Speaking of housing, the ABS reports that building approvals fell 7% in January from December. "Experts" were expecting a one percent increase. It was the first time approvals have fallen in five months. But with the expiration of the first home buyer's grant and rising interest rates, it shouldn't be that much of a surprise.

Yesterday's news came from the world's most akwardly named bureaucracy, the Australian Bureau of Agricultrual and Resource Economics, henceforth to be called ABARE. The group published its quarterly commodity outlook. It tells you how much Australia can expect to make from selling the family: silver, iron ore, and coal. Its conclusions were kind of surprising.

The main conclusion was that Australia would see rising export earnings on higher volumes but moderating commodity prices. In other words, the China boom will drive export volumes for the next five years. But you won't see any more mammoth increases in commodity prices.

Before we dive into the data, a warning: these kind of forecasts are usually worthless. Not that they aren't carefully prepared. But you just don't know what's going to happen in the world. You can be motoring along during a big boom and whammo! A credit depression hits and reveals a 25-year misallocation of resources in the consumer economy.

But for the sake of determining if Australian resource stocks are cheap or expensive to projected earnings, let's see what ABARE thinks earnings will be like. As you'll see, the big growth will come fromm mineral and energy commodities, with base metals giving a big kicker in the next year especially.

ABARE reports that "The value of Australia's commodity exports is forecast to be around $186.8 billion in 2010-11, which is an increase of 15 per cent from a forecast $162.5 billion in 2009-10. The value of Australian commodity exports in real terms is projected to rise over the outlook period. By 2014-15, Australian commodity exports are projected to be around $211.4 billion (in 2009-10 dollars), which is 30.1 per cent higher than forecast for 2009-10."

You're looking, then, at about 7.5% annual growth in the value of Australia's agricultural and mineral exports. That's slightly less than China's annual GDP growth rate (also a suspect number). But it's certainly a lot healthier than growth rates in the rest of the Western world.

ABARE says that in the next 12 months, export earnings will be driven by 19.8% increase in energy commodities (oil and coal, but not including uranium). Metals and bull commodity export earnings will rise by 17.6% to $87.9 billion. Iron ore and coal are the big winners here. For this year, higher prices will account for the increase.

But ABARE's rather muted conclusion is that increased volumes are going to drive earnings growth, and not just underlying gains in commodity prices (which will begin to be weighed down by increasing global production). For stock pickers that means you can't just find stock that you think are leveraged to higher prices. You're also going to have to find low-cost producers. And you are going to have to find projects with the best economics.

Good thing we've got Alex on the case at Diggers and Drillers. He's been on baby duty at home with his newborn. But he continues to check in with reports and is back on the case full time next week. We'll keep you posted.

We're taking the projections somewhat seriously. That could be a mistake. For example, take ABARE's estimates of crude steel consumption and production. Both are predicated at average annual growth rates in the Chinese economy of just under 10%. And both assume China's resource-intensive industrialisation has years to run, rather than having already run its race.

It's quite possible we're much closer to the end of the China-driven steel boom than a next higher phase. But ABARE's numbers are astonishing. It predicts that global steel production will have grown by 30% between 2008 to 2015, from 1.347 billion tonnes consumed in 2008 to 1.774 billion tonnes in 2015.

ABARE is projecting a 79% growth in Chinese crude steel production during that same period. In fact, by 2015, according to these figures, China will consume 812 million tonnes of crude steel per year. That's more than the U.S., Brazil, Russia, the 27 nations of the European Union, India, Japan, and Korea combined.

This either shows how cataclysmic things are going to get in the industrial West (and Far East). Or it shows how wildly unsustainable projections of Chinese steel consumption are. How many more empty cities can you build? How long can you sustain fixed asset investment at 30%+ of GDP, especially when much of it is in commercial and residential real estate?

On the production side - and this is the part that has the most to do with Australia's iron ore and coking coal industries - ABARE estimates Chinese steel production will be 880mt in 2015. The rest of the world combined will be 712mt. This means China will be a net steel exporter, if ABARE's production and consumption figures for crude steel turn out to be right.

Our guess is that they will be sensationally wrong. China has its own credit boom malinvestments that are bound to blow up in the next few years. Precisely when doesn't really matter. And don't forget the fact that the Global Financial Crisis has smoothly shifted into a sovereign debt crisis. This too has the potential to knock out the legs from under the world economy and hugely reduce resource demand.

"'Prepare for a very difficult economic time, which you will not be able to escape,'" said Hans Hoogervorst, the Netherlands Authority for Financial Markets chairman. He was speaking at an ASIC sponsored gig in Melbourne that sounded pretty interesting.

