Stock Market Investing: The Dubai Implications, Investment Strategy: Generational Move Unfolding For Gold and Silver Prices

NEW YORK (CNNMoney.com) -- The news that the sovereign wealth fund of Dubai requested a postponement of billions of dollars of debt this week could pose a big problem for U.S. banks...

...Bove said the underlying problem is that there is a lot of uncertainty floating around. For example, there's little information available about counterparty derivatives, guarantees that transfer default risk from lenders to other financial institutions. And it's unknown how much of Dubai World's debt guarantee is held by U.S. banks. Read More...

Stock Market Investing: The above story along with many others have filled the airwaves and blogosphere over the last 4 days. I will refrain from adding my voice to the din. Moreover, endeavoring to postulate on the repercussions seems to me a fool's errand. The sheer plethora of moving parts and back room deals makes a supposition worthless.

I will, however, offer some insight to a more pressing question: How will this event effect the US$, the equity markets and the price of Gold?

An avid reader of this blog will find the answer both simple and familiar. Bad news on the global economic front equates to good news for the U.S. equity markets and the price of precious metals, Gold and Silver.

Investment Strategy: The legend for deciphering this market environment:

Neg.Eco.News = Con't.Q.E.; (Q.E. = Quantitative Easing; catchall for liquidity creation)

Con't.Q.E. = Con't.US$.Dval.; (US$. Dval = US$ devaluation)

Con't. US$.Dval = Exponential Gold and Silver price increases + higher US equity prices

This legend, in all likelihood, will remain in force until major policy changes occur within the White House, U.S. Treasury and Fed. Never in history has the systematic devaluation of a currency led to sustained economic recovery and long-term growth. However, without fail, said devaluation leads to inflation, often hyperinflation, and a flight out of the currency into hard assets. The move unfolding in the price of Gold and Silver will be for most unimaginable, but for the few, the proud, the aware, it will be a move of a lifetime.

Stock Market Investing: Technical/Fundamental Battle, Investment Strategy: Ride the Gravy Train, FOMC Policy, Consumer Credit, Busi. Bankruptcy

Stock Market Investing: A battle between investment disciplines has developed over the last 3 weeks. As discussed in the Oct. 28th post, numerous warning signs of a technical nature are flashing. However, last week's news headlines were replete with US$ bearish/equity market bullish fundamental data. Which discipline will ultimately prevail, technical or fundamental? The answer is unclear, for now we remain bullish with a healthy dose of skepticism.

Investment Strategy: Never fight the trend. If the equity markets want to advance we will gladly participate and enjoy the ride. Stay focused on the areas of the market that have the strongest fundamentals for moving higher; namely the commodity space as this rally is pure and simple a vote against the US$. Remain over-weighted in the precious metals. The relative out-performance of this group was significant during the last market sell off which was, I will humbly remind you, anticipated by RCM.

Now, I would like to take you on a journey through some of the key events of last week. My intention is to reduce the noise generated from traditional news outlets and focus your attention on the important issues driving the markets. You will see how these issues have led to the resumption of the US$ breakdown and the mirror image breakout of the equity markets.

We will begin with some excerpts from the FOMC meeting on Nov. 4th. There was an expectation that the Fed may change wording to appear more US$ supportive. In the prior two weeks, the simple possibility of a discussion about an exit strategy for the current liquidity glut was used as an excuse by traders to bolster the US$. However, as you will read below, the Fed has no intention of changing the policy at this time...

ECONX Summary of FOMC policy statement; maintain the target range for the federal funds rate at 0 to 1/4 percent
...Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. (Is this a boldfaced lie? Surely the Fed knows inflation is a currency event, so why pretend there is no inflation when the US$ is collapsing in value? Simple: the scenario is called "between a rock and a hard place." If the Fed admits inflation is a problem then easy liquidity policies are more difficult to maintain.)

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trln of agency mortgage-backed securities and about $175 bln of agency debt...(Logic suggests rates must remain low while the Fed is buying said debt.) In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010....

