First and foremost, as to the purported discrepancy between the price of gold on commodities exchanges and that of physical gold, in my view, any real discrepancy would be jumped on by the arbitragers so fast, it might even break the land-sound barrier.

As for the shortage of gold and silver bullion products, we would attribute this to a couple of factors. The first is that there has been some poor planning on the part of the mints. Secondly, the poor planning is likely due to a failure to appreciate how many people are coming to the conclusion that it is better to own at least some precious metals, instead of holding only the unbacked paper of governments.

As for gold’s recent steep fall in the face of the clear signs of physical demand, it seems clear that this was largely caused by gold traders taking profits. At every step up in this bull market, the precious metals have been stuck, for months at a time even, in trading ranges... the bottom of which evokes buying and the top of which triggers selling.

It is always worth keeping in mind that the defining feature of commodities exchanges is the leverage the instruments that trade on these exchanges offer. Consequently, the traders who call those exchanges home are able to marshal considerable juice in their quest for a new Lexus with 16-way driver seat features and custom leather interior.

The salient point is that while those of us who believe in the values offered by gold and silver like to think of them as “substantial” markets, when it comes to futures markets, they are like a gnat on the tail of an elephant. To make the point, consider that the cash value of foreign-currency contracts traded globally each 24-hour period is on the order of $3.2 trillion. By comparison, over the same 24-hour period, on average, $26 billion worth of gold trades hands. For silver, the number is even smaller, just $4.5 billion.

All of which is to say that (a) these are markets that can be “pushed around” by the traders, and (b) when a large number of traders shift into “take profits” mode, the price of the metals can be trampled.

The long and short of it is that range trading will go on for awhile, until something occurs in the psychology of the market that shifts the majority into the long side... at which point the upper end of the trend is decisively broken and the range is reset to a higher level. It is my contention that the top of the range for gold is now $1,000, and we could see it continue to test that level, then fall back, for some time. But really, who can say? It could happen literally almost overnight.

Shifting to a somewhat nearer-term perspective, however, it is worth looking at the chart from Seasons of Gold, the archived article from the April 2006 edition of the International Speculator .

While the chart hasn’t been updated lately, the data used is so long-term – 30 years – that updating it wouldn’t have changed anything by any noticeable amount.

Viewing the chart, it doesn’t take a lot of imagination to assemble a scenario whereby the continued strong investment demand for physical gold meets the traditional strength of the Indian wedding season buying that contributes so much to the historical pick-up in gold prices in September.

Toss in the effective nationalization of Freddie and Fannie, putting the U.S. taxpayer as the guarantor of last resort on fully half of the mortgages in the nation...and mix in some of the ripe geopolitical apples now falling from tall trees, or the imminent realization that oil isn’t going back to $50 or that the inflation phenomenon is not temporary, and we could see a big bump in the gold price over the next couple of months.

Time to go long in the futures market? Well, on that topic, all I can say is, tread carefully...and use as little margin as possible just now.

That’s because, as wild as things have been in pretty much all the markets, we haven’t seen anything yet. If there is one thing you can take to the bank, it is that, in the months just ahead, the volatility of virtually all markets is going to go ballistic. For the attentive trader, that can mean big, and repeated, opportunities for profit. But for the casual trader, high volatility can lead to quick loss making.

Sticking to a longer-term perspective – buying and holding and, if resources allow, buying more on the dips – is the way to go.

Regards,

David Galland
for The Daily Reckoning Australia

• Gold and Silver!
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?
• 4 Ways to Protect Against a Falling Dollar
• The Price of Gold is Low – But It Won’t Stay There Forever!
• Transfer of Wealth

Don't be.

The evidence to support that statement would fill a telephone book at this point. Starting with the latest U.S. inflation numbers which, even using the government's own crooked calculations, rang in the last reporting period at 5.6%. Quoting John Williams of ShadowStats.com from a recent email I received from that organization...

"Reported consumer inflation continued to surge on both a monthly and annual basis, once again topping consensus expectations. The July CPI-U jumped to a 17-year high of 5.6% in July, while annual inflation for the narrower CPI-W - targeted at the wage-earners category where gasoline takes a bigger proportionate bite out of spending - annual inflation jumped to 6.2%. The CPI-W is used for making the annual cost of living adjustments to Social Security payments. The 2009 adjustment - based on the July to September 2008 period - remains a good bet to top 5%, more than double last year's 2.3% adjustment for 2008. Such is not good news for federal budget deficit projections."

Based on William's calculations, which use the same CPI formula used by the Fed prior to the jiggering of the Clinton years, the actual inflation rate is now running at 13.64%. And on August 19, we learned that the U.S. Producer Price Index rang in at a month-over-month increase of 1.2%, the third month in a row where that leading indicator has topped the 1% mark. Meanwhile, in Europe, the latest numbers put inflation at a 16 year high. And these are not anomalies, but the norm as the inflation tide continues to rise literally around the world.

A good analogy to the global currency devaluation is a slow-moving hurricane that, once over warm water, gains energy.

Right now the global inflation is a huge storm, slowly circling off the proverbial coast where it is gathering strength from the hundreds of billions of dollars being fed into it by governments desperate to avoid economic collapse...and from pricing decisions being made by everyone from manufacturers to local shopkeepers looking to cover rising costs.

At this point the skies are dark, the wind is rising, and the torrential rains are beginning to sweep in. The radio is broadcasting warnings to move to higher ground, but the hurricane has yet to hit the shore.

But when it does, it will be a Category 5 and maybe worse.

That's because, in addition to the straight-up consequences of the government monetary prolificacy and businesses raising prices to try and stay afloat, there is something else feeding power to the storm...something we have been warning about for years now: the rising odds that the global fiat currency system will fail.

Let me add some nuance to that remark.

In recent years, the global financial community, reflexively looking for an alternative to the obviously damaged U.S. dollar, has settled on the euro. But the euro is equally flawed, and maybe even more so, than the U.S. dollar. Now that the trading herd has also come to that conclusion, they are rushing back toward the dollar.

They are doing so not because the U.S. dollar is healthy, but rather because that is all that they know...a heads-or-tails continuum running something along the lines of "If the 'it's-not-the-dollar' play is over, then it must be time to go back into the dollar." The euro sinks, the dollar goes up.

And so gold, viewed by these same traders only in terms of its inverse relationship to the dollar, gets hammered.

