Paper claims on real assets

The United States, although a very wealthy country, has a finite amount of wealth in terms of the resources of its government, its land/natural resources and its citizens. When every tree, building, mine, deposit, bank account and company is valued and added together, there is an actual value that could be "assigned" to the country.

Every time we issue a new bond (also known as an "I.O.U."), this is essentially a claim against a portion of the assets the United States "owns." Alternatively, you could consider each U.S. dollar as a share of stock in the USA company. While these are wild oversimplifications, you get the idea.

If the USA company starts issuing bonds and stocks without increasing the value of its underlying assets and/or revenue streams, the company is diluting the value of the stocks and bonds held by existing investors. Investors know that when a company issues new stock, the stock price is usually punished because of the anticipation of the future dilution.

Currently, the USA company is issuing stocks and bonds at a record pace to stave off short-term pain caused by a recession. This weakens the future prospects of the USA company and also ensures that its stock price (i.e. the value of its currency) will be punished and will decline significantly.

Where this analogy fails is the fact that American citizens are essentially forced to own stock in the USA company, as this stock is the only legal currency in our country. When people begin to learn that every time they get a piece of paper with a number printed on it that the real value of the number on that paper bill is declining every year consistently, moral values change and begin to decay.

As inflation proceeds down the path of least resistance that has plagued every fiat currency in the history of the planet, hard work and savings begin to be replaced with speculation and borrowing. Since you cannot save money and maintain purchasing power without taking significant risks, why save at all? If you're going to embrace risk, why not go for a bigger risk and bigger reward? If it doesn't work, just borrow more money and try again!

Persistent, continuous inflation leads to moral and social decay. It has led to the bling bling, big screen TV, Hummer, McMansion culture that we find ourselves in today. Think end of Roman empire decay. Why save for tomorrow when you can borrow and have it today? The overwhelming majority of people don't realize that monetary decay leads to moral and social decay. As the government prints more and more money and gets itself further and further into debt in a fiat money system, it essentially encourages its citizens to do the same by both the example it sets and the debasement of our currency that it sets into motion.

The U.S. government is a subprime borrower looking to max out another credit card after it spent all its family's money and then hocked all their possessions and spent that money, too. Instead of correcting its ridiculous fiscal habits, it makes new promises to new naive family members (e.g., China) to draw them into yet another round of the ultimate Ponzi scheme. The current power brokers in Washington no longer care about debt reduction and are scrambling to increase the debt load of our country at an ever-increasing pace. In addition, the government wants banks to resume lending despite the fact that most people have already borrowed too much from banks as it is.

The government cannot save you. It hardly knows how to save itself and no longer even pretends to think beyond the next election. Common sense is ridiculed and bread and circuses are favored over serious intellectual or political debate. This is a direct end-stage effect of the cancer introduced into our society when we gave control of our money to a private, secret cartel of bankers and then severed all links between our currency and gold in 1971.

The early highs of an inflation cycle are positive and pleasant as they affect asset classes like stocks and real estate and make most feel prosperous and bold. Now, in the later stages of inflation, we have a rabid and unsustainable addiction to cheap money that reveals us for what we are: junkies needing a fix as bad as a heroin addict does. Though the printing presses will run full steam, the highs produced by this easy money are no longer pleasant and simply keep us from going into withdrawal. We spend more and more and accumulate more and more and feel hollower than ever.

The debt created by all this inflationary borrowing and spending in both the public and private sectors has painted our government into a corner. The only realistic options are extremely aggressive further attempts at inflation (which will either fail or lurch us into a hyperinflationary currency crisis) or a deflationary collapse where all domestic money moves from the stock market into government bonds. There is no turning back from this debacle and there is no "goldilocks" scenario. The world is not ending but your 401k might if you don't move to protect yourself.

Gold is a protector of savings in times of uncertainty. It holds its value in a deflationary debt collapse as well as a runaway inflation. In short, gold becomes strong when the currency it is denominated in becomes unstable. As we all know, promises made by an addict are not particularly reliable. If the government gets desperate, they will confiscate assets and will declare anyone making over $20,000per year a rich swine that deserves to be taxed at a 90% rate. Gold is no ones liability and asks for nothing. It can be buried in the backyard quietly until our government dries out, wises up and kicks its addiction so that a new cycle of prosperity can begin.

Got out of DIG with my 10% profit today. Got out of RGLD and looking to re-enter in the next several weeks on a decent correction. Looking to get back into SRS as a short-term trade if the price dips a little further into the 50-55 range.

Dow to gold ratio - how long will it take?

If a continuation of the current deflationary bust is the way we are going to get to a 1:1 ratio between the Dow Jones Industrial Average and the price of one ounce of gold, it won’t take very long if the last time it happened is a guide. The peak of the Dow:Gold ratio in early fall 1929 was slightly less than 19 when the Dow was at 386 and ratcheted down to a 2:1 Dow:Gold ratio nadir by 1933. The gold price didn’t change a bit during this period, as it was pegged to the dollar at fixed price of $20.67/ounce. The Dow, on the other hand, fell by 90% to reach 40 in the summer of 1932 – less than 3 years!

If you think a similar Dow:Gold ratio can’t happen again today, ask yourself why. Is it because we are smarter today than we were then? Gimme a break. Is it because we are more sophisticated today and have learned from our mistakes? The only thing we have learned is how to increase financial leverage to an even greater extent so that the subsequent bust promises to be even worse! Is it because you don’t want to believe it can happen? This is a plausible explanation for most, because who wants to believe everything we have been taught is wrong?

Buying and holding general stocks for the long haul was built into the psyche of the current generation of investors because it worked so well from 1982-2000. Everyone is now starting to realize that maybe it doesn’t work. We’ll have a nice stock bounce into the spring to keep a few holdouts in the bull camp, but then a tsunami of reality will destroy the portfolio of every Pollyanna praying for profits. Then you’ll really see the market crash as people stumble all over each other to get out of the market at any price.

For those who doubt this bear market can get any worse, do you honestly believe that our stock market can escape with a one year bear market when:

• The United States’ (and the world’s for that matter) banking system is insolvent
• Nearly half of the large Wall Street firms no longer exist due to recent bankruptcy
• A housing crash that is already giving the Great Depression a run for its money is just starting to pick up serious steam
• Our government has added nearly a trillion dollars of debt to its balance sheet in the last year despite already being bloated with debt
• Unemployment is still surging in earnest at the exact same time consumer debt loads are higher (in both relative and nominal terms) than ever
• Commercial real estate has begun to implode at an astonishing rate and retailers are about to start going out of business in droves
• The big 3 auto firms need government handouts just to stay alive until spring

This is not a gloom and doom scenario for the prepared, it is an opportunity. What a relief that all you have to do is buy some pieces of metal and hold onto them to come out of this mess with your retirement money unscathed! What could be easier and less scary? No need to worry about fraud, recession, counterparty risk, currency crisis, industry nationalization or corporate bankruptcy! Gold is the easy, low risk way to achieve a reasonable rate of return and maintain your savings. Buy physical gold and forget P/E ratios, growth estimates, and hot stock tips and just relax!