...And so the US$ began to lose its bid the minute this story broke on Wednesday last week. In response, the price of Gold rallied and the precious metals mining companies ended the week at new highs on major volume. Interestingly, this group has seen a lot of volume accumulation during a time when the rest of the equity markets are seeing volume selling and/or low volume rallies. This is one sure reason for the strong relative price out-performance the group has enjoyed.

Why does the Fed have no intention of changing policy? Because the economy is in trouble, plain and simple...

September Consumer Credit -$14.8 bln vs -$10.0 bln consensus, prior revised to -$9.9 bln from -$12.0 bln

As expected, consumer credit fell for the eighth consecutive month. Credit declined $14.8 billion in September, far worse than the consensus forecast of -$10.0 billion. The consumer credit decline for August was revised up to -$9.9 billion from -$12.0 billion. The reason for the decline in consumer credit has not changed. Consumers continue to believe they too highly leveraged and are working to repay their debts.

At the same time, banks are worried about possible loan defaults, and in return, they have tightened lending conditions and pulled available credit from even the most credit worthy borrowers.

...Without the consumer there will not be a sustained economic recovery. Furthermore, the state of small business in America would suggest consumer credit is not likely to see a recovery any time soon...

Business bankruptcy filings increased 7% in October - WSJ reports business bankruptcy filings jumped in October, reversing two consecutive months of declining commercial filings and indicating that bankruptcies could continue to rise as the economy struggles to stabilize.

Last month, 7,771 businesses filed for bankruptcy protection, compared to 7,271 that sought shelter from creditors in September, according to new data from Automated Access to Court Electronic Records, or AACER. After two months of decline, the 7% rise in commercial filings shows that businesses are still struggling to access financing and are facing weak demand for their products....
...Add to business bankruptcy problems the number of banks going bankrupt themselves and you get a morbid U.S. economic picture demanding Fed leniency...
Nine U.S. banks seized in largest one-day haul - Reuters.com reports U.S. authorities seized nine failed banks, the most in a single day since the financial crisis began and the latest stark sign that substantial parts of the nation's banking industry are being crippled by bad loans.

Five more banks fail - 120 for the year - CNN Money.com CNN Money.com reports five banks failed late Friday, bringing the 2009 tally to 120. The biggest to fall was United Commercial Bank of San Francisco, which had 63 U.S. branches as well as operations in Hong Kong and Shanghai. The bank held deposits totaling $7.5 billion.

A couple of weeks ago, we warned the "equity markets are trading at these lofty levels because of liquidity not reality and if the Fed-controlled gravy train of easy credit stops, then trouble will ensue." Well, when you combine recent Fed comments with terrible economic data the result is a gravy train of liquidity that continues to roll and keep equity markets buoyant.

Meanwhile, in this Greek tragedy we are watching unfold, the reciprocal of stronger equity markets is a weak currency. The US$ declines as economic numbers worsen and to add insult to very serious injury, the carry traders are having a field day. I warned "The U.S. $ carry trade will gain steam if European economic recovery/inflation outpaces the U.S. and leads to rate increases". It seems with every passing week this prophecy gains momentum and the US$ value declines...

Australia raises rates for second straight month - NY Times reports Australia's central bank on Tuesday raised its benchmark interest rate for the second month in a row, as widely expected, and suggested a gradual withdrawal of stimulus measures amid mounting evidence that the Australian economy is rapidly picking up speed. The increase in its key cash rate, by a quarter-percentage point to 3.5%, makes Australia the only country in the world to have ventured two successive rate increases this year.

Inflationary pressure returns as UK PPI rises - DJ reports U.K. input producer prices rose unexpectedly in October, suggesting that inflationary pressures could be building after remaining muted over the past year, official data released Friday showed. Prices paid by factories for raw materials rose to a 16-month high of 2.6% on the month in October compared with a 0.2% fall in September. On the year input prices rose 0.1%, that was the first annual increase since February, and compares with a steep 6.2% year-on-year decline in September, the Office for National Statistics said. The gains came as a surprise. Economists, on average, were expecting a 0.5% fall on the month and a 6.5% year-on-year drop.

