Right Under Your Nose

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Another week, another…Well, let’s be real, it’s almost impossible to summarize in one word a market that has been aggressively trading sideways for the last three months.

Spring time fever and the summer doldrums are beginning to set in quicker than ever. Bid support for many of the commodities-based stocks are falling by the wayside, forcing great stocks much lower than where they should be.

When things get volatile, people get scared and run. While I did tell our readers a few weeks ago to take some profits (before the commodities sell-off began), I did so with an emphasis that the commodities rally, in particular the precious metals rally, is not over.

Speculators, manipulators, government intervention, profit-taking, and regulations, it doesn’t matter what spurred the recent sell-off in commodities. The fact is, nothing has changed.

That means the overall trend in both gold and silver still remain to the upside. Short term volatility will stay over the next few months and is expected. If you’re positive in your precious metal investments, profit taking wouldn’t hurt – but adding to your positions wouldn’t hurt either. Just remember that we’re playing this rally for the long run, and not just for the short grind. Would I be surprised to see silver at $25? Nope. But I wouldn’t be surprised to see it $50 either. If silver goes back to $25, I’ll be loading up.

As with any major bull market trend, the real profits come from being long. And with any bull market trend, downside corrections do happen. Funds need to take profits and with record-highs, they should. Summer is fast approaching and we know things will lag during this time, as they always have in every market. The old saying “sell in May and go away” couldn’t be more apparent.

If you’re up in sectors other than commodities, it may be wise to take your profits now. Investing in a volatile market is about wealth preservation. Don’t get greedy.

June will be a month to watch as QE2 officially ends. While Bernanke has hinted that QE3 is unlikely, very strong and valid reasons show otherwise (see The World Will Listen.)

Bernanke has already told us that the Fed will keep interest rates low for an extended period of time, or until job growth numbers do better and the economy can sustain itself with tighter credit. Truth be told, this won’t be anytime soon. This leads me to believe that QE3 is not an option, but a must.

Why?

Some of the smartest and savviest investors are those who invest in the bond markets. The bond market is also one of the leading indicators for what is about to happen next, yet most retail investors never take it into consideration.

While current U.S. rates remain low, rates in other countries are rising. In many cases, they’re much higher than current U.S. rates. Combine that with Bernanke’s recent statements, you would think bonds would be declining, but they’re not…yet. Are the smarter bond investors telling us that inflation won’t be as strong as predicted and the U.S. economy is going to slow more than expected, leading us to a double-dip?

Not so fast.

We have been telling you time and time again that the US debt levels are ballooning to record levels. In order to fund the US’ reckless spending, it has been selling bonds to the Fed. As such, the monetary base is growing at an annualized rate of nearly 100%. That means the Fed has now become the biggest buyer of US bonds in the world, beating out the original number 1 and 2 spot crowned to both China and Japan.

But as we mentioned in “Age of America Over?” a few weeks ago, China is now diversifying its massive $3 trillion dollar foreign reserve stockpiles into investment funds designed to invest in precious metals and oil. Japan, on the other hand, has problems of its own and investing its resources into a foreign country is more than likely not its focus given their recent tragedies.

If the world’s largest buyers of US bonds are looking elsewhere, who will provide the US with the cash it needs to survive once QE2 ends? There is no way the US will be out of their mess within the next few months. There is no way it will survive without having to borrow more money.

Heck, the head of the world’s largest bond fund won’t be lending the US a hand. Bill Gross, the head of PIMCO, has not only sold all of their bonds but is now shorting the US bond market. His flagship, $235 billion Pimco Total Return Fund (PTTAX), now holds a net short position in “government-related” debt securities, while also sitting atop an enormous $73 billion pile of cash.

In a recent interview, Gross said the only way he would reverse his short positions is if, “weak economic growth or a future recession that substantially lowered inflation and inflationary expectations.” So unless we go double-dip, he’ll continue shorting US bonds (as I suggested in “Age of America Over?”

Here’s what the $1.2 trillion money manager had to say in his April 2011 outlook:

If I were sitting before Congress – at a safe olfactory distance – and giving testimony on our current debt crisis, I would pithily say something like this:

“I sit before you as a representative of a $1.2 trillion money manager, historically bond oriented, that has been selling Treasuries because they have little value within the context of a $75 trillion total debt burden. Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates.” – Bill Gross, Head of PIMCO

So far this year, the US Treasury has raised $293 billion in net cash by selling Treasury securities. And so far this year, the Federal Reserve has purchased a net $330 billion of Treasury notes and bonds. That means the Fed has provided 100% of the net new cash the Treasury has “raised” this year, and a mere $37 billion using what we call “old money.” 70% of the US bonds so far this year has been bought with money that basically came out of thin air, or as most would call it, the printing press.

It’s like I said before, there will be a QE3 – they’ll just call it something else.

“If the USA were a corporation, then it would probably have a negative net worth of $35-$40 trillion once our ‘assets’ were properly accounted for, as pointed out by Mary Meeker and endorsed by luminaries such as Paul Volcker and Michael Bloomberg in a recent piece titled ‘USA Inc.’

However approximate and subjective that number is, no lender would lend to such a corporation. Because if that company had a printing press much like the US with an official ‘reserve currency’ seal of approval affixed to every dollar bill, that lender/saver would have to know that the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways:

1. outright via contractual abrogation – surely unthinkable
2. surreptitiously via accelerating and unexpectedly higher inflation – likely but not significant in its impact
3. deceptively via a declining dollar- currently taking place right in front of our noses, and
4. stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain.”

– Bill Gross, Head of PIMCO

So while the US continues to arrest and take down the so-called financial baddies, its borrowing money to pay for…well, borrowed money. This is happening right under your nose.

Would the Real Ponzi please stand up?

Until next week,

Ivan Lo
Equedia Weekly

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