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June 02, 2006

Out of Bullets
by Christopher Galakoutis

The month of May brought with it, like clockwork, the long awaited correction in commodities, including the gold and silver sector, with both the physical metals and stocks taking a solid one the chin.

The question on everyone's mind therefore is whether this was a single, high-quality shot on the noggin, or the start of a ferocious combination that will ultimately leave our golden prize fighter down for the count?

Following the correction, as is usually the case with reactionary "experts" focused on rear view mirrors, commentaries flooded the newswires suggesting the commodities "bubble" might in fact be over. They pointed to reports of worldwide liquidity contraction and declining markets around the globe as proof positive that a shift to tighter money by the world's central bankers may finally have put an end to the commodities bull market.

What was clearly missing from any mainstream economic analysis, however, is that the United States, and its trillions of dollars in debt, credit market debt and other debt-linked instruments, can not afford a sustained liquidity contraction in a rising interest rate environment, as we will explain below.

It is widely acknowledged and accepted by many that the current arrangement of America consuming the products of foreign labor, and going further into debt in order to do so, is here to stay; a fine tuned globalization machine running on all cylinders benefiting everyone. They argue that perpetual consumption with no corresponding production by those doing the consuming helps explain away America's abysmal savings rate-- with all associated risks of such a lop-sided arrangement eliminated by the utopia that is globalization. Dangerously high debt levels are further underscored by increased US government deficit spending, resulting in an overall increase in total US debt outstanding.

A country that does not produce does not earn income with which to pay off the interest on its debt, let alone its debt balance. It therefore is forced to rely on a continuous cycle of debt growth for its very survival. While impossible to pinpoint the precise moment in time where this might occur, there arguably arrives a day of reckoning where if a large enough debt balance is created, the interest alone on that debt balance would exceed any one year's debt growth, bringing on debt defaults for a country with no savings from which to draw. The arrival of this day of reckoning is accelerated in a rising interest rate environment.

With tens of trillions of dollars in total debt the US can not afford to accelerate its march towards the inevitable day of reckoning. For this very reason, it is my opinion that what transpired in May in the commodities market was nothing more than a one time punch by a one-hundred-and-fifty-pound weakling, rather than a dangerous flurry mortally wounding anyone. As self-preservation is the most basic of instincts, politicians and central bankers will do anything in their power to ensure their own survival and well-being. They will do so by utilizing anything in their power to ensure the dreaded day of reckoning does not arrive on their watch.

What this means is that any talk of liquidity contraction and a tough Fed is nothing but a bluff-- yet clueless yield-chasing money runs scared at first-sight of a gun out of a Cracker Jack box. Given the enormous levels of US debt, the bluff should be an obvious sign of an attempt by a desperate Fed to talk the talk, when the truth is they have lost control and are in no position to walk the walk. This can only mean one thing for the dollar and the price of gold, silver and other commodities; the dollar will continue to fall while the US dollar prices of gold, silver and other commodities will continue to rise.

We also hear mainstream pundits talk about there being too many dollar bears/gold bulls, and the fact that so many are taking the same side of a trade, from a contrarian point of view, must mean that the opposite might in fact occur. This is nonsense. Using the same faulty logic, if a skydiver were to jump out of a plane with a parachute that fails to open, would anyone in their right mind want to take the other side and bet against the obvious disaster about to befall this individual?

There is no denying that there will be ups and downs in any bull market, as nothing goes straight up; unless of course we are talking about government data, where anything is possible. The only question in my mind is whether the longer term fundamental picture has changed enough for us to alter our long-term investment approach.

The answer is no. And while I am fully cognizant of the deflationary argument brought forward by several commentators whom I respect, it is my belief that under a fiat monetary system the inescapable end game to be pursued by bankers and politicians is inflation. Of course, we must keep a close eye on these folks and/or those who succeed them, and adjust our views accordingly.

Speaking of successions, it was just announced that Henry Paulson of Goldman Sachs will replace John Snow at Treasury. This to me is further proof that everything within reach of our bankers and politicians will be utilized to keep the US's "prosperity" game going. You just don't bring in a Wall Street heavyweight when you are about to cripple the economy with tougher Fed action.

In my view, this was done because the Fed is about to pause and eventually reverse course on interest rates. As such, it is believed that Paulson will be the right person at Treasury to "talk up" the US economy and the dollar, at a time when all fundamentals will point to a complete washout.

Bringing in a guy like Paulson, or anyone else loved by Wall Street, is really no different than a losing football team bringing in sexier cheerleaders. The hope is that the public will be so fixated with the action on the sidelines that they completely ignore the slaughter on the field, staying put in their seats a while longer when they should have run for the exits long ago.

The collective result of Fed and government smokescreen actions to this point will, in the end, succeed at only one thing: it will awaken the one punch wonder's opponent to the increasingly dubious nature of his opposition, forcing him to deliver a counter shot of his own; a shot I have no doubt will be one that is heard around the world.

To learn how to preserve your wealth and protect your purchasing power, I suggest that you download a free copy of Euro Pacific Capital's research report entitled "The Collapsing Dollar; The Powerful Case for Investing in Foreign Equities" available at www.researchreport1.com.

Christopher G. Galakoutis
CMI Ventures LLC
Westport, CT, USA
Website: www.murkymarkets.com
Email: info@murkymarkets.com

Christopher G Galakoutis is an independent investor and commentator, who in 2002 re-directed his attention to studying the macroeconomic issues that he believed would impact the United States, and the world, for many years to come. He works diligently to seek out investments for his own portfolio that align with his views, and writes about them on his website. With a background in international tax, he also works with clients holding foreign investments (ExpatTaxPros.com), ensuring their global income tax costs are being minimized.

Copyright © 2006-2009 Christopher G. Galakoutis

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