Gold & Hyperinflation ? The Future is Catching up with the Past

"We have reached a profound point in economic history where the truth is unpalatable to the political class - and that truth is that the scale and magnitude of the problem is larger than their ability to respond or comprehend - and it terrifies them."

"We are single-digit years away from the most profound market clearing moment in history" -- Dr. Aubie Baltin

CHINA

THERE'S TROUBLE BREWING IN SHANGHAI AS WELL AS IN THE REST OF THE WORLD'S EMERGING STOCK MARKETS.

It was November 2010 when I first warned about not to get too excited about China: That China too, must and will succumb to the Natural Laws of Economics like all centrally planned countries. Thus the Shanghai Stock Exchange Composite Index was due for a sharp selloff and would lead the rest of the world markets down. More recently, the index had just broken a downward sloping flag formation or consolidating-triangle pattern if you prefer. Which is a bearish development, and I figured the Shanghai Index could be headed as low as 1,800 to 2,000 this year. The Shanghai Index hit 2,200 last December. It has been rallying since then and today, it's 6% higher than where it started the year. But it's unlikely to hold on to those gains.

While the index may continue to bounce in the short term and test the former support line of the pattern giving an excellent opportunity to short with a close stop; it projects a downside price target of about 1800 for the index. That's a 17% drop from current levels - just above the financial panic low of 1,800 back in 2008. If you are bearish on China, you should use any rallies back up toward 2,400-2,500 to establish short positions. Buying shares of YXI is one way to establish a short China trade. YXI is an ETF designed to move in the opposite direction of China's stock market.

THERE IS NO SUCH THING AS A FREE LUNCH

Fed Chairman Ben Bernanke has taken a lot of heat for printing too much money, having been dubbed "Helicopter Ben." His last post-FOMC announcement and press conference contained no surprises. The Fed promised to do a small amount of additional harm in the short-term by continuing the distortion of the relative prices of long and short-dated government debt. It will do this via a 6-month extension to the program known as "Operation Twist"; just its name alone should cause you great concern. He also promised to eventually do a lot of additional harm via more aggressive price-distorting policies if the economy is unable to recover from the harm that has already been done to it in the past. The genius leaders of the Fed actually believe that they can help the economy by counterfeiting more, going deeper into debt, driving down the price of gold and silver and taking other measures that corrupt the price signals upon which all Free Market Economies rely, like interfering with the price of money (interest rates).

But if Bernanke's making it rain money from a helicopter, China's been bombarding its economy from multiple stealth bombers. Money supply rose markedly in May and the recent years' credit growth has surpassed even that of the U.S. in the period leading to the Lehman collapse. Unfortunately, instead of being put to good use, much of that money has ended up in the pockets of Government officials and in the hands of wasteful, state-owned enterprises (SOEs). Meanwhile, just as here in the US, cash-starved private entrepreneurs have been relegated to the sidelines, unable to get even a small share of either Washington or Beijing's ever increasing, politically driven, capital-misallocations. Is this another sign of the coming unsustainable American and Chinese growth?

IT'S RAINING YUAN

The SOEs get tons of money to splurge on fancy, wasteful items, get wined and dined by the country's most powerful and politically connected, yet contribute relatively little to the economy. In many cases, they're profitable solely because they're the only players allowed in strategically important industries. Meanwhile, the small and medium-sized businesses do the grunt work, contributing two-thirds of all taxes and industrial output, and employing more than 75% of the Chinese and American workforces. Yet despite the surge in bank credit, many smaller businesses are either denied access altogether or charged absurdly high rates on loans. Of course, China's four largest state-owned banks have a tremendous bias in lending to SOEs. And the government's vested interest in protecting the status quo has led to major restrictions on multinational banks looking to expand within China. So naturally, JPMorgan Chase, Wells Fargo and Bank of America have decided to avoid retail banking in China altogether.

As a result of their intimate connections with China's authorities, SOEs enjoy a number of remarkable advantages that private firms would kill for. They get huge government subsidies in the form of significantly lower tax rates, have access to much cheaper basic inputs like water, land, and energy, and enjoy barriers to entry by competitors in key industries. But despite their edge, SOEs are much less efficient than their private counterparts (something that is completely lost on Politico's of all stripes). In fact, many are loss-makers and there's mounting evidence they've misallocated capital on a tremendous scale. But thanks to the "wonders" of state capitalism, they keep getting funded, accounting for more than 75% of all bank loans and continue to expand. Sounds like the big banks here.

