Last week, gold prices briefly touched $1,100/oz before settling just under that number. Apparently the Indian government decided to sell US dollars and make a 200 ton gold purchase from the IMF, which created the spike in gold prices. Right now, the spot price for the yellow metal is $1,106.

According to Robert Zoellick, World Bank President and former Goldman Sachs head and U.S. Secretary of State, you shouldn’t take the U.S. dollar’s reserve currency status for granted. Swelling government deficits and the strength of emerging countries is weakening the demand for the dollar. Time to head for the exits?

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According to a quote in the Telegraph, HSBC (HBC) has issued a new report stating that the Federal Reserve’s ultra-loose monetary policy is forcing China and other emerging countries to create a new global currency “order”. According to David Bloom, HSBC’s currency chief, the dollar looks like the sterling did after World War I.

For those a little dusty on their history, the British pound sterling (so called because its value was backed by sterling silver) was the world reserve currency until the 1930’s. After that, the sun set on the British Empire and the sterling was replaced by the US dollar. Now it seems the dollar's time in the sun has come to end as well. The Telegraph article states:

If you’ve been reading the popular press for the past 6 months, there’s been a slew of articles talking about deflation. I’ve been somewhat skeptical of the long term probability of deflation and have been investing in gold and commodities in anticipation of inflation. Looks like I was a little early to the game (which, on Wall Street is just the same as being wrong!).

Now however, it looks like we are warming up the printing presses and gold has hit $1,000 twice in a week in anticipation of future inflation. Legendary hedge fund manager John Paulson, who made $2.5 Billion last year from his trades, has been betting heavily on gold and his fund has nearly 50% of its assets in gold or gold-related investments like gold mining stocks and ETFs. The gold ETF, GLD reportedly makes up 30% of his fund! He has also taken a large 12% stake in AngloGold Ashanti (AU) making him the largest shareholder.

Yesterday Gold hit an intraday price of $1005/ounce. While not a record, it’s definitely a historical moment, with this event occurring for only the sixth time in history.

We can only speculate as to why the run up to a $1000 was so quick but some of the likely reasons are:

In the last post we saw that China was slowly diversifying away from its usual investments in US Treasury Bonds and investing in hard assets, natural resources and maybe other currencies.

There is probably a very good reason why the world’s second largest holder of US dollars is weaning itself away from bonds issued by the world’s largest debtor nation. If you believe the Chinese know what they are doing, it might make sense to imitate their investment strategy.

The market has been defying gravity this summer, with the S&P500 up 49% since March. But most of the appreciation has been in what I consider lower quality stocks. Many homebuilders with doubtful prospects have doubled from their recent lows, while stocks that are somewhat recession proof like McDonalds (MCD), Walmart (WMT), Coca-Cola (KO) and Procter & Gamble (PG) have bounced a mere 15-20%.

According to Bloomberg, “companies with the worst earnings led the 45 percent gain in the Standard & Poor’s 500 Index since it fell to a 12-year low five months ago”. It might be a good time to sell some of your winners that have done exceptionally well and either wait for a pull-back, or, if you’re trigger happy, buy solid investment-grade companies.

Finally Warren Buffett said what I’ve been harping on about for two years. In his NYT op-ed piece titled “The Greenback Effect” he admitted that the government is setting us up for massive inflation and destruction of the US Dollar.

This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion.

With 1 ounce of gold selling for $955 and an ounce of silver selling for only $14.63, gold is currently about 65 times the price of silver. Last year the ratio was only 50 times. This is significantly above the long-term historical ratio of gold being worth 16 times more than silver. Even in nature, silver is about 17 times more abundant than gold, and unlike gold, the quantities above ground are constantly diminishing because of its industries use.

By these standards, silver is undervalued when compared to gold. Check out this Chinese news video advising investors to buy silver.

Thanks to a link on ZeroHedge, I read this report by Project Mayhem Research Inc. According to the report, the iShares Silver Trust (SLV) and London-based ETFS Silver Trust (SIVR) physical silver funds both have inaccurate records regarding the levels of physical silver inventory. The report states that there is significant duplication of silver and the actual amounts are lower than reported. This indicates a high statistical likelihood of “systematic fraud or gross negligence” in the accounting of both silver ETFs. Since silver ETFs are now accepted forms of delivery on the COMEX (futures trading exchange) proper accounting is the only way establish proper silver price discovery. No wonder prices of silver are so low! There’s fraud everywhere!

