The Best Gold Stock to Own Today

November 13th, 2010

The Best Gold Stock to Own Today

Gold and gold stocks have been the rage lately, as the price of gold reaches new highs. However, not all gold stocks are the same. Some have vast reserves of proven gold in the ground. Others have lower productions costs that give them an edge. Using three of the best major gold mining companies as a guide, let's explore how these factors can guide your selection of the best gold stock to own.

Proven and probable reserves
Like treasure hunters, gold miners know there is gold somewhere. The proven and probable number of ounces of gold in the ground is the company's treasure — only they know where it is.

“Proven” means they know how many ounces of gold are in the ground for sure. “Probable” indicates there is a statistical probability there are so many ounces in the ground. Geologists use standard procedures to derive the probable number of ounces.

The more ounces of gold that a company has in its proven and probable column, the more it should be worth. Updated annually, in 2009, Barrick Gold Corporation (NYSE: ABX) had 139,751,000 ounces of proven and probable gold in the ground, substantially more than Newmont Mining Corporation (NYSE: NEM), with 91,800,000 ounces and Goldcorp (NYSE: GG), with 48,470,000. With so much more gold in the ground, Barrick should be more valuable to investors.

If we take the enterprise value of the company, which represent's the company's value if it were to be acquired, divided by the number of proven and probable ounces in reserve, we can identify how the market values an ounce of the company's gold in the ground, known as Enterprise Value / Reserve Ounce (EVO). At the end of 2009, Goldcorp's reserves were valued at $63.18 per ounce, while Barrick's were less than half that number at $31.58, with Newmont achieving the lowest valuation at $27.39.

From this, you could imply that Newmont is the best opportunity, since the market places the lowest value on the gold it has in the ground.

But what about the cost to mine that gold?

Low cost producer
Remember, the market sets the price for gold — not the mining companies. The companies that produce their gold at the lowest cost per ounce make more money.

Mining for gold is a capital, labor and energy-intensive business. According to the GFMS, a precious metals consultancy based in London, the average cost to produce an ounce of gold has risen above $500.

Most gold mines extract other metals and minerals found when they mine for gold. Copper and silver are the most common. According to the Gold Institute Production Cost Standard, the best way to measure what it costs for a company to produce an ounce of gold is to subtract out the price received from the sale of other metals, known in the industry as the Cash Cost (by-product).

For the trailing 12 months ending in September 2010, Goldcorp leads the way, with by-product costs of $317 an ounce, well below the average cost and that of its large competitors. This price is up from $295 for the 12 months ending in December 2009.

Barrick has a slightly higher cost per ounce of $346, down from $363 for all of 2009, on the strength of its copper production. Subtracting the sale of copper from the gold helps to lower production costs.

Newmont realized a cost of $478 an ounce, down from $526 an ounce for 2009. Newmont is benefiting from a rather large amount of copper by-product in its reserves. As copper prices expand with the economy, it will have a greater influence on a number of gold miners.

In this case, Goldcorp is the clear winner, with Barrick coming in second. Newmont will see its by-product cost for gold fall as it reaps the rewards of higher copper prices.

Valuing gold companies
As we have seen, the market value of a gold company's reserve varies significantly. Without going into detail, this depends largely on the cost to extract the gold from the ground. It also varies with the value investors place on other metals the company might have in reserve and produce. Putting these together gives us a simple way to compare gold mining companies.

The plot below shows the Enterprise Value / Reserve Ounce (EVO) vs. the Cash Cost to Produce (by-product) gold.

Investors want to see a gold company move from the upper left part of this graph down and to the lower right. When this happens, it means the value of the enterprise goes up along with the miner's stock price.

Goldcorp wins on both dimensions, though it might not have much more room to improve. [Nathan Slaughter, Chief Strategist of our Market Advisor newsletter, turned his readers on to Goldcorp just in time. Now, they're sitting on a +58% gain.]

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5 New Industries That Could Topple Today’s Giants

November 13th, 2010

5 New Industries That Could Topple Today's Giants

Austrian economist Joseph Schumpeter first introduced the world to the concept of “creative destruction” by which, in his own words, sets forth a “fundamental impulse that sets and keeps the capitalist engine in motion [and] comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.”

In other words, just like in nature, business models and companies evolve over time. And if they don't, they eventually give way to new technologies or rivals or die out all together. Andy Obermueller, editor of the Game-Changing Stocks newsletter, is always on the hunt for firms that are already making shareholders significant profits for their successful, disrupting technologies. So I thought I would look into some areas I thought would be game-changers in the coming years myself and see if there was a potential way for investors to profit.

With that, here are five industries that I think could see significant disruption in the years ahead — and the players that could end up toppling the incumbent giants.

1. Cloud Computing
Incumbents: Microsoft (Nasdaq: MSFT), Adobe (Nasdaq: ADBE), Oracle (Nasdaq: ORCL)
Potential Winners: Amazon (Nasdaq: AMZN), Google (Nasdaq: GOOG), Intuit (Nasdaq: INTU), Microsoft

The current software business model consists of buying a copy of a software program and copying it to your computer. This leaves the maintenance tasks and updates to the computer user or corporate IT department. But software as a service, or SaaS for short, consists of using the Internet to access a program for a fee and leaves the maintenance and updating to the provider of the software.

This has major potential implications for those that currently benefit from the current business model. For the leaders, it is highly lucrative, as it has scale advantages — design the software once and sell it to a basically unlimited number of users. The new model could shift the advantage to those who fully embrace SaaS instead of fighting it to try and keep the current model intact. Amazon is a potential winner for providing servers to run all the software.

The music industry is a perfect example of fighting the migration of music to online servers and digital subscription services. Pure software providers, such as those listed above could benefit. Traditional providers could topple, but could also survive if they embrace the way the industry is shifting. [StreetAuthority contributor Tom Taulli recently gave his three favorite cloud computing clicks. Go here to read his article.]

2. Voice Over Internet Protocol
Incumbents: AT&T (NYSE: T), Verizon (NYSE: VZ), Sprint (NYSE: S)
Potential Winners: Google, Vonage (NYSE: VG), Skype.

Voice Over Internet Protocol, or VoIP for short, is simply the use of the Internet to transmit traditional voice telephone calls. It is in pretty wide use already, but if firms like Google have their way, they will use it to put traditional phone companies out of business.

If VoIP really takes off, it would make the existing fixed line networks that AT&T and Verizon have spent billions building and maintaining for more than a hundred years obsolete. Google recently acquired Swedish firm Global IP Solutions to beef up its VoIP capabilities and has supposedly acquired a firm with cutting-edge technologies in the space.

Vonage is a pure play in the space and has struggled to prove that customers are willing to pay for VoIP, but it is quite clear that the incumbents would be toppled if a low-cost or free option were made available. This threatens every incumbent telecom provider out there and could benefit firms including Skype, which recently announced plans to go public and could benefit investors if it can create an economically-viable VoIP business model.

3. eReaders
Incumbents: Barnes & Noble (NYSE: BKS), Borders Group (NYSE: BGP)
Potential Winners: Amazon, Apple (Nasdaq: AAPL), Barnes & Noble

eReaders, including Apple's iPad, Amazon's Kindle, and even Barnes & Noble's Nook, are rapidly stealing market share from printed books. The iPad is an early leader, whose success is largely already priced into Apple's share price. Amazon's offering is a small part of its strategy to dominate online sales, but could represent another key growth avenue to its operations.

The main potential play for investors is if the advent of digital books completely destroys the traditional book retailers. Barnes & Noble is somewhat hedging its bets with the Nook, but still relies heavily on its bricks-and-mortar book stores. Borders is at a clear disadvantage to B&N and could easily meet its demise with the onslaught of eReader competition. [My colleague David Sterman thinks Barnes & Noble is in trouble, too (and could be a compelling short play). Click here to read his analysis.]

4. Mobile Transaction Services
Incumbents: MasterCard (NYSE: MA), Visa (NYE: V), Global Payments (NYSE: GPN)
Potential Winners: eBay (Nasdaq: EBAY), LM Ericsson (Nasdaq: ERIC)

At some point in the future it will be possible to make payments and transfer money simply from your mobile phone. Of course, this is already possible on the web thanks to eBay's PayPal service. Certain features do exist on cell phones, but are limited and almost non-existent when transacting between two individuals.

Japan is a leading region for this type of technology and is offered by global telecom firm LM Ericsson. eBay is another clear leader that could benefit as it provides the technology over mobile phone networks. Leading payment processors including MasterCard and Visa are obvious beneficiaries, though as incumbent leaders, they could be toppled by more nimble competitors.