What they are missing, but not for much longer, is that rushing back into the dollar is akin to heading for the vulnerable coast, and not to the higher ground now proscribed. They are also missing the point that gold's monetary value is not limited to protecting only against a failure in the U.S. dollar, but against any faltering fiat currency...a moniker that the euro deserves in spades. Not only is it backed by nothing, but it is also backed by no one.

I hope that the above point is clear, because it is an important one. One way to think about it is to think about Zimbabwe. If you lived in that blighted country and a year ago you could have had an ounce of gold or a wallet full of that country's failing currency, which would have been the better bet?

The answer, while obvious, is illustrative...because the wealth preservation role that the ounce of gold would have played for a citizen of Mugabe's paradise had zero connection with how well gold did, or didn't do, against the U.S. dollar over the period.

Gold is viewed as tangible money right around the world, and has been for millennia. When the trading herd wakes up to the fact that neither the U.S. dollar nor the euro, nor any other fiat currency, will protect them against the monetary storm that will soon begin tearing the roofs off their cozy offices, they'll fall all over themselves in the rush for something that will: gold and other tangibles.

Many of you know that the scenario just described is one that we have forecasted for some time. If you think the thing through, precedent to the global monetary crisis, the euro first had to stumble. Well, it now has. The next stage - and given the volatility of the situation, I don't think we'll have to wait long for it - will be the realization that there is no safe fiat currency. It is at that point that the massive hurricane, a crisis of confidence in the entire fiat system, will begin ravaging the global economy in earnest.

The price action of gold and, especially, gold-related investments over the last year, have been frustrating...to say the least. But the scenario now unfolding remains step-by-step in sync with our base case. As such, the best way to view this latest correction in the price of gold is as a temporary setback of no real consequence from an investment perspective (unless you use it as a buying opportunity).

The failure of the euro, on the other hand, is not just important...it is as monumental as it was inevitable.

David Galland
for The Daily Reckoning Australia

• Gold, the Aussie Dollar, the Greenback and You
• Inflation Up… Gold Up… Oil up… Dollar up… Dollar down…
• Monetary Inflation the Old-fashioned Way!
• Aussie Dollar Ready to Storm Past US Dollar
• The Rise in the Dollar Doesn’t Have Everyone Convinced

In that article, he looked ahead and saw the inflation that the government’s loose money policies made inevitable. A quote...

“Of particular importance is that the U.S. dollar has been used as a gold substitute for decades by other countries. This has been very convenient for the U.S. – we can create almost infinite numbers of greenbacks and give them to people in other countries in exchange for real wealth. Idiotically, central banks abroad have been holding those dollars as backing for their own currencies.

“The amounts involved have grown so immense, and the eventual grim fate of the dollar has grown so obvious, that foreign central bankers are now looking at each other, trying to figure out who will head for the exits first. Many are ‘diversifying’ from dollars into other currencies – which are themselves backed mainly by other paper money, mostly dollars. At some point there’s going to be a panic out of U.S. dollars that’s going to dwarf any financial event in history.”

And in that same article he also predicted the current collapse in the housing bubble that the loose money had made possible. Another quote...

“What’s going on now in the residential real estate market is much like the tech bubble, but potentially much, much more serious than what went on in stocks a few years ago.”

Jumping ahead 3 years, to today, the unhappy scenario Doug then foresaw is now unfolding. Right on schedule the economy and markets are heading inexorably toward what might be termed the Scorched Earth Phase.

Even a casual glance at the devastation now being wrought on the very building blocks of the economy confirms the appropriateness of that term.

For instance, consider the U.S. financial firms, the single largest component sector of the S&P 500. So far, the losses to those firms are approaching half a trillion dollars. And the odds are high that there’s much more to come. With the exception of Bear Sterns, the big name financials have been able to cobble together the billions of dollars in additional capital needed to shore up their balance sheets...but they are quickly running out of rope. That becomes apparent when you consider that many of their major revenue centers are now either severely wounded or in the morgue. Last quarter alone Morgan Stanley saw its investment banking fees fall by half and toxic paper sales (ah err, I mean “fixed income”) sales and trading revenue collapse by over 85%. And this at a time when these same firms are being forced by regulators to repatriate their off-balance sheet assets...to wit, the aforementioned toxic paper.

Sovereign Wealth Funds (SWF) to the rescue? Not anymore. Those that initially rushed in were seriously burned and many are now on record as staying on the sidelines. But any that might wish to take a second roll of the dice, will only do so if they get much better terms, which is dilutive to existing shareholders.

Meanwhile, the housing meltdown persists and will continue for at least another year or two. Unless, of course, the government gets serious about “doing something”...in which case the downturn could last 5 or 10 years.

Why do I say that? What the market needs most of all right now is for house prices to fall, as quickly as possible, to a market-clearing price. The problem, of course, is that thanks to the self-serving exuberance shown by many appraisers during the real estate bubble-mania, at this point nobody actually knows where the bottom is. Another 10%? 20%? 30%?

There really is only one way to find out...let the brush fire burn, as painful as that will be. But as I don’t need to tell you, “doing nothing” is not a concept that politicians in an election year are very comfortable with. And so, like trained seals leaping after vote-fish, the politicians will jump though any number of hoops to keep people in their homes even though many can’t afford the carrying costs, let alone the mortgages. That only prolongs the pain and increases the government deficits that are at the core of the current crisis.

So, we have a tumbling collapse in the largest component of the stock market, coinciding with a tumbling collapse in the largest component of people’s net worth, their homes.

And we aren’t even warming up yet.

For a more complete accounting, you also have to add into the mix the intractable problems unfolding in energy patch, including the near-certainty that Mexico, the 3rd largest source of imported oil for the U.S., will stop exporting said oil within 4 to 6 years...max.

Rather than rushing ahead with emergency initiatives to open up new energy sources, the U.S. Congress just passed emergency legislation to prevent so much as exploring for uranium anywhere near that big hole in the ground, the Grand Canyon. It is this perfect world mentality that assures that the cost of what energy is available, will only get more, not less, expensive. Of course, as energy is required in the production of, well...everything, so the cost of everything will go up.

And that includes, food...which, as I don’t need to tell you, has been on a tear of late.

Sure, opportunistic new plantings will help, over time, to moderate the higher food prices...but not overnight. Meanwhile, the cost of filling the old tractor and shipping food to market will keep going up.

