. It is much too early for the inflation bomb to be going off, even though the powder has been packed and the fuse has been lit.
2. If the large and growing federal deficits and the Federal Reserve’s unprecedentedly easy policies tempt you to leverage up on inflation-sensitive assets, such as gold, give the idea a second thought. It likely will be a year or more until price inflation becomes obvious and undeniable (which is what it would take to bring the general public into the gold market). In the meantime, your inflation-sensitive assets could get paddled rudely as the deleveraging that began last year continues.

For at least the next year, the simple, fire-and-forget strategy is 50-50 gold and cash – gold for what looks to be inevitable but on its own schedule, cash to be ready for the bargains that may show up while we’re waiting for the inevitable to arrive.

The editors of The Casey Report keep their ears to the ground, listening for the first rumblings of the inflation stampede coming in. But you can bet on rising inflation – and interest rates – right now and be way ahead of the investing herd. To learn more about investing in this all but inevitable trend, click here.

With all the ’strong dollar’ rhetoric coming from the Fed and broken-record Bernanke, it’s a wonder any investors are making money. But one we know and trust is. . .because he’s not listening. “The U.S. will continue to take a laissez faire approach to the dollar,” says John Doody, Economics Professor for nearly two decades and current author and publisher of Gold Stock Analyst. In this exclusive interview with The Gold Report, John explains how he measures gold’s price performance, why he believes most investors don’t have enough gold stocks in their portfolios and which companies he’s making money on right now.

The Gold Report: John, why hasn’t the mainstream media caught on to what’s going on with gold?

John Doody: The CNBC types are always talking their own “book,” which is mainstream stocks. If no one buys the broad market stocks, there are no jobs for the talking heads, et al., at CNBC. They’re always pooh-poohing gold and love saying that gold at the current price, $1,060, hasn’t really done much from the $850 high in 1980. That’s a false comparison. If you want to use that, then why not point to the S&P high in the 1500s or the Dow high in the 14,000s as a measure, instead of the March 2009 lows?

The gold price was controlled from the 1930s until March 1968 by eight Central Banks (CBs) that were the gold cartel and fixed the price of gold at $35 an ounce. That ended in March 1968 when market forces overwhelmed the CBs. Unable to enforce $35/oz, they let gold’s price float in the free market. Between themselves, they still traded at $35 and then, of course, all of that fell apart when Nixon went off the gold standard entirely in ‘71.

The appropriate measure for me as to how gold has performed is to go back to when the price was set free, March 1968. If you take the $35 gold price and adjust it for 41 years of the U.S. CPI increases, the gold price would be about $220 an ounce, increasing at an average compound rate of about 4.5% a year. But since being set free in 1968, the gold price is now $1,060. So gold has provided great inflation protection, and growth. From $35 to $1,060 — that’s about an 8.5% compounded annual rate per year. That’s the true measure of gold’s value for inflation protection. (See chart.)

TGR: So what’s driving the price of gold? Is it just the devaluation of the U.S. dollar?

JD: Well, that’s part of it; but gold is still about 10% below the all-time high in other currencies, such as the euro or the yen. So part of the growth of gold price is due to all fiat currencies falling, but it’s mostly due to the dollar going down because it’s a dollar-denominated commodity and that’s what people want to escape—the dollar’s declining value. Gold provides appreciation and a safe haven.

TGR: How long do you expect this trend to continue?

JD: It could go forever. I don’t think we’re going to see the hyperinflation of Zimbabwe or the Weimar German Republic. The falling dollar will eventually cure the trade and current account deficits because we’ll stop buying foreign-made goods. They’ll just be too expensive. Currencies go through these ebbs and flows of value. In the ’80s we had high interest rates and the dollar was too strong. Central Banks met at the Plaza Hotel in 1985 to knock down the buck’s value, and they were successful. Now I’m not so sure, because foreign exchange markets and the dollar amounts are so big that the Central Banks can really change the dollar’s direction. Like a tugboat changing the direction of a battleship, they can nudge it a little bit in the short term; but long term, it’s the economic fundamentals that control. The U.S. will continue to take a laissez faire approach to the dollar. They talk a good game, they talk strong dollar, but they don’t do anything to defend it and that’s because they want a weak dollar. A weak dollar stimulates U.S. exports and job growth.