He said that "'Even for a country that has been so soundly managed as Australia, this will have consequences...The problem is that there is now too much on the shoulders of government. They have basically taken on all the problems caused by the financial crisis, with the effect that most of them are in really, truly horrible budgetary shape."

Large government deficits usually mean slower growth. For one, government borrowing robs the private sector of the capital it needs to resume growing. Australia doesn't have a lot of surplus domestic capital to begin with. But really the problem is what it always is: a world built on too much debt. It's gotta give.

Yesterday we promised to tell you about how some Australian savers/investors are being locked out of their money for as much as four years. Look for that tomorrow. We're runing out of time and space today.

The next few days should be busy but insightful. We're meeting with all the gathered editors from Agora Financial, a sister company here in Baltimore. And later in the week, the investment board of the Bonner Family Office meets. We're on the board there and are eager to here what other investors from all over the world are looking to buy or sell right now.

In the meantime, it's amazing how cheap things are in America. Coffee...haircuts...food. The dollar really is cheap right now. If we didn't know intimately how screwed up America's finances were, we'd think it was a buy.

Dan Denning
for The Daily Reckoning Australia

• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Posco’s Production Cuts May Be Bad for Australian Iron Ore
• The Future of the Australian Resource Market, Two Ways the Boom Could End
• BHP Billiton (ASX: BHP) to Report Second Half Results Today
• The Australian Resource Boom Isn’t Dead Yet

China is buying soybeans...lots of them.

The US trade deficit ballooned by almost 10% to $36.4 billion in November. Here's one very important highlight of that report: Chinese demand for American goods climbed to a record $7.3 billion, led by - of all things - soybeans. Drought in Argentina was partly to blame, but there's a trend under there that can't be denied:

One of the more certain ideas on China hinges on its appetite for something very basic: food. We've talked a lot about the world's growing appetite for food and China's role in that. The shifting diets...the straining of water resources...the diminishing acreage of arable land...

All of these things put pressure on the food supply. We've got a few ideas that answer the bell here, but I want to focus for a minute on just one - Saskatchewan, Canada.

We took note of this rich prairie to the north in a couple of letters in 2008. Half of all the arable land in Canada is here. It has one quarter of the world's uranium production and one third of its potash reserves. It produced 160 million barrels of crude oil last year.

Some of the growth in output here is astonishing. This from The Globe and Mail:

"On the farm front, the surprise is that much of the new prosperity comes from pulses, crops that were hardly known in the Prairies two or three generations ago - peas, beans, chickpeas, lentils. In 1981, 85,000 acres of lentils were planted; this year, there were 2.3 million acres. In 1976, 15,000 acres of peas were planted; this year, 2.8 million acres. Canada is now the leading exporter in the world of both foods, almost all of it from Saskatchewan."

We own one company that is in the heart of all this earthy goodness. We've owned it since August of 2006. It's given us an 11% annualized return since - which is one hell of a good return considering what the broader market has done over that time. I view it is a core Special Situations holding, and it still trades for just above book value.

Next up, James Turk:

Silver jumped out of the gate to begin 2010 with a flying start. It climbed a remarkable 9.7% in this year's first week of trading to end the week at $18.45. From its $8.79 low barely fourteen months ago after the de-leveraging and mass liquidation of assets resulting from the Lehman Brothers collapse, silver has climbed an astounding 110%. But the upside fireworks have hardly begun.

I believe there exists the real possibility of a short squeeze in silver this year or in 2011. That short squeeze will propel silver to - and probably over - its January 1980 record high of $50 per ounce. That event will mark an important step in silver's bull market. Everything that has occurred in silver over the last thirty years is simply base- building, as can be seen in the following chart.

The base-building is marked by the two long-term gold lines that look like a "huge smile," as one of my readers remarked.

From 1980 to the 1991 low, silver was being 'distributed'. In other words, silver sellers were more aggressive than silver buyers. Eventually, those circumstances changed, and silver's price stopped falling. The so-called smart money started recognizing silver's extraordinary undervaluation. Buying power began to exceed selling pressure. Its price began to rise and has been working its way higher ever since. Silver has been rising this decade within the uptrend channel marked by the two [red] parallel lines.

Silver's rise from $3.51 in February 1991 to $18.45 at present - approximately a 9.1% annual rate of appreciation over this 19-year period - pales in comparison to what lies ahead. Silver is still in stage-1 of its bull market; the big price gains don't start occurring until widespread participation by the public begins in stage-2, but that will not begin until silver breaks out of its base when $50 is eventually hurdled. With that event silver will start garnering worldwide attention just like gold started doing when gold entered stage-2 of its bull market by hurdling above $1,000.