So, to the list of serious problems for the economy, we have to add persistent high energy and food prices.

But even those fall short of the KING KONG of the set piece...the collapsing fiat monetary system that helped create the recent series of bubbles in the first place.

In a fiat monetary system the only tangible barriers to money creation are provided by a loss in stakeholder confidence. While the average American is, sad to say, almost completely ignorant of what a fiat monetary system is, let alone the consequences of same, the same cannot be said of the foreign holders of an unprecedented $6 to $7 trillion dollars.

To be a touch more specific, by unprecedented I mean as in “never happened before”. While, under other circumstances this fact might evoke a raised eyebrow or a concerned comment over cocktails...going into the jaws of a vicious economic/dollar crisis those foreign dollar holdings become akin to playing toss with a lit stick of dynamite. He who holds the dollars when the fuse meets the powder is in for a very, very bad day.

As a result, the foreign holders are watching the moves of the Fed very closely. Trying to avoid that scrutiny the Fed, like a curbside Three Card Monty dealer, has come up with some clever sleights of hand, including lending directly to investment banks and swapping Treasury bills for toxic paper. But that has accomplished little more than buying some time; it does nothing to resolve the “rock and a hard place” dilemma.

Which remains as thus: if the Fed raises rates to prevent a sell off in dollars, they’ll crush the highly indebted and already struggling populace and, in so doing, unleash a serious economic crisis. But if the Fed keeps rates where they are, or even lowers them, they’ll trigger a dollar sell-off and unleash a serious economic crisis.

Either way, the story ends the same: a serious economic crisis.

At this point, our bet remains that the Feds will go to default mode which means cranking up the printing presses into the red zone, letting the dollar move ever closer to its intrinsic value: zero. That they’ll follow this route is suggested by two inputs. First, a depreciating dollar means a reduction in the trillions of dollars in obligations now owed by the U.S. government. And, secondly, foreign holders don’t vote.

So, we are calibrating our investments toward a serious economic slowdown, but with high inflation. Some people would call that Stagflation. But given the severity of both sides of that formula, the situation may be better described in terms of Scorched Earth. Or, because people seem to find concepts ending in “flation” handy, Stag-flagration.

Businesses and personal net worth will be devastated at the same time that costs run out of control.

How to Play It?

Our strongest recommendation is to position your portfolio in anticipation of higher inflation and, in time, a turnaround in interest rates. The latter is because interest rates, which are still near a 50-year low, can only go up as the inflation rises to the point of banner headlines (at which point, the government is hoping, the economic downturn will have moderated).

In fact, we think the move towards higher interest rates is a trend that will surprise many, but, once it gets going in earnest (and corporate bond yields are already on the rise) last for at least the next several years.

In terms of other investments, it’s worth noting that in the last major bull market for tangibles, back in the 1970s, oil was the best performing investment, followed by gold, U.S. coins, silver and stamps.

Today the range of investment vehicles you can use to make the trend your friend is greatly expanded a wide variety of specialized ETFs (though an added layer of analysis is required to sort the strong, well structured, high volume variety from the thinly traded variety of suspect parentage). And while they continue to require patience, the highest quality junior Canadian gold exploration stocks remain one of the most prospective investments you can make. A number of these companies are now sitting on proven big discoveries, but thanks to the stop-start markets, are significantly undervalued. They won’t stay that way long.

Whatever you do, don’t be complacent at this point. If we are right, then the economic crisis will soon head into its next and most dangerous stage. Certainly, we should feel the heat, and maybe worse, by the end of the year. Therefore, at the very least, you’ll want to take measures now to protect yourself. For our own portfolios, we believe that the best defense is a good offense, and so are positioning ourselves in the sectors that will profit, and profit big, as the stag-flagration sweeps across the global economy.

Then it’s just a matter of sitting tight and being right.

David Galland
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• Bank for International Settlements Report Looks at Origins of Credit Crisis
• Gold and Oil are Acting as Though They Expect Higher Rates of Inflation
• Americans are Paying Record Prices for Energy and Food
• A View from the Peak of the Global Economy

A few key things to ponder as the battle for $900 gold rages...

1. The current correction in the price of gold is not yet exceptional: Since the current bull market began in earnest in 2001, there have been 9 corrections in excess of 8%.

During the three worst pullbacks, gold fell 15.98%, 18.27%, and 27.7%, respectively. And the average of those corrections is 13.6%, so the latest, which touched 18% at its worst, is only marginally worse than average.

Put another way, for the current pullback to match the sharpest correction to date, a drop of 27.7%, gold would have to fall to about $730. Could it happen, again? Sure, why not?

And if it does, rest assured that, just as they did when gold moved down by that percentage in May of 2006 - falling from $725 to $567 - analysts will line up to say that the back of the gold bull has been broken. But if you had listened to the naysayers back then and bailed out at the bottom of that correction, you would have missed a rebound of close to 100%.

I mention this to stress that the fits and starts in the price of gold we are currently experiencing are nothing unusual. Quite the opposite, they're the norm for any sustained bull market. In the 1970s' sustained gold bull market, a similar pattern occurred.

The bottom line is that if you are going to invest in the resource sector, you need to take a long view. And, I would stress once again, you have to be invested with money that you can afford to lose a substantial portion of and not be overly concerned. Otherwise you'll invariably become shell-shocked during periods of volatility and be prone to breaking ranks and selling at the worst possible time.

2. The big gold companies are delivering: One of the largest mining companies in the world, Newmont Mining (NYSE: NEM), recently released its first-quarter 2008 financials, the first of the big gold producers to do so.

As we have been forecasting, they had record sales of $1.94 billion, realized a record price of $933 per ounce sold, and saw their cash operating margin soar by 119% from the same period last year. Further, net income was up 444% from Q1 last year. And the company's cash operating margin rose to a record $537 million in Q108 over the prior record $419 million earned in the previous quarter.

Over the next couple of weeks, we'll see a string of similar results from the other major producers, offering a stark contrast to the billions upon billions in losses being suffered by the banks, investment houses, housing industry, airlines, etc.

So, what happened to Newmont's shares on releasing its financials? They fell, albeit modestly, victim to the softening gold price this week and a dumb remark by the minister of mines of Ghana - where Newmont has significant projects - about the need for mining reform in that country. More on that latter topic momentarily.

The key point is that the increase in the profitability of the gold miners, a prerequisite for the entire gold share complex to get moving, is now materializing.

