Gold Would Go Fast And Furious Soon.

This week, I’ve looked deeply into the issue of inflation, researching what some of the smartest people have to say on the subject.

There are those, like billionaire investor Warren Buffet, who believe that inflation is inevitable: "A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it's going to inflate its way out of the burden of that debt."

Then there are those, like Nobel Prize-winning economist, Paul Krugman, who don’t believe inflation is just around the corner. Although the powers that be have increased the money supply by a trillion dollars, most of that money is sitting in commercial bank vaults as excess reserves and isn't out in the real world creating “inflation” by buying up cars, houses, and flat-screen TVs.

Although in ordinary times, the Fed’s recent actions would cause “inflation," wrote Krugman in a New York Times article, these aren't ordinary times.

“Banks aren’t lending out their extra reserves. They’re just sitting on them -- in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.”

In my opinion, banks aren’t lending yet, but that's likely to change. Think about it in market terms: The short-run situation may be irrational and emotion-driven (banks may fear to lower cash reserves if case additional regulations are introduced), but in the long run, it's the fundamentals that drive prices. Banks have money but want to earn more, so they'll eventually lend it to earn interest.

Nobody can be absolutely sure what the future holds for inflation. In my view, the vast majority of signals are screaming “inflation ahead."

As far as implications for the USD Index are concerned, we've been sideways for approximately a month now -- a considerable amount of time -- thus making the correction more likely to be completed soon. This is naturally bearish news for the US dollar and bullish for the precious-metals market.

There are signs that the general stock market may move lower in the short term, because it has snapped the neckline of a head-and-shoulder of the S&P. Should that be the case, it could affect the prices of precious metals --particularly silver. Still, I believe this would only be temporary.

The breakdown below the neck level (currently below the 90 level) has been confirmed by a relatively high volume just after it materialized. Additionally, we witnessed a brief pullback to the neck line, which didn't close above it, thus confirming the formation. Unless we see a sharp move above this line (89 level) on Monday or Tuesday, the technical picture remains bearish for the general stock market.

GOLD

Last week has been disappointing for precious-metals investors as gold, silver, and corresponding equities followed the general stock market lower.

Gold moved lower despite the technical similarity to a previous pattern that was followed by higher prices. Higher prices were likely, but of course, not guaranteed. In order to make calls that have the greatest probability of being correct, it's important to always take what the market provides and use it on an “as is” basis.

Currently, gold appears to be close to bottoming out, as it seems to be forming the zigzag correction pattern. As mentioned in the past, precious metals tend to correct in a zigzag fashion, and this time we could see another example of this tendency -- meaning the bottom is rather near. Meanwhile, the medium-term chart has not changed much in the past week.

The bullish cup-and-handle formation is still intact, even though the “handle” is now considerably bigger. This doesn't change the overall bullish implications this chart has on gold prices. Additionally, the stochastic indicator -- which has proven a valuable tool in timing local bottoms in the past -- is also suggesting that the bottom is rather near. I'll provide you with one more chart from the premium version -- one indicator suggests that higher prices are likely in the future.

The long-term situation remains inflationary and favorable for the precious-metals sector; however, the short-term situation is rather cloudy. In the very recent past, precious metals have taken the general stock market’s lead, while the dollar has been trading sideways without a decisive breakout or breakdown from its trading range. The long- and medium-term trends are down for the USD Index, so a breakdown from here is more likely than another counter-trend upswing. Still, a significant plunge in the general stock market may negatively affect prices of gold, silver, and corresponding equities.

Investors who are already in the market and plan to keep their positions for at least several months don’t need to trade the rest of the downswing. Short-term speculators might want to wait a little longer before opening a long position in the precious-metals market.

Cheap VIX : Just The Slow Beginning Of 3rd Q, Plain And Simple.

You can't refer to the cheapness or the richness of the Chicago Board Options Exchange Market Volatility Index (VIX) outside the context of historical volatility. The VIX is, first and foremost, a measure of the anticipated volatility of the near-term options on the S&P 500 Index, and the most important clue over the years to the current level of the VIX has been the short-term (10-day or 20-day) historical volatility of the S&P (the VIX calculation doesn't exactly equate to a historical volatility but it is close enough).

So the use of the VIX level as a "fear gauge" must always be assessed net of the major influence of historical volatility on the VIX. While it is tempting after Friday's VIX implosion to less than half its peak levels in January to suggest that investor fear has dissipated to dangerously low levels, this assessment is seriously complicated by the fact that the VIX is not 'low' in the context of the recent volatility of the S&P.