The speculative stage-3 for silver, which will be marked by extraordinary price gains like those of silver's last stage-3 in 1979- 1980, is still far in the future.

Chris Mayer and James Turk
for The Daily Reckoning Australia

• Aquaculture: Soybeans and Corn Under Water
• Farming Cattle is Out; Farming Soybeans is In
• Beat Food Price By Planting Your Own Garden
• Price of Silver Climbing to All Time High of US $1,012
• Gold and Silver!

February gold traded above $1,218 yesterday and closed at $1213. Gold has closed higher 20 of the last 22 sessions. In that time, according to Dow Jones newswires, it's up 15% - nearly double the return of the S&P 500.

Does this mean investors are starting to give up houses and shares and speculate on gold instead? The U.S. government has been forced to suspend sales of American Gold Eagle coins, according to Javier Blas in the Financial Times last week. It's the second time the mint has had to suspend sales since Lehman went belly up in 2008.

There's a bit more to the story, though. The mint has sold 1.19 million ounces of gold this year. That's a 75% increase over last year. Hmm. But it's also sold 26 million ounces of silver coins - the highest level of sales in 23 years.

What does this tell you? Well, the rational answer is that bullion or gold and silver coins are assets without counterparty risk. True, the value of gold and silver coins fluctuates with metals prices and liquidity. But your payment does not depend on someone else's credit quality. Your payment is in your pocket.

That rational answer presumes that investors are now showing a preference for tangible assets that are...real. But is it more fear than reason? After all, a rational investor might prefer the leverage you get with gold stocks as the best way to profit from rising gold prices. That would be the easier investment strategy.

But that suggests to us the move to gold isn't so much an investment strategy as it is a financial survival strategy. Investors are less and less worried about capital gains and more and more worried about the preservation of their purchasing power and capital itself. Gold is the ultimate expression of that worry - a flip side of the lack of confidence in modern monetary policy (or just modern money).

Gee. It's soooo kooky to distrust central bankers, isn't it?

Morgan Stanley appears to distrust UK central bankers. Morgan released a report yesterday, according to Ambrose Evans-Pritchard in the UK Telegraph, which highlights the risk that capital will flee Britain and the country will be plunged into a debt crisis because of a mix of political and economic factors.

"Growing fears over a hung parliament would likely weigh on both the currency and gilt yields as it would represent something of a leap into the unknown, and would increase the probability that some of the rating agencies remove the UK's AAA status," report Morgan's Ronan Carr, Teun Draaisma, and Graham Secker.

"In an extreme situation a fiscal crisis could lead to some domestic capital flight, severe pound weakness and a sell-off in UK government bonds. The Bank of England may feel forced to hike rates to shore up confidence in monetary policy and stabilize the currency, threatening the fragile economic recovery," the analysts wrote.

Hmm. No wonder gold is making new highs. And not just in U.S. dollars either. If the GFC really has become a sovereign debt crisis, the UK may compete with Dubai to see which political entity is the first to put to the fiscal sword (made, probably, of gold).

Of course those are American and British problems. So what if Australia will have $120 billion government debt in five years? That's as small as a percentage of GDP. Why worry?

Well, frankly, there is a lot to worry about in a global financial system still weighed down by debt. You wouldn't know it judging by the performance of stock markets this year. But we can feel it (psychic like that). And we can see it in metals prices.

We're off to Sydney and then South Africa next week. We'll have more to report on the outlook for precious metals then.

Dan Denning
for The Daily Reckoning Australia

• 4 Ways to Protect Against a Falling Dollar
• Rare Coins as an Informal Way of Estate Planning
• Gold and Silver!
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?
• The Price of Gold is Low – But It Won’t Stay There Forever!

There's certain to be a rush into gold and silver, and buying before Main Street catches gold fever is the only way to play this trend. Because when Midas fever hits, prices will explode to the upside, for both the metals and the stocks. How do we know that?

First, let's look at gold. If we added up all the gold ever mined on the planet, its total value would equal no more than $5 trillion at today's prices. Yet, look at how this compares to the debt and bailouts and other monetary mischief of current governments...

Let's make this chart very clear. Of the $5 trillion in gold ever mined...

• The US government has thrown over twice as much at the economy in the past 12 months.
• The US debt is more than double this amount so far this year.
• Total global government bailouts are almost four times larger (and this is a conservative figure; one estimate puts it at $24 trillion).

I intended to include annual gold production as one of the comparisons, but the chart isn't big enough and neither is your monitor: 2008's global gold production equaled about $73 billion, and to make that figure discernable on the chart would require the Global Bailouts bar to hit the ceiling above your head. That's how small the gold market is.