3. Oil is stubbornly holding on over $100 and food prices are on the rise everywhere. This is simply the most visible evidence of the inflation now gripping the world.

We've said for years that there is a very tight correlation between rising oil prices and rising gold prices. While oil prices may moderate at some point - because, again, no market goes straight up or down - the trend is clearly for sustained high prices. This is additional support for the price of gold in our view.

So...given gold's correction, you might go right ahead and sell your gold. I'm hanging on to mine. And if I'm hanging on to my gold, I'm hanging on to my gold stocks, because that's where the real juice will be.

When I look at the alternatives and the amount of risk I have to take to get even a 10% return right now, I am comfortable biding my time, continuing to buy gold and gold share bargains with the expectation that the 100%, 200%, 500% gains down the road will catch me up in a hurry.

David Galland
for The Daily Reckoning Australia

• Has Oil Hit Its Peak Price?
• Consumer Price Inflation has Spooked Investors Everywhere
• Economy Free to Recover?
• The Price of Gold Has More Than Tripled
• Today’s Current Gold Price

So where will that lead the U.S. economy? Simply stated, surveying the landscape of current events, many of which are a direct consequence of excessive debt and an inevitable slowdown in consumer spending, we expect stagflation ahead. Loosely defined, that term refers to a general economic slowdown - a recession - but coupled with rising prices triggered by massive infusions of liquidity into the market.

That liquidity can come from governments - witness the billions upon billions now being thrown into the fray by the world's central banks - or it can come from, say, some percentage of the 6+ trillion in U.S. dollars held by foreigners coming home to roost. On that latter point, in recent weeks there has been almost daily news about foreign corporations and sovereign wealth funds unloading their greenbacks in exchange for shares in some of America's largest financial institutions. Doug Casey has correctly pointed out that it is when the trade deficit starts to shrink, which it recently has, that you need to look for cover... because, among other things, it means the tide of U.S. dollars is beginning to wash back up on U.S. shores.

Our view that the stagflationary scenario is the most likely is supported by a steady stream of data. For instance, despite an obvious slowdown in 2007 holiday season shopping, the Bureau of Labor Statistics reports that producer prices in November increased at the fastest rate in 16 years.

Rising prices make a stagflationary environment positive for the price of gold, if for no other reason than that investors reallocate depreciating paper-backed investments into tangibles with a demonstrated ability to float as the intangibles sink.

So, our view remains that we are headed for a stagflation. But what if we are wrong?

What happens if the global economic crisis gets so bad that it trumps any and all inflationary influences and we enter a straight-up deflationary recession?

That is, we are sure, a question on the minds of many gold investors.

Some quick thoughts...

Gold in a Recession

Traditionally, gold has been a safety net against inflation. Inflation is good for the price of gold, a case we don't need to make again here.

But, in a typical recession, the demand for everything slows and the prices of many things fall. The knee-jerk reaction of most casual market observers, therefore, might be that if inflation is always good for the price of gold, then the opposite is always bad.

Historically, however, that is not the case. The chart below shows the price of gold overlaid against official periods of recession as defined by the National Bureau of Economic Research. As you can see, about half the time gold actually rises in a recession.

Gold Has Risen As Many Times As It Has Fallen During A Recession

(Note: This chart uses monthly averages, so you can see that current prices are, in nominal terms, higher than the 1980 high, based on those averages.)

Simply, there isn't a specific historical precedent that demonstrates that the price of gold will fall during a recession.

But could we have a general deflation, one that might tip gold into one of the down cycles? Of course.

The developing recession, based as it is on a global contraction in credit, looks to be especially long and deep. Almost daily now we learn of multi-billion-dollar debt defaults. Those, in turn, trigger both a freeze-up in easy credit and a flight from risk.

In response, the United States government has responded with its predictable "fix-it" tools - stimulus and bailouts. The tools of government stimulus are lowering the Fed funds interest rate, and potential new large-scale bailouts like the Resolution Trust Corporation (RTC) that was put into action to straighten out the Savings and Loan crisis of the 1980s, to the tune of $200 billion. While the Europeans have just unleashed an amazing $500 billion in new liquidity, so far, U.S. Treasury Secretary Paulson and Fed Chairman Bernanke and friends have been surprisingly slow to act. They started with denial and have moved to inadequate Band-Aids.

In the absence of any concentrated and well-funded program - such as the RTC - to try and keep the wheels on (and, at this point, it is not clear that any imaginable measure will suffice), the deflationary pressures of the housing collapse are winning.

But there is an important, longer-cycle pressure that is not talked about much, although it is increasingly obvious to the American consumer: the U.S. dollars they're spending are buying less. They see gasoline and heating prices rise, but don't think much about the dollar itself as the underlying source of price inflation.

This decline in the purchasing power of the dollar is extremely important for the price of gold. That's because the pressures on the dollar seem overwhelming when aggregated: huge budget and trade deficits, wars and retirement demands of baby boomers, unprecedented foreign holdings of U.S. dollars. Watching the prices of internationally traded goods, including oil at $90 per barrel and wheat at a record $10 per bushel, it is hard to imagine a situation of serious deflation emerging.

Looking for Alternatives

The flight to quality by investors who no longer trust packages of mortgage loans, or anything that is not strictly labeled as government backed, is unprecedented. The interest rate on government-issued two-year Treasuries dropped to 3%, reflecting the demand for safety. Concurrently, other interest rates have risen in response to increasing mistrust and uncertainty.

Gold, of course, provides a different form of safe harbor alternative - an asset that is not only readily liquid but, unlike government paper, positively correlated with the very same inflation that will erode the purchasing power of paper assets.

Right now, gold is not on the front burner, but this is only to be expected because of the state of flux of global financial markets. Like observers of a war of Titans, the market is confounded by the sheer magnitude of all that is going on, from the devastation being wreaked on the world's best-known and most established financial institutions, to the unleashing of billions upon billions in experimental new liquidity measures by central banks.

As the fog of war begins to clear and it becomes obvious that not only will economic growth be severely curbed, but that the fiat currencies are going to be sacrificed in the fight, some percentage of the funds now sitting on the sidelines - much of it in U.S. Treasuries - will begin to move into gold and other tangibles. In the face of limited gold supplies, this surge in demand should create strong upward pressure on the price of gold and, for leverage, gold shares.