I have had people ask me how to reconcile this advice with the fact that their 401k/403b only offers limited investment choices. Let me give you a scenario to clarify your thinking: let’s say you know your stock investments in the 401k/403b are going to lose at least 40% more of their value over the next few years. OK, well that scenario is reality. What should you do? If your retirement option is to get a 30% tax break up front so that you can lose 40% of your money, I would say you should avoid that option!

If you have the energy, you can petition your employer to expand choice or allow you to set up a self-directed account. You can also sell everything in the account this March or April after the current bear market rally is near its end and move to cash. In the mean time, don’t throw more good money after bad just because you pray and hope things will get better! This means you have to seriously consider whether or not you should continue to put your hard-earned money into a retirement plan with shitty investment options.

General stocks will lose money/value relative to gold over the next few years and should be avoided except by short-term traders. For the more adventurous, a higher risk, higher reward play over the next few years would be to buy a basket of blue chip gold mining stocks. Government bonds have made the bulk of their bull move already and offer low returns and high risk and are no longer a good way to protect savings – cash under the mattress at this point has a similar return with less risk (and I would recommend gold as more reliable cash option).

Bottom line: I think the Dow to gold ratio reaches one in less than 5 years, which means stocks have a long way to tumble in the near future and gold will rise up to meet them. I also wouldn't be surprised if the ratio falls below 1 and one ounce of gold becomes worth more than the once mighty Dow Jones.

When trust evaporates

The Bernard Madoff ponzi scheme has everyone talking. Why don't most people seem to recognize these scams until it's too late? The short answer: trust.

Madoff was a former chairman of the NASDAQ stock market, so people trusted him. Hmmmm. Isn't this sort of like people now trusting Bernanke, Paulson, and Obama to fix the economy and restore prosperity?

Do you think government bureaucrats are smarter than average people? Do you think getting a PhD in economics from Princeton University (Bernanke) makes you an expert on what to do during a global financial crisis? Our current government leaders and central banksters are EXPERIMENTING with taxpayer money in an attempt to keep the biggest Ponzi scheme of all going: trust in the promises made by the United States government.

We as a country are broke and yet borrowing money at an accelerating rate. Does this meet the common sense standard? We have ABSOLUTELY ZERO MONEY SAVED to pay for baby boomer social security or medicare benefits, yet everyone pretends the money will somehow be there when the poop really hits the fan. Pretending to believe this lie told by our government is asking to be swindled. Why do people insist on believing things that are obviously unrealistic and likely to be false? Because it's easy.

The key to successful investing is to do your own learning, thinking and analysis, not to put all your money into an S&P 500 index fund and forget about it. Yes, it takes effort, but why wouldn't it? Do you think that everyone else will take care of your money and be concerned for your future because they are altruistic?

Trust is breaking down and it should be. The world is not ending, it is changing. All the people living in a debt dream who thought they were wealthy because they leveraged to the hilt to buy things they didn't need are silently (or not so silently) screaming in agony right now. The debt bubble has popped.

A debt bubble popping is a good thing for the long term global economy but requires a painful adjustment period to heal and cleanse the economy of the toxic sludge created by debt. Debt is a noose around the economy and it has reached the point where the noose is too tight. Bernanke and Paulson say they want to "stimulate" bank lending or the creation of more debt. This is the opposite of what is needed. Bernanke and Paulson, as financial people, should and probably do know this, but bankers make money by creating indebtedness. Obama most likely has no clue about economics and is listening to advisers who tell him the economy needs to be "stimulated."

The government stimulated the living shit out of the economy during the first great depression. Anyone who tells you otherwise is ignorant or dishonest. Period. What did it accomplish? Nothing except to prolong the recession required to liquidate the excess debt so that a new cycle could begin. Japan has been "stimulating" its economy for almost two decades now, to no avail. People who tell you the Japanese did it wrong or were too slow or nonaggressive are ignorant or dishonest.

Remember the most important lesson of economics to help you in your investing career: governments don't control markets, people with real jobs do. Bureaucrats are parasites on the economy who can only distort or divert the primary trend, not reverse it. A deflationary bust must run its course before central gangster (I mean bankster) money printing can work. Once the deflationary bust is over because the people with real jobs decide that it is, the bad monetary medicine applied by those who envision themselves as financial alchemists will make the recovery more erratic, fast and volatile than it would ordinarily be due to their incompetence and impatience.

Home prices will not stabilize until people with real jobs in aggregate decide they should and are able and wanting to do something about it. The stock market will not stabilize until people with real savings decide it is time to buy and have the funds to do so. Commodities will not stabilize until people who run private companies demand enough raw goods due to orders from people with real jobs.

When governments are buyers of assets, any price gains are temporary and illusory, as central planners have no incentive to be smart and careful with other people's money. If this were anything but true, communist governments would always have the fastest growing economies in the world and no one would espouse free markets or democracy!

Trusting in bureaucrats to save your house, pension or 401k account is as misguided as trusting in Bernie Madoff was. The preposterous paper promises of paupers are burning and when they go up in smoke, there is only hope to replace it, not truth or real money. Hope won't put food on your table. Buy physical gold, the only true money in today's world, and protect some of your savings from theft by aggressive devaluation and fraud.

By the way, happy holidays! I believe 2009 will be an enormously profitable year for those investors willing to turn off CNBC and do their homework. If you want to buy some stocks and forget about all this financial crap for a few years, buy solid, blue-chip gold stocks and come back in 2-3 years.

Went long DIG today

DIG is an ETF that is a "double bull" tracker of the Dow Jones U.S. Gas and Oil index ($DJUSEN), so when this index of gas and oil stocks goes up 10%, this ETF is supposed to go up 20%, although its tracking feature is far from perfect as with all these types of ETFs. This is a short-term trade that I am using in the hopes of making a quick 10% or so.

My rationale for this trade is based on technical-type analysis using charts such as the USO ETF chart as a proxy for oil price compared to the chart of DIG as a proxy for oil and gas stocks:





This outperformance of stocks relative to the commodity they are associated with is common with many commodity stocks and can signal a pending turn in the sector and/or the underlying commodity. Stocks typically lead the price of the commodity they are associated with on the upside and downside, thus stocks can signal both the start and end of a bull or bear move by diverging from the underlying commodity price they are associated with. Like everything in investing, there is no perfect indicator, but this one is pretty good as far as indicators go. This outperformance of oil and gas stocks relative to the oil price can also be displayed using a ratio chart of DIG divided by USO:



Lastly, a ratio chart of a general commodities index ($CCI) to oil ($WTIC) showing how the darling of all commodity investments, Mr. Oil, has rapidly been forced to eat humble pie relative to other commodities:



Bottom line: this is a short-term trade playing for an overdue bounce in the oil and gas stock sector. I am looking to make 10% quickly and will sell as soon as that can be achieved. I bought DIG just under $25 and already put my sell order in at $27.50. I think this sector will make a much greater than 10% trade over the next 3-4 months, but I want to focus my money on gold stocks this spring. I want to make some more money but not get tied up in any longer-term trades that will interfere with my planned re-purchase of gold stocks in the January to February time frame. I am already out of my recent SRS ETF trade with quick profits, but I am looking to re-enter this ETF as well if it comes back down into the low 50s.