The implications are undeniable: when the greater public rushes into gold - whether in response to inflation, dollar woes, war, whatever - the price will be forced up by an order of magnitude.

While physical gold will protect our wealth, it's the gold stocks that can potentially make us wealthy.

Once again, to get a sense of the Lilliputian size of the gold industry, I compared it to several other leading industries and stocks.

The value, as measured by market capitalization, of all gold producers around the world is less than Wal-Mart's. Every gold stock would need to nearly double just for the industry to match ExxonMobil. The oil and gas industry is about 12 times bigger.

When your neighbors and relatives and co-workers and friends all start clamoring to buy gold stocks, the pressure on prices will be enormous, rocketing our positions upwards.

Meanwhile - and admitting we're first and foremost gold bugs - the picture for silver is even more dramatic. The potential for silver stocks is jaw dropping.

If the gold industry is tiny, then silver's $9 billion market cap makes it a nano industry. The entire silver industry is over 21 times smaller than gold's! If gold explodes, silver will go supernova.

Consider these macro-facts about a micro-market and what they reveal about silver's enormous potential:

• There are over 200 companies in the S&P 500 with a market cap larger than the entire market of silver producers.
• There are five times more gold stocks than silver.
• Total silver production in 2008 was valued around $10.3 billion (at today's prices). That represents just 1.5% of the $700 billion bailout last year, and 0.006% of the current US monetary base.
• Of the 20 largest silver producers, only five actually call themselves a "silver" company, due to the fact that about 73% of all silver mined is a byproduct of other metals mining.

Any flood into the silver market would overwhelm it. In other words, the rise will be stunning. While it's not going to happen tomorrow, I strongly suggest you get on board before that rocket ship takes off.

Just putting these charts together stirred my feelings of restlessness, making me anxious for the mania in precious metals to arrive. But the timing is not up to us. Be patient, because if you're invested in gold and silver and the respective, high-quality stocks, you're on the right side of this trend.

Regards,

Jeff Clark
for The Daily Reckoning Australia

• Gold and Silver!
• Transfer of Wealth
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• The FDIC Is in Trouble
• Whiff of Economic Recovery Sends Prices of Industrial Metals Soaring

But then everything is up this year, at least since the markets started buzzing in March. The S&P 500 is up over 64% from its March 6th low. That's an exceptional bounce even by dead cat standards. With negative real interest rates in the States, owning cash is losing money. Hence the rise in stocks.

Yes, rising U.S. stock prices could have something to do with a fictitious recovery. But with labour markets weak and housing getting worse (rising foreclosures) we're not counting on it. So we'll stick with the credit-fuelled stock rally.

It's gotten so surreal on markets that yields on some three-month Treasury bills briefly dipped below zero in trading action. As it is, the yields on Treasury bills are hovering just above zero. Bloomberg reports that, "For the first time in seven decades, Treasury bills are paying no interest while stocks continue to appreciate."

Why would investors lend their money to the American government for nothing? And why would they continue buying stocks at the same time? Ponder....and discuss.

We think the answer is that the Fed's policy has forced global investor into an either/or situation. You either get out of cash and into equities to beat inflation. Or, you are so terrified of buying equities divorced from normal valuations that you prefer capital preservation in the form of Treasuries, even if you're losing out to inflation there as well. At least you get your money back at a non-inflation adjusted par value three months later.

Or, you could buy assets like gold, oil, silver, and copper.

Why the sudden move in markets yesterday? It could be that Federal Reserve of St. Louis President James Bullard told markets the Fed should keep buying mortgage-backed securities after its self-imposed March deadline for exiting the market expires.

The Fed's plan to purchase $1.25 trillion mortgage debt and agency securities has effectively kept U.S. interest rates from creeping up. It's also kept the housing market afloat, although even at these levels you are not exactly seeing refinancing boom. But it's the prospect of more quantitative easing by the Fed that must have markets spooked about inflation.

Bullard said, that, "If the economy came in very weak, let's say, in 2010, weaker than expected, we would have the option of doing further quantitative easing." The Fed would do this through additional asset purchases, presumably with more, uh, "money" it created.

Bullard also said that, "If the economy came in stronger than expected and inflation expectations started to ratchet up a little bit we could maybe sell off some of these assets and remove some of the accommodation from our quantitative easing program."

The market must not have heard that second part. Or maybe it didn't believe it. Maybe it concluded that the Fed loading itself up with mortgage-backed securities is not a healthy expansion of the central bank's balance sheet. Maybe that's why the dollar fell and gold rose.