It's a point I've always tried to hammer home. Implied volatility attempts to divide the volatility of the underlying over the stated time frame (usually the next 30 calendar days). There are always expectations of impending news events, and so on, but the best "prediction" tool is simply the volatility of the underlying over the past 2-4 weeks.

What else would you base your markets on besides what you "feel" right now? And as we know, realized volatilities utterly caved early in the cycle, and those "cheap" options actually overbid. That's not uncommon.

Equity volatility is seasonal. According to a recent study by Larry McMillan: 'There is also a seasonality to VIX patterns ...You can see several patterns (over the past 20 years). Early in the year, there is typically a small peak in VIX in January, followed by a slightly higher one in March. "

"Then it goes into a decline during the spring and into mid-summer. It probably comes as a surprise to no one that the low in volatility occurs around July 1 of each year. What might come as a surprise though is that volatility typically rises quite a bit during July and August. Then it really gets going in the fall -- In September and October, when the stock market typically has major declines. It peaks in October."

"After that, volatility becomes surprisingly docile for the rest of year, until by Christmas, it is almost back at the July lows. Not every year follows the pattern exactly, but most are a reasonable approximation. 2008 followed quite closely, and this year the pattern is typical as well.'

"So is it time to assume that the VIX will rally according to these past seasonal patterns? Perhaps, but I'd also suggest the possibility, based in part on the ongoing compression of historical volatility, that the VIX might continue to decline to surprisingly low levels -- perhaps as low as 20 -- before it bottoms."

Well, first off, I feel great that the absolute master in this business agree with some data I came to similar conclusions regarding the early July cycle trough.

Which is also why it drives me nuts when I see "analysis" on the cheap VIX that fails to put it in its proper context, which took the form of assertive directional calls in both directions. On the one hand, analysts said "smart" option money was right to lower bids, as they "knew" the bull would continue this 3rd Q. On the other hand, they said 26 VIX was a red flag of complacency, and bearish.

In truth, neither interpretation was correct. It was a prediction that the always-slow start of 3rd Q was upon us, plain and simple!

Dissecting The Minds Of The Pros.

Billionaire investor George Soros thinks the worst of the global financial crisis is behind us.

In a June 20 interview with Polish television, the Hungarian-born Soros acknowledged that: “Definitely, the worst is behind us.”

For those who like to interpret “Soros-speak,” that’s as powerful a sign as any that Soros -- one of the world’s most successful investors -- is “going long."

But is he wrong?

On the one hand, the World Bank's busy rolling the markets with recent updated figures that project a 2.9% decline in global economic activity this year. Then there are the signs that the green shoots (how I’ve come to detest that term) may be more like weeds. Debt's devastating the developed world, and the once-mighty G-7 looks more like a G-1 every day.

On the other hand, I wouldn’t bet against him. When it comes to financial influence and acumen, Soros is about as powerful and prescient as they come. He’s made billions over the years speculating on things that others simply couldn’t see -- or, more often, didn’t want to see. He’s legendary for making big bets on market timing, even if, by his own admission, he isn't always right.

For the millions of investors tempted to interpret Soros’ comments as bullish, I urge caution. In fact, this advice applies to any comments that might be made by such investment legends as Warren Buffett, or even Soros’ former investment partner, noted author and commentator, Jim Rogers.

I preach caution for 3 reasons:

1. Despite the fact that each of these men is fabulously successful, the typical retail investor has no idea how much money they’re betting on the upside, or what percentage of their wealth is involved in any publicized position.

2. It’s not clear what -- if any -- protective stops are being used, so you don’t know whether the positions they’ve taken represent core portfolio holdings or speculative trades.

3. These revelations -- disclosures, really -- are usually made after the fact, which means that investors who may want to tag along for the ride are put in the risky position of having to make “me too” investments.

So if you’re a savvy investor, what steps can you take to translate moves being made by 3 of the best investors of our time into profits of your own?

1. A good place to start is by taking the time to understand precisely what drives these guys. Even though superficially they're different -- Rogers hunts for opportunities around the world, Soros tends to pursue investment plays involving currencies and macroeconomic trends, and Buffett's a deep-value guy -- they have much more in common than you think. That’s especially true since the core elements of the strategies these 3 investors use to win and profit usually run counter to Wall Street’s conventional wisdom.

2. Take the very concept of profits, for example: Most people are surprised to learn that none of these gentlemen spends the morning rubbing his hands together and cackling over how much money he’s going to make that day. But nearly all have gone on record at one point or another about the importance of not losing money in the first place. They’ve also repeatedly stressed the importance of waiting until the really compelling opportunities develop before putting money at risk.