5. Waste-to-Entergy (WtE)
Incumbents: Waste Management (NYSE: WM), Republic Services (NYSE: RSG)
Potential Winners: Covanta (NYSE: CVA), Waste Management

I won't spend too much time covering the waste-to-energy industry, as I did more thoroughly in a previous article. [Read that article here] But WtE has the potential to permanently alter the business models of traditional waste management firms such as Waste Management and Republic Services. The ability to literally turn garbage into energy is fascinating, and Covanta is a pure play in the space and a global provider of WtE facilities.

As I detailed in the previous article, Waste Management already has ambitions in the space. If it embraces this industry transformation, the company could grow into a global player in WtE, given its clear advantage of having a huge supply of waste to transform into energy.

Action to Take —> As you may have noticed, many incumbents are also potential beneficiaries as long as they don't let creative destruction completely destroy their business models. In my mind, cloud computing and mobile transaction services have the greatest likelihood to be the most destructive to the status quo.

In terms of individual firms, Google, Amazon, and Apple are among the biggest disrupters, have already toppled larger rivals, and have healthy appetites for additional creative destruction going forward. But you may also want to look into some of the lesser-known disruptors on this list, such as Vonage or Covanta, and also be on the lookout for a Skype IPO in the near future.

– Ryan Fuhrmann

P.S. –

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36% Gains From a Takeover — and Two More Stocks That Could Follow

November 13th, 2010

36% Gains From a Takeover -- and Two More Stocks That Could Follow

Back on October 26th I suggested e-commerce software provider Art Technology Group (Nasdaq: ARTG) was an attractive buy at the then-current price of $4.39. [Click here to read the article] A few days later, the company was acquired by Oracle (Nasdaq: ORCL) at a price just under $6.00 — a nice +36% move in the span of about a week.

So how'd I do it? Well, it was actually quite simple. I was 100% confident the company was going to continue growing its bottom line, as it had been for a few quarters. I was about 70% sure those results would translate into a rising stock, as had been the case — mostly — since early last year. And, I had absolutely no idea the company was going to be snagged by Oracle.

I don't say that to create any self-deprecating humility that I'll turn around later; I really had no idea that Art Technology Group was a target. I just knew it was a great company I’d want to own, and as it turns out, Oracle agreed.

I have two more acquisition candidates like Art Technology in mind, but before I share them, it may be worth explaining my thought process.

The whole experience got me thinking about some of the other M&A chatter we’ve been dancing with during the course of this year, much of which never panned out.

Take Microsoft's (Nasdaq: MSFT) rumored buyout of Adobe (Nasdaq: ADBE) for instance. A mere meeting between Microsoft's head Steve Ballmer and Adobe's CEO Shantunu Narayen sent Adobe shares soaring as much as +16% when the buyout buzz was circulated on October 7th. The stock tumbled by about half that amount the next day when the rumors were snuffed.

Fortunately, Adobe shares have since reclaimed almost all of that lost ground, but surely more than a few investors bought at the high and then defensively sold at the low of that span.

California Pizza Kitchen (Nasdaq: CPKI) is another example of a fizzled acquisition-based rally. The company effectively put itself up for sale on April 9th, and pushed shares from $18.18 to $20.74 as traders jockeyed for a piece of the company before it was bought. By July, the stock had reached a low under $13.00, having never moved above that peak of $20.74, and still no suitor in sight.

The same story unfolded again when renewed whispers of a sale shot the stock to a peak price of $20.00 on July 28th. Since then, not only have we still not seen a buyout, but investors who bought it at $20.00 on acquisition hopes have yet to see the stock hit $20.00 again.

If you're keeping score, that's two buyouts that were well-publicized, then highly-speculated on, that ultimately fizzled — and cost investors money in the process.

Now contrast that with the acquisition of Art Technology Group, which nobody saw coming, yet managed to materialize and pay off on a big way.

Get the point? If your only goal is to step into a target company before a possible acquisition, you're likely to be disappointed more often than not — not to mention stuck with a stock you may not want. If you focus on owning great companies, though — as we all should — at the very least you'll own a great company and you may just win big from an acquisition anyway.

With that as a backdrop, I can unveil my next two potential acquisition targets. The first is A-Power Energy Generation Systems (Nasdaq: APWR), and the other is Xyratex (Nasdaq: XRTX).

No, neither of these company names has been spinning in the M&A rumor mill. That's the point. They are both great companies, however, that would be as attractive to another company as they are to individual investors.

Xyratex is a data-storage player, which is an arena that's seen more than its fair share of buyout interest lately. Most of the focus seems to be on Compellent Technologies (NYSE: CML) or STEC Inc. (Nasdaq: STEC) — I don't recall hearing Xyratex in any of the data storage consolidation discussions. Oddly though, Xyratex has been producing about 10 times the revenue that Compellent has been generating (with a similar income disparity), while Xyratex's market cap is about two-thirds of Compellent's. Better still, the stock boast's a strangely low trailing 12-month price-to-earnings (P/E) ratio of about 4.7.

A-Power Energy Generation Systems is primarily a Chinese energy management holding. It's not priced as low as Xyratex is right now, but the forward-looking P/E of about 6.1 is plenty attractive — and plausible. The kickers for A-Power here are growing institutional ownership and a growing wave of utility and energy acquisitions this year; a sector's merger-mania often develops its own inertia.

Action to Take –> If you're only jumping on a stock because the rumor mill is suggesting it is an acquisition target, you may find yourself stuck with a lousy stock — if you don't even want to own it for the long haul, why would another company want to? Besides, by the time you hear about an acquisition, it's probably too late to do anything about it.

On the other hand, winning the buyout lotto isn't a lost cause. Companies acquire other companies for the same reasons investors do: reliable income, leading technology, market share, etc. Find a good, undervalued company like A-Power Energy or Xyratex, and you'll do one of two things — you'll either (1) own a great stock, or (2) you'll benefit from a buyout. Either way, it's a win.


– James Brumley

James brings a wide degree of experience in the investment industry, including being the Director of Research of a trading newsletter. James' work has appeared in major investing sites such as Motley Fool and Investopedia. Read more…

Disclosure: Neither James Brumley nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

This article originally appeared on StreetAuthority
Author: James Brumley
36% Gains From a Takeover — and Two More Stocks That Could Follow

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36% Gains From a Takeover — and Two More Stocks That Could Follow

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5 Reasons Why This Chip Stock is Undervalued

November 13th, 2010

5 Reasons Why This Chip Stock is Undervalued

Despite a fairly bleak quarterly report from Cisco Systems (Nasdaq: CSCO) on Thursday, investors should realize that troubles for Cisco don't mean trouble for the whole sector. In fact, the tech sector has shaken off the gloom and doom of this summer, with the Nasdaq surging +20% since late August.

The rebound in the Nasdaq comes from an increasing sense that tech spending will rise steadily higher in 2011 — which means more profits for tech firms. And when tech firms are feeling flush, they go out and invest in new equipment. The prime beneficiary: Applied Materials (Nasdaq: AMAT), the world's largest producer of chip-making equipment. That's reason enough to be bullish on shares.

Here are five more reasons:

1. Rich and getting richer. Applied Materials has $2.3 billion in cash, and there's more to come. Citigroup figures the company will generate nearly $2 billion more in operating cash flow in the fiscal year that began this month. Applied Materials continues to buy back stock at a prodigious clip, yet cash could still approach $3.5 billion ($2.50 a share) by the end of the current fiscal year.

2. Cheap and getting cheaper. If you back out that cash balance, Applied Materials trades for around 10 times trailing profits, and around seven times projected fiscal (October) 2011 earnings. Looked at another way, shares trade for just 5.5 times projected 2011 EBITDA.

3. An imminent resolution to the Samsung ordeal. Applied Materials appears close to settling an embarrassing lawsuit with Samsung. Some of the company's employees in Korea apparently sold Samsung's secrets to a rival, leading Samsung to cut off its business and sue. Analysts think Applied Materials is about to cut Samsung a $200 million check to resolve the mess, at which time analyst think it will place some new orders with Applied Materials that had been on hold. Shares have been under pressure on fears that the issue would linger on and perhaps prove even more costly. A settlement could help fuel a relief rally.

4. Trends are rising, not sinking. Applied Materials operates in a highly cyclical industry. Company sales plunged -38% in fiscal 2009 and likely shot up more than +80% in fiscal 2010. (Full-year results will be out next week). Many analysts think semiconductor capital equipment sales will slump anew next year, although Applied Materials' market positioning should yield a +10% gain in revenue.