Hey it turns out that we were wrong and man-made global warming is real after all. A bunch of scientists have colluded to invent it by suppressing evidence that the earth is actually cooling. It turns out that empirical data do not support the agenda to expand government power and control over nearly aspect of our everyday lives.

How inconvenient!

You won't find the story of the leaked IPCC e-mails in too many main-stream press outlets. Most of the media is in collusion with governments to cram some sort of climate change carbon law down our throats. Publishing evidence that suggests there is still real scientific debate doesn't suit that agenda.

Before you send us e-mails condemning us to hell for hating the earth and clean air, let us make a small point. Of course the climate is changing. But - as these leaked e-mails show - the scientific community is not nearly as unanimous in its "interpretation" of what the climate data are showing as the political community would like you to believe.

Be sceptical. It works with investing. It works with politics. Any time a group of people tries to shout you down and make major changes to the law, you should be very concerned. The debate about how we inhabit our ecosystem is an important one. But it's obvious the science has been politicised.

And please don't write in saying that doing nothing is not an option. Doing nothing IS doing something. It means NOT doing something stupid until you have a fuller picture of what's going on. And there are still many in the scientific community who are modest enough to admit that the earth's climate is too complex a system to determine whether releasing carbon dioxide into the atmosphere is actually causing temperatures to rise today.

If you were even more sceptical, you might conclude that promoting global warming (or climate change) has become a lucrative industry for both scientists and failed U.S. presidential candidates with massive carbon foot prints. Both have a strong desire to tell other people how to live.

In any event, climate science is not our beat here. But the behaviour of hysterical crowds and how to survive it IS our beat. So have a look at the ClimateGate story in your spare time and let us know what you think. And in the mean time, keep an eye on your wallet and your mind on guard.

Dan Denning
for The Daily Reckoning Australia

• An Old Friend With a New Idea on Global Warming
• What Assets are Going to Beat Inflation in the Coming Ten Years?
• Quantitative Easing Explained
• 1 Out of 10 American Mortgages Are Owned by Other Countries
• Homebuilding Goes Down While Economy Gathers Strength

Daily Reckoning,

Mick.

Mick, you can read all about the history of the RBA here.

Dear Dan,

Colin B.

---"But if you're forwarding copyrighted material, you're breaking the law."

Peter

Peter, just because we don't like the State making rules doesn't there aren't rules for voluntary transactions that protect property rights and guarantee the terms of an exchange. The free e-mail is free. The paid services are not free. When you give them away you're giving away our intellecutal property. It's theft. Plus, it's just bad faith.

We can tell when an e-mail sent to a given address is forwarded and how many times, although we can't tell to whom (and wouldn't bother to find out.) We're not interested in getting in a fight with anyone over the issue. But we do think it's fair to ask you to quit giving away copyrighted material.

And if you don't, we'll reserve the right to terminate your subscription. We're within our rights to do that, although we'd issue a pro-rata refund as well. It's not a problem at all if you forward material from your work address to your home address. But serial offenders...

Dan Denning
for The Daily Reckoning Australia

• Diggers & Drillers and Australian Small Cap Investigator Being Republished
• E-mail Update for Paid-up Subscribers Only
• Bigpond Blocking e-Mail from the Daily Reckoning Australia
• Rare Coins as an Informal Way of Estate Planning
• Daily Reckoning Reader Mail

One of the most interesting news items I've found was on the cover of The Financial Times, where I learned that a guy named Lahde "made tens of millions of dollars from betting against the financial and property sectors during [the] past two years", and he now wanted to thank "the low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA" who made it all possible for him to find enough suckers.

He noted that "These people who were often truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the aristocracy," he says, "only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America."

This goes along with an article in the St. Petersburg Times about Tom James, chairman and chief executive of Raymond, James Financial, who had "some tough words for the wizards of Washington, DC who oversaw the $700-billion bailout package".

He reports, "The Brave And Wonderful Mogambo (BAWM) was right all along! Those government weenies are the biggest freaking morons you ever saw, and we as a country should be ashamed of ourselves for having elected such corrupt, half-witted, utter failures and congenital idiots!"

As you have probably guessed by now, he did not say those exact words, but he implied every syllable when he said, "Legislators were almost embarrassingly ignorant of how the financial system works", which I figure explains how they don't understand the linkage between their own Bad, Bad Performance (BBP) as legislators and the subsequent Bad, Bad Performance (BBP) of the economy, and he says that only 3 of 16 legislators that he talked to actually understood what was going on in the "credit crisis." Less than 20%! Hahaha! We're doomed!