In sum, even though the relatively sluggish and inept responses from the U.S. government in the face of the current credit crisis could produce a severely slowing economy, creating periods of deflationary fears that put stress on the price of gold, we continue to believe that the most likely case is for massive inflationary bailouts that support a positive outlook for the price of gold.

Bud Conrad and David Galland
for The Daily Reckoning Australia

Editor's Note: Bud Conrad and David Galland are, respectively, the chief economist and managing editor with Casey Research, publishers of BIG GOLD, an inexpensive monthly advisory dedicated to providing unbiased and actionable research on simple, effective and cautious ways to participate in rising gold markets.

• None Found

Certainly, the "easy" money was made by those who invested in the resource stocks before 2000.

But we remain convinced that the big money in the trend is still ahead...especially in the gold market. Since 2000, of course, the price of gold has better than doubled, but the quality gold stocks have gone up much more... 400%, 1,000% or more. Over the last 12 months, however, gold and gold shares have been languishing. But don't let this listless gold price action fool you. The current bull market in gold has the potential to produce an astonishingly powerful and enduring advance from current levels.

The only fundamental reason for the price of gold to go higher is when competing forms of money - usually paper money - lose their purchasing power. For instance, if you lived in Zimbabwe today and were offered an ounce of gold or a brown paper bag of rapidly depreciating Zimbabwean dollars, what would you take? (Hint: take the gold; inflation in Zimbabwe is so bad that a roll of toilet paper now costs over 200,000 Zimbabwe dollars.)

But the world doesn't trade off the back of the Zimbabwean currency unit. That honor belongs to the U.S. dollar which, as you are no doubt aware, has evolved into the de facto reserve asset of virtually every central bank in the world today.

That the unbacked currency of one country is now the core holding of all the countries in the world is unprecedented in the history of the world.

Books have been written about how it happened. The short version of this fascinating story is that it came about as a direct result of the U.S. being the "last man standing" after World War II. In 1944, as the war wound down, delegates from 44 war-battered countries gathered at Bretton Woods, New Hampshire, and, after some arm twisting, agreed to accept the role of the U.S. dollar as the currency of global commerce. The decision to make the greenback the supreme currency was made easier because, as a component of the Bretton Woods agreement, the U.S. agreed to make it forever convertible into gold.

Unfortunately, when dealing with politicians, "forever" has a different meaning than to regular folks. In 1971, when a rush of European dollar-holders began converting their greenbacks into gold, Richard Nixon unilaterally canceled the dollar's gold convertibility. From that moment on, the U.S. dollar became an abstraction, backed by nothing at all... and unrestrained by anything other than political whim.

The growth of dollars outstanding since Nixon ended convertibility has been stunning. There are many implications attached to this global flood of unbacked money. But the primary concept to understand is that the supply of dollars increases rapidly; the supply of gold increases slowly. The debasement of the dollar knows no limits. Over time, therefore, gold's value in dollars should increase substantially.

Since the end of gold convertibility, there have been no limits on what the politicians can promise or what they can spend. A fresh example is provided by the subprime credit crisis, in response to which the government has gone on record stating it would provide "unlimited" credit to banks.

But "credit creation" is just a clever way of saying: "dollar-printing." That's why credit creation is a dangerous game - one that threatens to eliminate the U.S. dollar as a serious competitor to gold.

Any number of the investors who entered the gold trend early look at the price action of the yellow metal over the last year - which has been flat to slightly down - and worry that this is a sign that this gold bull market is over.

What they are doing is letting their emotions run their investment portfolio, a classic reaction during the "Wall of Worry" stage of any bull trend. They have made big money in gold shares, they understand the fundamental arguments, yet declining prices or volatility in the shares (which is especially prevalent in the summer months) gets them to thinking, then worrying, then selling.

Big mistake. Look at the chart below. It is the price of gold during the height of the last major gold bull market. Notice the long, almost two year, decline right in the heart of the trend.

That is what we are looking at now... a very normal, to-be-expected consolidation phase. Understanding that fact opens the door to big profits. Right now you have the unique opportunity to buy the very best junior gold companies at a Wall of Worry discount, in essence taking an extraordinarily profitable, time machine trip back to an earlier point in this long trend.

When buying gold stocks, investors always face two basic choices: Major companies or "juniors." The first, more conservative path, is to choose from among the big gold stocks - the larger producers that will find favor with the big money institutional players and hedge funds. These giant mining concerns will, when things get rolling, provide solid double- and even triple-digit returns. In the last resource share bull market, triggered by a series of major discoveries in the mid-90s, for instance, Kinross went up 197% over a two year period; Barrick went up 57%; and Newmont 74%.Nothing to sneeze at when compared to "traditional" investment sectors.

The second, and most exciting path, however, is to invest in the better-quality junior gold stocks. These are the junior Canadian stocks overseen by seasoned exploration geologists - many of whom used to work for a major - who use their knowledge and investor capital to find prospective new geology. When they find something, they typically joint venture it to a major company, who spends the high-risk money on follow-up drill programs. Alternatively, the junior company will sell its projects, or even itself, to one of the majors.

Returning again to the mid-90s resource stock bull market provides a measure of the potential of the junior exploration companies: Cartaway, up 26,040%; Arequipa Resources, up 5,692%; Francisco Gold, up 3,350%.

Over the last few years, a record amount of money has gone into exploration programs around the globe - money which will start coming back in the form of major discoveries in the next year or two. Pick up your shares now, then plan on holding them as this gold bull trend regains momentum. In other words, buy right and sit tight.

Furthermore, given the financial turmoil gripping the world just now, gold-related investments provide extremely important diversification of risk. In times of crisis, gold shines particularly bright.

But don't delay getting on board this trend. The slow summer months, coupled with Wall of Worry concerns, are depressing the prices of many premier gold companies. So the time seems opportune to build a portfolio that makes the most out of gold's long-term advance.If the price of gold is going to $1,000 an ounce, you'll want to be along for the ride.

David Galland
for The Daily Reckoning Australia

David Galland is the Managing Editor of Doug Casey's International Speculator, now in its 27th year. Today, it is following over 30 high-quality resource stocks on behalf of subscribers, with new buy and sell recommendations monthly.

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Well, technically, they don't have to be. That's because, in the absence of government intervention, all a trade deficit should mean is that the people of one country are willing to trade their money for something on offer by the people of another country.