Top 5 October Investment Strategy Posts

For your convience, going forward we will be compiling a "most popular blog post" for the previous month as chosen by the readers. The recap post will consist of direct links to the fan favorties for a quick review of the month's commentaries. Enjoy the read...

#1 Gold Hits New High, U.S.$ Approaches New Low, Nouriel Roubini Rants, Geithner and Lamont Looking Similar, Saudi Central Bank Denies Replacement $

#2 Inflation, Hyperinflation, Stagflation and the Investment Strategy to Benefit, Richard Russell, Fed's Lacker, Credit Tightens, Banks Sift Reserves

#3 Investment Strategy Turns More Cautious, Existing Home Sales, Record Auctions This Week, Galleon Grief

#4 Investment Strategy: Batten Down The Hatches, Quantitative Easing to Slow, Consumer Confidence Suffers, CNBC Viewership Plunge

#5 US$ Carry Trade Intensifies, Pound Sterling Advances on BoE Comments, Fed's Yellen's Comments Add to US$ Decline, Mortgage Apps.Decline

Sept. Housing Data, PPI, Russia and China Talk of Replacing the US$ on energy Trade, UK Real Estate Heats Up

More economic numbers out this morning that suggest a continuation of the status quo.
The Fed can point to the PPI numbers and pretend there is no inflation...
September Core PPI Y/Y +1.8% vs +2.0% consensus, prior +2.3%
September PPI Y/Y -4.8% vs -4.3% consensus

...So rates can remain low to help the listless housing market...
September Housing Starts 590K vs 610K consensus, prior revised to 587K from 598K
September Building Permits 573K vs 595K consensus, prior revised to 580K from 579K

Somehow, all this data results in a U.S.$ rally, T-bond advance (rate decline) and an equity market sell off. I would expect this counter trend move to be short lived. In fact, there have been some developments regarding the U.S.$ that should concern any U.S. $ optimist.

Last week, Russia and China conducted meetings to begin settling trade between the two countries using their own currency. The trade will involve the energy markets. This development brings to mind recent denials we highlighted in the October 5th post out of the middle east that a similar plan is in the works. I believe the appropriate axiom begins, "Where there's smoke...."

BEIJING, October 14 (RIA Novosti) - Russia is ready to consider using the Russian and Chinese national currencies instead of the dollar in bilateral oil and gas dealings, Prime Minister Vladimir Putin said on Wednesday.The premier, currently on a visit to Beijing, said a final decision on the issue can only be made after a thorough expert analysis."Yesterday, energy companies, in particular Gazprom, raised the question of using the national currency. We are ready to examine the possibility of selling energy resources for rubles, but our Chinese partners need rubles for that. We are also ready to sell for yuans," Putin said. MORE...

A possible accelerant about to be poured onto the pile of burning U.S.$s may have a UK label. The real estate market in the UK appears to be heating up. Prices for both residential and commercial properties in London are hitting records. If this recovery turns into a trend that moves across the channel to the rest of Western Europe then Ben and Pinocchio could have a real problem.

The U.S. $ carry trade will gain steam if a European economic recovery/inflation outpaces the U.S. and leads to rate increases much like in Austraila (see Oct. 7th post). A lagging real estate market here in the U.S. will make it difficult for Ben to raise rates. Meanwhile, Pinocchio (Geithner) will continue to express the desire for a strong $ as his nose grows...

London Agents ‘Sold Out’ as Home Asking Prices Jump to Record Oct. 19 (Bloomberg) -- London home sellers raised asking prices to a record high this month and led gains across the U.K. as the shortage of properties for sale intensified, Rightmove Plc said. MORE...

UK property undergoes dramatic recovery - FT
FT reports the UK commercial property market delivered the highest monthly price growth for more than three years in September, capping a remarkable comeback for a sector that looked to have been wiped out only a matter of months ago. Investors are now chasing commercial property and some are complaining that the market has become too hot again. The switch in sentiment has been tangible as investors look to take advantage of a slump that wiped off about 45% from prices from the peak in 2007 by the beginning of the summer. The recovery has been building since, with IPD, the benchmark index, rising 1.1% for September, the highest since June 2006.