But a growing minority of analysts think the industry is actually set to fare quite well next year, and that Applied Materials can grow closer to +20%. (Consensus estimates range from 0% growth to +35% growth). The rising bullishness stems from an arms race among chip foundries. These are the folks that make chips on behalf of other tech companies that design and sell semiconductors without actually making them. GlobalFoundries, a new player in the foundry industry has been aggressively ordering new equipment, leading rivals to make sure they also own state-of-the-art gear. Goldman Sachs believes that GlobalFoundries “could invest $15-20 billion of capex cumulatively from 2010 to 2015.” And it thinks other foundries such as Taiwan Semiconductor (NYSE: TSM) will follow suit. Applied Materials is likely to focus on this topic on next week's conference call.

5. Solar goes from headwind to tailwind. The solar market held great appeal to Applied Materials, as many manufacturing processes for solar wafers are quite similar to the processes needed to make semiconductors. But the company got too greedy, also entering the commercial market by selling solar panels. That move dampened profit margins and soured investors. Applied Materials got wise this summer and tightened its solar focus to proven, profitable segments. As a result, year-over-year financial comparisons are likely to start looking better and better, and the whole solar operation should morph from a money loser in fiscal 2010 to a money maker in 2011.

Action to Take –> This is not a call for you to buy shares ahead of next week's conference call. Seasonal gyrations mean that October quarterly results may come in above or below forecasts. Instead, this is a call on 2011, when a series of real and imagined headwinds become tailwinds. This industry leader, with oodles of cash, still ensconced in a favorable phase of the cycle, and an ultra-low price-to-earnings (P/E) ratio, should move back into favor in coming quarters.


– David Sterman

David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

This article originally appeared on StreetAuthority
Author: David Sterman
5 Reasons Why This Chip Stock is Undervalued

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5 Reasons Why This Chip Stock is Undervalued

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Gold: The Market’s Global Currency

November 13th, 2010

World Bank president Robert Zoellick has stirred up a hornet’s nest with his recent call for a return to a gold anchor in the global financial system.

The usual suspects immediately denounced him, with Keynesian Brad DeLong anointing Zoellick the “Stupidest Man Alive.”

In the present article I’ll explain the resurging interest in the yellow metal.

I’ll also explain the dangers of Zoellick’s proposal, and why fans of the classical gold standard should be wary.

The Limitations of the Printing Press

In order to make sense of our current situation – and why Zoellick would timidly call for a return to a pseudo-gold standard – we need to first think through the logic of fiat money. Fiat money is not “backed up” by anything; it is intrinsically useless paper (or nowadays, mere electronic bookkeeping entries) that is valuable only because of its anticipated purchasing power. In contrast, a market-based commodity money, such as gold or silver, is a useful good in its own right, serving industrial and consumer purposes.

The critical difference between fiat and commodity money is that fiat money can be produced in virtually unlimited quantities at very low cost. In this respect, the person who controls the printing press of a fiat currency is in a much stronger position than the person who owns a gold mine. With just some ink and paper, the printing press can create a million new dollars quite easily, whereas the owner of the gold mine would need to hire workers to operate expensive equipment in order to bring forth new amounts of gold having the same market value.

Yet we shouldn’t conclude that the owner of a printing press has unlimited power. For one thing, prices would eventually rise in response to large amounts of new money creation. So printing off, say, $1 million in fresh new currency would buy fewer and fewer goods and services with each successive round of inflation.

Even more problematic, the people in the community would abandon the currency if the inflation became too excessive. For example, if a brilliant counterfeiter developed a machine to produce perfect $100 bills in his basement, he wouldn’t be able to literally buy the whole world. Long before that point – even if the authorities didn’t track him down – people would have ditched the dollar and switched to the use of other currencies.

Although our scenario sounds farfetched, it’s actually very close to the real world, right now. The only difference is that instead of our hypothetical, brilliant counterfeiter in the basement, we have our actual, less-than-brilliant economist in the Federal Reserve. His name, of course, is Ben Bernanke.

The Bretton Woods System

The original Bretton Woods system – so named because of the location of the meetings that established it in 1944 – governed international monetary arrangements in the postwar era until Richard Nixon’s fateful decision to close the gold window in 1971.

Under the Bretton Woods agreement, other nations would use US dollars as their “reserves.” The Bank of England, Bank of France, etc., would issue their own domestic currencies, but would maintain stockpiles of US dollars with which they could regulate the value of their own currencies. If the British pound sterling began to depreciate against the US dollar, for example, then the Bank of England could enter the foreign-exchange market and use some of its dollar holdings to “buy pounds,” thus bringing the value of the pound back within target. In this way, investors across the globe could feel comfortable with their British financial holdings, because the pound was tied to the dollar.

Note the tremendously advantageous position that the Bretton Woods system assigned to the United States. As issuer of the world’s reserve currency, the United States had a very captive market. If the Bank of England wanted to increase its dollar reserves by another $1 million, then ultimately Great Britain had to sell $1 million worth of goods and services to Americans in order to earn the dollars. The Bretton Woods system effectively expanded the scope for US inflation to the entire world, thus magnifying the benefits to those who controlled the American printing press.

Of course, the other members of Bretton Woods understood these details. The US achieved its privileged outcome in the negotiations because of its economic and military might at that point in world history. But in order to restrain the natural temptation for runaway inflation by US officials, the Bretton Woods system linked the dollar itself to gold. Specifically, any central bank could redeem its dollars for gold at the fixed rate of $35 per ounce.

The Bretton Woods system has been described as a “gold-exchange standard,” in contrast to the classical gold standard. In the original framework – which was smashed, like so many other aspects of Western civilization, in World War I – each nation tied its own currency to gold. Then, the currencies in turn traded at fixed exchange rates against each other, because of their mutual ties to gold. Individual citizens could present the currencies for redemption in gold, keeping a very tight check on inflation. If any central bank began to issue too much currency in relation to its gold reserves, speculators would begin depleting the reserves, causing the central bank to quickly reverse course.

Under the diluted Bretton Woods system, individual citizens had no right of redemption. Most currencies were only indirectly linked to gold (via their link to the dollar). And, of course, even this tenuous link was destroyed when Richard Nixon abandoned the dollar’s convertibility to gold in 1971. At this point, the entire global financial system was based utterly on fiat money.

No longer shackled by the peg to gold, the Federal Reserve began printing money with reckless abandon. The obvious results were an acceleration in US consumer prices, and an explosion in the US trade deficit, trends that noticeably worsen after 1971:

CPI for Urban Consumers

Consumer Price Index (Blue Line, Right Scale) and Balance of Payments as a Share of GDP (Red Line, Left Scale)

The Reluctant Return to Gold

Say what you will about the powerful people running the global monetary system, but they aren’t stupid. They can see as well as the rest of us that there is no “exit strategy” for Bernanke’s bouts of massive inflation, or “quantitative easing” as they now call it. At some point, the trillion(s) in excess reserves will begin leaking back into the broader monetary aggregates. At that point, Bernanke or a successor will need to choose between saving the dollar or saving major Wall Street institutions. I predict that he will sacrifice the dollar, and it seems many elites around the world have come to the same conclusion.

It is in this context that World Bank president Zoellick writes:

The G20 should complement [a] growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. (emphasis added)

To repeat, gold is the bane of central bankers; it ties their hands and limits their discretion when conducting monetary policy. However, the game collapses if people lose faith in the fiat currency underpinning the whole system. As the recklessness of Bernanke’s moves becomes apparent to more and more people, the central planners around the world will need to throw a bone to the fearful public. A “basket of currencies,” each of which is still fiat-paper money, will not suffice.

As Zoellick is a member of the Council on Foreign Relations, and a participant in the notorious Bilderberg meetings, some analysts are understandably suspicious of his motives. After all, if powerful people were trying to introduce a regional currency to replace the dollar – in the same way that the euro has supplanted the traditional European currencies – then it would be necessary to first wreck the dollar. In its place, it would be very tempting to offer a new currency with a tie to gold.

In this light, what appear to be “inexplicable” and contradictory actions by the Federal Reserve and other powerful figures would make perfect sense.

Conclusion

Regardless of the machinations of the political insiders, the laws of economics cannot be denied. Central bankers cannot be trusted with the printing press, especially when there is no formal check on their inflationary policies. It is no coincidence that gold is hitting such heights as investors the world over hunker down for what may very well be a collapse of the dollar system.