Well, maybe these Congressional losers will understand the unfolding economic slowdown, as evidenced by the Baltic Dry Index, which is an index of the cost to transport stuff by cargo ship, and which has fallen precipitously, which seems very important to me, and to Junior Mogambo Ranger (JMR) Riccardo, too, who is also alarmed by this like - as I previously said - me.

It's actually beyond scary, in a terrifying kind of "ain't nobody buying nothing in a consumer economy" kind of way, which means that without the consumer buying stuff as his or her contribution to the famous statistic of "the consumer is 70% of the economy", we are, in case you ain't heard, freaking doomed!

Well, maybe not all buying is drying up, as silver market analyst, Ted Butler, reports that in the last 10 months, "some 150 million ounces of silver can easily be documented to have been bought by investors. Undocumented purchases would add tens of millions more ounces."

In fact, when you add it all up, "Investment demand for silver this year is running at a full 25% of world mine production and over 20% of total production (including recycling). This is a remarkable historical turnabout."

Thus, it is easy to see why Mr. Butler is "bullish beyond belief for silver", since this kind of demand means that "In silver, the documented 150 million ounces bought in the first ten months of this year is equal to 15% of all the silver bullion equivalent thought to exist!" Wow!

More than one-seventh of all the silver bullion "thought to exist" in the whole world was suddenly bought up in less than a year, and yet the price of silver has been pounded down to less than 10 bucks an ounce? No wonder I am so bullish on silver!

He also notes that the gold/silver ratio is at more than 80, which is "one of the biggest differences in history."

And not only that, but since there are 4 to 5 billion ounces of gold in the world versus only 1 billion ounces of silver, that means that "the total dollar value of all the gold in the world is worth 300 to 400 times more than all the silver in the world (80 times 4 or 5)".

Talk about undervalued! Hey! This investing stuff is easy! Whee!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Silver and its Large Short Position
• Gold and Silver!
• Gold and Silver Demand Unprecedented
• Price of Silver Climbing to All Time High of US $1,012
• Silver and Gold Will Make You More Attractive

Although I have great sympathy for the deflation crowd, given the reckless attitude of the central bankers and their ability to create debt-based money, I do not believe deflation (contraction in the supply of money and total debt) is very likely.

For sure, in this post-bubble environment, American consumer debt continues to contract, but this is being more than offset by the expansion in federal debt. Over the past year alone, federal debt in America has surged from US$9.645 trillion to US$11.813 trillion. In other words, during the past twelve months, American federal debt has risen by a shocking 24.47% and it now stands at 83.52% of GDP! Now, given the ability of the American establishment to essentially create dollars out of thin air, I have no doubt in my mind that it be able to inflate the economy. However, this will come at a huge cost and the victim will be the American currency.

In fact, the recent weakness in the US dollar is a sign that central-bank sponsored inflation has started to dominate the private-sector debt contraction in the West. Furthermore, over the past few weeks, various governments have issued US dollar-denominated debt and this suggests that the carry-trade is back in vogue. In a startling move, Germany recently announced that it plans to borrow money in US dollars!

Now, given the ongoing federal debt inflation, debasement of paper currencies, sky-high budget deficits and competitive currency devaluations, the macro-economic environment has never been better for precious metals. Yet, both gold and silver continue to frustrate the bulls by staying below the record-highs recorded in spring 2008.

So, what is going on here? Have we already seen the end of the precious metals bull-market or are we about to witness an explosive rally? Before I attempt to answer this question, I want to make it clear that even though gold failed to better its all-time high during last autumn's panic, it was the only asset, (apart from US Treasuries) which stayed relatively firm. And looking at the various markets today, gold is the only asset that is flirting with its all-time high. So, whether you like it or not, gold deserves some credit for fulfilling its role as a safe haven.

Now, unlike some of the die-hard gold bugs, I don't believe that gold is the ultimate asset to own at all times. Without a doubt, there have been times in history when gold has proven to be a lousy investment. For instance, between 1980 and 2001, the nominal price of the yellow metal fell by an astonishing 70%. This horrible price action spawned an entire generation who grew up hating gold and up until a few years ago, the vast majority considered gold a barbaric relic.

However, during other periods in history, when macro-economic uncertainty was high and inflationary expectations were running out of control, gold turned out to be a fantastic asset to own.

If my take on the macro-economic situation is valid, then we are in such a period now and gold must form a part of every investment portfolio.

You may remember that over the past year, central banks have injected trillions of dollars into the banking system and it is only a matter of time before inflationary expectations start spiraling out of control. Up until now, this 'stimulus' money hasn't permeated through the economy in the West but once money velocity picks up, prices will start rising and the investment community will become very concerned about inflation. When the deflation scare abates and people start protecting the purchasing power of their savings, capital will start to flow towards precious metals.

