As the U.S. dollar rises sharply in tandem with gold, the odds of another global financial crisis go up. Editorial Director, Justice Litle discusses why…

It’s a funny thing about crisis – you can never be sure what the next catalyst will be. The really bad trouble always seems to spring from a place no one was looking.

This is a big reason why so many investors are caught off guard. They check the obvious places, but forget to check the odd places. (Or else they shrug and dismiss the possibility of crisis entirely.)

What’s worse, our global financial system is even more prone to crisis now because everything is so connected. When one financial system sneezes, another catches cold… or pneumonia… or worse.

As you well know by now, the eurozone is engulfed in systemic crisis. But did you know that a crashing euro has the potential to unleash a fresh new round of fiscal avalanches all around the world – even in countries that have no exposure to the euro at all?

The reason why has to do with the U.S. dollar. The surging U.S. dollar.

Dark Riders

On Friday we talked about how gold has gone parabolic. As the chart above shows, the U.S. dollar is going parabolic right along with it.

When gold and the dollar rocket higher at the same time, that’s a very bad sign. When the two get together like this, they are dark riders of deep fear and concern.

The dollar-gold parabolic pairing is rare. It happens as a function of last-ditch safe haven buying. When things get really bad, many investors want to seek shelter in gold, the last “neutral currency”… and the rest want to pile into U.S. Treasuries.

Right now we can say the U.S. dollar is rising for at least three reasons:

• Because the euro plunged into freefall (sending the $USD higher).
• Because U.S.-based investors are pulling their dollars from emerging markets.
• Because overseas investors are buying U.S. Treasuries (along with gold).

Squeezing the Shorts

Now here is the problem with this situation. The higher the dollar rises, the more the shorts get squeezed.

And who are the “shorts” in this instance? Anyone who has borrowed cheaply and heavily in U.S. dollars, with an eye for investing the proceeds elsewhere.

Take our good friend Hugo Chavez, for example. Chavez is the fiery leftist president of Venezuela – a man who, just to give you an idea how he thinks, recently hired some 200 people to manage his Twitter account.

Chavez is also – how to put this tactfully – a bit light in the brains department. The man is just not that smart.

And so, it was no surprise last year when, somewhere in the general vicinity of the dollar’s bottoming out phase, Chavez decided that Venezuela should issue dollar-denominated bonds.

This meant that Venezuela sought to borrow in U.S. dollars, assuming it would have the ability to pay those dollars back more cheaply – with lesser value inflated dollars – at some point down the road. Chavez cackled about the move at the time, thinking he was taking advantage of the despicable yanquis and their forever shrinking imperialist currency.

With the dollar now rocketing higher, though, Venezuela’s setup is looking like a very bad deal. To borrow in a foreign currency is to live or die by the fluctuations. For every tick upward in the buck, Venezuela’s potential payback costs go up.

The Asian debt crisis of the late 1990s – also known as the “Asian contagion” – was largely centered around dollar-denominated debt. Thailand had borrowed heavily in dollars to spend money on things like needless construction projects.

When the value of the baht plummeted, Thailand found itself unable to pay its U.S. dollar debts. Other Asian nations, lacking enough spare dollars to cover their scheduled payments, found themselves in the same spot… and the contagion was on.

A Heat-Seeking Missile

Now fast-forward to the present day. Asia is not the one at risk of a dollar shortage this time. They learned their lesson on the last go round, which is why so many Asian central banks have huge dollar surpluses.

The trouble is, others have taken the old Asia playbook and run with it. Many non-Asian countries, not just Venezuela, have borrowed heavily in U.S. dollars on the assumption of paying the money back cheaper.

What’s more, a number of exporters – particularly in Europe – have done the same thing. These exporting companies assumed that getting leverage against the greenback was a sure thing… a one-way bet. The dollar was going down and down when they effectively made a long-term wager against it (by borrowing in dollars). Never did they imagine such a sharp reversal of the trend.

So the faster the dollar rises, and the more sharply it rises, the more pain these “short dollar” players feel. Nor is this even to mention the world’s hedge funds, which have collective access to trillions of dollars worth of leverage… and have deployed much of that leverage in anti-dollar fashion.

Hopefully now you are getting a sense of why the rising dollar is a heat-seeking missile. As it climbs ever higher like a stage five rocket, it gets closer to exploding a whole new level of crisis.

You can get additional information about the U.S. dollar when you sign up and read my fellow Editor Adam Lass’ investment commentary.

A Dangerous Feedback Loop

What’s more, this new crisis has the potential to run on a dangerous feedback loop (just as most all leverage-fueled cock-ups do). As the pressure gets too intense, various countries will decide to buy back their short dollar exposure, either by retiring the dollar-denominated debt or purchasing $USD in the open market to hedge their risk.

This, in turn, creates more buying pressure for the dollar… which pushes the greenback higher still… and so on.

If you’ve ever wondered why markets can run wildly to high and low extremes that seem to make little fundamental sense, this is a big part of it. At a certain point, it stops being about factors like “yield” and “intrinsic value” and more about things like “sentiment” and “plumbing.”

In a nutshell, sometimes the feedback loop takes over – and there isn’t much anyone can do about it.

Equities can play a role too, through the leveraged nature of investment funds. If a large hedge fund is heavily invested in long equities with plenty of leverage, and the value of those equity positions starts to decline (i.e. stocks go down), the fund might need to sell stocks and cover some of its short dollar exposure at the same time, in order to “stop the bleeding” and reduce risk.

If just one fund takes the course of action described above, it should be no problem. If enough large funds do it simultaneously, however, you can have an immediate problem (of the type that fuels a 1,000 point drop in the Dow, for example).

On the equity side of the feedback loop, this means selling begets more selling. On the dollar side it means short-cover buying begets more short-cover buying. Like the ouroboros, the fat tail feeds on itself.

Be Careful Out There

This kind of thing is not reason enough to sidestep markets entirely. There are few “set and forget” type investments in the world, and central bankers everywhere are working hard to make cash in the mattress a bad idea.

But you want to be careful out there. If you can, cultivate the ability to go short as well as long, either through options and ETFs or individual equities. Learn when to be tactical in your deployment of capital, not just strategic.

And learn to take overly rosy forecasts with a grain of salt. Every projection has hidden risk, and that risk should be brought up front and dealt with. (The good news being, sometimes the risk is also opportunity.)

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Other Related Topics: Equity Trading , Exchange-Traded Funds , Gold Prices , Justice Litle , Taipan Daily , U.S. Dollar

Other Articles Related To Gold:

During the previous weeks much has been said about the declining Euro and what effect it may have on the price of gold – we argued that declining Euro doesn’t mean that gold has to decline. We don’t want to get into details once again in this essay, but instead we would like to remind you about several facts that we feel have been forgotten during the past several weeks.

It is often said, that the U.S. Dollar provides a safe haven status, but it that really the case? Did everyone forget about the gargantuan twin deficit that rises each day? Did the massive amounts of U.S. debt in the hands of foreign investors suddenly stop being a problem? Did really so much change yesterday as far as the global economic situation is concerned that the stock indices plunged so heavily? Not really. The thing that changed was market’s perception toward the abovementioned USD fundamental factors determining the currency exchange rates.

Therefore, fundamentals are one thing – but market’s participant’s emotions are quite another thing, and we still need to take charts into account before making any timing calls. So, let’s begin this week’s technical part with the analysis of the U.S. Dollar. Let’s start with the long-term USD Index chart (charts courtesy by http://stockcharts.com.)

In one of our previous Premium Updates we wrote the following:

We expect the USD local top to be reached in the next week or two. With the RSI still below 70 and past tops occurring at 70 or higher, we expect some sideways movement or slight uptrend as the RSI moves closer to 70.

With what we have seen last week, many signs point to this rally being over or very close to a local top today. The USD moved about 5 points higher since the April 2010 bottom, which marked the beginning of the rally. Regardless, we are now bearish for the short-term. We base this on a number of signals which are visible in today’s long term chart. First, we see that the USD is trading along the upper border of its trading channel, which serves as a resistance level. Secondly, the RSI has risen above the 70 level.

Please take a look at the previous rallies – we’ve marked them with different colors on the above chart. If the very recent rally is going to be similar to what we’ve seen in the past – and it is highly probable that it will – the rally is likely to be over or it’s very close to being over. We have extrapolated the previous rallies to the current situation (taking the April bottom as the beginning of this rally) and it turns out that we are now in the area that is very likely to mark the end of this upswing. Nearly all indications are that the USD top will be reached in the 84 to 85 level, and we have just seen the USD Index move slightly above the 85 level and retrace below it.