Robert Murphy
for The Daily Reckoning

Gold: The Market’s Global Currency originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

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Gold: The Market’s Global Currency




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

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Gold: The Market’s Global Currency

November 13th, 2010

World Bank president Robert Zoellick has stirred up a hornet’s nest with his recent call for a return to a gold anchor in the global financial system.

The usual suspects immediately denounced him, with Keynesian Brad DeLong anointing Zoellick the “Stupidest Man Alive.”

In the present article I’ll explain the resurging interest in the yellow metal.

I’ll also explain the dangers of Zoellick’s proposal, and why fans of the classical gold standard should be wary.

The Limitations of the Printing Press

In order to make sense of our current situation – and why Zoellick would timidly call for a return to a pseudo-gold standard – we need to first think through the logic of fiat money. Fiat money is not “backed up” by anything; it is intrinsically useless paper (or nowadays, mere electronic bookkeeping entries) that is valuable only because of its anticipated purchasing power. In contrast, a market-based commodity money, such as gold or silver, is a useful good in its own right, serving industrial and consumer purposes.

The critical difference between fiat and commodity money is that fiat money can be produced in virtually unlimited quantities at very low cost. In this respect, the person who controls the printing press of a fiat currency is in a much stronger position than the person who owns a gold mine. With just some ink and paper, the printing press can create a million new dollars quite easily, whereas the owner of the gold mine would need to hire workers to operate expensive equipment in order to bring forth new amounts of gold having the same market value.

Yet we shouldn’t conclude that the owner of a printing press has unlimited power. For one thing, prices would eventually rise in response to large amounts of new money creation. So printing off, say, $1 million in fresh new currency would buy fewer and fewer goods and services with each successive round of inflation.

Even more problematic, the people in the community would abandon the currency if the inflation became too excessive. For example, if a brilliant counterfeiter developed a machine to produce perfect $100 bills in his basement, he wouldn’t be able to literally buy the whole world. Long before that point – even if the authorities didn’t track him down – people would have ditched the dollar and switched to the use of other currencies.

Although our scenario sounds farfetched, it’s actually very close to the real world, right now. The only difference is that instead of our hypothetical, brilliant counterfeiter in the basement, we have our actual, less-than-brilliant economist in the Federal Reserve. His name, of course, is Ben Bernanke.

The Bretton Woods System

The original Bretton Woods system – so named because of the location of the meetings that established it in 1944 – governed international monetary arrangements in the postwar era until Richard Nixon’s fateful decision to close the gold window in 1971.

Under the Bretton Woods agreement, other nations would use US dollars as their “reserves.” The Bank of England, Bank of France, etc., would issue their own domestic currencies, but would maintain stockpiles of US dollars with which they could regulate the value of their own currencies. If the British pound sterling began to depreciate against the US dollar, for example, then the Bank of England could enter the foreign-exchange market and use some of its dollar holdings to “buy pounds,” thus bringing the value of the pound back within target. In this way, investors across the globe could feel comfortable with their British financial holdings, because the pound was tied to the dollar.

Note the tremendously advantageous position that the Bretton Woods system assigned to the United States. As issuer of the world’s reserve currency, the United States had a very captive market. If the Bank of England wanted to increase its dollar reserves by another $1 million, then ultimately Great Britain had to sell $1 million worth of goods and services to Americans in order to earn the dollars. The Bretton Woods system effectively expanded the scope for US inflation to the entire world, thus magnifying the benefits to those who controlled the American printing press.

Of course, the other members of Bretton Woods understood these details. The US achieved its privileged outcome in the negotiations because of its economic and military might at that point in world history. But in order to restrain the natural temptation for runaway inflation by US officials, the Bretton Woods system linked the dollar itself to gold. Specifically, any central bank could redeem its dollars for gold at the fixed rate of $35 per ounce.

The Bretton Woods system has been described as a “gold-exchange standard,” in contrast to the classical gold standard. In the original framework – which was smashed, like so many other aspects of Western civilization, in World War I – each nation tied its own currency to gold. Then, the currencies in turn traded at fixed exchange rates against each other, because of their mutual ties to gold. Individual citizens could present the currencies for redemption in gold, keeping a very tight check on inflation. If any central bank began to issue too much currency in relation to its gold reserves, speculators would begin depleting the reserves, causing the central bank to quickly reverse course.

Under the diluted Bretton Woods system, individual citizens had no right of redemption. Most currencies were only indirectly linked to gold (via their link to the dollar). And, of course, even this tenuous link was destroyed when Richard Nixon abandoned the dollar’s convertibility to gold in 1971. At this point, the entire global financial system was based utterly on fiat money.

No longer shackled by the peg to gold, the Federal Reserve began printing money with reckless abandon. The obvious results were an acceleration in US consumer prices, and an explosion in the US trade deficit, trends that noticeably worsen after 1971:

CPI for Urban Consumers

Consumer Price Index (Blue Line, Right Scale) and Balance of Payments as a Share of GDP (Red Line, Left Scale)

The Reluctant Return to Gold

Say what you will about the powerful people running the global monetary system, but they aren’t stupid. They can see as well as the rest of us that there is no “exit strategy” for Bernanke’s bouts of massive inflation, or “quantitative easing” as they now call it. At some point, the trillion(s) in excess reserves will begin leaking back into the broader monetary aggregates. At that point, Bernanke or a successor will need to choose between saving the dollar or saving major Wall Street institutions. I predict that he will sacrifice the dollar, and it seems many elites around the world have come to the same conclusion.

It is in this context that World Bank president Zoellick writes:

The G20 should complement [a] growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. (emphasis added)

To repeat, gold is the bane of central bankers; it ties their hands and limits their discretion when conducting monetary policy. However, the game collapses if people lose faith in the fiat currency underpinning the whole system. As the recklessness of Bernanke’s moves becomes apparent to more and more people, the central planners around the world will need to throw a bone to the fearful public. A “basket of currencies,” each of which is still fiat-paper money, will not suffice.

As Zoellick is a member of the Council on Foreign Relations, and a participant in the notorious Bilderberg meetings, some analysts are understandably suspicious of his motives. After all, if powerful people were trying to introduce a regional currency to replace the dollar – in the same way that the euro has supplanted the traditional European currencies – then it would be necessary to first wreck the dollar. In its place, it would be very tempting to offer a new currency with a tie to gold.

In this light, what appear to be “inexplicable” and contradictory actions by the Federal Reserve and other powerful figures would make perfect sense.

Conclusion

Regardless of the machinations of the political insiders, the laws of economics cannot be denied. Central bankers cannot be trusted with the printing press, especially when there is no formal check on their inflationary policies. It is no coincidence that gold is hitting such heights as investors the world over hunker down for what may very well be a collapse of the dollar system.

Robert Murphy
for The Daily Reckoning

Gold: The Market’s Global Currency originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Gold: The Market’s Global Currency




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

The Tale of André Prenner, a Parable for our Times (Part One of Two)

November 13th, 2010

Today, we take a brief pause from our normal economic and financial market commentary with this tale of common sense economic calculation and action. And no, we do not believe that the world is any more complex than we present it here. If you want to understand economics, you need first understand two things: That the human condition is one of scarcity and uncertainty; and that absent rational economic calculation and a certain degree of passionate risk-taking, nothing good can ever come of it.

Yeoville was a small Midwestern town of farmers, a few shops and cottage industries. It had grown slowly through the years and had not changed much. Once in a while there was a good year, less frequently a bad one. On occasion these were related to poor weather or other reasons for a poor harvest. There was also the difficult time when a large portion of the young men went off to fight in a war. Fortunately, most returned, although their absence put a huge strain on the remaining residents to make ends meet. But on the whole the townsfolk thought well of their position and went about their business with a healthy mix of realism for today and optimism for the future.

Mr. André Prenner was one of the more successful small businessmen in Yeoville. He was now in his 60s.  His father had been a baker and manager of the town bakery, Yeoville Bakers. He was descended from immigrants from France, or so he was told by his parents, hence his first name.

André learned the baker’s profession from a young age, at first informally, assisting his father outside school hours and, after graduating the local high school, working part-time while taking a degree course in business at the local community college in the larger town a few miles downriver. As time would tell, André was not only given to work, but to greater ambition.

