FXIS Market Insights

Weekly Snapshot 
• Real GDP in the US grew at an annual rate of 2.0% in the third quarter of 2010 (ESA)
• US consumer sentiment worse than expected in October, lowest in 11 months (Reuters)
• Euro area seasonally-adjusted unemployment rate was 10.1% in September (Eurostat)
• Britain’s economy grew by 0.8% in Q3, or 2.8% compared with a year earlier (Economist)
• The Euro zone economic sentiment index  rose to a 34-month high in October (Economy.com)
• Unemployment in Germany fell below 3 million in October, for the first time in 18 years (FT)
• Bank of Japan held its key overnight call rate unchanged and cut its growth outlook (Marketwatch)
• US durable goods orders in September 2010 rose 3.3%, to $199.2 billion (ESA)
• Industrial new orders up by 5.3% in Euro area (Eurostat)
• US consumer confidence in October increased to 50.2 up from 48.6 in September (NBER)
• Home price increases slow down in August according to the Case-Shiller Home Price Indices (S&P)
• For the first time ever, inflation-protected Treasury bonds sold with a negative yield (WSJ)
• US existing home sales rose 10% in September; median price fell 2.4% from a year earlier (Bloomberg)
• The G-20 agreed to move towards more market-determined exchange-rate systems (Bloomberg)

Weekly Market Barometers

Chart Of The Week
The US Treasury sold $10 billion of five-year Treasury inflation protected securities (TIPS) at an auction this week with a yield of negative 0.55%.  Granted, these government bonds are indexed to inflation and their par value rises based on the consumer price index.  But with a negative 0.55% yield, it may take a while just to break even.  Based on what happened during this week's auction, many investors must fear a substantial risk of much higher inflation in the next 5 years.  In their view, there is a high probability that these securities will still provide a positive return before they mature in 5 years, despite the current negative yield.

That said, I cannot think of any reason why someone would pay to lend his money even if it were just for a few months - and least of all to lend your hard-earned dollars to the government. 

This one should be filed under:  Things that make you go hmmm...

source: http://research.stlouisfed.org

Recommended Read 
Just in time for Halloween, the Bond guru Bill Gross issued a rather spooky article warning investors that the great three decade long bull market in Bonds is about to end.  Please consider:  Run Turkey, Run

His sentiment is shared by a large number of investors, namely those who lined up this week to pay the US government to take their money (see chart above).  With QE2 looming upon us, one would think that inflation must is coming to a household near you rather soon, if it hasn’t arrived already. 

Some caveats though.  It isn’t the first time that Bill Gross has called the end of the Bond rally before and was mistaken.  You can read up on his two most recent missed calls on Calculated Risk.

Then there’s this perhaps much bigger concern that the US may follow in the footsteps of Japan and endure at least another decade of sub-par growth and deflation. 

Here’s yet another angle:  As long as the government controls the determinants going into the consumer price index, stated inflation will likely be low for an extended period of time.  The real cost of living in US dollar terms however, is not going to stay at present levels much longer.  The effects of that are already apparent in higher commodity prices, stubbornly high gold prices and a loss of real purchasing power in US Dollar terms.  Do you still want to pay for the “privilege” of lending money to the US government?

Recommended Video 
In view of the widely anticipated QE2 which may be confirmed at the next FOMC meeting, here’s a good explanation of what happens when Uncle Ben goes shopping.

 

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

You may have expected yet another bumper week for the shiny metal. However, this week marked the first time since mid-summer that Gold has run into some head wind. After a massive bull run reaching new all-time nominal records nearly every week, Gold has retraced about 3% this week. Is this the beginning of the end or was it just a minor pause in an otherwise massive long-term up-trend?

