Buoyed by gold’s action, silver has also seen some price movement. After dropping as low as $15.13 in February 2010, it has jumped nearly 30% to 19.52. (Silver prices hit $19.70 today in intraday trading).

Seems like Marc Faber was right about gold being a bargain at $950/oz! Since that post about 2 years ago, gold prices are up about 29% versus the S&P 500 which is down about 8%.

Related Posts

• January 25, 2010 -- Venezuela Devalues Its Currency
• October 4, 2009 -- World Bank President: Time To Diversify Out Of The Dollar
• September 8, 2009 -- Why Is Gold At A $1000/Oz?
• August 24, 2009 -- China To Buy $80 Billion Worth Of Gold
• March 6, 2009 -- Global Economic Recession: Coming To A Town Near You!
• February 18, 2009 -- Demand For Gold Tops $100 Billion!
• February 2, 2009 -- Peter Schiff: Dollar Is The Next Bubble To Collapse

Millions of Americans are now deeply underwater on their mortgage. If you’re among them, you need to stop living in a dream world and give serious thought to walking away from the debt.

No, you shouldn’t feel bad about it, and you shouldn’t feel guilty. The lenders would do the same to you—in a heartbeat. You need to put yourself and your family’s finances first.

If you are reluctant to give up on “your” home, realize that it isn’t “yours.” If you are in negative equity, it’s the bank’s home. You’re just renting it. And right now you may be paying way above market rates. You need to be ruthless about your cash flow.

Still, when it comes to the idea of walking away from debts, many people are held back by a sense of morality. They feel it’s wrong to abandon their obligations. They don’t want to be a deadbeat.

Your instincts, while honorable, are leading you astray.

The economy is fundamentally amoral.

Whether we like it or not, walking away from debts is as American as apple pie. Companies file for bankruptcy all the time, and their lenders eat the losses. Executives and investors pocketed millions from the likes of Washington Mutual, Lehman Brothers and Bear Stearns when the going was good. They didn’t have to give back one cent of that money when the companies went into bankruptcy.

Wow, I’m speechless. It seems the greed of Wall Street has permeated down to the lower rungs of society and it’s perfectly okay to socialize your debts and losses. (By socializing, I mean the bank or taxpayer or a large group of people who are not affiliated to you end up paying for your debts/losses/mistakes/greed). Apparently its as American as apple pie. Is this the change I didn’t vote for? If everyone in all sections of society thinks its perfectly okay to default on your obligations, logically, the next question is

How much longer until the US Government starts defaulting on its debts?

Of course, the US Government cannot default, since it can keep printing US Dollars to pay for its debt. Which it is already doing. The only problem is that this increases the number of dollars in circulation and causes the currency to devalue. Sooner or later, we’re going to see a large of amount of inflation. No we may not see hyperinflation like Brazil or Zimbabwe, but we sure might see 10-12% inflation for a few years.

But 12% inflation for only 6 years would cause the price of everything to double. If you don’t think that’s possible, just look at a country which isn’t currently in deep recession, like India. Inflation in India is currently running at 9%. And over the past decade it has been running at a similar rate.

So what’s the effect on the average Indian? Highly skilled workers saw their salaries jump 10 times, while salaries for unskilled labor is up about 5 times. So everyone is better off, right? Not exactly, people living on fixed incomes basically got screwed as prices for everything else went up 5-10 times as well. It was great if you owned real assets like real estate, gold and to some extent stocks, but terrible if you owned bonds or cash. Just make sure your investments are tailored towards those investments that happen to do well during inflationary times.

Related Posts

• September 15, 2009 -- The Recession Is Over, Unemployment Expected To Rise
• May 26, 2010 -- US Debt Breaks $13 Trillion
• January 25, 2010 -- Venezuela Devalues Its Currency
• January 19, 2010 -- Suzie Says “Pay Off Your Home Mortgage”
• September 22, 2009 -- The Sun Sets On Dollar Supremacy
• September 10, 2009 -- Weekly Round Up Of Interesting Articles
• August 21, 2009 -- Buffett Finally Admits the Dollar is Doomed!