Taking advantage of youth, some savings from his part-time work, and a strong dollar, André celebrated completion of his business degree by taking an extensive trip to France–back to where, supposedly, his family was from–and also around various other countries in Europe. What he found astonished him: Unlike at home, where bread was simple, white and cheap, in France and in Europe generally, there was an endless variety of breads, in all shapes, sizes and even colors. It was as if the bread changed village to village. Even breads that looked the same tasted somehow different.

André returned to Yeoville some months later with a passion and a plan. He was going to turn Yeoville Bakers into something far greater than just a typical, small-town Midwestern bakery. He was going to introduce a range of European breads for distribution all over the state!

Now this was easier said than done. Anyone could, with enough searching around in a large city library, find a book with recipes for various types of European breads. But where to source the ingredients? And just because he loved the variety, would a range of pricey European breads sell well to a customer base which had lived its entire life chewing on the basic, cheap white stuff?

André promptly answered each such question with his passion. He was just going to have to give it a go.  He was young; he knew the trade; he had learned to love European breads in short order; he had the support of his father even, who had a soft spot for his presumed French heritage. The worst that could happen is that he would go bankrupt and, as an experienced young baker, would then seek an assistant manager’s job at one of the many small-town bakeries in the state. In other words, his worst case was really quite similar to what he would do if he didn’t even give it a try. So give it a try he did.

It didn’t take long to discover that, if you knew where to look, ingredients for European breads were not difficult to come by. Indeed, the bigger US cities, in particular on the mid-Atlantic coast, were home to some well-established bakeries producing European-style breads. He soon found how to get access to those same ingredients, transported to Yeoville for what he believed reasonable cost. He also researched the cost of distributing his breads to other towns in the region and how to partner with local shopkeepers to sell his product. That was the easy part. More difficult was that he was going to need to expand the existing bakery by adding new equipment. If he simply stopped producing basic white bread, the bakery would generate no income at all during an uncertain transition period and risk losing its client base. No, he would need to develop the new range of breads in parallel.

As the bakery had not generated enough retained earnings to cover the purchase of the required new equipment, André was going to have to go to the local bank for a loan. Business plan in hand, he took his years of experience, good local reputation and enthusiasm into the bank. When he departed that day, he had secured a business loan, itself secured on the new equipment he was about to acquire.

Once he had arranged for the purchase of the new equipment–which would be delivered, installed and operational within just two months–he set out looking for the three new employees that would be required to run it. Only one needed experience, as he had that himself in spades. The other two could just be hard-working, reliable and willing to learn. He found the experienced employee at a bakery in a nearby town who was keen on a new challenge. The other two he found locally, both of whom had been doing odd jobs since graduating high school a year before, but according to their references they did quality work when they could get it and were quick to learn new skills.

For the first few months André didn’t give a thought to making a profit from the new operation. He wanted to sample customers’ tastes and make the decision regarding on which breads to focus for the first year so that he could secure the needed ingredients in affordable bulk rates. He travelled to many towns and even some small villages in his bakery truck, giving away free, fresh samples everywhere he went. Once it became clear what people liked and were willing to pay a bit more for, he contacted his suppliers, ordered the necessary ingredients for regular, weekly deliveries over the coming year, arranged for the printing and distribution of promotional material, finalized agreements with shopkeepers all over the state, and sent the new baking operation into high gear.

Already in the first year the new breads were contributing a substantial portion of the overall Yeoville Bakers’ profit and André repaid one-third of the bank loan. The business was growing rapidly, but now all costs were variable, internally-generated cash was substantial and, as such, the loan was no longer required. He paid it down fully within three years, two years ahead of schedule. This freed up additional cash which was used the following year to finance the lease for a new bakery, in another town about 50 miles away, which would make full statewide distribution a reality.

André was pleased with his success as a businessman but nothing pleased him more than when he entered the bakery at 5am each morning–bakers are notoriously early risers due to their need to prepare for everyone else’s breakfast–and smelled those European breads that he had first encountered several years prior on that auspicious trip to Europe. Bread was his business but remained his passion.

Many years later André was the most prominent baker in the state. He even distributed some to neighboring states. He employed nearly 100 bakers and a handful of young apprentices. But then came hard times: A major national recession. Budget cutting was the norm and, when it came to bread, customers were buying far less of his gourmet European breads. The operation was losing money rapidly and something had to be done.

Setting his passion aside for expediency, André took immediate action to protect his business. Having learned his trade by baking the simplest, cheapest bread possible, he went back to his roots. He cancelled his contracts with his suppliers for the gourmet ingredients and, once existing supplies were depleted, reoriented his entire operation toward making basic bread again. A dozen employees focused on the gourmet breads business were let go on the understanding that they would be re-hired once business turned for the better again. Other staff was expected to take a temporary pay cut. A few resisted but, once it was clear most of their fellow employees were willing to accept it, they went along.

To be continued…

Regards,

John Butler,
for The Daily Reckoning

[Editor's Note: The above essay is excerpted from The Amphora Report, which is dedicated to providing the defensive investor with practical ideas for protecting wealth and maintaining liquidity in a world in which currencies are no longer reliable stores of value.]

The Tale of André Prenner, a Parable for our Times (Part One of Two) originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
The Tale of André Prenner, a Parable for our Times (Part One of Two)




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Commodities, Uncategorized

Euro Back Under the Microscope

November 13th, 2010

Bryan Rich

Investors, politicians and the media have had tunnel vision for the better part of the past five months. And it’s been directed squarely on the United States.

The world has been transfixed on the dollar. Experts have tirelessly surmised how the Fed’s recent decision to launch another round of quantitative easing was reckless. And they’ve claimed this action will do irreparable damage to the buck — the world’s primary reserve currency.

That script reads a lot like one we’ve seen before …

In mid-2009, the global markets became very U.S. absorbed. The anti-dollar crowd was out in droves. And they were insistent that this was the end for the dollar.

When they were asked for proof, they quickly pointed to the list of threatening emergency policies U.S. officials had rolled out, the rising American debt-load and the numerous attention grabbing headlines from leaders around the world …

Back in 2009, even the UN wanted to replace the dollar as the world's reserve currency.
Back in 2009, even the UN wanted to replace the dollar as the world’s reserve currency.

China called for a new world reserve currency. Russia piled on, calling for a new “supranational” currency and recommending the BRIC countries begin trading in local currencies, abandoning dollar-based trading.

But back then, here in Money and Markets, I warned you not to take the bait. I laid out the facts about:

  • The bigger problems residing in other spots of the world …
  • The vulnerabilities in Europe’s banking system …
  • The threat that China’s currency manipulation represented to the global economy … and
  • The role that the U.S. and the dollar played in the world — especially in times of such great crisis.

To be concise, on June 20, 2009, I said … “Beware of the scare headlines — the dollar’s demise is greatly exaggerated.”

And as it turned out, the crowd that was so heavily leaning against the dollar and the outlook for the U.S. economy was reminded that there’s a world beyond the borders of the United States. And the problems in other countries were just as big, if not bigger.

A crisis in the euro zone ensued, and abruptly, capital from around the world wanted to own dollars again. And the euro started a seven-month, 22 percent collapse against the dollar.

The currency that just months earlier was being hailed as the best candidate to supplant the dollar as a new primary world reserve currency, was in jeopardy of falling apart all together.

Act II for the Dollar Bears

Once again, the politicians are at work, trying to gain some political favor within their own countries and trying to leverage their way into more power on the global level, by taking verbal jabs at the U.S. policies and the dollar.

While they’ve been disparaging the Fed’s QE2 and claiming explicit weak dollar intent from the U.S., the dollar isn’t behaving according to plan for such dollar-destruction pontifications.

In fact, there’s a not-so-subtle turn taking place in the currency markets. And a stronger dollar has been at the center of it!

As I suggested in last week’s column, seven key charts were making a case for a bounce in the dollar and a return of a longer-term dollar bull trend.

And now, there are more reasons why this scenario looks even more likely …

While the attention has been on the U.S. and on another wave of quantitative easing, the threats in Europe have been quietly rising.

Insolvent Irish banks could reignite Europe's sovereign-debt crisis.
Insolvent Irish banks could reignite Europe’s sovereign-debt crisis.

Ireland’s failing banks have become its government’s problem. And the extent of damage on bank balance sheets now makes Ireland the most dangerously diseased country in the euro-zone economy.

Interest rates in Ireland have soared to record levels against German rates. And the price of insurance against an Irish sovereign debt default has spiked to record levels. Like last time, the disease in one spot of the euro zone is quickly affecting market sentiment in the euro zone as a whole.