While taking nothing away from this amazing bullish move in Gold during the past decade, we have been expressing concerns about a possible bubble and listed a number of caveats about loading up on Gold indiscriminately.  Most notably, the concerns are two-fold: a) Gold is not a traditional investment in that it provides no inherent yield or return other than price appreciation and b) Gold is a commodity nonetheless and as such exposed to significant volatility.  You can review some of our previous comments on Gold at FXIS/Gold.  With regard to external and fundamental factors causing concerns, John Authors of the Financial Times expresses these concerns much more elegantly than I can. Please consider: Remember 1980: all that glisters is not gold.

John Authors makes a sound argument in warning about the speculative element of this ongoing gold run.  Although highly unlikely, one must consider a possibility of a repeat of the implosion in gold prices after the bubble burst in 1980.  At the same time, one cannot ignore the fact that such a repeat would also imply that we are not yet in the final stages of a bubble. Instead, the current bull market might continue to prices above $2,000 comparing the 1980’s peak in today’s in inflation adjusted dollars.  A look at charts may give us a better sense of what some possible scenarios could look like.

A first indication of head-wind can be seen in the swift price decline of Gold mining stocks measured by GDX, an exchange traded fund tracking gold miners. The medium-term uptrend has been reversed this week.

With regard to Gold ETF (GLD) and Gold futures, both have arrived at the lower end of the up-ward trend-line, a test of which may ensue in the coming days.

Taking a slightly long-term view however, it is clear that the current retracement is just that, a pause in the otherwise continued up-trend.

Examining the near term trend in more detail, we have witnessed some profit taking resulting in typical price declines often measured by Fibonacci retracement levels. Plotting these retracements, we can see a possible further decline to about $1250.  Price declines measured with these tools imply a likelihood of prices within 38.20% and 61.80% declines from recent low to recent high.  Therefore, Gold could trade within a range of below $1300 and about $1250 without violating the ongoing longer term trend.

Taking a look at a more neutral Gold price indicator i.e. Gold valued in Euros, the precious metal is also trading at an interesting inflection point.  The near-term Gold trend has actually been bearish since the beginning of this summer.  Gold/Euro has now approached an important technical support area.  Failure of this support would make the case of a test of the 900 area.  That scenario would then be a more realistic test of whether the metal is still going to shine with all its brilliance. 

From a technical perspective then, the long-term bull market in Gold is still alive.  However, there are signs that further profit taking may test the lower boundary of this ongoing mega-trend.  The coming week might shed some more light into the longer-term direction. Meanwhile, short-term traders should be prepared for a bumpy ride ahead.

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy 
• US dollar rose modestly ahead of G20 meeting of finance ministers and central bankers (WSJ)
• Tim Geithner urges G20 countries not to devalue their currencies (FT)
• Fannie Mae and Freddie Mac may end up drawing $363B from the government (Bloomberg)
• US Leading Economic Index increased 0.3% in September to 110.4 (Conference Board)
• Bank of Canada announced it would hold its key overnight interest rate steady at 1% (WSJ)
• China's economy grew 9.6% in Q3, the slowest pace in a year and in-line with expectations (WSJ)
• German government sees GDP growth of 3.4% in 2010 (Marketwatch)
• China is said to widen its embargo of rare earth minerals (NY Times)
• China raised its benchmark deposit and lending rates by 25 basis points (WSJ)
• Japan's government cut its economic outlook for the first time since February 2009 (CNBC)

Weekly Market Barometers

Chart Of The Week
The foreclosure mess hit the airwaves in recent weeks.  Below is a nice graphic showing the impact of foreclosures across the US.  After all, foreclosures too seem to be bound by the three most important determinants in real estate:  Location, location, location.

source: Washington Post

Recommended Read 
We have covered the pros and cons of using a mortgage on a property as a cash chow at length.  If you like to review some of the previous articles, you can find all of them under the real estate label on our blog: FXIS/Real_Estate 

However, to get a good sense of what really happened in the past ten years and to understand some of the caveats going forward, please consider this excellent piece by David Kotok: The Foreclosure Mess

Recommended Video 
Tim Geithner appears to have this rare talent of making a poor impressions and coming across as hypocritical. First impressions do matter; during his confirmation hearings prior to taking the post of US treasury secretary, the general public had to question whether he was incapable of completing his own tax returns or whether he was simply “bending the truth”.  Either scenario does not bode well for one of the most important finance jobs in the country.