Let’s move on to the short-term chart for more details.

The above chart clearly shows another factor, which supports our belief that the current USD rally is in fact over or very close to its end. Last week we mentioned that the vertical red lines in the short-term chart frequently correspond to local tops and bottoms. We further stated that it was unclear, which would occur in early May. Now – taking into account the recent strong upswing – it seems very likely that it’s going to be a local top. The final confirmation comes from the analysis of volume.

Looking at the UUP ETF, ETF being a proxy for the USD, we see the RSI around the 70 level. This is a sell signal for USD. We also can see that previous tops have been accompanied by high daily volume. The daily volumes this week have dwarfed what we saw last week. This huge spike in trading volume is yet another factor which supports our belief that we have reached a local top or we will see one soon. Still, this is not the most bullish aspect of the above chart.

The most bullish part of the above chart is the relative performance of gold – and yes, also – silver. Although the white metal has just moved much lower, silver managed not to slide below its late March low. With the USD showing significant strength of late, the white metal overall has actually held up fairly well. With the outlook bearish for the USD, we remain bullish on all precious metals in the coming months even if we see a correction in the short run.

Summing up, indications are that the USD has reached a local top, which – along with the fact that gold was able to rise even along with higher USD values – is a positive factor for the precious metals market. We may see a short-term correction sooner or later (details and targets available to Subscribers), but once that decline is over, the rally is likely to resume, which could easily mean PMs much above today’s levels.

To make sure that you are notified once the new features are implemented, and get immediate access to my free thoughts on the market, including information not available publicly, I urge you to sign up for my free e-mail list. Sign up today and you’ll also get free, 7-day access to the Premium Sections on my website, including valuable tools and charts dedicated to serious PM Investors and Speculators. It’s free and you may unsubscribe at any time.

Thank you for reading. Have a great and profitable week!

P. Radomski
Editor
www.SunshineProfits.com

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by Bryan Rich 03-06-10

In my December 26 Money and Markets column I focused on the outlook for 2010, and the looming threats to global risk appetite. I warned that sovereign debt problems posed a major threat to global economic recovery. And I concluded that this threat represented a catalyst for a return of global risk aversion.

I also said that in a global crisis, these sovereign debt fears have the ability to be contagious. Such fears can destroy investor confidence in the capital markets of troubled countries, as well as in the overall global economy.

And when confidence wanes, capital flees … a surefire recipe for falling dominoes. That’s especially true in the wake of a deep global recession that has left many countries with bloated deficits and debt loads.

Despite the European leadership’s attempt to lessen the sense of urgency in the euro zone and despite the ambitious plans rolling out to shave outsized deficits, the problems with governments’ finances are not finding a resolution.

More likely, it’s just the beginning of another major destabilizing force for the global economy. And the result is looking more like another bout with recession … or perhaps depression.

Sovereign debt is setting the dominos up for a fall.

Here’s a brief look at how the dominos are setting up to fall, and ultimately why I think the British pound is the next vulnerable currency, as fear and instability spread from country to country.

Falling Domino #1: Dubai, the Wakeup Call

In late November the Dubai government created a hiccup in the rosy plans that many market participants were increasingly hitching their wagons to: A V-shaped economic recovery.

All of the sudden the new, innovative center for global finance was in default. And contrary to what was assumed, its rich neighbors weren’t there to provide a lifeline.

Now Dubai World’s debt holders are getting only 60 cents on the dollar for their government bond investment.

Falling Domino #2: Greece, Next in Line

Greece, the weakest of the sixteen-member European monetary union, the euro, was running a budget deficit more than four times the limits set forth in the euro-zone’s fiscal constraint guidelines.

The ratings agencies took the alert from Dubai. And they started slashing Greece’s sovereign debt ratings sending out a warning signal to all debt holders and making Greek government debt refinancing that much more difficult.

Falling Domino #3, #4 and #5: Portugal, Ireland and Spain The Next Troubled Spots

Greece isn’t the only euro-zone country in trouble … Portugal, Ireland and Spain all have severely bloated deficits and debt levels. That puts them in violation of European monetary union (Emu) guidelines, not to mention diminishes their outlook for economic growth — a tool desperately needed to start dealing with their red ink.

S&P stripped Spain of its AAA rating.

Consequently, the ratings agencies have put these weak countries under the magnifying glass. And ratings and outlooks have been downgraded. For example, Spain, the third largest economy in the euro zone, lost its AAA rating in January.

In prior Money and Markets columns I’ve discussed in more detail how the developments within these troubled Emu members have exposed structural flaws in the euro and have created an irreparable moral hazard.

Now, European leadership has stepped in and promised to provide support to the most immediate need: Greece.

By doing so it opens the floodgates. Meaning there is nothing to stop the other weak, fiscally-irresponsible members from lining up hat-in-hand to be bailed out by the stronger, more fiscally-responsible ones.

As for the euro, this total breakdown in the foundation of the currency union has it on a path for destruction or, at best, an extended period of uncertainty.

Falling Domino #6: The UK, Looking Grim

The next, most vulnerable and biggest domino in line to fall is the UK. Among G-7 countries, the UK has the weakest performing economy, the largest deficit and the worst deterioration of its debt position.

As conditions get worse in the euro zone and it becomes increasingly evident that there are no clean fixes, the UK is the most likely candidate to come under the gun.

The pound is becoming more exposed to speculators.

The British pound plunged to its lowest level in 24 years against the dollar at the height of the financial crisis … now just a year later it appears another test of that level is in the cards.

And that’s where the outlook for the pound looks grim. Already, this week, negative forces have gathered against the pound taking it to its lowest level vs. the dollar in more than ten months!

So while the uncertainty about the UK government’s finances continues to build, I expect the pound to be the next victim of currency speculators.

Falling Domino #7: The U.S.? In the Crosshairs

In this spread of sovereign debt fears, bond market pressures and falling dominos, the U.S. is in everyone’s crosshairs. And in a scenario where a sovereign debt crisis spreads through the major economies of the world and impacts some of the largest, most liquid currencies, the world doesn’t look like such a safe place any longer.

Therefore, if you’re evaluating your investment options, you’re likely seeking the highest probability for return of your capital rather than return on your capital. And I think the flow of global capital will demonstrate that the currency of choice will be the U.S. dollar and dollar-based assets.

Regards,

Bryan

About Money and Markets

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The ascending dominance of the “Currency Contagion” meme will raise the selling price of this asset 197%.

It’s all about faith, my friends. And unfortunately, that’s an increasingly rare commodity these days.

A body participates in a system if they have reasonable faith of making a decent return. If they have no faith – no expectation that the system will honor and reward their participation, they will eventually cease to take part in it, and the system will collapse.

Dogs pack up, because they figure that they might lose a piece of their next meal to the pack’s alpha male, but they have faith that the pack is the best way to assure that there will be a “next meal” on a pretty regular basis.

The Cost of Failure

It may take a while before they notice that they are missing out on a regular basis. But it is a given that a pack that does not expect adequate food will begin to slowly lose members. When things get bad enough, the remaining dogs will gang up and expel the failed Alpha.

Similarly, human participation in transactional relationships requires a certain measure of faith.

On the simplest level, one must have faith when one is trading goats for wheat that the gentleman across the table from you will not smack you upside the head with a large stick, and walk off with the goats, the wheat and perhaps your clothes, stone axe and mate. Thus we have open palm salutes and handshakes, wherein we establish to one another that we are not concealing a weapon of some sort.

Currency: A Valuable Fiction

Now let’s take things up a notch in complexity. Some say that currency exists because it is a bit of a pain dragging around goats and carts of wheat with you all the time. But really, currency exists because it allows for specialization of labor.

I might be particularly good at raising goats, while the fellow across the way is better than I am at keeping bugs out of the wheat. Neither of us makes a halfway decent boot mind you, but that’s OK, because a chap in the next town is a whiz with a scissors and a hammer.

A currency of some sort allows each of us to focus on what we do best. It also allows a body to store wealth without worrying about the smell a pile of dead goats inevitably generates.

However, any currency, be it shells, beads, coins or pieces of paper, requires a great deal of faith. One must trust that each iteration of that currency, each bit of specie will retain its value over time, or it cannot possibly be an adequate storehouse of value.