You can see in the chart below, the sharp spike in the credit default swap market for insurance on euro-zone debt suggesting the set up for round #3 of a euro crisis.

chart Euro Back Under the Microscope

And following suit is the euro — perhaps in the early stages of another plunge. It has fallen nearly 5 percent against the dollar in just seven trading days.

Perhaps again, the world is waking up to the problems outside the U.S.

The financial markets are one environment where those in the minority typically come out on top — and those that follow the herd tend to get slaughtered.

With that in mind, given the mass sentiment that leans against the dollar, there are plenty of good reasons to believe a sharp reversal is in order — if not already underway.

Regards,

Bryan

P.S. This week on Money and Markets TV, three panels of experts broke down what’s already been a momentous month in America … the historic mid-term elections, the Federal Reserve’s decision and the October jobs report have created a new political and economic landscape, and contributed to an atmosphere of optimism on Wall Street.

If you missed Thursday night’s episode or would like to see it again at your convenience — it’s now available at www.weissmoneynetwork.com.

Related posts:

  1. Next Leg for the Euro: Down
  2. Watch the Euro for Important Clues on Global Markets
  3. Global Markets Giving Three More Warning Signals for the Euro

Read more here:
Euro Back Under the Microscope

Commodities, ETF, Mutual Fund, Uncategorized

Sterilizing Money at the QE Corral

November 12th, 2010

There are a lot of intricacies in the Federal Reserve’s evil ways, especially as concerns creating $900 billion in the next six months in another round of quantitative easing, and one of them is explained by Daniel R. Amerman of DanielAmerman.com. He says, “There is something else essential for investors and savers to understand about the process which the Federal Reserve has just outlined. The Federal Reserve is not directly purchasing treasury bonds from the US government. Instead, US banks are purchasing the bonds from the US Treasury to fund the deficit, and then selling an equal amount of other bonds (likely at a nice profit) to the Federal Reserve.”

If you are a normal person, then you are positively terrified by the prospect of inflation, which means that you are terrified of the Federal Reserve creating so much, so incredibly much, so staggeringly much, so unbelievably much money – which is to be almost $900 billion in the first six months of 2011 – because a lot less monetary insanity than this gigantic clot of extra money caused ruinous inflations in stocks, inflations in bonds, inflation in consumer prices, inflation in housing, inflation in the sheer suffocating size of government and severe, bankrupting macroeconomic distortions and mal-investments.

Obviously, then, I am on to something when I say that “Inflation is the worst thing that can happen, other than the Earth being invaded by creatures from outer space to make us their slaves, forcing us to mine di-lithium crystals on some barren planet in the faint, farthest reaches of the Federation of Planets.”

So, besides keeping an eye on the skies for alien invaders from outer space and watching the neighbors to see what nefarious schemes they are plotting against me, I keep tabs on the money supply.

Mr. Amerman, whom I now suspect of being in concert with my wife to cause me to have a heart attack and die on the spot from the sheer horror of it all, writes that “by the end of the Federal Reserve’s mortgage security purchase program (the previous ‘quantitative easing’), about 10% of the approximately $12 trillion in US banking system assets consisted of sterilized money held at the Federal Reserve.”

Sterilized money? What’s that? It sounds a lot like the end-days of my relationship with Susan, when she suddenly announced that, from now on, if I wanted to kiss her, I had to first sterilize my lips with boiling water. As you can probably guess, things went downhill pretty fast after the first few times! Parenthetically, looking back on it, it was not worth it.

My amorous misadventures aside, the answer is that “while a (desperate) central bank wants to be able to spend money without limits, letting that new money escape into the general money supply can lead to major inflation in a hurry. So with the previous rounds, the Fed and ECB each used their ‘sterilization’ powers to essentially put a corral up around the new money, and keep it from escaping out into the economy.”

He goes on that “because the banks can’t really spend their ‘sterilized’ money, but must have an ever larger share of their balance sheet assets consist of those economically meaningless excess reserve balances.”

He figures that by June of next year this would mean “about 16% of total US bank assets would consist of ‘sterilized money’, i.e. balances at the Federal Reserve that can’t be used anywhere else.”

I immediately saw this as a chance to get my own economic house in order! At breakfast, I happily told the kids that I was going to quadruple their allowances! This wonderful news made them, as they said, “Happy for the first time in our miserable lives!”

I admit that I positively reveled in smug self-satisfaction as they fell all over themselves apologizing for hating my guts, and apologizing about how they regret calling me a horrible, stingy, miserly, gold-bug, silver-bug, worthless loser of a father who spends every dime on gold, silver and oil stocks so that I can make a lot of money when their prices shoot “to the moon” when the monetary insanity of the Federal Reserve creating so freaking much money, so that the insane Obama administration can deficit-spend almost $2 trillion a year, makes inflation in consumer prices start climbing to hyperinflationary levels.

After I was finished eating and having had enough basking in the fawning adulation, I broke it to them that while I was indeed quadrupling their allowances, being the generous, loving father that I am, I was “sterilizing” the money by making them keep it in my bank account.

Well, their reaction was immediate outrage, as compared to the lack of it demonstrated by the silly “journalists” (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation’s universities at such a monetary monstrosity.

Their loud hostility was not quelled one iota by my gently reminding them that the Federal Reserve was doing this same thing right now, and the Fed’s bank account has risen by more than a trillion dollars in one year, and which is apparently okay with the “silly ‘journalists’ (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation’s universities” as mentioned so prominently in the previous paragraph.

Well, what started out as a delightful breakfast with the family soon devolved into a distressing shouting match of sorts, with the kids telling me, “We hate you more now than we ever hated you before!” me yelling at them, “Morons! If you knew the kind of inflationary horror that is going to happen to us because of the Federal Reserve creating so much money, then you would happily give up one of your three generous portions of cold gruel per day to let me buy MORE gold, silver and oil!” and my wife pleading, “Everybody please shut up and calm down!” to no avail.

It was scene of insane pandemonium for awhile, which we can all agree shows the degree of insanity rampant in the world today, as is this sterilized quantitative easing, which Mr. Amerman says is “an insane strategy for a government that is desperately trying to revive the private sector economy, which is one of the reasons I find further sterilization to be unlikely.”

With all due respect to Mr. Amerman, I figure that the money was not actually sterilized at all, and although it did not enter the economy as a result of business and consumer loans, it entered into the economy via government deficit-spending.

Which, if either, is worse than the other from an economic standpoint is, of course, a matter for rigorous theoretical analysis, which means that it won’t come from me because it sounds like work, and I hate even the word “work,”, even if I could do the analysis, which I can’t because I haven’t a clue how to even start.

But I like making money without working, and I know (thanks to the Austrian Business Cycle Theory and 4,500 years of history) that buying gold, silver and oil will make me a lot of money because of all of this monetary and fiscal insanity.

And all without lifting a finger, which is so deliciously brainless that I say, “Whee! This investing stuff is easy!”

The Mogambo Guru
for The Daily Reckoning

Sterilizing Money at the QE Corral originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Sterilizing Money at the QE Corral




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Sterilizing Money at the QE Corral

November 12th, 2010

There are a lot of intricacies in the Federal Reserve’s evil ways, especially as concerns creating $900 billion in the next six months in another round of quantitative easing, and one of them is explained by Daniel R. Amerman of DanielAmerman.com. He says, “There is something else essential for investors and savers to understand about the process which the Federal Reserve has just outlined. The Federal Reserve is not directly purchasing treasury bonds from the US government. Instead, US banks are purchasing the bonds from the US Treasury to fund the deficit, and then selling an equal amount of other bonds (likely at a nice profit) to the Federal Reserve.”

If you are a normal person, then you are positively terrified by the prospect of inflation, which means that you are terrified of the Federal Reserve creating so much, so incredibly much, so staggeringly much, so unbelievably much money – which is to be almost $900 billion in the first six months of 2011 – because a lot less monetary insanity than this gigantic clot of extra money caused ruinous inflations in stocks, inflations in bonds, inflation in consumer prices, inflation in housing, inflation in the sheer suffocating size of government and severe, bankrupting macroeconomic distortions and mal-investments.

Obviously, then, I am on to something when I say that “Inflation is the worst thing that can happen, other than the Earth being invaded by creatures from outer space to make us their slaves, forcing us to mine di-lithium crystals on some barren planet in the faint, farthest reaches of the Federation of Planets.”

So, besides keeping an eye on the skies for alien invaders from outer space and watching the neighbors to see what nefarious schemes they are plotting against me, I keep tabs on the money supply.