This week, Tim Geithner did it again. In a letter to the G20 members he asked the nations “to refrain from exchange rate policies designed to achieve competitive advantage by either weakening their currency or preventing appreciation of undervalued currency."  Well hello Mr. Geithner, what has the US been doing all along?

Please consider the following discussion between Henry Blodget and Aaron Task which sheds some additional lights on the motives of Mr. Geithner.

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

As a former musician, I have sometimes looked at the music industry with a sense of dismay.  Disillusioned by an apparent lack of creativity in much of what has been put in front of consumers’ ears in recent years, I often wondered what happened to all those creative talents, those musical "outside-the-box" thinkers who have blessed us with so much musical joy in the past?

Some of those creative minds must have gone into banking and financial services.  It is rather apparent how "creative" the financial services industry has become - “creative” in terms of finding new ways to circumvent regulations and to "milk" consumers instead.  Today's Wall Street Journal has a good example of how some companies have become adapt at finding loopholes.  Please consider: Fed Aims to Tighten New Rules for Credit

As the article notes: 

The proposed rules also address fees frequently tacked onto cards marketed to people with weaker credit histories. The credit-card law, targeting confusing offers that often drew lower-income customers to sign up for costly credit, limited fees to no more than 25% of a card's credit line in the first year.

First Premier Bank has since offered a card with a $300 credit limit and $75 annual fee, plus a $95 processing fee that must be paid before the card is used. The bank, which didn't respond to requests for comment, told The Wall Street Journal earlier this year that the 25% limit only applied to fees charged after an account was opened.

Whether you are a musician, an artist or just a normal consumer, you have to watch out.  Creativity is great in music and in art, but it can have its downside when you let bankers & financiers get a hold of creative thinking.

Perhaps it is time to switch roles and have artists put on a banker's head for a change.  That analytical mind would do them well and should keep them away from ridiculous terms as described above.  In any case, don't forget to carefully read credit card offers. It's your money.  Don't let these credit sharks get a hold of it!

Noteworthy 
• US Treasury delays its report on currency practices of major US trading partners (Reuters)
• Euro area annual inflation was 1.8% in September 2010, up from 1.6% in August (Eurostat)
• US consumer sentiment index fell to 67.9 in October from 68.2 in September (Reuters)
• US Consumer Price Index increased 0.1% in September on a seasonally adjusted basis (BLS)
• Singapore’s central bank surprised global markets by tightening monetary policy (FT)
• Gold prices at another new high of $1387 on Thursday (FT)
• US Producer Price Index for finished goods increased 0.4% in September (BLS)
• 288,345 properties were foreclosed upon in the US during July-September quarter (RealtyTrac)
• US trade deficit in goods and services in August 2010 increased 8.8%, to $46.3 bn (ESA)
• Pay on Wall Street is on pace to reach a record high of $144bn up from $139bn in 2009 (WSJ)
• Industrial production in the Euro area was up by 1.0% in August compared to July (Eurostat)
• US foreclosure mess is spreading to other banks, GMAC and Wells Fargo to review documents (AP)
• China's foreign-exchange reserves surged by a record $194bn to $2.65 trillion as of Sep-2010 (Bloomberg)
• Minutes of FOMC meeting suggest quantitative easing will implemented soon (Reuters)
• Global financial leaders failed to find a currency resolution at last week-end's IMF meeting (Bloomberg)