Gold bugs are forever telling you to buy gold because it is ‘nobody else’s liability’. It’s become one of those hackneyed phrases that has almost lost its meaning.

But recent events in Venezuela give us a nice illustration of what that phrase really means. And there’s a stark, but important message for savers everywhere.

Inflation is currently running at 27% in Venezuela. That’s just the official figure. You can expect the real number to be considerably higher.

Earlier this month, the Venezuelan president Hugo Chavez, devalued the bolivar by half, from 2.15 per US dollar to 4.30 per dollar. There will be a second peg, subsidised by the government, of 2.60 bolivars per dollar for essential imports such as food, medicine and machinery.

This devaluation has effectively doubled the cost of imported goods and halved the Venezuelan people’s purchasing power in a single stroke. Savers – though I doubt there are that many given the country’s precarious situation – will have had half of their wealth effectively wiped out overnight.

Chavez is doing it, he said on state TV, ‘to boost the productive economy, to reduce imports that aren’t strictly necessary and to stimulate exports.’ But that won’t be the effect. All his actions will do is discourage people from working at all. Leaving aside the moral issue of whether government should have the power to do that (and, largely speaking, with our modern system of money and credit, they do), many Venezuelans will now ask themselves: ‘What is the point of my working at all, if the proceeds are going to be devalued so suddenly?’

But any Venezuelan who happened to have converted some of their wealth into gold would be protected from these government foibles – at least, as much as is possible under the circumstances. [LOD"s note: Not only gold and silver, but even real estate would hold its price in an event like this. Over the long term, real estate matches inflation, and to some degree population growth]. Chavez cannot suddenly devalue gold by half to ‘boost the productive economy’. So the proceeds of that individual’s labour would have been preserved. The purchasing power of gold against essential goods such as food, energy and shelter remains unchanged – in fact it’s probably risen.

I remember backpacking across South America in the early ’90s. Venezuela was one of the wealthiest, most advanced nations on the continent. It’s such a shame to now see the country on Hayek’s The Road to Serfdom, or, worse still, to Zimbabwe.

“Chavez”, writes Daniel Cancel on Bloomberg, “is trying to maintain spending for his 21st century socialist revolution as South America’s largest oil exporter fails to emerge from its first recession in six years. The government is seeking to stem its falling popularity and the highest inflation rate among 78 economies tracked by Bloomberg, ahead of parliamentary elections scheduled for September.”

Well, isn’t our own government doing the same thing? Haven’t they boosted spending over the last three years in an attempt to stem falling popularity ahead of an election? Isn’t quantitative easing an elaborate form of currency devaluation? The effect of their actions has been that sterling has been losing its purchasing power. It buys us considerably less food, energy, medicine, industrial goods and anything else you care to mention (except mass manufactured goods from Asia) than it did five years ago.

It even buys us less foreign currency, as the chart below – which shows sterling against a basket of foreign currencies – shows. (I’ve drawn on that white line highlight the market direction) The only reason sterling has not fallen further is that other foreign central banks have been doing the same things to their own money. It is a race to the bottom.

Our currency has devalued many times before. Anyone who remembers 1976 can tell you about the sterling crisis then. Financial markets were losing confidence in the pound. (I believe that loss of confidence is coming again. If sterling drops below $1.57 against the dollar, look out below).

The UK Treasury could not balance its books, while Labour’s strategy emphasized high public spending. The newly-elected prime minister, Jim Callaghan, was told there were three possible outcomes: a disastrous free fall in sterling, an internationally unacceptable siege economy, or a deal with key allies to prop up the pound while painful economic reforms were put in place. What will David Cameron be told should he win in the summer? The parallels to today are uncanny.