Fiat money instability

A long-term Dow to gold ratio chart over the past 200 years demonstrates what the Federal Reserve and government actions have done to the long-term prosperity of the United States (chart stolen from www.sharelynx.com):



Prior the the Fed taking the helm as the steward of our currency from 1800-1913, the dow to gold ratio was a choppy ratio indicating boom-bust swings, but in a steady uprising channel. When the Fed took over, a wild boom followed shortly thereafter, culminating in the bust that is now called the great depression. However, we stayed within the uptrending channel and recovered.

Once we severed the link between our dollar and gold in 1971 when Nixon closed the gold window, we broke through the 170 year trendline and embarked on a new era of instability and now, decline. The boom from 1980 to 2000 was even wilder in gold terms and the ongoing bust promises to be even worse than the 1930s or 1970s. The Dow to gold ratio should decline to less than 1 in this unstable megaphone-like chart pattern, portending severe economic crisis. I have absolutely no doubt in my mind that we will reach one for this ratio and probably decline below one. Remember that this ratio is based on the Dow Jones Industrial Average "price" divided by the price of one ounce of gold.

If the Federal Reserve and our government are so good at what they do, why are the boom bust cycles getting wilder rather than tamer? Where is the steady uptrending prosperity seen before the Fed took over? This chart is the most damning condemnation of the course our nation has chosen over the past 100 years. How can the price of one ounce of a barbarous relic metal be equal to the entire mighty Dow Jones industrial average? It happened as recently as 1980 and will happen again within the next 5-10 years (possibly sooner). This is not stability, but rather, a portrait of profound instability.

For those who believe "the powers that be" will fix the system, ask yourself a basic question: if "they" are so smart, why did they let this crisis occur in the first place? Why would the people in charge, who utterly failed to see or warn of this crisis even once it was obvious, be the people to ask to fix this mess?

Whether thru hyperdeflation, hyperinflation or a little of both, gold has a long way to rise and/or stocks have a long way to fall relative to each other before one should think about becoming a "buy and hold" general stock investor in the United States. By giving stewardship of our currency to a group of secretive bankers and then severing the link of our currency to gold, we assured a path towards decreased prosperity. We have now started down this slippery path in earnest. Invest accordingly and hold physical gold coins and/or bars as insurance and a way to protect any savings you have.

Want to see what our creditors are thinking?

Then read the article in this link. Or this link. Our federal government and for-profit non-federal central bank have pushed the monetary and fiscal pedal to the metal, increasing our country's debt load and causing deterioration of the balance sheet backing our currency. When, not if, a currency crisis happens in this country, you will not be warned in advance by our leaders or by the mainstream media.

They will claim they could have never seen it coming and then, after failing to alert you at all, they will tell you not to worry and to remain calm. When this doesn't work, they will impose banking holidays and refuse to give you your money "for the good of the country." If Asia (i.e. China and Japan) decides to stop buying our bonds due to mistrust or lack of available money, we're in big trouble. The reserve status of our currency around the world is in danger and if we lose that status as the reserve currency, chaos will ensue.

The major chaos will be for the United States, as our currency will go into freefall and interest rates will skyrocket. Global trade will also become problematic and will shrink even further than it already has. We are at a major turning point in history here, and, though it may progress at a glacier's pace most of the time, a sudden event will likely precipitate a rapid devaluation of our currency.

Those who have their money in the bank at 0.3% interest or some similar ridiculously low rate will then be concerned about whether or not they will ever get their money back. Yes, the FDIC will step in and replace the nominal value of the currency, but this will further devalue the U.S. dollar and the purchasing power of that currency will be only a fraction of what it was.

Having some physical gold can protect you against this scenario, which seems almost a guarantee within the next 5 years or so. Not a question of if, but when. The U.S. has caused a global economic crash and resentment runs high. Our military is weak and overextended and we are running out of willing creditors to continue to loan us money to finance our ridiculous wars that have no end or purpose. Corruption is so rampant as to be expected in the highest political, military and business offices in the land. The parallels to the end of the Roman empire are astounding. Don't say you weren't forewarned and nobody saw it coming.

Royal Gold breakout

A confirmed stock price break out has occurred with Royal Gold (RGLD), one of the gold stocks I hold and have been watching closely. This is bullish not only for this stock, but for the gold mining sector as a whole. A breakout above a previous congestion zone/resistance price levels on a chart clears the way for a stock to go higher. You want to see good volume on the breakout and you want the stock to close at least two or three days above the breakout to confirm it.

First, a longer term 5 year chart:



Next, a shorter-term 3 month chart:



Though RGLD could potentially move higher over the next week or so, it is due for a correction, which will help "test" the breakout levels at the 38-40 range. If the stock holds those levels on the next correction into early 2009, then a bull's paradise awaits those bold enough to hold. Look to buy at this point if you want to take the plunge. The last big bull move in this stock from mid-2001 to mid-2003 yielded over 800% in 2 years.

Our greatest inflationary moment

Was in the 1933-1934 time frame. At the time, our currency was on a gold standard. In 1933, 20.67 U.S. Dollars was equal to one ounce of gold by government decree. The dollar was "as good as gold." In late 1933, Franklin D. Roosevelt (our president at the time) declared gold possession and gold payments by its citizens were illegal. He ordered Americans to turn in their gold to the government.

A few months later, in early 1934, the greatest one day currency debasement (i.e. inflation) event our country has experienced in the last century occurred. On this day, FDR changed the dollar-to-gold peg to $35/ounce. This intentionally debased the paper U.S. Dollar by roughly 70% in one day. Nine years later, in 1943, the stock market was at the same level as when the decree was passed. The forced grand experiment in currency debasement failed to do anything but enrich the government (because they stole people's gold then declared it to be worth more than when they stole it) and increase its power. It also made every American who saved paper money poorer.

Neat trick, huh?

Today, with no major economy of the world having a monetary system pegged to anything real/tangible, the race to prove which currency is the most worthless is ongoing. Every central bank is slashing interest rates and rapidly taking on more debt to prove they are the most financially unsound organization. This attempt to destroy paper currency value is somehow supposed to help average citizens by "stimulating" the economy. This reckless game of chicken between bankers affects everyone who tries to save money and plan for the future. It also exposes our paper monetary system for what it is: a fraud.

This system of fiat currency encourages and creates market manipulation and rampant corruption through interest rate adjustments and monetary printing. Anything is possible when the means to pay for it can be created out of thin air, or so we are told. This system pays for bread and circuses for the masses by both confiscating people's savings through currency destruction and by forcing heavy debt burdens onto future generations. Of course, those asking for bread and circuses share the blame with those who provide them.