In the 1800s, the U.S. ran big deficits and did quite well because our country was full of opportunity and promise, so foreigners invested here, more than we invested there.

The problem comes when a government, say China, steps into the picture and deliberately suppresses its currency to attract businesses to certain sectors of its economy - for instance, city dwellers. That causes an aberration, the result being a lot of U.S. dollars shipping out to China in exchange for all manner of consumer goods... dollars that the Chinese have then turned around and invested in U.S. Treasuries. More on that momentarily.

The massive deficits with China are unstable because, rather than being the result of open trade, they are based largely on political decisions made by a handful of people in the Chinese government.

In time, those people - or their successors - may decide that there is more advantage to spending the dollars. Or they will be forced to do it. Say, to appease other segments of the economy now penalized by the higher cost of foreign goods. Or they might have to spend the dollars to pay the cost of a war or to bail the country out of a financial crisis.

Regardless of the reason, at some point the political advantage of spending those dollars, rather than hoarding them - which the Japanese did to their detriment in recent decades - will reach a tipping point after which those greenbacks will come flooding back to the market, devastating the value of the dollar on foreign exchange markets.

The dollar has already, since 2002, lost about 26% of its value. Of course, a good deal of the pain that depreciation has caused to the wallets of foreigners has been offset by the interest they earned on their Treasuries. But treading water is one thing, and standing by while your pile of cash starts to go up in the flames of a monetary crisis is another.

Viewed from another angle, over time it isn't the trade deficit that is inflationary. Rather, the trade deficit is effectively a subsidy provided to the U.S. by China... a subsidy that comes from the Chinese having used the river of dollars provided by U.S. consumers to buy the unbacked paper of the U.S. government. That has allowed U.S. interest rates to remain artificially low and forestalled inflation in the U.S. It is as if China is building up a big bank of inflation points. Sooner or later, they are going to spend those inflation points.

Make no mistake, we are in uncharted water; it is unprecedented that the claims represented by the fiat currency of one government - that of the U.S. - have been accumulated in such massive quantities for the reserves of other governments. And we're not just talking China but virtually the world. And the world is getting nervous.

To quote Thai Finance Minister Chalongphob Sussangkarn in his recent address to the annual meeting of the Asian Development Bank in Kyoto:

"Should the financial markets lose confidence in the U.S. dollar, huge capital outflows from the U.S. could lead to a rapid depreciation of the U.S. dollar, and thus dramatic appreciation of other currencies."

The whole matter of trade deficits is, unfortunately for investors not paying attention, just one of far too many aerosol cans now roasting in the fire. When they start exploding, you'll want to be safely hiding behind a wall of gold and silver.

In the final analysis, every day gold goes up and gold goes down, with the movements based on any number of inputs. To avoid being panicked one way or the other, a long-term perspective is required to see these fluctuations in their proper perspective. And, despite all the jagged fits and starts these past few years, and all the nay saying along the way, three years ago, gold was trading for $393 an ounce... 40% lower than it is today.

And the better gold shares have offered exponentially higher returns than that.

While now is the time to begin accumulating your gold and gold share positions - if you have not already started doing so - how will you know when things are about to get really "interesting"? My partner Doug Casey recently made the observation that it is not when the trade deficit is rising that you should be concerned, but when it starts to contract... because that is a sign that the flood of greenbacks is starting to return home.

Regards,

David Galland,
for The Daily Reckoning Australia

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On March 3, 2007, for instance, we had the following report out of Bloomberg:

"Saudi Arabia, the United Arab Emirates and four other Persian Gulf nations will discuss revaluing their currencies' peg to the U.S. dollar before a proposed monetary union in the region in 2010.

"The states would only change the dollar peg simultaneously, U.A.E. Central Bank Governor Sultan Bin Nasser al-Suwaidi told reporters today. The six countries form the Gulf Cooperation Council and their central bank officials next meet in April. The other countries are Bahrain, Qatar, Oman and Kuwait.

"'We will not act unilaterally,' al-Suwaidi said in Dubai, U.A.E."

On March 15, Bloomberg followed up with this…

"The dollar may also be buoyed after the six Gulf Cooperation Council members, which include Saudi Arabia and Kuwait, agreed not to revalue their currencies against the U.S. currency.

"'We have no plans to revalue,' Hamad Saud al-Sayari, the governor of the Saudi Arabian Monetary Agency, told reporters in Dubai today. 'The U.S. dollar is still very important to us.'"

Apparently, someone forgot to copy the Saudis on the memo, because on March 20, Kuwait announced that it was tossing the dollar peg over the side and replacing it with a basket of currencies.

This will almost certainly lead to a domino effect in the Middle East, a move that would likely be warmly welcomed by the local citizenry there, and not so warmly welcomed by those in the U.S. government charged with maintaining the U.S. dollar hegemony.

And then there's China…

On announcing last year that it was forming a new agency to help better manage its foreign reserves, China took pains to assure the markets that they were not doing so in order to begin unloading dollars. But then on May 18, it announced it was going to invest $3.3 billion in Blackstone, a private equity group.

Now, you can be assured that Blackstone is going to go all out to impress their deep-pocketed new partner. And it won't impress them very much if they only buy U.S. stocks that have to then fight against the tide of a depreciating dollar.

In our view, this is just the beginning of a much larger strategy, the core of which will be trading out of U.S. treasury bills and into all manner of other investments… an international basket of stocks, natural resource deposits around the globe… pretty much anywhere and anything offers the prospect for a higher return with lower currency risk.

Or, if the currency risk is going to be taken, then the potential returns will have to offset those risks. Earning a 4.5% yield on a Treasury bond while taking a 10%, 20% or even 30% risk on the dollar doesn't make a lot of sense to us. And, we expect, neither does it to the Chinese.

There are some very interesting implications in all of this. For instance, if the Chinese slow down their buying of Treasuries in favor of other asset classes, who is going to step up to take their place?

Of course, at the right interest rate, far higher than those on offer today, someone will. But then there's that whole collapsing housing bubble thing.

The U.S. continues to be trapped on the horns of a dilemma, wedged squarely between a rock and a hard place. Raise interest rates to head off a devastating mass exodus from the dollar and sink the economy… or, lower interest rates to keep the economy afloat and doom the dollar.

Or, simply continue printing money like there's no tomorrow, steadily devaluing the $6 trillion in the hands of foreigners, and hope no one will notice.