In more recent memory, we have had the sterling lows of March 1985 (when we almost hit parity with the dollar), then another crisis with ‘Black Wednesday’ in October 1990, when we were forced to drop out of the European Exchange Rate Mechanism.

What is worrying is that our current deficits, debts and spending are all at far greater levels than during any of the previous crises. So many toxic assets have been transferred from the balance sheets of banks to governments, that sovereign debt default – not just here, but throughout the Anglo-Saxon economies – is now a major risk.

You can read the entire article on moneyweek.

So Why should you care?
If you invest in US companies that do business with Venezuela, then your portfolio returns will definitely be adversely impacted. US companies that do business with Venezuela like Haliburton are likely to feel the impact of this currency devaluation. Haliburton CEO just announced that they may face a $30 million loss in the 1st quarter because of this.

While I liquidated almost my entire stock portfolio at the market open this morning (including Harvest Natural Resources which does business in Venezuela), I’m still keeping my gold and silver coins!  Talking the about market, its risen 50% since the March lows of last year. I might even go short some weaker stocks on any market bounces too.

Related Posts

• May 12, 2010 -- Gold Closes At Record High
• February 15, 2010 -- Taleb: Everyone Should Short US Treasuries
• October 6, 2009 -- Gold Hits Record High!
• September 8, 2009 -- Why Is Gold At A $1000/Oz?
• August 24, 2009 -- China To Buy $80 Billion Worth Of Gold
• June 24, 2009 -- Protecting Yourself Against Inflation
• March 6, 2009 -- Global Economic Recession: Coming To A Town Near You!

And despite the decent performance of gold over the past 10 years, they’re correct. Gold is a lousy investment. It creates no income and just barely keeps up with inflation.

But do you know what the best performing asset class was during the past 10 years? No, it wasn’t your stock portfolio or your real estate. It was gold, and it returned a decent 270% over that period.

Despite its out-performance of all major asset classes, gold still gets no respect from the investment community. That’s because it is only a store of value and typically only does well in periods of currency crisis, or times of poor monetary policy.

For example, during post-WW2 Germany and in post-Mugabe-school-of-economic-policy Zimbabwe, their currencies have faced severe devaluation and gold prices sky-rocketed against those currencies. Faced with hyperinflation and an inability to buy basic necessities, people flock to gold causing the price to soar.

But that wouldn’t happen in the US right?

Economic research has shown that consumer psychology is affected by the amount of wealth people feel they have. If they’re broke and living pay-check to pay-check, but have tons of equity in their homes, they still feel wealthy. But even if they still have a job, but are upside down on the mortgage and have negative equity in their home, they feel poor and their spending decreases. Since the US is a consumer spending driven society, with spending constituting 70% of our GDP, the Federal Reserve has been trying desperately to get the consumer to start spending again.  Part of this entails propping up housing prices by keeping mortgage rates low, and another part is keeping interest rates low on non-collateralized consumer debt (that’s credit cards and student loans).

In an effort to stem the free-fall in the housing market, the Federal Reserve has been trying to keep the interest rates for mortgages as low as possible. Historically, the Fed has tried to manipulate the short-end of the yield curve by adjusting the shortest of short-term rates – the Inter Bank Overnight Rate (also called the Federal funds rate in the US. The UK has something similar called the LIBOR). This is supposed to have a trickle down affect the interest rates of long-term interest rates (such as the 10 year and 30 year Treasuries).  The rates for 3o year fixed rate mortgages are impacted by the rates on the 10 year Treasuries. So by keeping the federal funds rate at zero (or 0.2% which is close to 0%), mortgages rates should stay quite low. However, given the fact that this is not a typical economic scenario, the fed isn’t quite sure that mortgage rates would stay below 5%. So it has been buying billions of long-term Treasury bonds as well as mortgages, which is a quite a bold move away from its historic stance. When the 800 pound gorilla starts buying bonds, the prices rise and the yields go down.  When the Federal Reserve decides to buy $300 Billion dollars worth of mortgages and government bonds, something is definitely wrong with the economy.