Gold gives you a way to maintain the value of some of your savings in an environment where interest rates on short term cash holdings are zero and the value of the underlying cash is under attack. Avoid stocks, all but federal bonds and real estate. Federal bonds have had a wonderful bull run and have been a great investment (the stampede to safety should not be underestimated). However, these instruments no longer provide the potential for significant returns and their lack of significant interest payments makes these instruments similar to stuffing cash under the mattress when the risk of loss is factored into the investment equation.

Capitulation in oil

Though we may re-test these lows and potentially go minimally below them, yesterday's action constitutes capitulation in real-time. As a proxy for investor sentiment in oil, the ETF with ticker USO attempts to track the price of oil and its chart is compelling:



Also encouraging is the percentage of bullish sentiment among investors:



Oil, using the ETF USO, is a low risk short term trade regardless of where you think the long-term price of oil is headed, because no market moves in a straight line. Going long at the 32-33 price level in the USO ETF should be good for an easy 40-50% gain over the next 3-4 months.

Taking out the trash

And trash is the best way to describe the mantra of "buy and hold stocks for the long term." This is very misleading, wrong, and inappropriate advice, yet it is dispensed as sound advice for retail investors and taught in academic finance courses. An example of the fallacy of this proposition is about to be painfully experienced by millions of American (and global) investors.

General U.S. stocks, using the proxy of the Dow Jones Industrial Average, are in a wicked bear market that is absolutely not over. Before this bear market is over, the Dow Jones average should fall below 6000 and it might be significantly lower at some point during the ongoing readjustment of stock prices.

Gold, on the other hand, is in the midst of a secular (i.e. measured in decades) bull market that should take the price conservatively to $2000/oz and potentially much higher. The gold price is currently near the end of a normal corrective phase in its bull market.

Cash is the place everyone is clamoring to be right now, but I think even novice investors know cash is a dangerous long-term investment option due to inflation.

Stocks are risky, but no risk no reward, right? Holding gold is silly because it doesn't pay dividends and has no growth potential, right? Well, let's look at the potential 100 year returns for stocks, cash and gold. I am picking 1913 as the start date, because this is the year we gave a no-bid cash printing contract to the [not so] Federal Reserve and it will give us nearly 100 years of data.

The assumptions I am asking you to swallow are that the Dow will reach 6000 in the next few years and gold will double from its closing price yesterday. I know there are no guarantees in life, but this is a very conservative estimate of what's to come. If this occurs as predicted, then the roughly 100 year returns will look like this:



Now, the effect of dividends for the Dow was ignored for this calculation. If we assume a 4% dividend yield (generous assumption and clearly hasn't been the norm over the past 20 years) over 100 years, this would make the return for the Dow closer to 7300%, still far less than gold. Don't forget also that until roughly 20-30 years ago, you had to buy individual stocks in the Dow and couldn't buy mutual funds or ETFs, so the company risk was much higher and companies would come and go from the index.

This table carries a powerful message that is about to get very loud in our lifetimes: burying pieces of metal in your backyard can be a better way to plan for your retirement than general stocks. The data doesn't lie. Please do not forget the Dow to gold ratio chart, which predicts a return to a one to one ratio where the price of one ounce of gold will equal the "price" of the Dow Jones Industrial Average. This would make the returns on gold obscenely higher than the Dow Jones over the past 100 years!

Do you think you'll ever see a table like this on Cramer's show? How about Suze Orman's show? Maybe in one of Ben Stein's columns or on CNBC?

For the skeptics out there, how about an actual long-term example from history? How about 1913 to January 21, 1980, the day the gold price reached roughly $850/ounce? The high (not the closing price) for that day in the Dow Jones was 880. Using the table above for the 1913 prices yields a 67 year return on the Dow of 980%, though if you include a 4% average annual dividend yield your return would be more like 1350%. Gold had a 67 year return of 4100%! Any questions?

In the gold versus paper debate, gold is about to show once again how delicate the pieces of paper backed by the promises of Wall Street, bankers and bureaucrats really are. Buy and own some physical gold coins and/or bars to anchor your investment portfolio. Hold this physical metal yourself and keep it out of the hands of those who make promises too easily and fail to consider how they will make good on those promises when times get tough. It is the one investment choice for a long-term buy and hold philosophy that currently makes sense.

Gold - it just sits there

Gold is the only currency not able to be debased by human decree. In fact, humans made it the world's currency of last resort through centuries of trial and error. Since every single fiat/paper currency in history has eventually gone extinct due to the whims and errors of politicians and bankers, people in the know have learned to trust gold to store their wealth in bad/hard times.

Every major world government is now trying to debase their currency (woops I mean "stimulate the economy"). Japan, not to be outdone by the new U.S. rate of "somewhere between zero and zero-point-two-five," slashed its central bank-set rate to 0.1%. China is allowing its currency to devalue and other governments around the world are aggressively slashing interest rates, including the Swiss. Everyone wants to have the most worthless currency in order to prosper. This is the paradox of a global monetary system built on a foundation of quicksand.

Meanwhile, gold just lays around looking all shiny and shit. It doesn't pay any interest for the average Joe on the street - you have to be a fancy banker or real rich Wall Street dude to get involved in receiving interest payments on your gold. Yet somehow gold manages to have bull markets periodically. Why is this?

Paper promises are revocable/modifiable at will when made by governments and corporations, often without recourse for the average person on the street when the promises are broken. Think of gift cards or warranties at retail outlets that have gone under. What are they worth once the company declares bankruptcy and closes its doors? When you hold $100 in a coffee can on top of your refrigerator, you are holding a paper promise whose value can fluctuate radically depending on the state of confidence the world has in that promise. When times are good and confidence runs high, there is little concern for what could go wrong. Times are no longer good and confidence is no longer high, nor should it be.

Our central bank in the United States has devalued its paper promises by roughly 98% since 1913. Putting money under the mattress is simply not a good idea for long-term investing. Gold, on the other hand, has increased in nominal price (i.e. relative to paper U.S. dollar promises) by more than 40 times since 1913. This is without dividends or growth potential. This is based solely on currency value destruction!

The big, manic leg of the gold bull market has not yet begun but it is coming to a country near you soon. I believe that $2000/ounce for gold is a very conservative estimate of its potential to be reached within the next 5 years and a price of $5000/ounce is quite feasible. Meanwhile, the stock market is guaranteed to do poorly relative to gold and carries considerable risk related to the companies invested in and the counterparties involved in the transactions required to buy stocks.

Trust is a valuable commodity and when it breaks down, gold is where those in the know turn for safety. Getting a less than 1% return on a depreciating asset (e.g., paper dollars) when that depreciating asset can be swapped for a real non-depreciating asset (i.e. gold) with the potential for substantial gains in value over the next five years is one of the best trades you can make. While the paper economy burns as we head into Great Depression II, gold will shine brighter than ever.

As a matter of fact, once the Dow to gold ratio returns to near one, which it will, one ounce of gold will equal or nearly equal the price of the Dow Jones Industrial average. At this point, which we will probably reach within the next 5 years, the long-term gains of physical gold since 1913 will be much higher than those of general stocks. That's right: by the year 2013, the roughly 100 year return on the Dow Jones will be lower than gold buried in the backyard!