RCM Investment Strategy, Earning GS/JPM/INTC/GOOG, Industrial Production Surges, Michigan Sentiment Misses, 60% Of Borrowers Underwater, Fed's Fisher

Tea Leaves; in the last couple of days there have been a lot of them, so let's start reading:

Earnings from the technology space, Intel & Google to name a couple, have been well above expectation. This could be a positive development, but of course expectations are a joke. Analysts constantly get it wrong so let's dispense with the "better than expectations" farce. A note a caution on the Intel number and others on that end of the food chain; an inventory rebuild is occurring at an aggressive pace. This rebuild is only a good thing if consumers spend. I would be more apt to cheer a good earning number out of, say Best Buy, as that would show end user demand. Inventory build without end user demand spells trouble for the economy in Q1 of 2010.

I am loath to discuss the earning of the banks. JP Morgan and Goldman Sachs showed strong results. However, when we parse the numbers it appears that earning were again created with clever accounting.

The tangible parts of GS's earnings were suspect (Investment Banking -38%, Asset Management -6%, Trading and Principal Investments -7%) while the FICC unit (Fixed Income, Currency, Commodities) showed all the gain. "Net revenues in FICC were $5.99 billion, significantly higher than the third quarter of 2008. These results reflected strong performances in credit products and mortgages, which were significantly higher compared with a difficult third quarter of 2008." In other words, last quarter this division had mark downs and this quarter the assets were marked up. Is that a sign of a strong business or clever accounting?

JP Morgan's results were similar to GS. Should we cheer or should we be concerned with this ugly little fact buried in the announcement: "JPMorgan’s loss provision to cover current and future home loan defaults rose to $3.99 billion, while its provision for credit card losses surged to $4.97 billion"

We will choose to be concerned. However, the share prices of the financial group remain in an uptrend and while it may be stupid to believe the earning "surprises" it may be equally stupid to fight the trend of higher share prices. I would suggest you keep the above discussion in the back of your mind so when prices begin to falter you will not be the proverbial "deer in the head lights."

A review of our investment strategy may be in order before we begin the reading of economic tea leaves. I have established over the last few months that the inflation trade is under way. Assets are inflating, both the commodity and equity markets, because of increasing U.S.$ weakness. Hence, weak economic numbers are actually positive for the aforementioned markets because the Fed can not raise rates and defend the U.S.$ while the economy is still in trouble.

So, how is the economy looking?


ECONX Industrial Production Surges
Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%. The jump in production was expected to be driven by the auto industry, and the sector didn't disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.

The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.

There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a "double-dip" as production rises today and quickly falls back in a few months.

Ok, we know from the recent spat of "good" earnings that production is up, but as we discussed this will be negative down the road if consumers don't wake up.

How is the consumer doing...? Briefing: October University of Michigan Sentiment-prelim 69.4 vs 73.3 consensus. This was a bad miss and could spell trouble. Again I will say, this is good for stock market investing.

One reason for this bad Michigan number may be related to the on going problems in real estate as evidenced by this Fitch story...

Fitch Sees 60% of Current RMBS Borrowers Underwater

"The majority — 60% — of remaining performing borrowers within ‘06- and ‘07-vintage residential mortgage-backed securities (RMBS) bear negative home equity, meaning they are underwater on their mortgages and owe more than their houses are worth.The rating agency noted the number of non-agency borrowers 90 plus days delinquent reached 1.66m in September — the highest level on record. The rating agency expects US unemployment to peak at 10.3% in the middle of next year, further pressuring current borrowers. House prices will ultimately decline another 10% over the next year."

What has been the Fed's response to all these tea leaves? Read on...
Fed's Fisher says keep rates low, inflation not a risk - Reuters.com
Reuters.com reports the U.S. economy is recovering but the upturn will be slow and it makes no sense to raise interest rates in this climate since inflation is not a risk, a top Federal Reserve official said.(I humbly suggest someone clue in Fisher to the reality that (all together now) Inflation is a currency event, not an economic event.)