There are times, like today, that any reasonably astute observer can look to the horizon and see what's coming. A monetary crisis is headed in our direction, and the pace of its arrival is, in our view, quickening.

Gold, and for more pep in your portfolio, gold stocks, are no longer an option but a prerogative - even for conservative investors.

Meanwhile, pay close attention to the comments of high government officials about their intentions on the dollar…

Regards,

David Galland
for The Daily Reckoning Australia

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By far the largest group would identify with the phrase "go along to get along." They invest in "ideas" from their broker and mainstream financial rags. If feeling adventurous, they tune in to Cramer's Mad Money for a hot tip.

There is, in our view, much wrong with that approach. For starters, a broker is paid to move stock and generate commissions, a built-in conflict of interest. And once a stock gets written up in Forbes or shouted up by Cramer, it is the exact opposite of a "hot" story.

The second group are the dice-rollers. They buy touts from telephone salespeople and haunt the financial chat rooms looking for "home runs." In their youth, they were the "opportunity seekers" who sent away for the kit guaranteeing a six-figure income from the comfort of a living-room chair. There isn't much one can do for them. They will either learn their lesson on the cheap and reform, or lose all or most of what they have.

The third type is the rational speculator. This rare breed understands the key tenets of serious investment success. In no particular order:

You rarely get hurt paying less for an asset than it is worth... and just because no one seems to want it at the moment doesn't mean it's worthless.

Risk and reward are linked. While not all risky ventures hold the promise of high returns (e.g., sending money to a Nigerian bank in the hope of receiving a fortune is all risk and no potential return), all investments offering high returns carry higher risk.

Understanding this link, savvy speculators do their homework to understand the risk side and, where possible, reduce it.

Think contrarian. That is the polar opposite of getting your investment advice from mainstream media. When Doug Casey first spotted the spectacular upside for uranium stocks in 1998, nuclear power was being universally shunned. But Doug saw what others didn't - that (A) nuclear was the only practical mass power alternative, (B) uranium had fallen so out of favor, and its price beaten down so low, almost no exploration was being undertaken, even though (C) supplies were being drawn down to critical levels.

In hindsight, spotting that speculative opportunity seems a no-brainer. And, if you had been thinking like a contrarian and avidly studying out-of-favor markets, it would have been.

There is one final tenet to keep in mind about speculation.

Most people invest 100% of their money in the hope of earning a 10% return. A rational speculator, on the other hand, looks to invest just 10% to 20% of their money in investments that hold the potential for a 100% or better return.

Over the last two weeks, I've heard from two old acquaintances whose retirement nest eggs - millions in all - were wiped out by a series of bad trades in traditional stocks recommended by their mainstream brokers. A rational speculator, even after a complete wipe-out, would still have 80% to 90% of his money to start over with.

Now let me bring all these points together in a way that could hand you returns most investors would consider outlandish. In fact, it may be the best contrarian speculation of your lifetime. It starts by answering a simple question...

When asked about the outlook for the economy, most investors will answer something to the effect of... "My broker at XYZ Securities thinks the broad U.S. stock market still has a good run ahead of it." In other words, they leave their thinking about the future to their brokers, the individuals who tend the myth of the permanent bull market (perhaps gently interrupted by occasional "soft" landings).

Which brings me to the speculative opportunity.

Simply and for some good reasons, take the contrarian side of the mainstream broker's trade by investing in the sector that historically does best when the economy does worst: precious metals and, for serious leverage, carefully selected precious metals stocks.

Remember, the potential is so great that no more than 10% to 20% of your portfolio is required.

Here's what you'll be betting on.

1) That the Fed won't be able to juggle the Mt. Everest of debt, the deflating housing bubble and the potential stampede out of the U.S. dollar by foreigners. Something has to give, and we think it will be the dollar... inevitably good for precious metals.

2) That because - for the first time in history - the unbacked currency of one nation (the U.S.) is the de-facto reserve currency of all the world's central banks, a collapsing dollar will lead to a global monetary crisis.

3) That the current war in the Middle East will have serious and long-lasting consequences that require massive new infusions of money on top of already out-of-control government spending. And the fighting may trigger a larger conflagration that sends oil over $100... a highly inflationary outcome.

There are more reasons to make your contrarian bet on precious metals just now, but those should suffice, given the space available here.

Your contrarian bet gets even more compelling when you consider that, historically, gold bull markets last a minimum of ten years. Gold bottomed in 2001, so we are just a bit over 5 years into the current bull market. And, based on the historic dislocations in the global economy, we don't think that this bull market will be anything close to "average."

One important early result of the bull market in gold and silver is that the junior exploration sector has been energized by an infusion of new capital. Serious exploration and drilling programs are already running on serious targets.

It has taken time and patience, but that patience is about to be rewarded, as exploration programs head into their advanced stages - where we can actually see which companies have found deposits big enough and rich enough to be mines. In that regard, 2007 should be a banner year... and you definitely want to place your contrarian bets before the newest crop of discoveries are announced in the weeks and months just ahead.

Historically, when you match up a bull market in precious metals with major mining discoveries, you get the kind of roar that can turn your speculation into a fortune.

The mere fact that you are reading this hints that you are thinking about jumping on the precious metals bandwagon - but don't stop thinking like a contrarian. Keep this most important point in mind: not one in ten U.S. investors currently owns a single gold stock. They know nothing about them, but they do have brokerage accounts and they do like a good story.

As the U.S. dollar comes under pressure - as it must - the story of gold and silver as alternative stores of wealth will begin to make the rounds, and it will be a story that tells very well. At that point, public interest will soar, and the contrarian bet you make today will start flying on afterburners.

Early pays. Early pays big. So the time to act is now, before the stocks get pricey - not when you are hearing about junior precious metals explorers in Forbes or from the mouth of Jim Cramer on Mad Money. At that point, the tide will already be cresting, and we'll be cashing in on what now is shaping up to be the speculation of a lifetime.

Regards,

David Galland
for The Daily Reckoning Australia

David Galland is the Managing Director of Casey Research, LLC., publishers of Doug Casey's International Speculator, one of the nation's oldest and most respected publications dedicated to identifying rational speculations with the very real potential to earn 100% or more in a year or less. Do you have what it takes to be a rational speculator?

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78 million is the number of baby boomers who are in or approaching retirement. That's the biggest demographic bulge in U.S. history, fully 26% of the population.