Ready to pay?

How will cash-strapped local, state and federal governments cope with rapidly expanding deficits? Simple. The Federal government will ignore the problem and continue to kick the can down the road. They will continue to be irresponsible, continue to run up mind boggling deficits, and will set us up for a currency crisis within the next decade. Just when a critical mass number of baby boomers start asking for Medicare and Social Security benefits, the game will be up.

However, on the local and state level, the luxury of ignoring expanding deficits generally does not exist. Some municipalities will declare bankruptcy and clear the slate of many prior obligations. Some will tighten their belts and cut staff, benenfits and programs. Others will raise taxes in a number of ways. Most will have to do more than one of these things.

New York has already proposed raising multiple taxes. From this article, I quote:

The new charges include an 18 percent sales tax on soda and other sugary drinks, called an "obesity tax," an elimination of a sales-tax exemption on clothing and footwear under $110 and a sales tax on cable and satellite radio.

... also pitched a "digital property taxation," which would impose sales taxes, typically 8 percent, on downloaded songs to an iPod.

In the end, debts must be paid. The federal government would like to inflate away the value of the U.S. dollar so that the debts can be repaid with paper dollars of lesser value, pretending that this will not cause an unreasonable burden on its citizens. Or, more properly, that citizens won't be smart enough to put two and two together and blame the politicans for destroying the currency. Of course, politicians who don't promise bread and circuses can't get elected, so there is plenty of blame to go around.

The creditors (i.e. those owed money) would prefer the currency stays strong so they are paid what they are owed, though smart creditors plan for a degree of inflation in a paper money/fiat system. Until sanity returns, creditors will not be engaging in lending more money to "unworthy" borrowers with insufficient assets. In other words, those who most need to borrow money will be unable to do so.

The bottom line is that the bailouts and Federal Reserve response affect all of us negatively. Every time Washington or a local government gives something away, it must take something from its citizens in return to pay for these gifts. There is no free lunch and our society as a whole is about to learn this in a very real way. Rather than let the correct people fail and get hung out to dry financially, our political machine has decided to hand money to the "chosen ones," ensuring our economy takes longer to recover and that it will be led by the bloated and weak, rather than the lean and strong, when the delayed recovery finally occurs.

Great Depression II has started and cannot be stopped by the bankers and politicans who helped create this mess. When governments need money, they always know where to look. Get your finances in line, pay down debt, keep enough physical cash on hand to meet at least 1-2 months of living expenses, and buy physical gold coins and bars to be kept outside the system away from prying (and needy) bureaucratic eyes.

If you have enough energy and desire to invest, put your money in gold stocks around mid-January to mid-February or so when they are finishing a short-term correction. Avoid general stocks like the plague other than as a short-term bull trade or as a shorting opportunity.

Looking for the exit

In terms of short-term trading tactics. To review the big longer-term picture:

*Secular and cyclical bear market in general stocks is ongoing
*Secular bull market in gold stocks in effect and the cyclical bear market within this secular bull has ended and a new cyclical bull market has begun
*Cash is king during the current deflationary bust but I trust gold more than U.S. Dollars as a cash equivalent
*"Buy and hold" general stocks for the long term is a foolish proposition right now

Now the short-term picture:

*The 1929-like crash in general stocks ended November 21st and we are in a bear market rally that should last until March or April, 2009. The first mini-leg of this bear market rally is just about over
*The first bull market mini-leg in gold stocks should end before the month is over.
*U.S. Goverment 10 and 30 year bonds are in a blow-off top for their current bull move

Today, I took profits on FCX and UYM and tried unsuccessfully to take profits on my SSO (double bull S&P 500) calls. I immediately plowed my profits into SRS (double bear on U.S. Commercial Real estate) at roughly $53/share. This is a very short-term play in an attempt to make 15-20% in a few weeks during the pending mini-correction in the stock market.

I am holding my gold stocks for a little longer but plan to sell after one or two more days of strength as this sector is also ripe for a correction soon (GG & RGLD are my primary current "trading" stock holdings).

Gold closed up for the day (as of 4 PM EST) but gold stocks closed down - this is not a good sign and suggests the impending correction in gold stocks is near. This impending mini-correction should last 4-8 weeks and will provide another outstanding buying opportunity.

I'll leave you with a "bubble alert" chart in long-term U.S. Bonds, with the ETF that has ticker TLT serving as an easily tradeable proxy:



This is what happens when deflation meets a government that gives risk-free money to banks that don't want to lend to businesses or consumers. Think about it. Zero percent interest money that can be invested in "safe" U.S. Treasury bonds at 2-3%. The credit crunch continues unabated despite the first helicopter drop. Sorry, Ben...

Bone crushing gains

Gold stocks have re-emerged and are telegraphing their upcoming outperformance relative to general stocks in grand style. Alas, the first gold stock mini-advance leg will likely be over before the month of December is, but it has been a wonder to behold. Blue chip leaders in the sector such as GG, AEM, KGC, and RGLD are either even or ahead on a 1 year return basis and have had gains of 100-150% (not a typo) since the bottom in this sector 2 months ago. How many stocks can claim these stats after the crash we just went through?

After today's rate cut, the Fed is "all in" on this game of chicken with deflationary market forces that risks the value of our currency. The fight to re-inflate the system is on as bankers go through withdrawal and margin calls and require easier and easier money to stay high and solvent, respectively. Always vote for market forces to trump bureaucrats. Deflation is too powerful to be stopped in the short-term. Gold is your insurance policy in case the government gets so reckless that a currency crisis develops sooner rather than later, but the deflationary play on gold miners is valid and acting as advertised.

The gold to oil and gold to commodities charts look very "toppy" and are running out of gas on daily charts, suggesting a correction in these ratios and the gold stocks as well:





I am familiar with terminal wedges on charts and have both lost (first) and made (after I learned my lesson) money on this type of pattern. Human folly repeats.

Both the gold stock and general stock rallies will likely be over before the month of December before they take a break. I will be looking to get 100% long gold stocks after the anticipated upcoming correction, which should end by mid-February of 2009. You don't want to miss the gains from winter to spring of 2009 in the gold stock sector, which is only a taste of what's to come in this sector over the next few years.

I ain't hatin'...

but trust is cyclical just as markets are. Indeed, the P:E ratio and dividend yield are nothing if not about trust and trust is a fragile thing. When a long-term trust cycle ends and people get suspicious (just because you're paranoid don't mean they're not after you, right?), you need real counter-cyclical assets on your side. No, that doesn't mean tech versus foreign bonds versus high-yield blue chip U.S. corporate bonds, that means something like gold versus gold stocks. We're in that kind of anti-trust cycle here.

When the dust settles after all the staggering debt has been purged, a new cycle of trust will emerge. But that's then, and we're in now. The amount of debt deleveraging that needs to take place first will not happen overnight. In addition, there is the guarantee of storm-like conditioned monetary/printing press responses from the central banks around the world.