"I am worried about unemployment and I see an enormous amount of slack. I hear it everywhere," Federal Reserve Bank of Dallas President Richard Fisher told Reuters in an interview. "I am super-hawkish on inflation. I don't think that is where the risks are right now," Fisher said.

His comments will reinforce the impression that the U.S. central bank is in no hurry to raise interest rates, despite guarded optimism that the U.S. economy is healing. Fisher, who takes pride in a reputation as an anti- inflation policy hawk, said the U.S. central bank would not lose sight of its long-term obligation to keep price pressures at bay. But he stressed that this was not the current issue. "Right now that is not the risk. The risk is a disinflationary/deflationary risk," he said...

Fisher, who is not a voting member of the Fed's policy-setting committee this year, said it would take "a while" to work off excess capacity in the economy. "I don't see a 'V'-shaped recovery. I see a couple of quarters of growth and then the question is where do we go from there. That is the real key question in 2010 and 2011."

Inflation, Hyperinflation, Stagflation and the Investment Strategy to Benefit, Richard Russell, Fed's Lacker, Credit Tightens, Banks Sift Reserves

Welcome back, today we will continue our discussion about the inflation/hyperinflation/ stagflation trade. In my last post I illustrated how the important news stories of last week clearly unveiled the footprint of the inflation trade. You may recall that I ended with the familiar refrain: "Inflation (particularly hyperinflation) is a currency event, not an economic event."

Therefore, the investment strategy required to profit in this environment is one that begins with the close monitoring of the U.S.$ and ends with the investment in assets that appreciate in value when the U.S.$ suffers.

What is the number one asset we expect to benefit from this developing trend? I will pause here and allow long time readers, clients of RCM, and partners of the Fortune's Favor Family of Funds the chance to shout in unison...GOLD! And as Ed McMahon used to say, "Yes, you are correct!"

With the above investment strategy in mind, I would like to continue our journey following the footprints with a recent word from a respected investment professional. One who has vast experience and in a succinct manner uses his success through the years to impart some valuable wisdom...

The Sage, Richard Russell: "...What happens next is that the cheap dollar is dumped on the market in huge quantities. When any currency or any item is created in massive quantities, that item must fall in value. And the dollar is falling. Ah, Professor Bernanke, what do you do now? To make a currency more attractive, you raise the rates that it pays. But raise the Fed Funds and you squeeze that already gasping US economy. Also, when you raise rates you raise the cost of carrying the gigantic US debt. Total public and private debt in the US is around $57 trillion. A one percent rise in interest rates would drain $500 billion each year out of the US economy...."

Well said! So what are the Fed members saying this week? Is there a will to raise rates...?

Fed's Lacker says he doesn't: "think we should tighten policy today"; willing to go along with purchasing full amount of long-term securities purchases for now...Seeing rise in losses from commercial real estate lending, likely to continue for a while...

No, there is no will to raise rates and to make matters worse the bulk of the commercial real estate tragedy has yet to unfold. In fact, the tentacles of the commercial real estate problem are winding around the neck of small businesses. Without small and midsize businesses recovering, unemployment will continue to get worse further impeding the Fed's ability to raise rates...

Credit tightens for small businesses - NY Times reports many small and midsize American businesses are still struggling to secure bank loans, impeding their expansion plans and constraining overall economic growth, even as the country tentatively rises from its recessionary depths.

Most banks expect their lending standards to remain tighter than the levels of the last decade until at least the middle of 2010, according to a survey of senior loan officers conducted by the Federal Reserve Board. The enduring credit squeeze appears to reflect an aversion to risk among lenders confronting great uncertainty about the economy rather than any lingering effects of the panic that gripped financial markets last fall, after the collapse of the investment banking giant Lehman Brothers. Bankers worry about the extent of losses on credit card businesses as high unemployment sends cardholders into trouble.