Long-term clients and subscribers will recall that about two years ago, I highlighted gold's tendency to rocket higher every other year. Figure 1 captures this trend perfectly and you can see that since the outset, gold's bull-market has been punctuated by lengthy consolidations and the yellow metal has surged to a new high every alternate year.

So, if gold remains in a bull-market and its trend consistency is intact, its price should surge over the following months. Conversely, if the price of gold fails to climb above its all-time high before year-end, it should start to ring alarm bells as this would open up the possibility that the bull-market may be over. Remember, certainty does not exist in the investment world and savvy investors should remain open to all outcomes.

Now, given the uncertainty in the world today and the ticking inflationary time-bomb, my view is that gold will soon embark on its north-bound journey. So, I suggest that investors hold on to gold and the related mining companies which will probably continue to perform well until next spring.

As far as silver is concerned, it has always been a high-beta play on the direction of gold. If the next up leg in gold's bull-market materialises, the price of silver will also head towards the heavens. Accordingly, investors may also want to allocate a portion of their investment portfolio to silver bullion and silver producing companies.

Regards,

Puru Saxena
for The Daily Reckoning Australia

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The importance is dependent on your perspective. Those people who are not borrowing money to spend are thus suffering the pangs of a lowering of their lifestyle, which depended on borrowing money to spend; and then they come around, whining about stupid things like, "Daddy, things have gone up so much in price that I need more money, which you would give me if you loved me. Don't you love me? I love you! Won't you please love me, daddy?"

And so I ask, "Can't you love me if I don't give you any money?" and they say, "No. You could borrow the money, and then we would love you", and I reply, "I have been borrowing money and now I can't pay them back" and so the kids say, "Then borrow some more!"

And, in a terrifying revelation, I realized that it is not only my children, but all the rest of the economy that is totally dependent on everybody else borrowing money to spend, too.

So now you see how Chaos Theory was right, and that all things are connected to all things? If not, then pay attention to how they will now commence to all drag each other down into the Nightmarish Hell Of Inflationary Insolvency (NHOII).

And it doesn't take a real genius to see why, but the point is not that the American people were stupid enough to think they could get a perpetual free lunch by borrowing money to pay for it, or even that a smaller subset of those who are suffering the pangs of a lowering of their lifestyle is composed of those who also think that they can call me on the phone and either 1.) Ask to borrow some money from me, or 2.) Ask me to pay them back the money I borrowed from them.

My response is the same, in that I give neither one of them any money because I don't have any money; so to one I laugh in scorn, and to the other I say that I have just put a check in the mail to them, and that they will get their money soon, and if it hasn't arrived in a few months, call me back and I'll write you a new check and get it right into the mail.

The point is that a much larger subset of those who are suffering the pangs of a lowering of their lifestyle is composed of those people who think that they can elect government representatives who legislate all problems out of existence, that will tax me and then give the money to them, or the Federal Reserve will create more money to loan to investors with which to buy government debt so that the government can spend, spend, spend us into blessed Utopia. Either way, it's Bad, Bad News (BBN).

And, alas, one way or the other, they are right. Unfortunately. And that is one reason that I weep, alone, in the Mogambo Bunker Of Bunkers (MBOB), doors locked, radio blaring, machine guns cocked and loaded, mostly drunk or nearly so, soon to be blissfully comatose.

Another reason that I cry so piteously and drink so abusively is that all this new government borrowing will create so much new money that it will destroy the dollar's buying power, taking my own country down with it.

The only reason that I stop bawling like a little crybaby is the knowledge that the people who own gold, silver and oil will get rich, rich, rich, and since I own gold, then people will want me to loan them a few bucks out of my huge stacks of money because they are starving, and their children are starving, and I will say, "No!" and it will be thin gruel indeed for them to hear my mocking voice again echoing in their heads, "Buy gold, silver and oil, you morons, because your stupid government is letting a private bank (that misleadingly calls itself the Federal Reserve when it is, in fact, neither) to create so damned much fiat money that it will produce catastrophic inflation in consumer prices that will destroy the country, just like it has done to every other stupid country in the last 4,000 years that let its stupid government increase a fiat money supply at its whim! Hahahaha! Now you see why I always said you were freaking doomed! Hahaha!"

But I feel terrible, as this constant infliction of inflationary pain by heedless expansion of the money supply is so unnecessary, and that is why I was pleasantly surprised to read in The Wall Street Journal the headline "Central Banks Consider Gold" in its Commodities Reports column.