This whim of monetary printing press action to avoid pain is of course addictive and of course not limitless. You can only carry so much debt based on a finite base of assets before waves of collapse occur as the addict overdoses. When debt turns bad and the over-leveraged are given a margin call but have no equivalent assets to tender in bankruptcy, a cycle turns. In this case, it's a big cycle that started in 1971 when we left the gold standard because the damn French caused a run on Fort Knox.

Currencies like the ones that exist today have a funny long track record of running into trouble. When trouble hits, whether inflationary or deflationary, gold tends to do well if the extreme ends of the spectrum are reached in either direction. We are in a heavily deflationary environment and the Fed is trying out all the zany reflationary schemes written about in academic economic papers authored by people like Bernanke. Did you know Alan Greenspan had a pretty lousy track record as a financial/investment analyst before he became the Maestro? Henry Paulson was a Goldman shark and now he regulates them?! This decade, gold is a better bet than the wisdom and character of bankers and Wall Street partners.

When deflationary market conditions meet a strong monetary inflation attempt by the governments that know better than we, the result, it is claimed, is a sort of Goldilocks scenario. Like the acid cancels out the base and the resulting solution is just a-OK. Gold reminds us that in times like these it is more reliable than Goldilocks. When trust turns positive again, which will begin around the time the Dow-to-Gold ratio gets near 1:1, I'll trade me some gold for a new Goldilocks bull market in general stocks.

I leave you with a one-year daily chart and 10 year weekly chart of Royal Gold (RGLD), a gold stock I hold long term call options on (Jan 2010 LEAPS):

The world is a printing press

Every country in the world is essentially on a paper money fiat system of currency, which is why it seems so normal and gold seems so kooky to some. Now that times are getting really bad, governments of these countries have started their most aggressive campaigns to re-ignite inflation and avoid deflation. Every country is aggressively lowering interest rates, handing out money/giving tax breaks/employing fiscal "stimulus," and many are propping up and/or bailing out banks with money they don't have.

All this global money printing of course has long-term consequences and makes the currency game a mug's one: saying the U.S. Dollar is strong is a relative thing, because you are comparing one piece of mark-to-fantasy paper with another, and they are ALL GOING TO BE DECLINING IN VALUE now that this "war on deflation" has been officially waged. Yes, the U.S. Dollar will benefit for a while because it is the reserve currency of the world and the currency of the world's senior economy during a deflationary crash, but this is a relative benefit. All paper is suspect when the poop hits the fan.

If you don't believe me, think about this: if everyone went and took their money out of their bank tomorrow, every bank in the country would not only immediately fail, but would not have enough actual money on hand to meet even 10% of the customers' demands for their money. How is this sane or rational? Your money is not available because the banks don't have it. The 1-2 bank failures occurring every week or two aren't even interesting enough to make the news any more.

When times are good, this paper system matters not. But now that Great Depression II has started, all bankers' and politicians' promises are more suspect than ever and having hard pieces of physical cash paper in your possession to cover 1-2 months of expenses is a good idea. State and federal imposed bank "holidays" were used many times during the first Great Depression and we can expect to see them again. Trust me, they won't be announced in advance!

For longer term savings, gold is the only currency that makes sense as a long term store of wealth. Politicians can't debase it (though they villify and ridicule it) because it can't be created out of thin air. Its scarcity is what creates its value. Gold's day in the sun is coming soon. Buy it now while it's still cheap and hold it outside the system to protect a portion of your wealth.

GLD and SLV

I have had people ask me about GLD and SLV, which are ETFs that track the price of gold and silver, respectively. My answer is simple - stay away! If you want to play in the paper world, which most of us do, buy GDX (a gold stock ETF) or a gold stock. Gold (and to a much lesser extent silver) is portfolio insurance because it is guaranteed to pay off if/when the poop really hits the fan. GLD and SLV are paper claims on the insurance potential of physical metal. In other words, you are a hen buying insurance from a fox. The GLD and SLV derivative instruments are backed by the foxes who caused the current Greater Depression/Great Depression II that is now upon us.

Gold and silver are a vote of no confidence in the paper system. My advice is simple. If you agree there is a reason to be concerned about the paper system, buy some physical gold, hold it in your possession, and forget about it for several years. The worst case scenario is that you maintain purchasing power and don't make any significant percentage gains in paper terms. That's the worst case scenario - no losses.

In the early 1930s, did you know that the U.S. government made it illegal for its citizens to own/possess gold? Did you know that after the government confiscated everyone's gold that the price of gold was raised by government decree from $20.67/ounce up to $35/ounce, netting the government a profit of 70% on the assets it stole from its citizens? The corporations who "back" the paper promises of GLD and SLV are the corporations who the government will turn to when it wants citizens' gold again. I say fuck 'em (excuse my French).

Hold physical gold outside the system, avoid counterparty risk, and don't surrender it to tyrannical governments that refuse to exercise prudence or restraint. Did you know that Hoover, who presided over the early stages of Great Depression I, villianized the "hoarders" of physical cash (no one trusted banks) and gold and called them unpatriotic? Did you know that governments of the world are the largest "hoarders" (rational people would substitute the word "savers" but rhetoric is required to demonize the prudent, eh?) of gold in the world and were during Hoover's time as well? Did you know that those who decided to be unpatriotic and ignore Hoover's message were some of the only people who retained their wealth during Great Depression I?

Great Depression II will be worse for the U.S., because we have gone from a creditor nation to a debtor nation. Hold 10-50% of your wealth (depending on your individual risk tolerance and investment goals) in physical gold coins and bars and sleep well at night. If you have the desire to speculate, like me, go long/bull on gold stocks as your core holding and get ready to short the hell out of general stocks come April for obscene profits.

By the way, did you know that Hoover went after the "evil" short sellers in 1932 and contributed to one of the worst legs of the bear market for the entire Great Depression? Gee, where have I recently heard about those damn short sellers? I think the markets went up significantly when short sellers were banned a few months ago if I remember correctly (peeing myself from laughter!)...

The mistakes are the same, the consequences will be the same, and the only investments that make sense will be the same.

Paper revulsion means gold profits

Wall street and all the major banks in the United States are essentially bankrupt and being propped up by our government. It is not one or two institutions that are unsound, but our entire financial system. What recession are you aware of in our history where the entire financial system was at risk and asking for government handouts? How about entire states, roughly 40 of them at last count, being in debt up to their eyeballs and pro-active and desperate ones like California already begging at the Federal trough? How about the entire auto industry needing government assistance just to survive another year? How about a real estate crash that has already almost exceeded the decline during the Great Depression I?

We have to be realistic and assess where we are in historical terms to get a feel for how deep and long this recession and stock bear market is going to be to successfully navigate as investors. The bear market is not over and wishing for it to end won't help.

The problem is that we have maxed out on debt and now it is time to cleanse the system of debt so that a new productive cycle can begin. Companies, governments and individuals are all overly burdened by debt. When debt gets to a certain level, it can no longer be serviced (i.e. the interest on the debt can no longer be paid). All it takes is a sneeze in the economy at this point and loans start blowing up left and right. This is what has happened in our system, not just in the U.S., but in the entire developed world.