They are also reckoning with anticipated failures in commercial real estate. Until the scope of these losses is known, many lenders are inclined to hang on to their dollars rather than risk them on loans to businesses in a weak economy, say economists and financial industry executives.

These developments are all U.S.$ bearish. Central bankers around the world see the writing on the wall and are moving towards the exits...

Dollar reaches breaking point as banks shift reserves - Bloomberg.com Bloomberg.com reports central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two- quarter rout in almost two decades.

Policy makers boosted foreign currency holdings by $413 billion last quarter, the most since at least 2003, to $7.3 trillion, according to data compiled by Bloomberg. Nations reporting currency breakdowns put 63% of the new cash into euros and yen in April, May and June, the latest Barclays Capital data show. That's the highest percentage in any quarter with more than an $80 billion increase... The diversification signals that the currency won't rebound anytime soon after losing 10.3% on a trade-weighted basis the past six months, the biggest drop since 1991.

Meanwhile, the price of Gold has advanced roughly 22% since the beginning of the year. Our hedge fund, Fortune's Favor Precious Metals, has exceeded the performance of gold year to date. You can review our investment philosophy as well as the quarterly and annual returns on our website: http://www.rosenthalcapital.com/.

I have received many questions recently about the sustainability of the precious metals move higher. As Gold took out the $1,000 level a menagerie of analysts and letter writers wrote of the impending doom of the Gold rally. As Gold moves above $1,050, I hear countless tales of certain failure, of commercial shorts winning the day. I LOVE THIS TALK! This type of bearishness is typical of continued momentum higher.

To sum up, I will simply reprint the headline from a recent Barron's story: Gold Is Still a Lousy Investment By Dave Kansas. Need I say more?

Until next time, chew on this:

"It is not because things are difficult that we do not dare; it is because we do not dare that they are difficult." Seneca, philosopher

The Inflation Trade, Alcoa EPS, Obama's New Stimulus Plan, Australia's Interest Rate Increase, Commercial Real Estate Woes

Today we are going to follow the footprints of the hyper-inflation/stagflation trade that I have been writing so much about. By simply understanding the impact of the important news stories and avoiding the noise of the traditional media outlets, tracking our quarry will be relatively easy.

Footprint number one: Alcoa has a much better than expected earnings number. However, the key takeaway here is not that a 33.8% decline y0y was better than analysts thought. The gem in this story is that Alcoa beat expectations because of rising prices. Revenues beat expectations because the price of the commodity is rising. We call this little phenomenon INFLATION.

AA Alcoa beats by $0.13, beats on revs (14.20 +0.31)
Reports Q3 (Sep) earnings of $0.04 per share, excluding restructuring and non-recurring items, $0.13 better than the First Call consensus of ($0.09); revenues fell 33.8% year/year to $4.62 bln vs the $4.55 bln consensus. Sequentially, revenues were helped by an increase in realized prices for primary aluminum to $1,972 per metric ton from $1,667 per metric ton in the second quarter, as well as stabilization in the end markets. Co reports cash sustainability are exceeding targets. "In the second half of 2009, there are signs that key markets the Company operates in are stabilizing. Due to low inventories at distributors and rising shipments, regional premiums are improving and global aluminum consumption is expected to increase 11% in the second half of 2009." (Stock is halted.)

Footprint number two: The administration recognizes the economic recovery is in trouble and is preparing another stimulus package. So, we have rising commodity prices and no economic recovery. This combination is called STAGFLATION.

Oct. 6 (Bloomberg) -- President Barack Obama is considering a mix of spending programs and tax cuts to respond to widening job losses that would amount to an additional economic stimulus without carrying that label. Read More

Footprint number three: The commodity based economy of Australia heats up and its central bank raises rates. This morsel of a development will have a significant impact on the value of the U.S.$ going forward. The Australian announcement obviously strengthens our case for higher commodity prices and in turn inflation, but the real important consequence of the move will be its influence on the carry trade. The currency of choice for the carry traders of the world is now the U.S.$.