Rogers, once Soros’ partner at the Quantum Fund -- a hedge fund that’s often described as the first real global investment fund -- goes a step further: He describes his investment process as waiting until somebody puts money down in the corner, then “walking over and picking it up.”

3. Moreover, none of these 3 investors believes you have to take big risks to make big money. In fact, all 3 believe, as I do, that it’s how you concentrate your wealth that matters.

This flies in the face of what Wall Street pros would have you believe, which is that you need to diversify your assets to get ahead. Diversification as Wall Street pros practiced it is a complete misuse of the math and a proxy for an entire establishment that doesn’t know what it’s doing.

The thinking is that by spreading your money around willy-nilly, some of your holdings will rise in value, even as other parts of the portfolio fall. Even so, by diversifying, Wall Street pros say that you'll be better off for it over the long run.

Granted, there are some instances where taking steps to “diversify” leaves you better off than if you’d done nothing at all, but one of the critical problems with diversification as Wall Street pros have practiced it is that it doesn’t work when everything goes down at once ! -- as so many investors who'd been led to believe they were protected found out the hard way in 2000, and again in 2007.

That’s why, for example, I’m a proponent of concentrating my efforts on a few relatively high-probability choices, especially when it comes to trading services. It’s a strategy that individual investors should consider, as well.

4. But what matters most is that people put the comments they hear from these guys into perspective and think for themselves. It’s important to remember that Buffett, Soros, and Rogers don't care about what other people think. That’s one of their real strengths. Nor do they care what the markets will or won’t do.

In fact, none of the 3 -- at least as far as I can tell from the research I’ve done -- subscribes to the “random walk” theories, which I take to be complete bunk.

5. The bottom line is that Soros, Buffett, and Rogers have demonstrated time and again that they’ll only make a move when they’re darned good and ready -- when they’ve done all they can to scope out the situation at hand, and to make sure that the percentages are in their favor.

That, by itself, is a terrific lesson for retail investors to learn. Wall Street tries to push investors into action with advertisements portraying “real” people making trades from their kitchens, or getting the latest quotes on their mobile phones. They show attractive retired couples who’ve achieved their dreams with big sailboats, or antique cars, or expensive vacations. Ignore those messages, and you’ve effectively elbowed aside the artificial sense of urgency that Wall Street pros are trying to create.

Not only is this manufactured urgency designed to separate more of you from your money, but they wouldn’t do it if they knew that most investors got it “right” more often than they got it wrong.

Buffett, Soros, and Rogers act only when they believe the time is right. Buffett has referred to this as waiting for the Sunday pitch. If you’ve never heard that term before, it’s one that dictates extreme patience. You only take action when the one pitch you know you can hit out of the park is on its way -- then you swing from the heels, and give it all your effort.

There’s one final thing these guys do better than almost anyone: Keep everything in perspective. They assemble their portfolios with diligent planning, attention to detail, and an emphasis on the objectives they expect to achieve. They make investments based on a clearly defined set of expectations and don't hesitate to cut their losses if they find out they were wrong.

In that sense, every investment choice they make fits a specific role in their portfolio. Nothing, if they can help it, is left to chance. So to the extent there’s any action to be taken right now, let me leave you with one final thought.

No nation in the history of mankind has ever bailed itself out by doing what the US is doing now, which means that placing bets on a “recovery” is really a fool’s errand. On the other hand, making choices that capitalize on the trillions of dollars now being injected into the world’s financial system is the place to be. History shows that it’s better to be generally long resources, inflation-resistant choices, and real companies with real earnings.

Not only will these kinds of profit plays fall less than others if the markets stumble and fall from here, they’ll also rise faster and farther once the capital infusions start to work their way through the global financial system and the rebound gets under way.

And I’ll bet my bottom dollar that George Soros knows it.

The Sidelines Exist In Order To Preserve Capital.

Friday's strong weekly closing, it was made clear that bearish patterns weren't just going to roll right over, once again throwing a wrench into a traditional technical-analysis (TA) approach.

Let me explain a bit further.

Assuming you've become fed up with fundamental investing - which still has you long some loser of a stock that someone else is calling "cheap" - you venture out into the unknown, curious to see who's actually weathered the recent storm. You stumble upon technical analysis, and - once you get past the fact that it isn't some voodoo investing plan, complete with lot-casting or Tarot cards - you start to understand what makes certain patterns work and why.