I’m  interested to see the effect on mortgage rates once the Fed stops buying Treasuries and mortgages.

The government is increasing its deficit spending at a steady clip. If this continues, eventually we will be unable to repay the debt and barely just able to service the debt. Obviously this is not a viable long-term strategy, but it doesn’t look like there is any other back-up just in case helicopter Ben’s strategy of throwing money at the problem doesn’t pan out.

Clearly, we are currently in a crisis period in regards to fiscal policy and gold prices are likely to keep going up. During times of good fiscal policy, gold does nothing. This does not seem to be one those times.

A well-known hedge fund manager (and world poker champion) David Einhorn shares the sentiment.  And someone else who agrees with him is Liu Mingkang, chairman of the China Banking Regulatory Commission. He recently said, “Low U.S. interest rates and a weaker greenback have “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

Someone I know who works at a very well-known bond fund company recently advised me to sell my gold holdings. He advised me the same thing last year when gold was only $800/ounce. And I told him the same thing I said last year – Not yet.

Disclaimer: I’m long gold/silver bullion, gold mining stocks and short long term treasuries.

Related Posts

• May 12, 2010 -- Gold Closes At Record High
• January 25, 2010 -- Venezuela Devalues Its Currency
• November 9, 2009 -- Gold breaks $1,100: Does It Matter?
• October 6, 2009 -- Gold Hits Record High!
• October 4, 2009 -- World Bank President: Time To Diversify Out Of The Dollar
• September 12, 2009 -- Guess Who’s Betting On Inflation!
• September 8, 2009 -- Why Is Gold At A $1000/Oz?

The IMF still has another 203 tons of gold to sell and the hot favorite to make the purchase has been China.  However, according to a report by Reuters, its a lot cheaper for China to buy domestically mined gold than purchase bullion from the IMF at the current spot price. According to Li Yang, a former adviser to the People’s Bank, “China’s gold is much cheaper than that.”

You may not realize it, but China is the world’s No. 1 gold producer, and its mine costs are much less than $1,100 per ounce. And given China’s propensity to put national well-being over any private individual or firm, they’re likely to just pay for the gold being mined at cost, which would be a lot lower than the spot price.

According to another Chinese Central Bank official,

China is the world’s biggest gold producer, so there’s no urgency for us, as there is for India, to snap up big volumes whenever they come onto the global market. It’s cheaper for us to buy gold from the Chinese market, but it doesn’t help diversify our huge foreign exchange reserves.

To diversify our portfolio, we should spend dollars on things like gold. But the catch is that even if China bought half the world’s annual gold supply, it would only cost a few tens of billions of dollars, which is tiny compared to China’s huge reserves.

China has 2.27 trillion dollars in reserves. Spending 25 Billion a year buying gold is chump change. The question that’s relevant is whether they will, because that will put upward pressure on gold prices.

While no one knows whether China will or will not buying gold on the open market, the one thing we do know is that the monetary base of the US Dollar is growing exponentially making each existing dollar less valuable. Check out this graph from the St. Louis Fed:

While its not obvious from the graph, the monetary base has in the past year. Its true that this money hasn’t worked its way in to the economy, but if and when it does we should expect higher inflation and a spike in prices of real assets like gold, silver and real estate.

If I had a few trillion dollars, I’d be buying a few hundred tons of gold every year!

Related Posts

• August 24, 2009 -- How To Invest Like China
• August 24, 2009 -- China To Buy $80 Billion Worth Of Gold
• May 6, 2009 -- China Buying Gold On The Sly!
• August 23, 2008 -- Why Jim Rogers Hates Investing In India
• August 15, 2008 -- Rogers Still Bullish On Commodities
• October 15, 2007 -- Jim Rogers Backs The US Dollar
• May 12, 2010 -- Gold Closes At Record High