Mr. Amerman, whom I now suspect of being in concert with my wife to cause me to have a heart attack and die on the spot from the sheer horror of it all, writes that “by the end of the Federal Reserve’s mortgage security purchase program (the previous ‘quantitative easing’), about 10% of the approximately $12 trillion in US banking system assets consisted of sterilized money held at the Federal Reserve.”

Sterilized money? What’s that? It sounds a lot like the end-days of my relationship with Susan, when she suddenly announced that, from now on, if I wanted to kiss her, I had to first sterilize my lips with boiling water. As you can probably guess, things went downhill pretty fast after the first few times! Parenthetically, looking back on it, it was not worth it.

My amorous misadventures aside, the answer is that “while a (desperate) central bank wants to be able to spend money without limits, letting that new money escape into the general money supply can lead to major inflation in a hurry. So with the previous rounds, the Fed and ECB each used their ‘sterilization’ powers to essentially put a corral up around the new money, and keep it from escaping out into the economy.”

He goes on that “because the banks can’t really spend their ‘sterilized’ money, but must have an ever larger share of their balance sheet assets consist of those economically meaningless excess reserve balances.”

He figures that by June of next year this would mean “about 16% of total US bank assets would consist of ‘sterilized money’, i.e. balances at the Federal Reserve that can’t be used anywhere else.”

I immediately saw this as a chance to get my own economic house in order! At breakfast, I happily told the kids that I was going to quadruple their allowances! This wonderful news made them, as they said, “Happy for the first time in our miserable lives!”

I admit that I positively reveled in smug self-satisfaction as they fell all over themselves apologizing for hating my guts, and apologizing about how they regret calling me a horrible, stingy, miserly, gold-bug, silver-bug, worthless loser of a father who spends every dime on gold, silver and oil stocks so that I can make a lot of money when their prices shoot “to the moon” when the monetary insanity of the Federal Reserve creating so freaking much money, so that the insane Obama administration can deficit-spend almost $2 trillion a year, makes inflation in consumer prices start climbing to hyperinflationary levels.

After I was finished eating and having had enough basking in the fawning adulation, I broke it to them that while I was indeed quadrupling their allowances, being the generous, loving father that I am, I was “sterilizing” the money by making them keep it in my bank account.

Well, their reaction was immediate outrage, as compared to the lack of it demonstrated by the silly “journalists” (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation’s universities at such a monetary monstrosity.

Their loud hostility was not quelled one iota by my gently reminding them that the Federal Reserve was doing this same thing right now, and the Fed’s bank account has risen by more than a trillion dollars in one year, and which is apparently okay with the “silly ‘journalists’ (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation’s universities” as mentioned so prominently in the previous paragraph.

Well, what started out as a delightful breakfast with the family soon devolved into a distressing shouting match of sorts, with the kids telling me, “We hate you more now than we ever hated you before!” me yelling at them, “Morons! If you knew the kind of inflationary horror that is going to happen to us because of the Federal Reserve creating so much money, then you would happily give up one of your three generous portions of cold gruel per day to let me buy MORE gold, silver and oil!” and my wife pleading, “Everybody please shut up and calm down!” to no avail.

It was scene of insane pandemonium for awhile, which we can all agree shows the degree of insanity rampant in the world today, as is this sterilized quantitative easing, which Mr. Amerman says is “an insane strategy for a government that is desperately trying to revive the private sector economy, which is one of the reasons I find further sterilization to be unlikely.”

With all due respect to Mr. Amerman, I figure that the money was not actually sterilized at all, and although it did not enter the economy as a result of business and consumer loans, it entered into the economy via government deficit-spending.

Which, if either, is worse than the other from an economic standpoint is, of course, a matter for rigorous theoretical analysis, which means that it won’t come from me because it sounds like work, and I hate even the word “work,”, even if I could do the analysis, which I can’t because I haven’t a clue how to even start.

But I like making money without working, and I know (thanks to the Austrian Business Cycle Theory and 4,500 years of history) that buying gold, silver and oil will make me a lot of money because of all of this monetary and fiscal insanity.

And all without lifting a finger, which is so deliciously brainless that I say, “Whee! This investing stuff is easy!”

The Mogambo Guru
for The Daily Reckoning

Sterilizing Money at the QE Corral originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Sterilizing Money at the QE Corral




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Bernanke Equally Handy With Paintbrush, Printing Press

November 12th, 2010

The G-20 meeting wraps up in Seoul today with little more to solve currency devaluation than a 30-page report. In it, the Group of 20 proposes that the IMF help the situation by offering guidance toward more market-determined exchange rates… not exactly a sure-fire plan.

All the while, President Obama played his expected role, blaming China for manipulating the yuan as most other nations were more inclined to level criticism against the US’ own monetary shenanigans. The US was the proverbial pot calling the kettle black, and in the unilateral fashion that seems reminiscent of a previous presidency, the US once again goes it alone.

Bernanke Equally Handy With Paintbrush, Printing Press originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Bernanke Equally Handy With Paintbrush, Printing Press




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Bernanke Equally Handy With Paintbrush, Printing Press

November 12th, 2010

The G-20 meeting wraps up in Seoul today with little more to solve currency devaluation than a 30-page report. In it, the Group of 20 proposes that the IMF help the situation by offering guidance toward more market-determined exchange rates… not exactly a sure-fire plan.

All the while, President Obama played his expected role, blaming China for manipulating the yuan as most other nations were more inclined to level criticism against the US’ own monetary shenanigans. The US was the proverbial pot calling the kettle black, and in the unilateral fashion that seems reminiscent of a previous presidency, the US once again goes it alone.

Bernanke Equally Handy With Paintbrush, Printing Press originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Bernanke Equally Handy With Paintbrush, Printing Press




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Junk Science

November 12th, 2010

“The most ignorant remarks ever made by a central banker.”

“When I started my economics studies at 16,” wrote Paul A. Samuelson not long before he died last year at aged 93, “Carlyle was right to call economics a ‘dismal science.’ Thanks to modern science and better economic knowledge, this Malthusian curse has been vanquished. Good modern economics make economics the Hopeful Science. At last!”

Lucky professor Samuelson! Like an aparatchik who joined the shades before 1989, he went to his reward with his delusions intact.

This week, the scientists began to have doubts. Like the pope wondering about the resurrection, or the Mormons questioning the veracity of the angel Moroni, the head of the World Bank, Robert Zoellick, shocked the learned world. It’s time to start discussing a gold-backed currency, he said. Maybe the crown of creation of modern economics – its centrally managed money – was not such a good idea after all.

Like Christianity, the dollar only has value as long as people have faith in it. But that is true of almost every trick up the modern economist’s sleeve. If people stop believing, the spell is broken and they’re worthless.

Two years ago, when the financial world was melting down, we were told that the volcano needed to be appeased. Without immediate injection of funds, the whole system would blow up, they said. Where was the science behind that? The financial system melted down countless times in the past. No central bank came to its aid before the 1930s.

Or how about the corollary article of faith: that the public had to rescue the big banks, a tout prix? It was practically a universal constant – like the Golden mean or Brownian motion. When bankers make profits, it is theirs to keep. When they lose money, the losses are moved onto the public. The US bailed out its banks. Britain, Ireland, and Iceland did the same. But where was the evidence that bank failures were so horrible? During America’s Great Depression 9,000 banks failed. And history is full of the wrecks of banks that were “too big to fail.”

A hick Congressman from one of the corn states once proposed to round off pi to 3 to make it easier for schoolchildren to remember. He must have been joking. In the world of science, water boils at 212 degrees Fahrenheit, at sea level, whether you believe or not. Pi is always a long string of digits. The mathematicians can sweat and shake all they want; it doesn’t change. But modern economists take the joke seriously. They think they can command water to run uphill and reset the Periodic Table with fancier china. That’s why they hate gold: they can’t control it. And it reminds them that they imposters, no more effective than witchdoctors or marriage counselors.

As of this writing, it takes more than $1,400 to buy a single ounce of gold – a new record. Why? Isn’t it obvious? People are losing faith. Last week, the US Federal Reserve said it was creating another $600 billion to buy US Treasury debt. That will mean a total of $2.3 trillion added to America’s monetary footings since the Fed began its QE program almost two years ago. This will also mean that Ben Bernanke has added three times as many dollars to America’s core money supply as ALL THE TREASURY SECRETARIES AND FED CHAIRMEN WHO CAME BEFORE HIM PUT TOGETHER.

