Dear Readers,

Another historical week just passed.

Last week in my letter the Dawn of a New Era, I said “more investors will participate in 2013 leading to a stronger retail market”:

“Conformity is part of human nature. Retail investors still like to chase and will invest more when things are moving up. With the stock market now up significantly over the last few years, perhaps now the retail market will participate.”
A whopping $22.2 billion flowed into equity funds this week — that’s the second-largest weekly inflow into equity funds ever.

According to Business Insider, $7.4 billion of inflows went into emerging market equity funds this week — that’s the largest of all time.

Long-only mutual funds recorded $8.9 billion in inflows — the largest since March 2000.

Retail investors have only purchased more stocks than they did this week twice before, according to BofA strategist Michael Hartnett.

Bonds also recorded $6.5 billion in inflows.

Sounds like the market is heading up.

But here is the caveat: Retail investors rarely get it right.

Time to Sell the World? A Look at Global Stocks

I believe the markets have topped in many countries around the world, including Germany, France, and the UK. That means it’s probably time to sell Europe; the U.S. is getting very close. A rise above 1475 in the S&P next week could lead us to 1490. I predicted we would peak at 1500 last year within a twelve-month time frame, and we’re awfully close to that number.

I am not saying it’s the end, but I we have more downside than up at these levels – especially in the short-term.

Next week may not be pretty for European markets. But then again, fundamentals haven’t mattered in years, why should technicals?

(Btw, Greek unemployment data was just released and it wasn’t good. The broad unemployment rate for October has been revised to a new record high of 26.8%. The youth (15-24 age group) unemployment also rose to a new all-time high of 56.6%. The ratio of those employed (3.68MM) to unemployed (1.34MM) has now dropped to a record low 2.75x. What’s even more staggering is that the total number of inactive workers (3.34MM) could soon surpass all those who are working. Inactive are those persons who are neither classified as employed nor as unemployed.)

Bearish on Gold and Gold Stocks?

People have turned bearish on gold and gold stocks. Generally this would signal a good time to buy them. The concern here is that when stocks and the economy – even with all of their artificial stimulants – look good, people believe safe haven investments are no longer necessary.

But they’re wrong.

The Fed will continue to print which forces interest rates to remain at low levels — it’s the natural causality of printing (see The Rarest Real Estate). However, interest rates really have nowhere else to go but up.

So what happens then?

Historically, gold has always surged in price under strong inflationary pressures.

A number of significant events have taken place in the last decade that were expected to create a major surge in inflation. That’s why gold has been in an incredible bull market for the last decade.

Everyone talks about the Fed printing now, but they’ve
been doing it for a long time.

During the dotcom bubble, from March 2000 to October
2002, the stock market lost around $5 trillion in market cap. This resulted in significant monetary easing by the Fed in an effort to re-stimulate the economy.

Then the 9/11 terrorist attacks accelerated the stock market drop. This resulted in dramatic increases in government spending on Homeland Security and the subsequent invasions of Afghanistan and Iraq.

Those events alone caused significant inflationary worries and the price of gold doubled from around $250/oz, to $500/oz by 2005.

But it didn’t stop there.

The costs of war continued to grow. Federal budget surpluses became growing deficits, while revenues from taxes fell as the economy continued its struggle. More money needed to be printed.

This resulted in even higher inflationary pressures and sent gold further ahead. In 2007, just before the 2008 crash, inflation as measured by the Consumer Price Index (CPI) finally grew to 4.3% for the year — the highest in the last decade.

Gold continued to climb.

Then 2008 happened.

Government deficit spending increased yet again as massive stimulus efforts were undertaken to prevent the subsequent recession from worsening into the next Great Depression.

This helped gold double yet again to $1900/oz last year.

In 1990s, CPI inflation averaged 2.8% annually. Since 2001, it has averaged 2.5%. The Fed has now printed more money than ever and interest rates are at all-time lows. Yet, over the past year, inflation has averaged only 1.8%. What gives?

First of all, the government measures CPI in their own way and there is no publicly detailed way of how they come up with those numbers. You can try and find out more here: http://www.bls.gov/cpi/cpifact5.htm

Good luck with that.

The Fed wants inflation, but they know it would kill the economy and send the U.S. into a deflationary state if it rises too fast. So they print and fudge the numbers of the CPI.