Weekly Market Barometers

Chart Of The Week
The race to the bottom continues and the US Dollar is still in the lead in terms of losing purchasing power.  When the market commentators pronounced the Euro as “toast” earlier this year, we advised to be patient and not write the single currency off just yet.  The US Dollar has been in a similar predicament in recent months.  Expectations for further quantitative easing have pushed the US Dollar to all-time lows against the Swiss Franc, the Australian Dollar and the Singapore Dollar.  It is near historic lows against the Japanese Yen as well.  Just how much the US Dollar has been loosing value over the long-term is not all that clear to the general investing public.  A long-term chart showing the US$ versus Japanese Yen shows the significant decline of the greenback against the Japanese Yen since the early 70’s.  

source: www.fxistrategies.com

As much as this trend is alarming, there is a silver lining in all this.  Japan had near zero interest rates and deflationary pressures for two decades now.  Property prices have never recovered since the boom years of the 80s.  The Stock Market Index is barely 1/4 of it's peak in 1990.  And yet, the Japanese currency has continued to make gains against the US Dollar.  It has also performed remarkably well against other currencies since the financial crisis.  Although this may seem somewhat counter-intuitive, despite near zero interest rates and essentially no return on Japanese denominated assets, the currency has remained strong.  If the US were to follow a similar fate as Japan, it would be a nightmare for property and equity prices.  But there may just be some hope for the US Dollar.  The pressure on the Dollar remains strong, particularly in view of the ever-mounting US debt burden.  But don’t write the greenback completely off just yet!

Recommended Read 
The threat of a currency war has been the preferred theme in recent weeks.  The much anticipated report on currency practices of major US trading partners which was scheduled for release on October 15, 2010 has been delayed by the US Treasury department.  At the same time, China who was seen as the biggest culprit in the currency mess has continued to amass foreign currency reserves now amounting to over $2.6 trillion, the majority of which is in US Dollars.  Needless to say, the situation is tricky and sudden adjustments to the current exchange rates could have massive impacts on a country’s domestic economy.  An interesting proposition is presented in the Economist article Fumbling towards a truce:

Managing currency tensions will require greater harmony on all these fronts. Fortunately, for all the rhetorical barbs, there are some signs of progress. In a little-noticed comment during the weekend’s meetings, Yi Gang, a deputy governor of China’s central bank and head of the country’s foreign-exchange reserves, said that China aimed to bring its current-account surplus below 4% of GDP within 3-5 years. In the hope of shifting the conversation away from currencies, South Korean officials have been pushing the idea that G20 leaders embrace goals for current-account surpluses and deficits at the Seoul summit.

Recommended Video 
Some people hate him, others flock to him especially when the economic going gets tough. The ever-so vocal Peter Schiff gives his opinion on inflation, the Fed and the Dollar.  Please consider the views of a prominent inflation hawk: Peter Schiff: "It's Scary How Clueless Bernanke Is"

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

The financial news media has a way of shifting people’s focus on certain key issues that are supposed to occupy an investor’s mind for certain periods.  Sadly, the bold headlines encourage the spread of fear and often do more damage than good. 

In this day and age, who has the time to read details and go beyond the headlines? This causes investors to pay too much attention to the bold statements and to make investment decisions based on fear.  The fear is caused by headlines such as:  Currency Manipulators, Currency Crisis and even Currency War.  The amount of fear is evident in the continued rise of Bond prices, Stock prices above fair value and most obvious in the price of Gold which hit $1,364 this week.

At this week-end’s G20 meeting, the finance ministers will then engage in some diplomatic battles and there will be some finger pointing towards an easy target: China - as if all economic woes could suddenly be resolved if and only if China would revalue its currency.

But China is not the only and certainly not the first country to peg its currency with the US Dollar; for instance, most countries in the Middle East have done so for decades.  It is also not the first time in history that nations have had major arguments about the “correct” rate of exchange.  Ever since the major currencies abandoned the Bretton Woods agreement and were allowed to freely float, there have been periods of much debate about correct values of exchange rates.  Starting with the Plaza accord in 1985 when it was agreed to depreciate the US Dollar against the Japanese Yen and the Deutsche Mark, the perceived currency culprits then, there have been rambles in the markets and political opinions as to what might be a correct exchange rate. Misgivings about a chosen currency framework, be it fixed or floating, have come to the public on a number of occasions. Take Britain’s exit from the Exchange Rate Mechanism (ERM - a forerunner of the Euro). Or consider the 1997 Asian financial crisis which resulted in massive debasements of some Asian currencies. 