One must have faith in the creator of said specie, or the whole system falls apart, and we are stuck hauling about cartloads of stuff again. Worse yet, I would have to make my own shoes, and I am quite sure that my feet would suffer awfully.

The Gold Bug Fallacy

As long as we are discussing currencies, I’d like to take a moment to address a common fallacy. Many folks in this business like to label all command currencies as fictive and therefore undeserving of your faith.

They frequently have a good point there, as most every government has inevitably debased its command currency so as to ease the burden of paying its debts. In plain English, they borrow goats and print bucks to pay off the loan.

But these same folks will point to certain minerals as having “genuine value.” Gold and silver are the usual favorites because of their pleasant coloration and heft and relative resistance to corrosion. However attractive these bits of rock may be, their ability to retain value is simply a meme, a thought shared by millions perhaps, but still just as fictive as any paper currency.

But Can You Eat It?

A friend asked me recently if I concurred with the idea that “all hell was about to break loose,” and what they might to do about such things. They thought that perhaps they ought to convert a substantial portion of their holdings into gold coins of some sort.

I am not so sanguine as to the eventual fate of our current systems as to completely disregard his point. But I did suggest that if he really thought that our civilization was verging on one of its periodic dark ages, he might do better to invest his money in a few courses at his local community college.

In particular, he should acquire the ability to grow corn, clean and patch wounds (and given a little more time, deliver babies), prop up roofs, and brew alcohol (the basis of most all chemistry). Learning to make shoes wouldn’t be a bad idea either.

In a real crisis, you can’t eat gold. At best, I suppose you could put a chunk or two in a sock and kill marauders with it.

As much as it is romantic to ponder such dramatic turns of affairs as dark ages and depressions, I am not really looking to address such complete societal breakdowns in today’s column.

Looking for more market analysis information? Sign up to read fellow editor Justice Litle’s latest on financial market trends and investment commentary delivered right to your inbox.

The Price of Faith…

Let’s presume for a moment that we will indeed be able to buy shoes for some time to come, and focus instead on the decline of the meme of faith as it pertains to certain of our fiscal systems.

Currencies are not the only fiscal contracts that require faith in the issuing party. The same is most certainly true for both stocks and particularly, bonds.

No one in their right mind would lend to a company, town or country if they had no faith whatsoever in the borrowing entity’s intent or ability to repay that loan, preferably with some interest. But these things are seldom absolute, so we posit an inverse relationship of faith in repayment against additional cost asked of the borrower.

…And the Cost of Risk

Right now, for example, the more fiscally sound portion of the EU (read as Germany and France) is pondering how much interest it must charge the less sound “PIIGS” states in return for lending them adequate funds to avoid bankruptcy.

The problem is, very few honest observers have any faith that Greece et al. will ever change their spendthrift ways. So if Germany and France participate in a rescue package, will this increase faith in the European Union’s future? Or will the rest of the world lose faith in Germany and France as well?

And once this “Loss of Faith” meme begins to ascend and replicate, will it become dominant within the “Menome,” the total global kettle of conscious thought? Once folks start to ponder the ability of sovereign governments to honor debt through their own specie, the illusion of both debt and command currency (always a bit tattered around the edges) begins shred entirely.

A Dangerous Descent

The last time we saw such a breakdown was the Asian Contagion episode of 1997, wherein faith in the ability of government to control the ability of currency to act as a reservoir of value was stretched to the breaking point. And that time around, the focal point of the loss of faith was halfway around the world. We were able to comfort ourselves – to find faith – in the idea that Western governments would never engage in such dangerous shenanigans.

View Larger Chart

This time, the focal point is right here in the West. When one peruses such newspapers as the International Herald Tribune, one is treated to multicolored displays reveling in the sheer impossibility of genuinely solving Europe’s Gordian knot of debt.

Stateside, one cannot go a day without reading of the overwhelming weight of debt Washington has taken on. These figures are critical both as facts, and as ascending memes, ideas that are gathering power in the minds of more and more investors. As faith in sovereign debt and currency declines, investors (at least those who are not pondering a new dark age) are looking toward the usual safe harbors of gold and silver.

Critical Memes

As mentioned earlier, I have no particular faith in gold and silver’s inherent values. But I do note with much interest the relative increases in the rate of uptake of the “Gold” and “Silver” memes.

Gold has long been the obsessive’s dream, the stuff they make movies like “Treasure of the Sierra Madre” about. But silver does a heck of a lot more of the heavy lifting. As Nobel Laureate economist Milton Friedman is said to have told Jim Blanchard, “The major monetary metal in history is silver, not gold.” Think about it: Gold is kept in vaults around the world – but most every coin in your pocket right now is covered in silver.

Both gold and silver have been used to hedge against inflation driven crashes like we saw in 2007 (and like we are about to see again in 2010). In October of 2007 the S&P 100 was trading at 714.51, Gold futures were $745 an ounce, and silver was available for $13.89. (That’s a ratio of 53-to-1, an important figure we will come back to in a moment.)

Six months later, the stock market was down 18.32% (on its way to a total loss of 56.79%). Gold futures were up to $1033.9 an ounce (a gain of 38.78%) and silver was up to $18.85, a similar gain of roughly 36%. The relationship between gold and silver was still holding even at about 55-to-1.

A Curious Gap – and 197% Gains

We are approaching a critical moment in the market very similar to the precipice we stepped off in 2007. Oil is skyrocketing again, and is spreading its inflationary poison throughout the system.

But investors are facing an extraordinary problem: Gold’s nonstop rise over the past year has already pushed futures to $1,166 – just a whisker away from its all-time high. Silver has also been rising. But its current price of $17.27 an ounce leaves it 18.46% shy of its March 2008 high of $21.18.

More importantly, there is a unique distortion in the ratio between gold and silver: Right now it takes almost 68 ounces of silver to buy an ounce of gold! This gap cannot last more than a moment or two, as investors looking to hedge against stocks rush in to take advantage of silver’s discount to gold.

With this closing gap in mind, I suggest to you that you expose yourself to silver’s pending upside. Since I retain the view that even silver’s value is in the end just as fictive as any five dollar bill, I suggest instead a vehicle such as iShares’ Silver Trust ETF (SLV:NYSEArca). My charts indicate a pending upside run that could easily add 30% to SLV’s current share price of $17.19.

Taking this idea another step, I have suggested to my WOW readers that they divorce themselves even further from physical silver, and involve themselves primarily in SLV’s upside motion via the purchase of select SLV calls, with the intent of harvesting gains ranging as high as 197%.

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In the event of a full-blown sovereign debt crisis, hard assets will become deeply desirable as one of the few “stores of value” left.

…all too often the size of debts, especially government debts, is hidden from investors until it comes jumping out of the woodwork after a crisis.
– Prof. Ken Rogoff, Financial Times column, “Bubbles lurk in government debt”

Last week, in “How to Protect Against Currency Collapse,” we talked about the mounting debt problem and how Western governments will deal with it.

If the debt is issued in your own currency, you ultimately just print more currency to inflate that debt away. (If the debt is issued in someone else’s currency, you are in deep trouble… as Greece, Latvia, Iceland and others have all found out.)

Right now the global economic recovery has the appearance of being cost-free. This is due to an age-old confidence trick known as “ignoring the bill.” To pull off this trick, you spend huge amounts of money on a high-limit credit card… ignore the mail when the bill comes due… and conveniently forget to reconcile your accounts.

Complacency reigns because the true costs are not being tallied. The Bank for International Settlements – an age-old central banking watchdog based in Switzerland – is having none of it.

The “simmering fiscal problem” of sovereign debt is set to bring industrial economies “to the boiling point,” the BIS reports in a new study. “Bond traders are notoriously short-sighted,” the BIS further scolds, “assuming they can get out before the storm hits… the question is when markets will start putting pressure on governments, not if.”

The Bank of International Settlements further believes that, if we do not turn from this path, inflation will spiral out of control. “Monetary policy may ultimately become impotent to control inflation,” the BIS scowls, “regardless of the fighting credentials of the central bank.”

Not China or Japan

Last week, readers wrote in to ask whether China’s currency might count as a viable hedge against collapse – perhaps through a vehicle like the Dreyfus Chinese Yuan Fund (CYB:NYSE).

The answer there would have to be: “Nope. Too risky.” China’s fortunes are still deeply linked to those of the United States:

• China’s currency is still pegged to the USD.
• China’s economic future is still heavily dependent on exports.
• China still owns massive quantities of U.S. Treasuries.