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In case you haven’t heard, Congress will soon implement a “Cash For Clunkers” program. If you trade in your old car, you’ll get $3,500 towards the lease or purchase of a new one. If you have an old SUV you’ll get $4,500. Seems like a good plan doesn’t it?

Yesterday I had a short phone call with Bob Meigan, VP of TurboTax and we discussed the short-comings of this program. First of all, your car has to be a clunker. That is it shouldn’t be worth more than $3,500 since you won’t get anything extra if it is worth more. By law, the dealer will have to scrap the car so even if its worth $5,000 he’s not going to give you a dime more than the $3,500 he’s getting from the goverment.

According to a recent report from Bloomberg, Northwestern Mutual Life Insurance Co., the third-largest U.S. life insurer, has been buying gold. This is the first time in its 152-year history that Northwestern has purchased gold.

According to Northwestern CEO Edward Zore, “Gold just seems to make sense; it’s a store of value. In the Depression, gold did very, very well.”

The publishers of Mobs, Messiahs, and Markets: Surviving the Public Spectacle in Finance and Politics (Wiley, 2007), were kind enough to send me a free copy to review.

I’m glad they did. It was an excellent read, similar in some respects to one of my all-time favorite investment books: Extraordinary Popular Delusions and the Madness of Crowds, which delves into human psychology and crowd behavior. Mobs, Messiahs & Markets is like a modern-day version with emphasis on investing and explores popular delusions like “real estate never goes down”, “stocks always go up”, “deficits don’t matter”, “you are either with us or against us”. When rational, intelligent human beings become part of a group, they are fine. However, as soon as they become part of a crowd, they lose all rationality and turn into blockheads! I found the book quite entertaining, with great wit and sarcasm to keep me amused.

In a previous post on deleveraging, I promised I’d talk about an interesting long-short bond trade that I entered last week.

If you believe that US Treasuries are over-valued, or foreigners will lose their appetite for US debt thus forcing up the interest rates, you’re probably looking to short treasuries. OK, maybe you haven’t looked into shorting anything. In that case, maybe you should read this link in Barron's and then come back. (Barron’s thinks that investors are buying gold as an alternative to near-zero yielding treasuries.)

One of the advantages of going to a top-tier MBA program is that you get to meet a lot of succesful, well-known people. Last week, billionaire real estate investor Sam Zell was on campus and gave an hour-long speech about his views on the economy.

Zell made an analogy: the economy was like a bus being run by a monkey who let everyone drink, smoke weed and fornicate like crazy and then crashed it! There’s no free lunch. We’re going to have to pay for the past excesses.

California is running out of cash. Yields on California Municipal Bonds are therefore pretty high right now. But is it safe to buy them?

According to the Wall Street Journal, it would appear that it is. They asked the California state treasurer Bill Lockyer whether the California public debt was completely safe. “Absolutely, the only way we’re going to default is if there’s a thermonuclear war.”

The media has been going on and on about deflation. Long-term bond prices have also been trending up and long term yields have been dropping, which means that the market thinks there will be long-term deflation. Even the Consumer Price Index numbers that came out claim that inflation is under 2% annually!

(Of course, if you’re one of the unlucky 533,000 people who lost their jobs last month, you really couldn’t care less about deflation).

I’ve been an avid collector of gold and silver coins and have been following their prices for years. Gold is supposed to have a negative correlation with the stock market. This year has proven otherwise. Of course, as we’ve seen repeatedly in the past, all asset classes correlate to the downside.

Gold which peaked at $1030/oz earlier this year, has been trading in the $700 range for a few months. There has been a flight to safety, which for most people means buying U.S. Treasuries. Indeed, the flight has been so large that it has pushed the yields down to absurdly low levels. The yield on the 3-month Treasury was almost zero at 0.4% and the 10 year is 3.52%. (The yield on the S&P 500 was 3.55% this week, higher than the 10 year Treasuries rate for the first time since 1958).

I got into a lively debate yesterday with a fellow student about the bailout of the auto-industry. He said the social ramifications of letting them fail were too high. The impact on the local communities would be too high and so they should be bailed out by the tax-payers.

I said they were not cost-effective and there wasn’t enough demand for their cars to keep them in business. Even if the government gave them $25 billion, they’d plow through it and be back at the door asking for another handout. The government, too ashamed to admit it had wasted the first $25 billion would probably hand them another $25 billion. (This is called the Concorde effect, after the failed Concorde partnership between England and France which was a financial disaster).