For better or worse, China has chosen to peg its currency closely to the US Dollar at allegedly artificially low rates.  The general assumption is that by artificially debasing its currency, China was able to export its way to prosperity and become the world’s largest exporter. On first glance, it is indeed remarkable how closely China’s initial economic growth correlates to the debasing of its currency starting in the Mid-80’s with the major push in 1994 when the Yuan was debased by over 30% in one big adjustment.

Since then however, China has allowed to let its currency regain some value and Beijing has expressed a willingness to continue a gradual appreciation versus the US Dollar.

Currency War might be an overstatement but there is indeed a growing discontent of some nations with the way their currencies are currently valued most notably against the US$.  Branding China as a currency “manipulator” though is somewhat misplaced.  China has chosen to implement their multi-decade economic plan via a currency that is not freely convertible and is essentially fixed against the US Dollar.  That policy has also come at a cost, most evident by the rampant domestic inflation in China.  The Yuan rate versus the US Dollar therefore is not manipulated but is rather actively managed.

To give some credit to China, we must also consider that it is sitting on a foreign exchange reserve of some $2.5 trillion, most of which are in US denominated assets such as US Treasuries.  The values of these assets have to be taken into account when considering a correct rate of exchange for the Yuan.  If China were to revalue its currency by say 10% only, the value of their substantial US$ holdings would decrease by 10% as well.  It is therefore unlikely that China will do any sudden changes in their current policy.

The real manipulation however, is happening elsewhere.  From the perspective of countries like Brazil or Australia, whose currencies have been soaring against the US Dollar, the exchange rate versus the Chinese Yuan is perhaps an even bigger issue.  The US$ has continued to loose value in recent months and commodity-rich countries like Brazil and Australia are finding it increasingly hard to price their exports to China competitively.  China piggy-backing its rate on the US Dollar however did not manipulate things from their perspective. It is rather more likely that the easy money policy since the beginning of the last decade with currently near zero interest rates led to a depreciation of the US Dollar in real terms.

A weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. Broad currency index includes the Euro Area, Canada, Japan, Mexico, China, United Kingdom, Taiwan, Korea, Singapore, Hong Kong, Malaysia, Brazil, Switzerland, Thailand, Philippines, Australia, Indonesia, India, Israel, Saudi Arabia, Russia, Sweden, Argentina, Venezuela, Chile and Colombia.

Financial markets respond to incentives first and foremost.  For the time being there are very few incentives to invest in US$ denominated financial assets; near zero interest rates are one big factor, the growing US deficit maybe the next one in a long chain of arguments that give rise to a capital flight out of the US.

The huge US debt burden however is an incentive to debase the US Dollar in real purchasing power terms, perhaps the only real way to ever get out of the miserable debt spiral (the Weimar Republic argument).  Countries like China and Japan who continue to feed into this debt (refinancing) know that the deficit spending cannot continue forever and they must be concerned about the true value of their holdings.  Japan, which is sitting on close to $1 trillion in US assets, has already shown their level of concern by intervening in the currency markets and embarking on further easy money policy in the hope to reverse the rise of the Yen against the Dollar.  Others have expressed similar concerns which is why there has been so much talk about a debasement of all fiat currencies resulting in a race to the bottom.

The US however, must look to its own backyard in terms of finding solutions for economic and fiscal policies that stimulate sustainable long-term economic growth rather than finding the fault with the economic policies of other countries.  Branding China a currency manipulator does nothing to renew economic growth in the US, nor will it really lead to significant job growth in the US.  It is not in China’s interest to have their largest customer go broke. They have too much at stake and too much of a vested interest.