In years past the Japanese Yen was the whipping boy of the currency carry trade as traders sold Yen and bought U.S. treasuries or other assets to benefit from the spread in interest rates. Now, with interest rates held down by the Fed, carry traders can sell U.S. dollars and invest in, for instance, Australian government debt and profit on the interest rate spread. This trade also benefits as the Aussi $ goes up in value versus the U.S.$. As you can see, this behavior begins to feed on itself. The more U.S.$ sold and Aussi bonds bought with Aussi $s the faster the value of one currency goes down while the other goes up adding to the profits of the trade. The result is a progressively weakening U.S.$ leading to a nasty little thing called HYPER-INFLATION.

SYDNEY (Reuters) - Australia's central bank raised its key cash rate by 25 basis points to 3.25 percent on Tuesday and heralded more to come, saying it was safe to row-back on stimulus now that the worst danger for the economy had passed. The Australian dollar jumped to a 14-month high and interbank futures slid as investors rushed to price in at least one more hike by Christmas, and rates above 4 percent in a year. Read More

Why don't the powers that be do something to prevent the tsunami of U.S.$ selling you ask? Well, their hands are tied as the story below illustrates. With commercial real estate teetering on the brink, an increase in interest rates is out of the question. You can forget all the verbal attempts the Fed and Treasury secretary Pinocchio (Geithner) make to support the greenback.
Fed frets about commercial real estate - WSJ
The Wall Street Journal reports banks in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month. The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst.

"Banks will be slow to recognize the severity of the loss -- just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal. A Fed official confirmed the authenticity of the document, prepared by an Atlanta Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking examiners throughout the U.S. I

In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007. The Journal's analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses.
Tune in next time for a discussion on the best way for an investment portfolio to benefit from the scenario discussed above....

Gold Hits New High, U.S.$ Approaches New Low, Nouriel Roubini Rants, Geithner and Lamont Looking Similiar, Saudi Central Bank Denies Replacement $

Gold breaks out to a new high up 2.4%, Silver up 4.36%, the equity markets are up over 1.5%, and the U.S.$ is down another .66%. The inflation trade is alive and well.

I would like to begin with a quick comment on Nouriel. I have reprinted the essence of his most recent comments for your perusal:

Nouriel Roubini appears on CNBC discussing his weekend comments about stocks rising "too much, too soon"
Says there are several reasons the recovery is going to be anemic: 1) the labor market is just awful; 2) the consumer is shopped out, saving more and consuming less; 3) there is a glut of capacity; 4) the financial system is damaged with limited credit growth; 5) fiscal stimulus will become a drag by next year; and finally, overspending countries like the U.S. are spending less while spending in oversaving countries is not picking up.

While I agree with his thoughts on the economy, I feel we should avoid placing any weight behind his stock market call for three reasons:

1. The media loves to cheer Nouriel for his historic bear call on the markets last year. But you see, that's the problem, the call is history. Now, every time the markets fall for a week or two the media trouts out Roubini for another "Dr. Doom" market call. What they don't tell you is that he has felt the same way all year and yet the market has rallied. Point being, how helpful has his market opinion been this year?
   
2. I fear Roubini may join a long list of pundits who get it right once and make a career out of the call but they don't help your investment career going forward. Anyone remember Elaine Garzarelli? She called the 1987 crash right and nothing else since. Or, how about Ralph Acampora and Abby Cohen? They called the bull market right at the turn of the century and had every financial network scrambling for a sound bite right at the top. Where are they now? The markets collapsed and they missed the call so Ralph loses his job and Abby gets shuffled. You see, inherent in every right market call are the seeds for failure on the next call. Successful tools that help during one market environment may not necessarily help when the environment changes and the hubris that inevitably infiltrates the minds of these "correct" pundits clouds their ability to spot the change. It is only human nature and happens to the best of us. I'm simply saying beware.
   