“Easier financial conditions will promote economic growth,” wrote Mr. Bernanke, in The Washington Post, “…higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Where is the proof? Where is the controlled test? Where is the peer review? Such an extravagant assertion ought to be accompanied by extravagant evidence. But there is none at all. Throwing virgins into a volcano would be no less scientific. The virgins appeased the gods; that was the theory. Mr. Bernanke has a voodoo theory too. He says all that new money will make people feel richer…and then they will act richer…and then they will be richer!

John Hussman, also an economist with a loyal following of his own, read Mr. Bernanke’s explanation and pronounced judgment: “the most ignorant remarks ever made by a central banker.” The latest $600 billion gamble may or may not increase stock market prices, he says. Even if it does, it is unlikely to produce the “wealth effect” that Ben Bernanke is counting on. People spend and borrow when they think they have permanent wealth. World stock markets have suffered two major shocks in the last ten years…with no net gains for investors. An increase in stock prices now – driven by the Fed’s printing press – is unlikely to create the kind of expectations that lead people to spend money. Especially when they don’t have any.

Which makes us wonder too. If modern economists are scientists, it makes us suspicious of the rest of them. What about the physicists? The molecular biologists? The archeologists? Are they all quacks too?

Bill Bonner
for The Daily Reckoning

Junk Science originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Junk Science




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Junk Science

November 12th, 2010

“The most ignorant remarks ever made by a central banker.”

“When I started my economics studies at 16,” wrote Paul A. Samuelson not long before he died last year at aged 93, “Carlyle was right to call economics a ‘dismal science.’ Thanks to modern science and better economic knowledge, this Malthusian curse has been vanquished. Good modern economics make economics the Hopeful Science. At last!”

Lucky professor Samuelson! Like an aparatchik who joined the shades before 1989, he went to his reward with his delusions intact.

This week, the scientists began to have doubts. Like the pope wondering about the resurrection, or the Mormons questioning the veracity of the angel Moroni, the head of the World Bank, Robert Zoellick, shocked the learned world. It’s time to start discussing a gold-backed currency, he said. Maybe the crown of creation of modern economics – its centrally managed money – was not such a good idea after all.

Like Christianity, the dollar only has value as long as people have faith in it. But that is true of almost every trick up the modern economist’s sleeve. If people stop believing, the spell is broken and they’re worthless.

Two years ago, when the financial world was melting down, we were told that the volcano needed to be appeased. Without immediate injection of funds, the whole system would blow up, they said. Where was the science behind that? The financial system melted down countless times in the past. No central bank came to its aid before the 1930s.

Or how about the corollary article of faith: that the public had to rescue the big banks, a tout prix? It was practically a universal constant – like the Golden mean or Brownian motion. When bankers make profits, it is theirs to keep. When they lose money, the losses are moved onto the public. The US bailed out its banks. Britain, Ireland, and Iceland did the same. But where was the evidence that bank failures were so horrible? During America’s Great Depression 9,000 banks failed. And history is full of the wrecks of banks that were “too big to fail.”

A hick Congressman from one of the corn states once proposed to round off pi to 3 to make it easier for schoolchildren to remember. He must have been joking. In the world of science, water boils at 212 degrees Fahrenheit, at sea level, whether you believe or not. Pi is always a long string of digits. The mathematicians can sweat and shake all they want; it doesn’t change. But modern economists take the joke seriously. They think they can command water to run uphill and reset the Periodic Table with fancier china. That’s why they hate gold: they can’t control it. And it reminds them that they imposters, no more effective than witchdoctors or marriage counselors.

As of this writing, it takes more than $1,400 to buy a single ounce of gold – a new record. Why? Isn’t it obvious? People are losing faith. Last week, the US Federal Reserve said it was creating another $600 billion to buy US Treasury debt. That will mean a total of $2.3 trillion added to America’s monetary footings since the Fed began its QE program almost two years ago. This will also mean that Ben Bernanke has added three times as many dollars to America’s core money supply as ALL THE TREASURY SECRETARIES AND FED CHAIRMEN WHO CAME BEFORE HIM PUT TOGETHER.

“Easier financial conditions will promote economic growth,” wrote Mr. Bernanke, in The Washington Post, “…higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Where is the proof? Where is the controlled test? Where is the peer review? Such an extravagant assertion ought to be accompanied by extravagant evidence. But there is none at all. Throwing virgins into a volcano would be no less scientific. The virgins appeased the gods; that was the theory. Mr. Bernanke has a voodoo theory too. He says all that new money will make people feel richer…and then they will act richer…and then they will be richer!

John Hussman, also an economist with a loyal following of his own, read Mr. Bernanke’s explanation and pronounced judgment: “the most ignorant remarks ever made by a central banker.” The latest $600 billion gamble may or may not increase stock market prices, he says. Even if it does, it is unlikely to produce the “wealth effect” that Ben Bernanke is counting on. People spend and borrow when they think they have permanent wealth. World stock markets have suffered two major shocks in the last ten years…with no net gains for investors. An increase in stock prices now – driven by the Fed’s printing press – is unlikely to create the kind of expectations that lead people to spend money. Especially when they don’t have any.

Which makes us wonder too. If modern economists are scientists, it makes us suspicious of the rest of them. What about the physicists? The molecular biologists? The archeologists? Are they all quacks too?

Bill Bonner
for The Daily Reckoning

Junk Science originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Junk Science




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Inflation Hedges

November 12th, 2010

The Federal Reserve recently announced a second wave of quantitative easing — promising to put $600 billion into the markets by buying up U.S. Treasuries. But instead of propping up the economy, the move really just opens the door to a wave of massive inflation.

It could get very ugly, so you need to understand exactly what’s about to happen and how to prepare for it.

Of course, as far as the Fed is concerned, inflation is firmly under control. After all, the core consumer price index — which excludes volatile things like food and energy costs — is very low. So low, in fact, that many investors believe we’re on the verge of a great deflation.

Trouble is, central bankers don’t seem to understand what inflation really is. Rising prices themselves aren’t inflation — they’re merely one of many potential outcomes of inflation.

True inflation is an increase in the supply of money in an economy. As Milton Friedman once said, “Inflation is always and everywhere a monetary phenomenon.”

So by that classical definition, the Fed injecting $600 billion into the economy fosters inflation. The message is, since we can’t grow our way out of this recession, the Fed will have to try to inflate our way out.

But don’t expect see its affect on prices for awhile. The Fed can control the amount of money in the system. But it can’t control what happens to that cash next.

That is, it can’t force banks to lend it out. It can’t force consumers or corporations to spend it. Without their cooperation, the velocity of money slows down to a crawl — and stagnant money has no effect on consumer prices.

But at some point, people realize their dollars are losing value, especially if there are rock-bottom interest rates. There will be a sudden urge to put their money into things with better yields… or to at least spend their dollars before they become worth even less.

The surge in spending increases money velocity — fast.  And just as quickly, prices increase. Forget the CPI jumping to 6%… it could easily go to 12%…or 25%…or 100%.

Then there are the people holding U.S. Treasuries to consider.

America is going to need to borrow an additional $1.6 trillion this year. And then keep borrowing $1 trillion-plus for years and years to come. There are no surpluses — ever again — in any plausible budget forecasts.

As you probably know, a good portion of that money will come from tax revenues. But the recent elections seek to lower those taxes. And if spending doesn’t follow suit, the government will need to rely even more on bondholders.

But what will the bondholders make of this? How long will they keep buying U.S. government debt before they worry about the government’s ability to pay it back? What if they see inflation increasing? (As inflation increases, their returns plummet because each dollar they receive is worth less.)

What if the Fed buying decreases bonds’ value? And what if the bondholders revolt — becoming the dreaded “bond vigilantes” — dumping their bonds and using the proceeds for other, more lucrative investments?

Exactly how it will play out is beyond the scope of the Daily Reckoning. Besides, we don’t know. But we do know what investments make the best inflation hedges.

Gold is at the top of the list. It’s what people always buy when they fear a crack-up in the monetary system. And that’s part of the reason the yellow metal is hitting historic highs.

Currently, you see ads for companies offering to buy your gold — in exchange for paper dollars. If people knew what was coming, they’d hold onto every piece of gold they own.

Another place to put your dollars while they still have value is Asia. The continent’s fast-growing economies promise strong returns as the America wanes.

Our favorite stock markets are China, India and Vietnam. And the preferred sectors are precious metals (of course), energy and industrials. Together these are likely to generate superior long-term returns.

Michael McLeod
for The Daily Reckoning

Inflation Hedges originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Inflation Hedges




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

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