If we really want to give China an incentive to continue their currency revaluation process, US officials should start by finding ways to balance their budget and make a sincere effort towards eliminating the US debt burden.  Once that is in place and the US Dollar is no longer “manipulated” into loosing its real value, we might find that it is also in China’s interest to make currency adjustments, possibly to let their currency freely float.

Noteworthy 
• Australian dollar hit 0.9918, highest level since the currency was freely floated (Reuters)
• Brazilian Real closed Friday at its strongest level in more than two years (WSJ)
• Dow Jones Index closes above 11,000 for first time since May (AP)
• Bank of America halts foreclosures in 50 states amid growing furor over document errors (AP)
• US nonfarm payroll employment down by 95,000 in September (BLS)
• US unemployment rate was unchanged at 9.6%; U6 unemployment rate at 17.1% (Bloomberg)
• IMF predicts that the global economy would grow by 4.8% over the year as a whole (Economist)
• Gold price at yet another record briefly above $1360 on Thursday (Reuters)
• European Central Bank kept interest rates steady at 1.0% (Economy.com)
• Euro area GDP increased by 1.0% during the second quarter of 2010 (Eurostat)
• US 30-year mortgage rates fall to 4.27% lowest on records dating back to 1971 (AP)
• The Bank of Japan cut its overnight call rate target to a range of 0-0.1% from 0.1% (Bloomberg)
• The Reserve Bank of Australia kept its key cash rate unchanged at 4.5% (Reuters)

Weekly Market Barometers

Chart Of The Week
The US Dollar continues to be the leader against other currencies in a race to the bottom.  Meanwhile, Gold has been picking up the pieces appreciating in value to make up for the perceived loss in purchasing power from the declining US Dollar – at least in part. The Gold bugs continue to cheer while ever more retail investors seem to develop a desire to jump on the running train. Before loading up and jumping on this train, take a look at the very colorful history of the most precious of all metals.  Please enjoy this fascinating chart.

(Click on the chart for a larger image)

source: http://www.onemint.com/2010/09/20/how-did-gold-progress-through-the-ages

Recommended Read 
Please consider this illuminating write-up on QE2 by Ed Yardeni:  Why QE Doesn’t Work

Here’s an interesting quote from the article:

Bernanke knew back in 1988 that quantitative easing doesn’t work. Yet, in recent years, he has been one of the biggest proponents of the notion that if all else fails to revive economic growth and avert deflation, QE will work.

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

You’ve read the news, Gold at $1320 this week and the analysts are beating each other over their heads as to where the next gold target might be.  We heard everything from $1,500 to $5,000 within a few years.  All that accompanied with the ongoing debate as to whether we will see continued deflation, inflation or possibly hyper-inflation.  So what’s it going to be then?

The short answer is: “It depends”. Let’s forget about semantics for a minute however, and look at the general cost of living and the cost of running a business.  There are a myriad of factors influencing the overall cost of running your life or your business.  The best assessment of a sort of felt-inflation is a comparison of the overall cost of living with your income.  In that sense, on a macro level, the majority of consumers have experienced a significant rise in the cost of living, felt-inflation if you will...

To some extent, that is reflected in the rise of some commodities and most notably in the form of the run on gold which appears to be gathering pace as we speak.  Is Gold then the panacea for each of the dreaded outcomes in terms of a protection against deflation AND (hyper)inflation?

In his Investment Outlook October 2010, Bill Gross concludes that:

The most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living.

If you (still) have a job, that lower standard of living might not be obvious just yet.  But the current decline in the value of the Dollar has been gaining pace, despite efforts by some countries (Japan, Brazil) to slow down the rise of their currencies against the Dollar.

While the Gold bulls are tooting their horns, we cannot ignore the fact that a big part of the recent rise in the gold price has been the declining US Dollar.  That is apparent when valuing Gold in Euro...

even more apparent when valuing Gold in Australian Dollars...