3. The driving force behind the equity market rally may, in fact, be something other than the economic turn around and if so then Roubini's call will be based on the wrong issues. As I have stated many times over the last few months, we believe this market rally is building momentum because of the inflation trade (please see the Sept. 7th post for details). Roubini's call for economic trouble plays right into our inflation trade theory and is the impetus for higher, not lower, equity prices. Those of you who are subscribers to this blog know the familiar refrain: Inflation is a currency event not an economic event. The more negative economic numbers come out, the longer easy credit will flow, the more the Fed will monetize U.S. debt and the U.S. $ will continue to weaken. This progression leads to an ever increasing exodus out of the U.S.$ into hard assets and equities that benefit from inflation or have a growth rate much greater than inflation.

Since, inflation is a currency event not an economic event, it behooves us to keep our collective eyes on the greenback. By closely monitoring the developments involving the U.S.$ we may glean some valuable insight into the direction of both the commodity and equity markets....

UUP U.S. Dollar loses ground to Euro - WSJ WSJ reports the 16-nation euro rose Monday against the U.S. dollar despite attempts over the weekend to boost the strength of the American currency. The euro bought $1.4648 in morning European trading, up from $1.4588 late Friday in New York. The British pound rose to $1.6010 from $1.5919 in New York, while the dollar rose slightly to purchase 89.77 Japanese yen from 89.63 late Friday.

The dollar weakness came even after finance ministers from the Group of Seven wealthy nations talked up the currency amid fears it could fall farther and disrupt the global economy. U.S. Treasury Secretary Timothy Geithner and France's Christine Lagarde stressed the need for a strong dollar. Mr. Geithner said it's "very important for the U.S. that we continue to have a strong dollar," while Ms. Lagarde said "we need to have a strong dollar .. volatility is not welcome."

...When world leaders assemble to talk about supporting a currency and the currency breaks down anyway often an inflection point is rapidly approaching. During the collapse of the British Pound in 1992, British central bankers repeatedly stressed the desire for a strong currency much like "Pinocchio", I mean Geithner, has over these many months.

Norman Lamont was the British "Pinocchio" from 1990 -93. He famously announced he would borrow $15 billion to defend Sterling right before the ultimate devaluation of the currency. At the time George Soros was short $11 billion worth of the Pound sterling and pocketed a cool $1 billion on the day of the devaluation. I only wonder what Geithner will say right before the ultimate fall? (Click for Soros' opinion on the U.S.$ today)

I love the smell of fresh denial in the morning....

Saudi central bank says report on replacing dollar is wrong - Reuters Reuters reports newspaper report that Gulf Arab states are in secret talks to replace the U.S. dollar in the trading of oil is wrong, Saudi Arabia's central bank chief said on Tuesday. Asked by reporters about the story in Britain's The Independent, Muhammad al-Jasser said: "Absolutely incorrect." Asked whether Saudi Arabia was in such talks, he replied: "Absolutely not." The Independent quoted unidentified sources as saying Gulf Arab states were in secret talks with Russia, China, Japan and France to replace the U.S. dollar with a basket of currencies in the trading of oil.

U.S. Dollar Downtrend / Equity Market Rally, Inflation Trade vs. Economic Recovery

Take a good look at the chart above courtesy of "The Market Ticker." The secret to the equity markets' strength recently and perhaps going forward may be revealed by the downtrend highlighted.

Most of the conversations I've witnessed on the topic of the current market rally have centered around the recovery of the economy. I've heard countless arguments about earning rebounds and V shapes.

As readers of this blog it will come as no surprise to you that we at RCM would question the validity of V shapes. We would also caution against extreme excitement over EPS "surprises" and we would suggest there is a significant difference between inventory build and actual sales to consumers. The Intel "beat" should be taken with a Dell "miss" grain of salt.

However, I would like today to suggest that the whole Earnings argument may be mute. The real reason we are seeing equity prices inflate may be tied to the beginnings of the inflation trade. The chart above illustrates a rather precipitous slide in the ongoing demise of the US$. Since the beginning of March the dollar has dropped in value roughly 13%, which has coincided (or more appropriately expressed: created) an equity market reflation trade.

Keeping a close eye on this US$ trend and spending less time worrying about possible recoveries may be the best formula for investment success going forward.