You realize that it isn't about predicting the future, but rather about seeing investor psychology in terms of a picture. You start learning and understanding basics such as pennants, wedges, the Holy Grail, and cup-and-handle. You back-test your newfound knowledge, beginning to judge whether these patterns would have actually helped you out.

Pretty soon, you're sold, and ready to start putting capital to work with TA as your guide. You notice that many patterns are setting up in bearish wedges, meaning that -- after a thrust lower - stocks/indexes are consolidating around those lows, implying that another move lower is on its way.

Daydreaming about the Maseratti you'll buy with your TA riches, you begin to lay out a line, taking in some attractive shorts in anticipation of a certain drop.

Then it happens: Rather than a continuation lower, you meet with a doozy of a snapper that not only gobbles up your stocks, it also runs your stops and leaves you with a ding in your portfolio that wasn't there 24 hours before.

It's at this point when new TA traders typically throw in the towel, and when seasoned vets start wondering whether so many are now following TA that it might just not work any more. In my experience, this is precisely when you shouldn't abandon it -- it's a strategy that's remained true for centuries. Instead, you should understand that the sidelines exist in order to preserve both financial and emotional capital.

There's nothing that says traders have to trade each and every day, and, in fact, many of the greatest traders in history stepped away at those points when the picture wasn't clear.

Today, I find myself thinking the same as I review my existing positions and stops, and choose to be patient as we head into the weekend.

Rest up this weekend. Enjoy the time off, and I'll see you back here bright and early on Monday morning.

Try Competing With This Economic Juggernaut.

The United States began its long trek to becoming a worldwide economic powerhouse during the nineteenth century, and became the dominant economic force in the twentieth century. In 1970, US GDP was $1 trillion; it’s risen to $14 trillion today.

In 1970, China’s GDP was $92 billion. Today, it’s $4.2 trillion - a 4,450% increase in 28 years. They now have the third largest economy in the world, and will surpass Japan as the second largest economy on the planet within the next 5 years. Sometime between 2030 and 2050, China will overtake the United States as the largest economy in the world.

This tremendous growth is being driven by the migration of millions of people from farms to the cities. By 2007, 594 million Chinese lived in urban areas, and the United Nations has forecast that China will have an equal rural and urban population distribution by 2015. In the long term, nearly 70% of the population will live in urban areas by 2035. According to Professor Lu Dadao, president of the Geographical Society of China, China’s urbanization took 22 years to increase to 39.1% from 17.9%. It took Britain 120 years, the US 80 years, and Japan more than 30 years to accomplish this.

This rapid urbanization will create huge infrastructure growth, since more roads, sewers, houses, manufacturing plants, power plants, public transportation, and office buildings will need to be built. This trend is identical to the trend seen in the US in the 1800s, with urbanization causing crises in pollution, congestion, and public health. The efforts to solve these problems will create even more growth. The manufacturing of goods for export will slowly be replaced by production for China’s own internal demand. Eventually, China won’t be as dependent on the US for its economic existence.

The population of China is currently 1.3 billion, more than 4 times the size of the US. China’s population isn’t expected to grow much, if at all, between now and 2050. This is a dramatic difference from the US in the 1800s, as immigration and high birthrates increased population exponentially. The Chinese birthrate, which now stands at 1.7 children per family, isn’t high enough to even maintain its current population over the long term.

Most of the arguments that I hear regarding why China won’t surpass the US relate to its aging population. After examining the current age distribution and the projected distribution between now and 2050, there’s very little difference between the US and China on a percentage basis. It’s clear that young populations lead to more vitality, growth, and invention. 20.1% of the Chinese population is under the age of 15. In the US, 21.4% of the population is under the age of 15.

But here’s where the rubber meets the road: Because China’s total population is 1.3 billion, 20.1% under 15 years old equals 267 million people, versus 60 million in the US. China’s youthful population is therefore almost equal to the entire US population.

In 1860, the median age of the US population was 19.4 years old. With 50% of the US population under the age of 20 from 1860 through 1880, there was an unlimited supply of labor to supercharge the engine of growth. America’s youthfulness led to a tremendous sense of vitality and optimism about the future, and young Americans changed the world. In a youthful society, failures are dismissed, and youthful recklessness leads to discoveries, inventions, and new ideas.

But the older a society gets, the more cautious and set in its ways it becomes. In 1860, over 50% of the US population was under 20 years old. By 2040, less than 26% of the population will be under 20 years old. With 20% of the population expected to be over 64, the passion, reckless adventurism, and vitality will be in limited supply. Just the cost to support 80 million old folks will be crushing. Developing countries with young populations will be gaining on the U.S.