The above factors make it hard to determine how China will fare in the event of Western currency meltdown. The Japanese yen is also a deeply risky proposition, given its heavy export dependence, major UST holdings and massive internal debts.

This all goes back to a talk your editor gave in Chicago last summer, discussing the shape of the world’s next reserve currency. The gist was that all those who would seek to dethrone “King Dollar” are impostors.

China’s currency regime is not ready for primetime. Japan is struggling with a demographic death spiral. And the euro is crumbling before our very eyes.

In a paper-debased world, that leaves hard assets as the last option standing.

Where Have You Gone, Joe DiMaggio

Try as they might, investors will not be able to ignore the sovereign debt problem forever. When the reckoning comes due, the printing presses will kick into hyperdrive… and faith in the system will crumble (or perhaps shatter like brittle glass).

At this point, investors will turn their lonely eyes to hard assets, looking at precious metals and basic building-block commodities in a new light.

Up till now, hard assets have more or less been treated as a “hot money” play on global economic recovery. Price movements have been linked to speculative appetite and the general degree of optimism.

The onset of a sovereign debt panic could thus lead to a short, sharp and temporary drop in hard asset prices, as the “hot money” beats a hasty retreat. But over time, a post-crisis shift in psychology will occur. In a world where all major currencies are being debased, oil and metal in the ground will stop looking like speculative plays and start looking more like stores of value.

A Pending Rocket Ride

The Reuters/Jefferies CRB index tells the story of commodities’ lackluster performance. While equities have been going gangbusters, the CRB has been more or less flat for half a year.

That is because focus remains on cost-free recovery for now. There is widespread belief that the U.S. economy is in a sweet spot, with a goldilocks-like ability to push profits up while keeping short-term interest rates near zero. The Fed is widely revered at moment for having succeeded in its mission. Some bulls are even musing aloud now whether the “great recession” was even all that “great” – as if it were over and done, finis, all consequences postponed indefinitely.

It is an environment, in other words, that very much favors “paper” (leveraged financial plays) over “stuff” (hard assets).

But when faith in Western governments’ ability to shoulder the sovereign debt load evaporates, that equation will reverse rapidly. (And as the BIS noted in its gloom-and-doom report, it is a question of “when,” not “if.”)

And so, after a period of renewed fiscal panic, in which it is driven home, yet again, that the grossly indebted central bankers of the world do NOT have control – only the illusion of it – a need to take shelter from the ensuing inflationary paper-debasement storm will become paramount.

THAT is when hard assets will become most attractive… not as hot money speculative vehicles, but emergency stores of value. A true rocket ride for commodity prices – the likes of which we haven’t seen yet – could be the result.

A Simple Proxy

Not to beat a dead horse, but the above is further reason to consider the EverBank Ultra Resource Index CD (as mentioned last week).

The countries represented in the Ultra Resource Index CD were selected not just for their attractive cash positions, but their rich abundance of hard assets. Countries with vast quantities of natural resources “in the ground” – like Canada, Australia and Norway for instance – will be seen as sitting on vast treasure chests.

Such resources would have permanent and lasting value even if the entire global financial system melted down completely. (People can go without paper, but they will always need to eat, drive, build, and so on.) As the sovereign debt crisis unfolds, investors may well flock to these “hard” currencies in droves as their home-based scrip turns to confetti.

To find out more about the Ultra Resource Index CD – a product created at Taipan’s request, for which we receive a small commission – follow this link.

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Other Related Topics: Currency , Debt Problems , Justice Litle , Macro Trader

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Jim Willie CB, editor of the “HAT TRICK LETTER”

Use the above link to subscribe to the paid research reports, which include coverage of several smallcap companies positioned to rise during the ongoing panicky attempt to sustain an unsustainable system burdened by numerous imbalances aggravated by global village forces. An historically unprecedented mess has been created by compromised central bankers and inept economic advisors, whose interference has irreversibly altered and damaged the world financial system, urgently pushed after the removed anchor of money to gold. Analysis features Gold, Crude Oil, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and US Federal Reserve monetary policy.

While the multitudes debate over whether an economic recovery is coming to the United States, signals sound loudly in harsh tones. While they point to the recent rise in the USDollar, signals sound loudly in harsh tones. Admittedly the signals are confusing, but they are important. The long-term bond yield for USTreasurys threatens the 4.0% mark. The crude oil price is close to threatening the $100 mark. Sleepy financial market anchors and mavens offer comment, but might miss altogether the significance of the signals. The signals clearly mean great strain on the credit markets still, and gradual decay of the major currencies led by the USDollar.

PREFACE ON MARKET RIGS

The hearings took place two weeks ago. The news of Andrew Maguire’s testimony on March 25th has circled the globe, ringing shrill in the ears of anyone half awake. Maguire is a metals trader from London, but watch somehow that his career takes a turn for the worse. So far the car carrying his torso has been run off the English roads. He still walks and talks, but whistle blowers usually have short lives and shorter careers. Laws protect them, but not from the powerful syndicates. Maguire outlined the corruption in the gold market, and abused domination by JPMorgan in particular. The monolith transmits its signals and enlists the support of a small army of traders who pile atop the price suppression tactics. Despite almost 20 years of complaints lodged with the Commodities Futures Trading Commission, JPMorgan continues to operate with such a high degree of impunity that their staff openly boasts about after their illicit profits are garnered. Maguire guided the CFTC, headed by Goldman Sachs alumnus Gary Gensler, through recent gold price manipulations before during and after a non-farm jobs report was issued. Maguire outlined in some detail how orders to short gold arrive in volume over 2500 contracts, designed to overwhelm the market, often when the market is thin. They are almost always naked short sales, without benefit of bullion posted as collateral. They are executed with the implicit blessing of the USGovt and UKGovt. The trades are not intended to seek the optimal price, but rather to corruptly reduce the market price. The GATA warrior (aka El Cid) named Bill Murphy offered his testimony at the hearings, running fleet footed past the secondary coverage easily. He has submitted many complaints over the past few years, all falling on deaf ears and blind eyes. See the Gold Anti-Trust Action article on the unprecedented hearing (CLICK HERE), which has been covered by dozens of other web journals. Nowadays, in order to be treated to the actual news, one must rely upon the alternative locations from the internet, like Zero Hedge and their small platoon of Wall Street soldiers in service to the truth (CLICK HERE).

The US financial markets are slowly being revealed as a series of corrupt Ponzi schemes. The gold market is the vulnerable linchpin for the USDollar and USTreasury markets. That is why gold is so important to be controlled and suppressed. The diverse sanctioned illicit and illegal activity renders it a damaged market screaming to be freed. Some readers and subscribers alike have written to the Jackass email inbox with messages of hope and some satisfaction, in the wake of the Maguire testimony about the CFTC lapses. The meeting organizers might have thought the hedge funds would be blamed for outsized illicit positions, but the blame was squarely place upon JPMorgan and the Big Four firms. The exposure process is long and slow, however. The Goldman Sachs class is still in control of the USGovt purse, still guides funds to Wall Street after first feeding at the trough, still operates as the great vampire squid in search of money pools as Matt Taibbi bravely describes. The news has circled the globe, finding the financial pages in London and Germany. Some believe the news is too hot and viral to be reported on the mainstream US press networks. Do not hold your breath for exposure in the Untied States, where the syndicate maintains controlling ownership of the press networks, bringing them to heel, dictating their many messages, filtering their stories as suitable for coverage, painting patriots as villains and criminals as heroes. But, lest one despair, there is hope that exposure will come as powerfully and broadly as the morning sunrise. The lackey US press might cover the story eventually, but only after almost the entire planet covers it. My Jackass article about the corrupted gold market last May 2009 made a splash, earned some accolades, but also invited some mockery by nitwits who have turned silent. The bust of the gold market is in progress, whether or not people wish to see it. The hitmen cometh to the gold exchanges.

London has been selling gold contracts without gold bullion in inventory since mid-December. They almost entirely settle long gold futures contracts with cash settlement, offering a 25% cash bribe. One must wonder if a non-disclosure contract is signed on the way out the door. Gold bullion has been flying out the vaults and doorways at the London Bullion Market Assn for months. The Chinese and Arabs no longer trust the London or New York syndicate in control, since behind the curtains much gold has been improperly leased and replaced by gold certificates. The gold wars are fast turning ugly, with murder a recourse used by one faction versus another in the quest for power in the next global chapter. From the aerial view, not burdened by details of routes, names, and gory items, one can find safety during the battles waged among titans, the templars if you will. The Jackass is a pure observer in the process of syndicate exposure, never wishing to hold detailed evidence, as in EVER, since lifespans are cut off. My work is to connect the dots and to identify the patterns revealed by them, then to say “I TOLD YOU SO” afterwards each time.