The massive gains in Gold are no longer as profound in other currencies which reflects the decline in the purchasing power of US denominated investors. 

Taking nothing away from the incredible bull run in Gold during the past decade, we need to put things into perspective though. An investor faced with uncertainty may seek some relief in Gold.  From a safe-haven perspective, Gold has been a good hedge against uncertainty and its most dreaded symptom deflation.  The historic inflation record of Gold is somewhat mixed but if official inflation were to resume, the majority of Gold bulls will seek exactly that hedge against inflation by shifting more of their depreciating cash assets into a real asset. 

Having said that, one must consider the possibility that the continued rise in Gold will be less pronounced when valued in other currencies.  From an investment perspective the Australian Dollar could be a good alternative to Gold in terms of a hedge against the decline of the Dollar. While both the Australian Dollar and Gold can be similarly volatile, there is an added advantage favoring the Aussie.  The yield differential against the US$ is about 4% which beats Gold, a non-yielding asset.

However, whether you invest in the “real” currency Gold or in a paper currency such as the Australian Dollar, do not underestimate the volatility both of these currencies can experience.  As always, carefully evaluate the risks before investing.

Noteworthy 
• Gold price at yet another record, reaching $1320 on Friday (Reuters)
• SEC/CFTC report says: Trading software sparked flash crash on May 6, 2010 (CNN Money)
• S&P 500 posted 8.8% gain in Sep-2010, best September performance since 1939 (FT)
• Euro area seasonally-adjusted unemployment rate was 10.1% in August 2010 (Eurostat)
• US real disposable personal income (DPI) increased 0.2% in August (ESA)
• US personal savings rate as a percentage of DPI was 5.8% in August (ESA)
• Euro area annual inflation is expected to be 1.8% in September 2010 (Eurostat)
• Cost of bailing out Irish banks could rise to as much as €50 billion (Economist)
• US GDP grew at an annual rate of 1.7% in the second quarter of 2010 (ESA)
• US House passes tariff bill to stop China's yuan imbalance with US (Washington Times)
• European Economic Sentiment Index rose again in September, to 103.2 from 102.3 in August (EC)
• US consumer confidence Index dropped to 48.5 (1985=100), down from 53.2 in August (AP)
• Eurozone banks (plus Sweden and Switzerland) have all but stopped selling gold (FT)

Weekly Market Barometers

Curiosities
• FINRA agrees to more disclosure on pay, rejects Madoff probe
• Deflation is it, but some prices are sure to rise: FedEx to raise rates
• "Great Recession" Pushes Gap Between Rich and Poor to Record Levels
• Europe’s central banks halt gold sales
• CFTC's and SEC's report on the causes of the "flash crash"

Chart Of The Week
US housing prices have been creeping up ever so slightly in the past 12 months.  Some regions and some specific cities however, have been hit  a lot harder than others and prices have seen some additional pressure on the down-side.  Worst hit, Las Vegas with a 57% price decline since the peak.  After all, the three most important factors for property prices are still location, location, location. 

source: www.calculatedriskblog.com

Recommended Video 
Please consider this excellent interview with John Lekas. As he remarks, the critical factor for the US economy going forward is employment. He considers the unemployment number U-6 which is at 16% as the “real” unemployment rate. The potential of 900,000 job losses in the municipal sector would equate to a decrease of about 1% in GDP.  The prospect of some States and Municipalities filing for bankruptcy smells a lot like more bailouts knocking on the doors of taxpayers...

Highly Recommended Read
When some gurus speak, the markets listen. Bill Gross, Managing Director of PIMCO, is one such person.  Please consider his Investment Outlook October 2010.  Mr. Gross sums up his outlook as follows:

Investors will likely not know whether the mouse has grabbed for the cheese for several years forward. In the meantime, they are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns. And the most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living.

Good luck and good investing!

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