TGR: What’s your long-term target for the gold price?

JD: I really don’t have one because my investing strategy is to find undervalued gold stocks at every gold price. So it’s not necessary for me to say that the stocks I recommend are going to go up because gold’s going to go up. My Top 10 Stocks should go up because they are not properly valued vs. others of comparable stature based on the three metrics I use: 1) market cap per ounce of reserves, 2) market cap per ounce of production, and 3) operating cash flow multiple. My Top 10 so far this year is up 124% and that’s with one stock being flat. So the other nine have, on average, more than doubled. That’s vs. gold at $1,060 up 22%, and the XAU up 45%.

This appreciation is why you should own the stocks more than the metal. Every dollar of price increase gives you a dollar more profit from current production, and it makes all the ounces that you’ve got in the ground that haven’t been mined each worth a dollar more. Typically, a mining company has 10 times the reserves in the ground vs. what it’s currently producing. So that 10 multiple—it’s even higher for some—that’s where you get the leverage from a gold price.

TGR: At a certain point, of course, stocks become overvalued. In your recent newsletter you said that they’re fairly valued at a gold price of $997. We’re now at $1,060. Are we getting close to being overvalued?

JD: Not yet, because the gold price of $1,060 now justifies higher values than at last month’s $997 gold price. What I’m looking for is the market to go to overvalued, as it’s done in the past. I measure overvalued and undervalued based upon past relationships between the market cap per ounce values we calculate every month vs. gold price at that time. Right now we’re at a fairly valued situation. But there’s been four instances, in 2002, 2003, 2006 and 2007, when gold stocks were 20% or more overvalued based on my market cap/oz. metrics. It’s investor enthusiasm that creates these overvalued situations, and as can be seen in the chart, we’re not there yet.

People bid up the prices of the stocks so that the market cap per ounce we calculate goes to overvalued levels vs. where they’ve been in the past. So, even if gold did nothing from here and just stayed around this $1,050–$1,060 area, investor enthusiasm could drive the stock prices higher to make the stocks 20% overvalued.

So I see a lot more upside from here and I think this is evidence that we don’t have a big retail participation in this market yet. People have been thinking there’s a $1,000 an ounce ceiling and they don’t realize that it’s become the floor. Maybe it’s going to take a few months hanging over $1,000 or maybe we’re going to have to get to $1,100. At some point investors are going to realize this gold bull market has much further to go and as they pile into the small gold sector with only a $250 billion market cap, they’ll drive stock prices much higher.

One rationale for more investors coming to gold can be found in studying the S&P500 vs. gold price. As seen in the chart below, from 1973 to 1991, the gold price was higher than the S&P. From 1992 to 2008, the S&P 500 was higher than the gold price. Now we’re back in the area of uncertainty where the gold price and the S&P price are about the same. As you look forward, I can’t make any argument for the S&P going higher. I think that it’s overpriced now and that analysts are building in earnings numbers for the S&P that aren’t going to be earned. The consumer’s tapped out. So the banks have come back some, but they’ve got a lot of bad debt still to write off from credit cards and commercial loans The consumer is 70% of the economy. Without them aggressively participating, I just don’t see any driver for the S&P 500 to even support this level. But I can see lots of drivers to support a higher gold price. Just look at monetary and fiscal policy, printing and borrowing too many dollars The years ahead, in my opinion, have to be good for gold and not so interesting for the S&P 500 and I think as people realize this, we’re going to get more retail investors coming to the gold sector.

TGR: So your Top 10 list that you came out with last January is up 124%. Nine winners and one flat one. Do you come out with another Top 10 list in January 2010?