The other controversial stories continue to find verification at some levels. Consider the tungsten gold bars, which some myopic editors refuse even to consider as valid. A grand swap took place during the Clinton-Rubin Administration, to remove the gold bars and replace them with gold plated tungsten bars, then flood the system. A full replacement would entitle the thieves a $500 billion net profit, a solid motive. The gold bar lists are no longer consistent even at the US Federal Reserve. The Street Tracks SPDR (GLD) exchange traded fund also has no longer any consistent bar lists. The tungsten story broke out within the Hong Kong bank sector, where they reported several hundred tungsten fake gold bars. The tungsten gold substitutes shown below arrived at the W.C.Heraeus foundry, which is the world’s largest privately owned precious metals refiner and fabricator, located in Hanau Germany. The bar was due for melting, and originated from an unnamed bank. More details are likely soon enough. See the YouTube video (CLICK HERE) and the Zero Hedge article (CLICK HERE).

The Gold Anti-Trust Action committee made a statement after the German display of tungsten laced gold bars. They wrote, “What appears to be the first documentation of counterfeit gold bars made of plated tungsten was noted today by Zero Hedge as having been reported by a German television station. The counterfeit bar reportedly is in the possession of the W.C.Heraeus gold foundry in Hanau Germany, said to be the world’s largest. This sort of thing might shake the gold market even more than, say, the International Monetary Fund’s confession that it really does not have any gold and that it has been selling only bookkeeping entries all this time.” Almost every single claim of impropriety, price suppression, falsified accounting, corruption in metals exchanges, and treason by US and British financial leaders lodged by GATA have come to be proven true. My contacts report the source of most tungsten gold bars is the United States during the Clinton Admin, using a clever trail with shutdown smelters and the same shipment routes as the narcotics (see Panama and Arkansas). Evidence is being gathered, and mounts, for release at the strategic moment by more direct players, since so dangerous to possess. For a fine article about the competing properties of gold versus tungsten, and detection methods, see the article entitled “Fake Tungsten Gold Found” by Trace Mayer (CLICK HERE). The tungsten gold theme is blossoming and going mainstream.

STRAIN ON LONG-TERM RATES

The Jackass has a string of correct major forecasts in the last few years. See the call of a growing trade gap with a falling USDollar exchange rate. See the call of an unending housing decline. See the call for absolute bond market breakdowns beyond the subprime. See the call of an insolvent US banking system. See the call about Lehman Brothers going bust. See the call about Fannie Mae going from mortgage finance sewage plant to USGovt sewage plant. See the call for the Saudis to reject US$ payments for crude oil, pending action. See the call about Dubai being the focal point of debt collapse. See the call about the ruin of the gold market with gradual exposure, complete with bullion raids. Now watch the call about Germany not aiding Greece, which gradually enters default.

By far the area of my worst forecasting record is long-term USTreasury Bonds. After the autumn death of the US banking system, never to recover, my forecast was for much higher prevailing interest rates. All claims to remedy the banking sector are masked events to pilfer trillion$ in official rescue packages without a hint of disclosure, pure syndicate activity. While the long-term USTBond yield has touched 4.0%, the upward thrust is hardly strong. The incredibly large USGovt debt issuance supply should have sent the long-term rate to 7% or 8% or 9% or 10%, but JPMorgan has a device made by the same foundry as the US Federal Reserve. While the USFed can print money at near zero cost, the JPMorgan shamans can put to work Interest Rate Swaps at near zero cost. The IRSwaps are instrumental in pushing down long-term interest rates, using powerful leverage, the short-term USTBill as the fulcrum, and the USGovt as the protective cover shield. A Double Dip recession perception would go a long way to reducing the 10-year USTreasury Note yield, as demand would shift from stocks to bonds. Notice the significance of the 4.0% level. A huge reversal pattern is underway. The critical right side resistance level has been 3.9%, well defended. The left side critical resistance level has been 4.0% and 4.1% from late 2008. The trend is up, accentuated by the stochastix index since October. Watch a breakout above the important 4.0% level.

The chief nemesis of Gold is the USTreasury, both a US$ instrument and a traded paper security. THE NEMESIS USTREASURY BOND IS IN TROUBLE. Lately, something seems to have gone awry. The official USTreasury auctions have not turned out well. The direct bids and indirect bids and bound bond dealer participation and bid ratios and accounting all stink to high heaven. Yet regulators are nowhere to be heard. The USDept Treasury even has resorted to a new fictional ledger item called “Households” to hide their vast monetization. Recall USFed Chairman lied to the USCongress about continued monetization. The Household item, so we are told, pertains to Fannie Mae and the oodles of Pension funds out there who buy up hundreds of billion$ worth of USTreasury paper. They are joined by armies of private bank CD investors. How preposterous!! Fannie Mae is selling USTreasurys, if truth be known, since slower repayment of mortgages has reduced the need for hedges. The Fannie Mae convexity is a remarkable phenomenon, whereby they dump their USTBond hedges as rates rise, and as homeowners hold loans longer into maturity. The hedged protection offered by USTBonds, in offset to mortgage bonds in performance mode, would not be needed if the mortgage defaults continue. The defaults are still increasing. So Fannie Mae sells off huge blocks of USTreasurys. But they are the Household ledger item doing the buying, right??

Other factors are at work. The Greek Govt debt situation has brought about a serious decline in confidence for all government debt. It is becoming widely understood and accepted that sovereign debt receives high credit ratings not deserved. Institutions are not lining up to purchase USTreasurys at auctions. The USGovt with its masters JPMorgan and the USFed are deeply committed to a gigantic circle jerk. They are buying up all the auctioned bonds, hiding the evidence of their trails, using offshore entities to bid, colluding with British bankers in the process, but they are facing a dead end. They have forced the primary bond dealers into a state of terminal constipation. Then the Chinese have been net sellers in the last few months. Were we not told just last year that the Chinese had no choice but to finance the USGovt debt? Yes, we were, and wrongly so!

The long-term USTreasury Bond yields will not go out of control high, at least not until JPMorgan is dead & buried. The yields might rise a little more, enough to spark a response by the financial syndicate that is Wall Street. They have a new trick in their repertoire. They talk up the optimism and wondrous rescues for the Greek Govt debt, so that volume on auctions rises significantly, enough for Wall Street firms to sell into the rally they assist in creation. Then the Wall Street firms put out news stories that the ugly nasty hedge funds are to blame for the fast decline in those sovereign bonds. Notice how the Greek 10-year Govt bond yield has risen to 7.19% this week, the highest ever. All talk of an aid package is just a ruse for Wall Street to exploit. The other ploy used by Wall Street is an old one. THEY WILL CAUSE A STOCK DECLINE IN ORDER TO PRODUCE FRESH USTREASURY DEMAND. If the financial news networks obediently report the economic recovery that graces the fictional pages of the US press is suffering from non-existence, then the bond demand will grow in a huge way. Even sporadic reports of a return to recession would greatly aid the USTreasurys.

Thus the USGovt has a grandiose vested interest to promote recessions, and they are expert in producing, sustaining, and deepening them. They must after all enable demand to keep the USTreasury Bond bubble alive at near 0%. They promote the nonsensical contradictory story of a jobless recovery. It should elicit much more laughter, like claims of prevalent virginity at a house of prostitution, like claims of wealth by a indigent street bum who holds a stolen credit card. A quick shift to a temporary recession would be easy.

The USDept Agriculture has reported this week that 39.4 million Americans, the most ever, received food stamps in January. They are participants in the jobless recovery. They are legion, whose recipient numbers are 22% from a year earlier. The total number of Americans receiving the subsidy has reached a record for 14 consecutive months. If one wishes for a whiff of reality, check the February and March reports within the paid Hat Trick Letter. Details on the powerful recession are provided, including home foreclosures, Fannie Mae default and delinquency rates, bankruptcies, municipal bond craters, tax revenue declines, and state budget shortfall crises. Such destruction must be the dark side of the recovery process. NOT! It is part of the propaganda process that conceals the deterioration with extreme power and momentum. These aspects are the rotten underbelly of the USEconomy deep in deterioration. It lacks an adequate industrial base, in case its clueless cast of economists fail to notice. It suffers from debt saturation, which explains why new debt offered in aid rescues cannot succeed in producing much of any benefits.