NO DEMAND FOR STEEL? TRY RAISING PIGS

A recent piece in the Financial Times outlined how several state-controlled steel companies, faced with falling demand and big losses are branching out beyond their core lines of business. Baosteel Group, the world's third-biggest steel producer, used more than half of its net borrowing last year for non-steel related businesses, which ran the gamut from real estate to telecommunications to manufacturing. Wuhan Iron & Steel, the country's fourth-largest steel producer is investing $4.7 billion over the next five years in pig, fish, and organic vegetable farming; they went from steel to pigs. WOW… More worrisome, this trend isn't just confined to steelmakers. Cofco, a state-controlled grains company, is now building luxury hotels in Beijing, and Tongling, the nation's second-largest copper producer, is diversifying into timber. What do they know about hotels and timber?

Instead of reducing capacity in response to falling demand, China's SOEs forge onward and upward with their grandiose schemes, lured by potentially higher profits, but encouraged primarily by preferential access to large quantities of cheap credit. After all, if the cheap money keeps flowing, you just have to INVEST it. Otherwise, it might be cut back if you don't. Besides doesn't everyone have a brother who could use a few extra Sheckles? Haven't they learned anything about the perils of excessive and cheap credit from the rest of the world? Oh I almost forgot a centrally planned Fascist economy does not have to follow the Natural Laws of Economics, especially if they do not have a Congress to answer to, like Obama is always complaining about.

Despite growing evidence of huge capital misallocations in the huge state-run sector, many investors remain indifferent, clinging to their faith in the effectiveness of central planning. They agree with Obama that China is a special case and that an authoritarian government can more easily control the economy, even given the abundance of historical evidence to the contrary. Just because an authoritarian regime has tight control of the levers of the economy doesn't mean it has the faintest idea how to use them. Especially given the degree of cronyism associated with political appointments. Unless there's a meaningful rebalancing of the economy that involves severely curtailing lending to the SOEs, China will not only cease to prosper, it will crash. Only through policies that raise households' disposable incomes and their purchasing power might we finally see the Chinese start to spend: A godsend not just for China, but also for the hundreds of multinationals, like Yum! Brands (NYSE: YUM) and Starbucks (NYSE: SBUX) etc., that are banking on the tremendous promise of 1.3 billion new Chinese consumers.

Maybe I don't fully grasp the benefits of state capitalism. Maybe all the historical evidence against central planning doesn't apply to China. Maybe this time it really is different. And maybe those pigs that Wuhan is raising will also fly one day?

HOW NOW DOW

Our domestic equity markets are still hanging tough when compared to the rest of the world's markets. Their charts still trade above long-term support of their 200-day moving averages. Although we did fall below this key level briefly in early June since then, money from around the world has been seeking the relative safety of the U.S. equity markets, especially when compared to Europe. SO WHAT SHOULD WE DO NOW? Well, I have been speculating for a while now that we were due for one last speculative BLOWOFF to perhaps as high as14,300 to slam the door shut on the biggest Bull Market TRAP in history in conjunction with the BURSTING of HISTORY'S Biggest Bubble; THE US TREASURY BOND MARKET BUBBLE. Well it looks like that last rally may have started this past Friday. The question is how do we play it? My number one investment is still gold and silver securities, which have never been more undervalued in relation to bullion; but in the name of being prudent, a little diversification may be in order. You can either buy your favorite stocks and/or some leveraged ETF's or their underlying options. But you must maintain 8% trailing stop loss open orders on your stocks and 18% trailing stops on your options.

REMEMBER: We at are at most 2 to 3 months away from history's BEST SHORTING OPPORTUNITIES -- and we certainly don't want to be caught going the wrong way.

Central Bank Gold Manipulation; Steady As Ever. " Avoid Paper Gold"

Chris Powell, Secretary and Treasurer of the Gold Anti-Trust Action Committee (GATA) told Bernie Lo on CNBC Asia that central banks are continuing to manipulate the gold market as they are interested in supporting government bonds and the dollar and keeping interest rates low While buying as much Gold as they can on any weakness.

Further evidence of rising interest in gold is seen in the fact that due to the increased flow of gold bullion into Switzerland, the most respected depository, Via Mat International, is currently adding capacity to their storage facility. Powell also warns about "paper gold" and says that we "try to persuade investors that if they are purchasing gold, they had better get real gold - the metal. They should not get "paper gold" nor keep it or real gold within the confides of banking system."

He further asserts that "there are huge naked short positions in gold" and estimates that perhaps "75% to 80% of the gold that the world thinks it owns does not exist and is just a claim on a bullion bank that is underwritten basically by the British and American FED's."

Gold rose after European leaders agreed to a "deal" (but not really) which has helped bring down soaring borrowing costs in Italy and Spain. Stock and commodity markets have greeted the news with enthusiasm and strong gains. While the move helped ease fears over the region's debt crisis, large structural issues remain unaddressed and all of the debt still remains overhanging the markets and rest assured there is still a lot more debt yet to come post this 'deal'. This certainly explains a lot of the current machinations in the gold and silver markets.