JD: We do it on an ongoing, not an annual basis. We calculate the results on an annual basis, which is very unique in this industry. Nobody else does this unless they’re a mutual fund. Every other newsletter wants to tell you what their results were based upon when they first recommended the stock, which might be five years ago. But we track the Top 10 the way any private investor would their portfolio and we put a monthly statement in the newsletter. We’ve had one sell in 2009. We took one off that was up 58%. It hit our target price and we didn’t see a reason to raise the target price. We sold it and we had 10% cash for about four months, and we just found a new company, to put on the Top 10 list in September.

You know, these all can trade up and down. They’re volatile. Sometimes you get a new fund manager that doesn’t like the story and so he dumps whatever’s in the fund that he doesn’t like. They’re going to get judged on what they buy, so they buy the stories they like. It happens with these stocks, where all of a sudden you can get a 20% or 30% selloff. I tell investors they should keep a mental 20% trailing stop. But then if the stock falls 20%, is that a reason to sell or buy more? And, more often than not, it is a reason to buy more. Sometimes if something basic changes, we’ll take the stock off the Top 10 and tell people to sell. But if nothing basic changes, it becomes a back-up-the-truck opportunity.

TGR: Many of your stocks are starting to approach your target price, yet you still sound pretty optimistic that there’s a lot more upside.

JD: Yes, and we have to change the target prices. We’ll probably do that in the November issue. The target prices were basically set when gold was $900. That’s been my working price for the year and for the first six months, the average price was $912, so that was a good enough number. Now we’re getting not only to the end of the year and we’ve got a much higher gold price, but we’re also starting to look forward to what production is going to be next year. One of the things we look for, in addition to the three main metrics, is growth in production. So we’ll start looking at what higher production will do for the stocks next year. We raised the target prices for two stocks in the October mid-month update, and because the November issue updates our reports on four of the Top 10, we’ll probably be raising more targets.

My philosophy is you’ve got to buy 10 stocks because if you buy one stock and it’s got a permit or similar issue and it doesn’t get it, you’re going to get killed. But if you’ve got all 10, you can take that risk. But too many investors think that they’ve got gold exposure with one or two stocks. And then when I ask them what the one or two are, they’re exploration plays. That doesn’t give you any gold exposure at all. That’s just exploration exposure.

At the gold shows I speak at, such as the coming one in San Francisco, people show me their portfolios. Most of them suffer from not having enough gold stocks. They have a big enough percentage, the proverbial 10% or 15% of the portfolio. But too often it’s all in a couple of stocks and that’s too much risk. You need to diversify your risk. In the old days when it cost you $200 commission, it was expensive to own 10 stocks. But now with $10 internet commissions it’s no big deal. Or they own too many and the risk of that is that you’re just going to mimic the market at best. The typical gold mutual fund has 40 stocks in it and that’s why they can’t do so well. There aren’t 40 gold stocks worth owning.

TGR: John, you offer a trial subscription, correct?

JD: Yes, you can subscribe for three months, and there’s a free issue on the Gold Stock Analyst website, which you can download. It’s not the current one, but it’s free, and you’ll get an idea of the detail of our work. It takes seven issues to cover all 75 stocks, plus we have the mid-month update of two to six pages. And we often make changes to the Top 10 in the update. The main monthly issue features reports on all the stocks we cover. The updates focus more on what’s going on in the gold market and what’s happening at just the Top 10.

TGR: John, thanks once again for your input. This has been great.

John Doody brings a unique perspective to gold stock analysis. With a BA in Economics from Columbia and an MBA in Finance from Boston University, where he also did his Ph.D.-Economics course work, Doody has no formal “rock” studies beyond “Introductory Geology” at Columbia University’s School of Mines.

An Economics Professor for almost two decades, Doody became interested in gold due to an innate distrust of politicians. In order to serve those that elected them, politicians always try to get nine slices out of an eight slice pizza. How do they do this? They debase the currency via inflationary economic policies.

Success with his method of finding undervalued gold mining stocks led Doody to leave teaching and start the Gold Stock Analyst newsletter late in 1994. The newsletter covers only producers or near-producers that have an independent feasibility study validating their reserves are economical to produce.