The reason is easy to see if you read the article backwards, in that there was a question about central bank buying "last week, when gold saw a record single-day gain", especially Chinese central bank buying of gold, which is already the ninth-largest holder of gold in the world but which holds only 1% of its foreign-exchange reserves in gold, although it actually said it would like to hold more. And Mark O'Byrne at Gold & Silver Investments says that he would "be surprised if the Chinese hadn't been nibbling at the gold market," which leads to the news that Asian banks "are seen as keen buyers" of gold, which leads to the news that "other central banks are now far more likely to be holders of gold", which leads us back to the second paragraph that "Turbulence in the financial markets and recent US dollar weakness are helping the precious metal claw back its reputation as the central monetary anchor within the international monetary framework", which leads to the opening paragraph of "Central banks may be starting to turn one of the few assets in which they can invest; gold."

In short, those crafty Chinese, a fifth of the world's population, may be getting ready to issue a gold-standard money, which will instantly make their currency the strongest in the world, which is just what a country needs if it wants to import a lot of things cheaply so as to respond to demand for internal economic growth without stoking inflation in prices!

And, fortunately for those of us who both love to have large profits handed to us and who also own gold, a Chinese gold-standard may soon make a dream come true as gold would skyrocket when priced in suddenly depreciated dollars.

Whee! This investing stuff is easy!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Borrowing Money is no Longer in Fashion
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One of the reasons for my bullishness and bullheadedness about silver is the large short position, which is the number of ounces already sold (opening the short position) but which have not been bought yet (closing out the position), which means these shorts are going to get clobbered if they have to cover their short position by buying silver at a higher price than they sold it.

So I was very interested when Ed Steer's Gold and Silver Daily reports says that the commodity futures market report shows that bullion banks' "silver net short position now stands at 213.6 million ounces...about a third of world silver mining production...all held by 'four or less' bullion banks."

He characterizes this as "grotesque beyond description", which I guess it is, since it is hard to even imagine such a thing, which implies that these "four or less" banks are so stupid that they would be short silver when the fundamentals are so compelling that my throat is bloody and raw from screaming, "The fundamentals of silver are compelling!"

And this is even ignoring the headline "Gold & Silver Market Alert - Buy before the Breakout!" from Julian Phillips at Goldforescaster.com, which reflects my sentiments exactly.

In gold, the situation is similar, in that Mr. Steer says, "The bullion banks' net short position now stands at 211,342 contracts... 21.1 million ounces. This is well over 25% of world gold production. This is also grotesque beyond description".

Suddenly I see an opportunity to hide my rising excitement and get a quick laugh! So I said, "This means it is NOT 'beyond description' when it is perfectly described by silver, which is also 'grotesque beyond description' and which can be described as 'like gold'! Hahahaha!"

Well, I am laughing at my own joke and having a wonderful time when I looked around and noticed that nobody else appreciated my little joke about circular reasoning, which, upon reflection, I admit is pretty bad, and I am pretty embarrassed about it.

I don't know why I thought it was funny, except for maybe it's these new pills that are supposed to keep me from screaming my guts out in fear about the coming collapse of the dollar and the attendant horrific rise in consumer prices that destroys America and plunges us into a post-Apocalyptic nightmare. And, parenthetically, they work pretty well, too, except for the catatonia and the, you know, drooling.

Mr. Steer sees my embarrassment and starts talking about how many of the owners of futures contracts in gold and silver said, "We want our metals!"

People with inquiring minds want to know, "How much gold and silver was delivered so that we can maybe see if the Mogambo Who Thinks He's So Hot (MWTHSH) is actually turning out to be right about gold and silver going so much higher in price because the despicable Federal Reserve is creating so much money and credit that inflation in consumer prices is guaranteed, which would be indicated by a rising price for silver!"

Well, it turn out that "The final totals for August are as follows... gold 5,728 contracts [572,800 ounces] and silver 91 contracts [455,000 ounces]", which doesn't seem like a lot, but what in the hell do I know?

So, I report these things without knowing what they mean because I am pretty stupid and I am just in it for the money, so all I can ever see is the obvious, especially when it is pointed out to me, which he apparently does when he says it means, "August was a big month for gold deliveries...but not for silver. September is a big month for silver deliveries...but not for gold."

I still don't know what it means, but a big buying of gold and silver every other month is plenty enough to keep their prices rising and demand growing, which is Another Good Reason (AGR) to buy gold and silver beyond the obvious good reason that they always soar in value and price when the government is acting so irresponsibly, or when the Federal Reserve is acting so irresponsibly, but especially when both of them are acting irresponsibly, like now!

It's enough to make you squeal with delight, "Whee! This investing stuff is easy!"

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

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