GOLD IS NOW MORE THAN 50% BELOW REAL RECORD HIGH OF 32 YEARS AGO - In January 1980, gold traded at $2,600/oz in real terms, adjusted for the significant inflation of the last 32 years.

GOLD AND THE CPI - 10 YEAR TREND ANALYSIS

There are very few assets in the world that are trading at significantly below their real price in 1980. An example of this is the Dow Jones Industrial Average which was trading at 1,000 in 1980 and is trading today at 12,500. Therefore, it is nearly 13 times higher than its nominal high in 1980. The gold market however, has yet to see any kind of irrational exuberance, let alone that kind of mania phase with gains being gradual in recent years, including last year and so far in 2012.

No mania has come anywhere near the gold market; with the majority of the public having no allocation to gold whatsoever and especially given that even when the financial media does occasionally cover gold, they do so very skeptically. There continues to be a complete failure to understand gold's importance as a store of value, an important diversification asset and as a crucial safe haven asset.

Alexei Kudrin, Russia's former Finance Minister said that a full-blown economic and financial crisis in the Euro Zone is inevitable and will develop within a year. On the other hand, Russia like China is planning to give the ruble some form of gold backing in order to protect the ruble from devaluations and protect Russia from an international monetary crisis.

Eugene Kim, chief Korean Investment Officer at the central bank's foreign-exchange reserve management group, said its gold holdings are "too small" given the size of its Forex reserves, which stood at a record-high of $310.87 billion at the end of May, and that the BOK will be buying more bullion this year, given its symbolic presence and usefulness as a safe haven in times of crisis. The Bank of Korea's gold reserves remain tiny as a percentage of their large foreign exchange holdings. They are also very small when compared to the gold holdings of western central banks many of whom, such as the Federal Reserve, supposedly have over 50% of their reserves in gold bullion. (There has not been an audit of America's Gold holdings in over 50 years.) Mr. Kim said the central bank needs to boost its gold holdings even after two purchases last year that took the amount to 54.4 metric tons or about 1% of their total reserves.

SPECULATORS AND TRADERS SELL WHILE LONG TERM STORE OF VALUE BUYERS ACCUMULATE ON DIPS

Managed money longs boosted their net longs in gold by 4,962 to 104,646 lots in the week up to June 19, but their positions remain near record monthly lows showing that what little speculative froth there was has been washed out of the market. With investment demand, particularly from ETFs, Asian demand and central bank demand remain robust.

Investors and store of wealth bullion buyers have not been selling; quite the opposite, most continue to accumulate more on dips.

Of the small amount of people selling bullion in recent weeks, the majority of those sellers sold because they had to sell due to having financial difficulties. Gold came to their rescue as it always has for many, being one of the few liquid assets that they can sell in order to pay down debts. Those with a long term perspective will continue to be rewarded as currencies continue to be debased and devalue versus each other and especially versus gold.

Today, fiat currencies throughout the industrial and non-industrial world are vulnerable to further devaluation. There is indeed the real risk that the slow but steady decline in the value of fiat currencies seen in the last 100 years accelerates. The coming global monetary crisis, once realized by the public, will likely result in a massive flight to gold.

Turkey, Russia, Ukraine and Kazakhstan Further Diversify Into Gold

Incredibly, this will be the 20th time EU leaders have met. While gold has not surged in value as many expected, gold has performed well during the period having again preserved wealth.

Central banks are expanding reserves due to the Euro Zone and American debt crisis and concerns about fiat currency debasement. They are on course to buy more bullion this year than the purchase of about 456 tons in 2011 as countries continue to diversify their reserves.

Central bank demand and Chinese demand alone should be enough to put a floor under prices near these levels and gold looks well positioned for another summer rally akin to the one seen last July and August.

CYCLES

Very few analysts, brokers and especially media commentators ever look at cycles and few if any take cycles into account when commenting on gold or silver. As usual, the only thing they look and comment on is yesterday's prices and the morning's news and then try to relate the current news to the day's price movements. They usually cannot see any further than their noses. So when it comes to gold and silver, the only thing they talk about is yesterday's price movements. Few, if any ever notice that PM's move in cycles (short, intermediate and long term cycles) and none that I know of have noticed that gold and silver most often bottom out in July and August and peak out in October to December. However, when it comes to their stocks, they all do not peak or trough on the same day. Since we are approaching the beginning of the bottoming cycles, the time is ripe to start bottom fishing and buying your favorite PM stock on any weakness over the next 2 months. Since stocks have never been as oversold in relation to their bullion as they are today, it is time to do your bottom fishing in stocks instead of bullion. Have a little more patience, THIS DOG can still hunt and is about to have his day!

In historic times, like we are in today, it is worthwhile maintaining an historic perspective.

GOOD LUCK AND GOD BLESS

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Aubie Baltin CFA, CTA, CFP, PhD.
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