Despite the fact that USTBond yields will not go out of control on the upside, what might be growing much worse is the fires in the JPMorgan credit derivative workshop. As long-term rates rise, the Interest Rate Swap contract turns hostile, electric, and viral. Enter leverage in support of trillion$ in debt securities. The USGovt has the hidden credit derivative losses at JPMorgan, at Fannie Mae, and at American Intl Group to contend with. If the accounting were properly reported from basement labs, the new US$ creation might be much more than a measly $200 billion per month seen in the USTreasury issuance. The toll for credit derivative fires might be a few trillion$ per month!!! The truth would kill the USDollar and send gold skyward.

ECONOMIC COST OF RUINED CURRENCIES

The dynamics of the Competing Currency War are truly amazing and fascinating. When the Euro currency shows fundamental weakness, if not turmoil within the union, the USDollar benefits. Nevermind the $1.5 trillion deficit in 2009 and the similar $1.4 trillion deficit in 2010 that the USGovt must drag along. The USDollar has risen by about 10% against the Euro currency since November. Some properly call the FOREX market a reverse beauty pageant whereby the least ugly contender wins. The region with the least wrecked finances can boast of a rising currency. We are in Chapter 2 to the Dollar Death Dance. The first chapter occurred in autumn 2008 when Lehman Brothers was killed, when Fannie Mae was nationalized, and when the dead AIG corpse was adopted by the USGovt, the home of dead giants and fraud clearing houses. The demand from credit derivative payouts for ruined corporate bonds and destroyed mortgage bonds actually lifted the USDollar valuation. Payouts for Credit Default Swaps, those perverse insurance contracts against collateralized bonds, took place and did so in US$ denomination. The demand for the US$ zoomed. Uncle Sam danced hard, but without benefit of a functional heart, without benefit of oxygenated blood, without benefit of a circulatory system to distribute blood. The dead man danced.
The second chapter is centered upon the Greek Govt debt. Unfortunately for Europe, but fortunately for the USGovt, the second chapter has many pages yet to be written, from Spain, from Italy, and from Portugal. The Irish pages have already been written, crumpled sheets lying in the corner. This note came today by an email from an Irish friend. “Just heard from a good friend in Ireland that the austerity measures adopted by the Dublin government are causing untold hardship. He thinks there will be an uprising among the people that could get very nasty indeed.” Outsized staggering Irish bank losses have been reported. The IMF fix is in and the destruction will be completed. But the Greek tragedy plays out slowly. Hope rises but is dashed. Aid is announced only to be illusory. Support is shown but not sincere. Bickering has turned ugly, evidence of no rescue even remotely possible.

The beneficiary, we are told, of the Euro currency distress, is the USDollar. If the US$ exchange rate indeed was improving with tangible ancillary benefits, then a confirmation would come with gold and the crude oil prices. Gold holds its own, refusing to falter. But the crude oil price has just broken above the $80 mark. It threatens the $90 mark and is a clear lock to hit $100 and cause global shock waves. If the US$ is on the mend, on the rise, gaining ground versus other major currencies, then the crude oil price should be moving toward $50, and not toward $90. What we see demonstrates the broken nature of the major currencies in general, and the USDollar in particular. If the USDollar was returning to health, a breakout in the crude oil price would never happen.

The consequence is not pleasant of a rising crude oil price. The entire commercial sector of the USEconomy has a cost structure tied to energy costs. The natural gas price is indeed subdued. But crude oil is widely used in the futures markets to hedge against the USDollar. The demand for such hedges has increased. The light sweet Saudi crude oil is no longer available to meet WTIC crude oil contract demands. The rise in the crude oil price for Europeans using the Euro currency is even more pronounced, brought to view in previous articles. The collection of major currencies is under siege, deeply damaged, and subjected to constant debasement. The ongoing credit crisis and strong recession requires a governmental response on all continents. In Europe, the Untied States, Great Britain, and Japan, the printing of new baseless money continues at an astonishing pace. All major currencies are together in a death spiral. One key item of proof is the West Texas Intermediate Crude oil price shown above. When it hits $100 per barrel, listen to the quacky silly lunatic explanations given by the mainstream press and financial arenas. You will not hear any argument that all major currencies are mortally damaged. You will not hear any arguments that the central bank franchise system of monetary management has failed in spectacular fashion. You might even hear that the jobless recovery is strong enough to withstand the greater pressures of higher energy costs.

THE STEALTH RISE IN GOLD & SILVER

Give a hat tip to James Turk of Gold Money. He wrote in December that the gold low for 2010 would occur in the first quarter with a $1075 price, and a possible impulse low of $1050. We saw it almost exactly, but the year has nine more months to slug through. The 1Q2010 has been put to rest, the quarter ended last week. The March futures contracts are also put to rest, enough to clear a possible path to a higher price for both gold and silver. The gold price chart has a pennant pattern embedded that hints of a slow release to a higher price. It should start slowly and gain momentum once above the enclosed pattern. The news of the gold price rigging has had a positive effect on the psychology of this gold market. The endless monetary growth and federal government deficit explosion adds power to the gold price. Actually, the flip perspective is more accurate. The major currencies are all being diluted in value, while gold remains almost fixed in value. Seen from the currency point of view, gold is rising. Notice the uptrend in the MACD, which addresses the moving averages and the support offered. The long-term trend is still up, seen in the 200-day MA. The consolidation could be at an end. One thing is for certain. The gold community has been put to sleep. Most investors wait for the breakout in price, only to pay a higher price. They tend not to be savvy and capture the lower price during sleepy times. All claims of a gold price plunge to $900 were stupid and baseless, but were given plenty of airtime. To have a falling gold price when trillion$ of new money is created and dispersed into the ether is pure nonsense, the part & parcel of Wall Street syndicate tenets. Such invalid notions rely upon the goofy discredited deflation argument that circulated.

The gold price is slowly moving up. Its psychological basis is gaining firm strength. The recognition of ruined major currencies is gaining broader acceptance. The corruption of central banks is being more widely understood. The solutions offered to Europe are not only vacant, but they expose the Untied States and Great Britain to comparisons of equal vulnerability and similar fundamental wreckage. The gold price has made its lows in year 2010. The next important level is $1150. The resumed Quantitative Easing programs in the US and London will soon be given more publicity, more monetary debauchery via rampant dilution. All talk of an Exit Strategy is pure diversion, if not moronic. The USGovt cannot afford to pay higher borrowing costs, nor can the USFed afford to dump its bloated balance sheet on the credit market. Doing so would reveal that there is almost no market for what they hold in leveraged toxic mortgage bonds. Doing so would result in mortgage rates rising another 1% to 2% quickly. Not gonna happen! Instead, mortgage rates will rise 1% on their own without an Exit Strategy, without USFed liquidation of worthless bonds.

What would really ignite the gold market would be further investigation of the rigged gold market, some prosecution, demands by formal audits by USTreasury creditors, and revelation of absent gold at the exchanges that trade in the gold market. What would really ignite the gold market would be a resignation of the Goldman Sachs preppy Geithner at the USDept Treasury, or better yet, prosecution for bond fraud by him while serving as New York Fed Governor during the Lehman Brothers scandal, its coverup, and its kill job.

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting.   He holds a PhD in Statistics. His career has stretched over 25 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com. For personal questions about subscriptions, contact him at JimWillieCB@aol.com

The Gold Report: Your investment strategy has long involved finding undervalued or overlooked opportunities. What metals does that umbrella cover these days?

David Morgan: The byline of The Morgan Report is “Money, Metals and Mining” and I approach the market in that fashion and in that order. Mining—that’s where you get the greatest leverage. And metals—are the best asset class, particularly the precious metals, during these uncertain times. From the metals-only perspective, I’m a top-down analyst. We determine supply-demand fundamentals, what would cause a price to be higher or lower or stagnant. With the precious metals, we look at some timing cues as well. And then we look for resource opportunities, not just in the precious metals or base metals, but throughout the sector, and we do a fair amount of work in the REE, the rare earth elements side. But overall we look for undervalued situations.

TGR: What looks undervalued these days?

DM: Nickel is probably one that’s pretty undervalued, although it looks to be breaking out now. If you study the London Metals Exchange (LME), you’ll find pretty good inventory buildup in some of the base metals at this time—high enough to cause some concern on a short- or intermediate-term basis. Unlike wheat, corn, oats, cocoa or sugar, metals don’t deteriorate. From an economic point of view, if you can buy any of the metals under or near the cost of production and store them, you’ll make money in the long run. You might have to wait longer than you think because markets “can be irrational longer than you can stay solvent.” But all that aside, I do see opportunities. If you want me to pick one, I’ll pick nickel.