Think about it on an individual level. People with average jobs and average incomes became leveraged to the hilt with debt via real estate, autos, and credit cards in our order to live beyond their means and worry about paying for it later. At the peak of the housing bubble in 2005-6, many places in California had a median house price of 7-10 times the median income for their area. This is completely insane. To add to the insanity, after many of these people bought these houses they couldn't afford using no money down, they took out home equity lines of credit based on home appreciation, increasing their leverage.

At the corporate level, JP Morgan Chase, which is completely and hopelessly bankrupt (thank God they don't have to play by the rules!), has roughly $100 trillion worth of derivatives on its balance sheet. That isn't just a lot more than the company is worth, it is more than the entire output of the global economy! Financial firms and banks (at least the ones left standing) are so overleveraged that a move in underlying asset prices of a few percent will wipe out entire corporations.

Our government and governments around the world are trying to "pick up the slack" and keep the debt party going by taking on more debt despite being broke and by passing out free money to corporate friends and citizens alike. This is akin to a mother finding out that her child Johnny has maxed out his credit card and is in financial trouble. This mom, who is herself in debt, would then decide to take out a cash advance on her own credit card and give Johnny the money to pay off his credit card.

The debt party is over globally, but especially for the U.S., and this has investment implications that are profound. If ignored, this will result in serious losses to your portfolio. Those waiting for bureaucrats to "save" the debt-based economy are failing to understand the critical point: governments are part of the problem and are not the engines that drive economic growth! Liquidity, a vague term that applies to the availability of money and credit, is drying up. See the chart below for a long-term view of the debt to GDP ratio in the U.S. over the past 90 years (chart stolen from Ned Davis Research):



When liquidity dries up, we are loosely said to be in deflation and certain investing principles apply. The first is that general stocks, most bonds, real estate and most commodities are toast. The second is that cash (and gold as cash extraordinaire) is king. It's that simple. The last time the debt bubble popped, we had the so called Great Depression. Expect a replay of these conditions in financial markets. Perhaps the ready availability of a printing press and a fiat system means we only get the Japanese experience instead, but perhaps not.

A guy by the name of John Exeter created a liquidity pyramid diagram that illustrates what this process looks like and it has already started (diagram stolen from the Long Wave Analyst website and slightly modified):



Toward the very bottom of this inverse pyramid is cash/federal reserve notes/paper money. Having the 90 day Treasury bill at a 0% yield (no, 0% is not a typo), indicates the flight to cash. Next comes the flight to gold once everyone realizes the risk in holding a paper promise backed by nothing with no potential for returns/yield. As liquidity dries up and deflationary forces increase, people gravitate lower and lower into the bottom/apex of the pyramid. Soon, a gold fever will erupt as everyone begins to seek shelter from the storm.

This flight to gold has already started, as requests for deliveries of physical gold bars at the Comex warehouse, the repository for the futures market in gold, are at record levels that could literally deplete the warehouse of gold in a few months if the trend continues. Physical gold coins and bars for retail investors already have an historic premium to the spot gold price attached to them and delays in delivery are now the norm rather than the exception.

Gold stocks will outperform gold over the next few years, but a component of physical gold in your possession is an insurance policy akin to holding cash, which is always reasonable during a bear market. The tide is turning and within 12-18 months, most will see gold as more valuable than cash. By that time, you may not be able to buy physical gold at a reasonable price. And if our silly bureaucrats insist on printing as much money as they can and passing it out willy nilly to any con, crook or sad sack that asks, we may well lurch from deflation into a currency crisis and aggressive inflation. In this case, that gold insurance policy will pay handsomely. If all gold does is hold its value, which is a no-brainer proposition, you've simply missed out on 0.05% returns on your cash.

Buy gold for protection. Buy gold stocks for investment gains. The time for excuses and procrastination is past.

Gold versus paper - can you handle it?

The problem with understanding the difference between gold and paper money is the same problem as discovering the Matrix before critical mass. Everyone is asleep and prefers to be asleep. Paper money is comfortable, darn it, and why should we think about bad things? Gold is seen as a negative thing when it is absolutely the quintessential embodiment of what money should be.

People are now making jokes about bailouts. Let's just give money to everyone! Just print more money! Where's my bailout? Bernanke can just drop money from Helicopters!

History has shown that every single fiat currency in history has returned to its intrinsic value - zero. A fiat currency is one backed by nothing but promises. You must understand that every paper promise made on behalf of our government has consequences. Every time a paper promise is made, an I.O.U. is created in the form of a Treasury Bill, Note, or Bond. We have to pay interest on that obligation. Now, some would argue that we can just print more money to pay the interest and that is an absolutely valid argument that gets to the heart of the problem.

Printing paper money or creating digital money in a computer requires NO significant effort. Do you know how much effort is required to find/mine an ounce or two of gold? If infinite money can be created with little or no effort, ya think maybe the ability to create money out of thin air might be abused by those in power?

How can you save and plan for the future in this environment? If you think you need a million dollars to retire, this is probably based on what one million dollars means today, not in the future. The U.S. dollar has been devalued by roughly 98% since the Federal Reserve was given a no-bid contract to print money for the U.S. in 1913. This means that the purchasing power of one million dollars in 1913 is now equivalent to $20,000.

Why does this system exist? For what purpose? Inflation benefits those closest to the printing press, who can use the freshly printed money to purchase assets or pursue other schemes before the general price level increases for everyone, thus those nearest the printing press can make money off the inflation, while the rest of us see our savings dwindle in purchasing power.

Forget conspiracy theories, this is about looking out for you and your family. Our currency is strong right now because we are in a deflationary bust. Once this ends in the next 1-3 years, a serious currency crisis is likely at the rate we are printing money. If you think losing 3% purchasing power per year is no big deal, how about 50% in a few weeks?

Gold cannot be created out of thin air. Gold is hoarded by EVERY CENTRAL BANK IN THE WORLD, yet individuals who hoard gold are considered kooky. Why is that? If gold is such a barbarous relic, why do central banks in every major world economy hold TONS of it? Why are the governments of China, Russia, Iran and Saudi Arabia buying so much physical gold right now while the jag-offs on CNBC laugh or roll their eyes every time gold is mentioned? Did I mention that the U.S. and other governments have stopped production of their gold coins for retail investors with no valid reason given? Think these governments might know something you don't?

Time to grow up and understand where we are in history. Cycles and human folly repeat over and over. The coming times will be ugly and you can absolutely protect yourself and your family by buying gold and gold stocks. If this weren't true, how do you explain the almost sine wave nature of the dow-to-gold ratio chart since the Federal Reserve took over our money supply duties (see below, chart stolen from goldmoney.com)? Is this sine wave now suddenly going to end because Paulson and Bernanke are the smartest bureaucrats in history? Gimme a break, yo.



Buy gold and buy gold stocks. Get out of general stocks. Don't trust banks with too much money as most are bankrupt and running on fumes and government promises of a bailout.