And many of those 78 million are in a jam. As they approach retirement, they are still carrying historic levels of debt and, on average, have woefully inadequate net worth -- and much of that based on shaky housing prices.

In fact, 25% of the retiring U.S. boomers - nearly 20,000,000 in all - are facing retirement with a net worth of less than $50,000. You don't need to be an accountant to see that, with today's degraded currency and longer life expectancies, the large majority of U.S. boomers are drowning in debt.

This is a real tragedy in the making. After all, what could be sadder than millions of people striving for a lifetime to reach the American dream and then discovering that the "golden years" are just a fantasy, their wealth having been sucked away by decades of inflation and taxes so that politicians and bureaucrats could squander it to grease the skids for their own political success.

In 1930, the total share of the U.S. economy directly controlled by or dependent on government was about 11%, leaving the balance of 89% firmly in the hands of private enterprise.

Today, by the late Milton Friedman's calculations, the government's share of the U.S. economy - including the time and resources required to comply with all the regulations - has ballooned to over 50%, reducing the wealth-creating machinery of free enterprise to an auxiliary engine for government.

No wonder so many people live paycheck to paycheck.

U.S. government debt now tops $9 trillion, before taking into account its unfunded obligations for Social Security and Medicare - debts that the retiring boomers will soon have their hands out to collect.

After adding in Social Security, Medicare and all the government's other pay-later obligations, the current debt actually comes in at over $60 trillion - an amount so large, not one person in a million has a real sense of it. So let's try to put that number into perspective.

A trillion is 1000 X 1000 X 1000 X 1000, or a million millions. In his first address to Congress, President Reagan, himself a big spender, accurately pointed out that a stack of $1,000 bills four inches high makes you a millionaire, and that a trillion dollars would be a stack 67 miles high!

The U.S. government owes 60 of those sky-piercing stacks of $1,000 bills.

It's a lot of money. And it's not just any kind of money. Amazingly, this unbacked currency of a bankrupt government is still the reserve currency of virtually every nation in the world today. But not, we think, for much longer.

To service its debt and keep the game going, the U.S. government must sell on the order of $2.5 billion per day in new Treasury bills, much of it to foreigners already sitting on something like $6 trillion of U.S. paper.

Absent the foreign buyers of U.S. Treasury securities, the whole scam begins to unravel. And once it begins to unravel in earnest, with wealthy foreigners and then governments rushing to switch out of dollars, the speed and steepness of the monetary collapse will be breathtaking.

While millions of boomers will be lucky to scrape by for a year or two of hard living in a trailer park, their meager assets won't carry them through the 20 or 30 years of retirement that medical science now promises. For that, they'll have to rely on scraps from Washington. And if they have nothing else, every one of them has a mailbox that's just right for receiving government checks.

In fact, according to the Fed, a majority of retired Americans already rely on Social Security for 80% or more of their income.

And that makes Social Security and Medicare politically untouchable, no matter how badly the programs trap the U.S. economy.

Recognizing that the United States has little capacity to rein in its profligate spending and has neither the intent nor the ability to actually pay off its $60 trillion debt in money worth anywhere near what it's worth today, foreigners are increasingly leery about accumulating more greenbacks.

On November 9, for instance, Reuters reported that, "The bond and foreign-exchange markets were struggling to come to grips with comments from China's central bank governor Zhou Xiaochuan, who said his country had a clear plan to diversify its $1 trillion in foreign-exchange reserves and is considering various options to do so." Normally, the more skeptical foreign investors become, the higher interest rates must go to entice them to continue raising their hands at Treasury auctions... and to keep them from dumping their existing holdings.

But even that route, at least for now, is closed. That's due to the critical role of housing in today's economy and in the financial statements of so many millions of American homeowners. Simply, higher interest rates would devastate the already weak housing market and bring ruin to a heavily indebted populace, especially cash-strapped boomers, and further ratchet up the cost of government borrowing. In other words, raising rates is not an option.

So what are nervous bureaucrats to do?

The answer is to depreciate the currency - and as quietly as possible. That allows the government to meet its obligations, but with ever more worthless dollars. It's their only way to buy time.

In fact, Fed Chairman Ben Bernanke virtually gave the game book away in a speech in Frankfurt on November 10.

"It would be fair to say that monetary and credit aggregates have not played a central role in the formulation of U.S. monetary policy."

In other words, the total amount of money in the system - what we "print" -- is whatever the government finds convenient from one day to the next. That's a politic way of admitting that the U.S. government is planning to paper over all its many obligations and accelerate a trend that has been in motion since the creation of the Federal Reserve in 1913.

Make no mistake, it's a desperate strategy, but at this point it's the only option for a government whose decades of reckless spending have led the economy into a box canyon, the floor of which is covered in quicksand. There is no way out. The best they can hope for is to stall the inevitable for as long as they can. "Not on my watch" is the phrase of the day.

In this age of instant communication, the government can't hide the truth - at least not for long. So, no matter that they have stopped publishing M-3 money supply numbers, recognition that we are between a rock and a hard place is spreading.

Reckoning day is not far off. And when it comes, it will rush in faster and more brutally than almost anyone expects. The world's financial picture will be redrawn from scratch, and a painful unwinding of the economic dislocations built up by decades of political pandering will begin.

While no one can say with certainty how the disaster will play out, there is one truth you can take to the bank. Throughout all of human history, gold has always held its value as a monetary instrument. That sort of shockproof durability cannot be claimed by any paper currency, certainly not by the dollar, which has lost 95% of its value since abandoning the gold standard in 1971. With the dollar untethered from gold, the worth of the $20 bill in your pocket is headed for its intrinsic value... as a recyclable.

In the weeks, months and years just ahead, gold, silver and other tangible assets are again going to become much more than financial obscurities tucked away on the commodities page. They're about to become front-page news.

When that happens, the prices of the metals - and of the high-quality gold and silver shares we follow -- are heading for the moon.

Hopefully, enough of the 78 million baby boomers will catch on to the underlying realities of their situation early enough to take advantage. For many, it may be their last chance at enjoying dignified golden years - instead of laboring through their eighth decade under the Golden Arches.

Regards,

David Galland
for The Daily Reckoning Australia

Editor's Note: David Galland is Managing Director of Casey Research, LLC., publishers of Doug Casey's International Speculator, a monthly newsletter focused on identifying high quality natural resource stocks with the potential for a double or better over the next 12 months.

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