TGR: All the metals or nickel?

DM: All the metals should go higher relative to the U.S. dollar, but I think 2010 will be very back-and-forth. Stress levels are high on both sides—the inflationary pressures for governments trying to print their way out of this mess and the deflationary side of the equation because so many countries are on the edge of default.

TGR: What key economic factors are you watching to decide which side of the fence you’ll go to?

DM: The velocity of money. Enough money has been printed to have a hyperinflation in milliseconds, so obviously it’s not a function of the size of the money supply. It’s a function of the velocity of money or how quickly some of it—we don’t know how much—starts moving out of a currency. We’ve already seen it, with India moving into 200 tons of gold, for example. That’s very small relative to the amount of debt out there, but still it’s a very strong signal to the markets about the fact that India values gold over U.S. dollars at this time, and believe me, they are not the only nation that thinks this way.

We could come to a situation of the straw that breaks the camel’s back, some subtle tipping point that the market may not recognize initially. When the Creditanstalt bank went bankrupt, nobody said, “Oh, my goodness, that’s going to take us down and cause a global depression—yet most of us who study such things can point to that as a contributing factor to the Great Depression in the ’30s.

You have to think of it in broader terms than inflation or deflation: are we in the grips of a currency crisis? That’s when you don’t trust the underlying currency. Judging from what we see in the mainstream press, it’s pretty evident that other nations are questioning their trust of the U.S. dollar.

In economic situations such as this, history shows that there’s a price to be paid by everyone. It’s an issue of productive capacity. True wealth isn’t money. Real money is a store of value component. To produce wealth, you have to produce something of value to the marketplace. The productive capacity of the United States has been in decline since 1974. The productive capacity of China has increased substantially from that timeframe to the present day. Today the problem is that the means of exchange is not trusted (longer term) on part of the producer—China in this example. That portends some very serious issues ahead.

TGR: Going back to the undervalued or overlooked resources, in this environment where we don’t know whether to expect inflation or deflation, what sorts of investment opportunities are presenting themselves?

DM: As far as I’m concerned, there’s none better than gold if you’re worried about a crisis hedge however it unravels eventually, either total deflation—a debt-liquidating depression or a hyperinflationary blow-off. Silver has done best in periods of high inflation.

People really get hung up on the inflation-deflation debate, but let’s face it, in both cases there are so many similarities. High unemployment, declining productive capacity, distrust of government, more government interference, general malaise throughout the economy—a great deal of uncertainty.

I would ask anyone who’s worried about this debate to put a silver coin or a gold coin in their right hand and their currency of choice in the left hand and ask themselves, which one has retained purchasing power over time? If you’re going to have savings, do you want the kind that has stood the test of time for thousands of years? Or the type of savings that has always failed throughout recorded history? If you’re not sure, divide it in half. Keep 50% of your savings in your currency of choice and the other 50% in the precious metals.

TGR: If people have cash ready to invest in equities or precious metals, would you say put all of your cash into precious metals now, and then liquidate as you want to invest in various equities? Or keep cash on hand just for equity opportunities?

DM: You can buy the precious metals themselves at almost any time. That’s a different asset class than the mining equities. The mining equities generally follow the stock market to a certain point. Then comes a point—which we haven’t reached yet—when the mining equities start to take on a life of their own. In other words, you’ll see gold and silver mining equities generally going opposite the general stock market. At this time I think mining equities will follow the stock market down. A week or so ago I posted an article on my website about Harry Dent seeing the stock market debacle starting at the end of February. I would not be real quick to jump into the mining equities right now. But if you’re not invested in the physical metal itself, I would definitely buy some. I prefer a dollar-cost-averaging approach to accumulating the precious metals.

And as far as selling the metal to buy equities goes, I would never do that. I’d do the opposite. If I have a big gain on a mining equity—say I made a three, four, five, 10-bagger—I usually turn that in precious metals. I’d rather turn paper into gold than gold into paper.

TGR: You were talking about currency of choice and in this case, gold. A lot of gold investors expect that at some point silver will stop trading as an industrial metal and start trading as a precious metal. A lot of people use the gold-silver ratio as an indicator of how rapidly silver can move up. Do you believe in that ratio and what it portends for silver?

DM: There is a lot made of the silver-gold ratio. Silver probably will reach what I call the classic, or the monetary ratio, which is 16:1. It could even get down to the natural ratio, which at this time is about 10:1, but I don’t see it getting to any better ratio than that. Of course, this implies that silver is undervalued relative to gold.

When will silver take on this monetary aspect alone? That’s part of what I’m writing for the March issue of The Morgan Report. It’s basically looking at the silver market over the next 10 years. We have a 10-year bull market behind us and in my view we have several more years to go.

What happens is at the end of these great bull markets is you get into the euphoric or manic stage and this happens in almost all markets. You’ve seen it in the technology sector, when people were buying dot-com stocks that had no business plan and no equity, just an idea.

TGR: It was the new economy.

DM: Yes. So that will take place. I think we’ll see the biggest run up of all time in gold and silver, especially the equities, a euphoric state of panic buying driven by fear and greed. I’ll probably face a lynch mob me when I say “sell,” because no one will want to trade physical metal for paper currency and I don’t blame them. Anticipating this, I’ve already planned some techniques to use to preserve our physical metal and still allow us to sell to a strong market, but those are days ahead.

When the panic hits, gold probably will go up to $2,000 and beyond—the average person will wake up thinking, “Oh, I’ve got to get gold equities; I listened to my friends and I thought they were idiots and now I see the light.” Many will turn to silver because it’ll still affordable relative to gold.

Significant money will move in to the metals. And because silver is cheaper than gold, a lot of it will go silver, which will cause the ratio to spike relative to gold. You’ll see the ratio drop from 60:1 to 50:1 to 40:1 to 35:1 to 20:1, maybe to 16:1 or 10:1 because there’ll be more money, relatively speaking, moving into silver than in the past. And since silver is such a small market, any small increase in buying power will send the price far higher.

TGR: The way you explain this, these ratios are really only short term.

DM: It depends on where you start the line. One of my earliest lectures, which I still do from time to time, is about the gold-silver ratio. If you go from the 12th century, it’s a 12:1 ratio, which was exactly the natural ratio at that time. In other words, 12 ounces of silver in the ground for every ounce of gold, and that’s basically how it was mined up to about the 17th century.

So the market figured out that 12:1 ratio, and it held up for centuries. We got to the monetary ratio when England was having a problem similar to what the world economy is having today, and during the turmoil of a currency crisis Sir Isaac Newton told the Bank of England to go on a gold standard and they did. He said the correct silver to gold ratio in the new monetary regime was 15.5:1—where the market was at that point. This ratio, roughly 16:1, remained static for hundreds of years.

So does it matter? Yes and no. Once silver was demonetized and deemed an industrial metal, there was no longer a tie to silver as money per se and so it was revalued. The important point is if silver is undervalued or not and if you think it is then obviously it represents opportunity.

TGR: The interesting thing when you bring up the histories of ratios is that silver gets consumed and gold doesn’t. It’s back to the silver as an industrial metal. Silver is also the by-product of mining for other base metals. You’re projecting the economies are not growing over the short term. If silver is a by-product of base metals, should silver production decrease and would that have an impact on silver prices?

DM: Yes, it should decrease and it could affect prices short term. The industrial demand on silver was roughly 35% of the total market in 2000. In 2010, industrial demand now is 54% of the market. The industrial demand for silver is not only the largest demand, but it’s the fastest-growing. But that’s really not totally true because since 2006 you’ve had a huge increase of commercial buying of silver because its investment demand has increased extremely quickly. Since the advent of the SLV, the silver ETF, and other silver ETFs, there’s been a huge amount of money, relatively speaking, moving into the silver market as investment!

So you’ve got the industrial side. Regardless of mining activity being up or down, industrial demand is always off-taking silver and a lot of that off-take never comes back into the market. Recycling is significant, but it’s not total. In some cases, it gets used and it’s gone.

So that is an underlying eating away at the above-ground stockpile. When you throw an increased investment demand on top of that, especially in a small market, you can see an explosive situation approaching. Everybody wants to know when it will take place. I’ve said that the earliest it would take off in that manner is probably 2012 and I may be wrong. Markets do what markets do, but such explosive moves go in phases and we’re still somewhat in the skeptical phase.