Yes, this message is bearish. No, things are not going to get better in 2009 because Obama, a member of the Council on Foreign Relations, has been elected. Do his cabinet member choices seem like fresh new blood that has never been part of the Washington machine and are opposed to the current establishment? Hee hee, I just peed myself laughing.

I promise once the dow-to-gold ratio gets back to one (whether at dow 10,000, dow 1,000 or somewhere in-between) that I will turn bullish on general stocks. I promise. Until then, bull is a short term word for bear market bounce unless we're talking about gold or gold stocks.

Scoreboard

A typical investor's time horizon is not infinite. We want our money to grow for a certain period of time and then we want to do something with it. The buy and hold forever mantra pushed by traditional financial planners and managers and columnists like Ben Stein is perfect, but only if we are in a long-term/secular bull market for stocks. We're not and haven't been since the year 2000. Having 5 or 10 year returns that are near zero or negative can be devastating to portfolios when it happens at the wrong time.

Let's take a look at the scoreboard of recent financial history, using today's closing prices. The effects of dividends, inflation and yields on cash were all ignored, so this table is not 100% accurate (what do you expect for free?):



The important thing to realize from this table is that these long-term/10 year trends are set to continue for a while longer. There is no reason to "suffer" through a long term general stock bear market when there are viable alternatives. Cash will continue to outperform stocks for a while, but I'm not interested in generating zero to slightly negative returns on my money. The yield on short-term cash is now well under 1%, so why not hold physical gold as a cash equivalent with a greater likelihood of substantial appreciation over the next few years?

Gold stocks roared today and I wanted to show you a one year chart of a mid-sized gold miner that I follow and own a little of as a long term investment, Kinross Gold (ticker: KGC):



The current first mini-leg of this gold stock cyclical bull market should be over before the end of the month and those not in the game yet should wait for the subsequent 1-2 month correction to buy into the sector.

Gold versus gold stocks - back the other way

Ratio charts can be helpful to compare asset classes and can help define turning points in markets. The fundamentals for gold stocks in a deflationary/contractionary economy are superb, because the gold price declines less than costs and expands profit margins. If this concept seems odd, think of Walmart in the 1990s. They kept dropping prices but were dropping costs even faster, thus they made money hand over fist. Gold stocks are wild, volatile creatures but can provide phenomenal gains in the type of environment we are in now. While general stocks crash, burn and dwindle over the next few years, gold stocks will provide extraordinary gains.

The $HUI or gold bugs index is an index comprised of unhedged miners, meaning those that don't sell forward future gold at a fixed price, so they are subject to the whims of gold price fluctuation. This can be of benefit when costs are declining and the gold price is stable to rising, thus these stocks provide higher leverage going up. However, this is a two-edged sword and rising costs and a flat to declining gold price crushes these stocks on the way down more than hedged companies (i.e. unhedged gold miners are more volatile). The ratio of gold to gold stocks is a long-term chart of beauty, though I never expected the ratio to get as low as it did last month:



An historical chart of the $HUI gold stock index (which you can't buy, but you can buy the individual stocks or the slightly less impressive GDX ETF) shows the potential gains using the last time gold stocks outperformed the metal (the ratio of the $HUI to gold price is plotted at the bottom for comparison):



The current mini-leg up in gold stocks should be over before December is and there will then be a 4-8 week correction. Gold stock corrections can be brutal (i.e. 20-50% of the previous mini-leg advance) but will provide an outstanding buying opportunity in mid January-early February of 2009. Anyone not positioned in this sector currently who wants to be should plan on buying then. From the bottom in January-February, a 50% gain in this sector in 3-4 months is a reasonable expectation.

Thinking ahead for short-term trades

Short-term, the current stock market rally has already been fast and furious. I am now starting to think about protecting profits for my short-term trades (i.e. FCX, UYM, SSO, and URE). I think the top to the current "sub-leg" of this countertrend rally will be in before Christmas (it could even happen this week if things get too overheated too fast), then a 2-6 week mini-correction, then a good bull run out to March or April to finish the intermediate-term rally. I am going to try to game the anticipated mini-correction for a few weeks within the intermediate-term rally, then I'll probably buy many of my current short-term bull plays back in January.

The current short-term rally that began at the end of November for most general stocks has been led by two of the most beat up and fundamentally terrible sectors: banks/financials and real estate. How's that for stock market logic and investing based on fundamentals? I follow the $BKX (Philadelphia banking index), $DJUSFN (Dow Jones U.S. Financial index), $DJUSHB (Dow Jones U.S. homebuilders index) and $DJUSRE (Dow Jones U.S. commercial real estate) indices.

Below, the financials ($DJUSFN):



The Homebuilder's index ($DJUSHB) is leading the pack up and blasted thru its 50 day moving average already:



I have decided to trade the expected upcoming temporary spike down by using SRS, which is a "double bear" ETF on the commercial real estate index ($DJUSRE). I am doing this because I see this as a 1-4 week quick trade and don't want to get too overleveraged or deal with the option liquidity issues (i.e. bid-ask price spreads eat heavily into profits for small moves) for such a short-term trade. Below is a current chart of $DJUSRE:



A potential road map for this $DJUSRE trade is the chart from one year ago for the $DJUSHB (December, 2007).



Perhaps even better would be the 2006 crash and recovery into 2007 in the $DJUSHB chart:



See previous post for my "phase shift" trade logic between $DJUSRE and $DJUSHB. Anyhoo, with SRS giving double leverage, there is the possibility for a 40-60% gain. I'll be shooting for a 20-30% gain by buying SRS if the set-up presents itself as anticipated. I'll be using a stop-loss to minimize risk on this trade, since this is a shorter time horizon than I typically use for a trade. Stop losses allow you to enter a maximal loss level you are willing to accept before dumping the trade and taking a small loss.

Also, it is important to keep in mind that $DJUSRE, $DJUSHB, $DJUSFN and $BKX are not done rallying yet, I just think they're going to take a breather in the next 1-2 weeks, as the correction has been fast and furious so far. Once the current sub-leg of the stock rally ends, almost certainly before Christmas, a 2-6 week correction should occur, then another leg up of the rally into the March-April time frame, when the rally should end and the next BIG leg down of the bear market should begin.

Gold stocks will follow the general markets fairly closely over the next few months, but will finish the spring rally much stronger than regular stocks and will then undergo a bull market correction after the spring. The disparity between gold stocks and regular stocks will become quite apparent in the summer of 2009, as regular stocks will be heading for new lows while gold stocks undergo a routine correction and resists the full downward pull of the general markets.

If you're not a believer now, you will be by the end of the summer, when it will be time to load up heavily on gold stocks. Me, I'll be buying long-term call options on gold stocks next summer, but without options, 100-150% gains will be achievable by buying gold stocks in the summer of 2009 and selling them in the spring of 2010. For those interested in buying and holding for ASTOUNDING 3-4 year profits, the exact entry point isn't as important. However, this current gold stock sub-leg up should be ending in a few weeks and a better buy entry point will come in January-February, 2009.