Second, so many of our goods are now made in developing countries for next-to-nothing. These countries fight for our business with low costs, which translates into lower costs for us. Ever wonder how you can buy a steel hammer for $1 at the dollar store? Ever wonder how this was even possible? Heck, the shipping costs to ship it from China to America would be more than that…

However, costs also go up for the developing countries. As a result of American and worldwide printing, these developing countries also have to print to keep up, or they face a decrease in exports as things get too expensive to produce. I have talked about how this works in detail in my letter, “A Weapon of Destruction.

While it may not seem like inflation has hit, prices have already gone up significantly for a number of goods.

The Rise of the Chicken Wing

Chicken wings are now at all-time highs. Of course, Football playoffs play a big role, but its definitely not the major factor.

Three years ago, the Agriculture Department of the U.S. estimated that the average wholesale price of wings in 2009 was $1.47 a pound, up 39% from 2008 and the highest it has been, adjusted for i
nflation, since the mid-1970s. It continues to climb this year, with estimates of another 30% hike over last year.

The key, however, is how the rise in price compares to the 1970s.

I’ve compared the 1970s to our current scenario many times before (see When to Sell Gold). As a refresher, the 1970s marked a decade of great inflation; a time where economic growth was weak, with a rising unemployment that reached double-digits.

Many blamed the great inflation on oil prices, currency speculators, greedy businessmen and union leaders. But the truth was clear that the monetary policies supported by political leaders, which financed huge budget deficits, were the cause.

Today’s world doesn’t seem so different…except now the printing press is in overdrive, printing out more money than ever.

Inflation and Gold

It may seem that the last 12 years of gold’s rise has been met with an expected inflation rate that has not shown up in the markets. As a result, the bearish sentiment towards gold is racking up. But is it justified? While gold may still be at risk to short-term dips, its long-term value is what truly matters.

The recent bearishness in gold has allowed China to rack up its gold holdings to record highs. Contrary to what numbers are telling the retail market, when the figures are released, I am confident that China will have already doubled its yearly gold import amount in 2012.

If that is indeed the case, China will have imported more gold in one year than all of the gold in Japan’s official holdings, and well over the ECB’s minimal 502.1 tons. We still don’t know how much gold China has accumulated in secret (see A Weapon of Mass Destruction).

Inflationary Dragons

Bill Gross, the world’s largest bond fund manager and one of the smartest in the business, has been very bold in his statements regarding worldwide monetary and fiscal policy, and gold.

In his most recent monthly investment outlook:

“Investors should be alert to the long-term inflationary thrust of such check writing. While they are not likely to breathe fire in 2013, the inflationary dragons lurk in the “out” years towards which long-term bond yields are measured. You should avoid them and confine your maturities and bond durations to short/intermediate targets supported by Fed policies.

In addition, be aware of PIMCO’s continued concerns about the increasing ineffectiveness of quantitative easing with regards to the real economy. Zero-bound interest rates, QE maneuvering, and “essentially costless” check writing destroy financial business models and stunt investment decisions which offer increasingly lower ROIs and ROEs.

Purchases of “paper” shares as opposed to investments in tangible productive investment assets become the likely preferred corporate choice. Those purchases may be initially supportive of stock prices but ultimately constraining of true wealth creation and real economic growth.

At some future point, risk assets – stocks, corporate and high yield bonds – must recognize the difference. Bernanke’s dreams of economic revival, which would then lead to the day that investors can earn higher returns, may be an unattainable theoretical hope, in contrast to a future reality. Japan we are not, nor is Euroland or the U.K. – just yet. But “costless” check writing does indeed have a cost and checks cannot perpetually be written for free.“

Gross said that subject to the debt ceiling, the Fed is buying everything that Treasury can issue. He warns that we have this “conglomeration of monetary and fiscal policy” as not just the US is doing this but Japan and the Eurozone is doing this also.

Gross is a bond king, not a gold investor. But even he cannot stay away from the lustre of the shiny metal.

On December 30, Gross tweeted:

“2013 Fearless Forecasts: 1) Stocks & bonds return less than 5%. 2) Unemployment stays at 7.5% or higher 3) Gold goes up……”

Gross may not always be right, and his timing not always be spot on, but he is certainly more right than wrong. And in the investment world, that makes him a superstar.

Gold bears may want to rethink their strategy…

Until next week,

Ivan Lo

Equedia Weekly

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