For example, some of the people who bought gold above $1,000 are skeptical right now. They’re not sure it’s going to go to $1,200 ever again. I believe it will go far higher, but the longer it wallows between $1,200 and $1,000, the more likely these people are to listen to their friends, neighbors and brokers and say, “Gee, you know, gold isn’t a good investment. I’ve held it for a year and it’s gone nowhere. Put me back in the Dow or something.” Even worse, if we do break the $1,000 level, which I doubt but it could happen, they’ll be very unsure and probably will sell back into the market, causing it to depress in price further for a short time.

TGR: How do you see nickel, which you brought up early on, play out in scenarios you’ve been talking about?

DM: I believe all commodities are in longer-term trend upward. If you dig into the archives, I made a good call in the early 2000s on the Financial Sense Newshour with Jim Puplava. I said the new era is here. We’re going from an era of having things we want to an era of having things that we need. Of course, we need food and shelter and raw materials. Those needs will continue. So do we need nickel in the future? You bet. It’s used primarily in stainless steel. If you’re going to build any food processing plant—and there are always more mouths to feed—you’ll use a great deal of stainless steel. And that’s not the only application.

You can play nickel, other metals or any commodity or stock short term if you wish, but I like to take the major trend and stick with it because that’s where you could make substantial money. Certainly some traders can do extremely well. But really successful traders are very rare and most people don’t have nearly enough discipline, because you have to be willing to take loss after loss after loss after loss. Even if they are small losses, psychologically that’s very difficult. Most people are not suited for it. They can’t handle the stress that comes with a trading strategy.

TGR: Some people suggest the equities because there’s substantially more leverage, thus more upside than with the metals themselves. What’s your feeling about equities at this time and are there any equities you’re looking at that represent good opportunity?

DM: We put out something in the rare earth elements (REE) area recently and it’s a speculation, so it falls in the class of fun money or money you can afford to lose. It’s a very hot sector right now. I believe it’s fairly safe to invest in, as safe as you can be in a speculation. But overall, right now I think it’s a good time to build cash. The next couple of months bear watching. I like the old adage: when in doubt, stay out. There’s nothing wrong with staying out of this market right now and if the market tells us something we have techniques for getting in quickly.

TGR: But when you buy, you like the undervalued stocks.

DM: We always like to buy bargains. I like to invest for value. If I find something worth $10 and can buy it on sale for $5, that’s when I’m more interested in making the purchase. I have people who bought Silver Standard Resources Inc. (NASDAQ:SSRI) at under $1 and now it’s at $17. They’re probably not happy if they didn’t sell some at $40, although some have. But how can you be unhappy about a 17-bagger over 10 years? On the other hand, if you just came into this sector and bought it at $20 or so a few weeks ago, you’re going to be unhappy now that it’s sitting at $17.

My timing is more of an intermediate-term basis. I cannot day trade; it just doesn’t interest me. But longer term, yes, timing can definitely help you, but you have to really know what you’re doing and no one can get it right all the time. So for the average investor a dollar-cost-averaging approach makes the most sense. Technical analysis is a very useful tool, but you can’t rely on it 100% and I’ll give you a quick example. There is no charting service or no human being that can make a 100% accurate case because you can’t chart, for example, where a 9/11 event is going to take place.

My approach is to hold about 75% of the total precious metals stocks through thick and thin. And the other 25% can be traded in and out of the market.

TGR: You suggested that you like to find $10 stocks that are on sale for $5. Do you have any companies that fit those criteria now that you’re watching?

DM: Not at this time, at least not at that big a discount, but I just returned from Phoenix where I gave a lecture on the mining cycle. If you look at Minefinders Corporation (TSX:MFL, NYSE.A:MFN) and you look at the mining cycle, we bought that stock at around $1 and sold it at $13 right at the top. That’s a classic. It’s a good value at this point in time and I believe as things progress, it’s undervalued now. Based on my lecture people will have a pretty good idea where this company could go over the next several years. Buying MAG Silver Corp. (TSX:MAG; NYSE:MVG) is discounted by the market right now, but that one could be discounted more.

TGR: What makes these two companies undervalued at this time?

DM: It’s their internal rate of return. It’s the growth rate of their assets, which are precious metals. People get hung up on the dollar price of the metals. As an example, if you started off in 2000 with 10 ounces of gold and you ended up in 2010 with 50 ounces of gold, by definition you’re wealthier because you own more gold. The price variation is very significant to most people, but in the big scheme of things, it is not that important because gold is wealth and you have more of it. In other words your real wealth has increased regardless on a temporary paper price.

It’s the same with a mining company. If it has more wealth in the ground or is producing more wealth above ground, that’s what you need to focus on. Markets are very psychological and emotional, so what you want to focus upon is the increase of book value per share and you want to see how the company’s growing internally. If the market price doesn’t reflect the increase in book value on an annual basis—that would be an undervalued situation.

Let me say that I don’t want anyone to jump in to either of these companies just because I think they’re undervalued. I believe they are, but it doesn’t mean that they can’t be more undervalued. Still, if you like those, you can take a beginning position. If you want to own a lot of one of those companies (as an example) and don’t do technical work or subscribe to a newsletter or whatever, just take a long-term view and dollar-cost-average your purchases. If you have a disciplined rational approach and know it’s undervalued now and you buy it, you want it to go lower because you know you’re buying value. Instead of being upset about your loss when it goes lower, you say, “Fantastic! I’m not buying that $10 stock for $5. Now I’m able to buy it for $4.” And then next month comes along and you can get it for $3. You are ecstatic because you know what you’re doing. The problem is some people use this technique in stocks that have no real value, that is a huge mistake and too common by the way.

TGR: Good words to the wise. Are there any other undervalued situations that you can share with us?

DM: Again, I want to keep my integrity and value to my members but longer term, Great Panther Silver Limited (TSX:GPR) is a very strong company with a good return rate. First Majestic Silver Corp. (TSX:FR; OTCQX:FRMSF) is a big growth story. SilverCrest Mines Inc. (TSX.V:SVL) is very near production. Fortuna Silver Mines Inc. (TSX.V:FVI) is another company with good assets in the ground and probably not a very well-known story because they’re not very promotional.

So Fortuna, Great Panther, First Majestic, SilverCrest, MAG, Minefinders, and then one that I’ve come back to. I was first on the Silvermex Resources Ltd. (TSX.V:SMR) story. Silvermex is good. We got in probably at the initiation of the company and then the credit crisis hit and we basically were stopped out of the stock. They’re moving toward production. It’s probably a higher risk than, say, some of these other companies that are producing metal or will be shortly. I wouldn’t consider it particularly undervalued at this point, because we haven’t had a long enough history on the company as an up-and-coming producer. And again, all these are speculations in my view, although almost all of them actually mine metal.

TGR: Very good. David, I really appreciate your time. Once again, you’ve been a wealth of knowledge and insight.

When people ask David Morgan, “What do you do for a living?” he has the good fortune of being able to respond, “I do what I love.” A precious metals aficionado armed with degrees in finance and economics as well as engineering, David created (and recently revamped) the silver-investor.com website and originated The Morgan Report, a monthly newsletter that covers—very broadly speaking—money, mining and metals. A dynamic, much-in-demand speaker all over the globe, he considers himself a big-picture macroeconomist whose main job is education—including helping people understand money, the benefits of a sound financial system, and the importance of research and patience in investments. In addition to The Morgan Report, David has written for Kitco’s Money, Metals and Mining Review, The Herald Tribune, Futures Magazine, The Gold Newsletter, Resource Consultants, Resource World, Investment Rarities, The Idaho Observer, Barron’s, The Wall Street Journal and (of course) The Gold Report. In addition, he has been on CNBC, Fox Business, and BNN in Canada. Searching “David Morgan Silver” on YouTube yields pages worth of links to some of these (and other) programs he’s appeared in.

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DISCLOSURE:
1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Minefinders Corp., MAG Silver Corp., Great Panther Silver Limited, First Majestic Silver Corp., SilverCrest Mines Inc., Fortuna Silver Mines Inc. and Silvermex Resources Ltd.
3) David Morgan—I personally and/or my family own shares of the following companies mentioned in this interview: MAG Silver, First Majestic, SilverCrest and Silver Standard. I personally and/or my family am paid by the following companies mentioned in this interview: None.