By 2050, the US demographic picture will only be slightly better than China’s on a percentage basis. China, however, will benefit greatly from the shift from a rural society to an urban one. The US already has 80% of its population living in non-rural areas. By 2050, China will likely reach a similar percentage. This means that approximately 600 million people -- many of them quite young -- will move from rural areas to urban areas in the next 40 years. This figure is mind-boggling. The youthful urban population will drive progress and advancement.

The piece of the pie that’s overlooked by many is the rapid education of China’s youth. In 1978, there were virtually no Chinese students enrolled in postgraduate programs or studying abroad. Today, there are close to 1 million Chinese students in postgraduate programs and in excess of 100,000 students studying abroad. One-third of all the graduate students in US science and engineering programs aren’t US citizens. With 267 million children under the age of 15, combined with rapid urbanization and the desire for advanced education, China is an economic juggernaut. There will be no denying it the economic crown by the middle of this century. It’s inevitable.

China’s ascendancy doesn’t necessarily mean that the United States will fall. The UK entered the 1800s with a tremendous amount of public debt. Through economic growth, fewer military conflicts, and controlled spending, they were able to reduce their debt from 250% of GDP to 50% of GDP by 1900.

The current US economic position appears to be more dire than that of the UK in 1800. With total debt exceeding 350% of GDP, troops stationed in 120 countries, 2 ongoing wars, a national debt that will reach $14 trillion over the next 2 years, $56 trillion in unfunded future liabilities, and a rapidly aging populace, the US ability for rapid economic growth is compromised. The Americans have lived beyond their means for decades - and now the US is broke.

But Americans have a lot of fight left in them. If they successfully kick their addictions to debt and spending, they can still save themselves. If they continue on their current path of fiscal recklessness, the Chinese -- among others -- will surpass the US before the middle of the century. The choice is on the US.

Dollar : Default or Debase?

While the bond market may have bounced over the last couple days (which I suspect is mostly because the bond market knows the Fed will soon be getting more aggressive with its monetization programs), that bounce has only occurred in terms of dollars.

Because of the dollar’s steep decline, the US bond market continues to crash as far as foreigners are concerned - and these foreigners obviously own a lot of US Treasury debt.

And gold, on the other hand, continues to rally in all the major fiat currencies (see chart above).

What’s the message there? I’ll leave that for readers to decide for themselves, but I'd submit that the market may be catching on to the predicament that the Fed and Treasury are in. There are only 2 options that lie ahead for the biggest debtor on the planet (i.e. the US government), and those options are :

1) default or

2) debase - and they both lead to more inflation.

Can China Allow Its Largest Exporting Partner To Fall Apart ?

Realistically, how high can the 10-year rise from the 3.40% level? Looking at low rates in Japan (and now in the US), there seems to be a bigger force in control. It seems to me, traders don't have the courage to step aside and let rates rise.

China certainly isn't going to step aside and allow its largest exporting partner to fall apart. The government isn't going to stand by and allow rates to rise. There just seems to be a large collusion of groups keeping rates low. I'd like to see rates rise, as I believe it's unfair to prudent investors who are deprived of higher safe rates.

They'll do whatever it takes to keep rates low. My point is that if the dollar falls apart -- and they cannot control that dynamic -- then rates will be jacked for them whether they like it or not.

And if they stand in front of it by monetizing Treasuries, it will actually exacerbate the problem. So they're at the mercy of the dollar here, and the lower the dollar goes, the harder it makes it for them to prop up rates. If I were Ben Bernanke or Tim Geithner right now, I'd be going long on Pampers, extra-absorbent in size.

Not sure if this makes sense, but some are arguing they want the dollar down to stimulate exports, and in fact, are behind this dollar devaluation. Why didn't they lose control of rates as the dollar dropped from 2004-2008? How did Japan keep rates near zero with "quantitative easing"? I'm not challenging anyone, but trying to understand why this go-around, the drop in the dollar would create a problem. Personally, I hope they get what they deserve for playing with Mother Nature!

I think there are two main differences though.. : one, during that period I don’t think the U.S. was being viewed as bankrupt yet, so people were buying U.S. bonds and pushing rates lower as the “safety trade." Two, I think the currents of protectionism are rising to the surface - today’s pissing match over steel being the latest.

And to add to that, I'm wondering whether China has as much an interest in buying U.S. bonds, considering the money isn't being recycled into buying their exports, rather to fund U.S. financial capital holes -- healthcare, education, union paybacks, etc. -- none of which would send the money back to China.