Caveat Emptor II: Terrifying Gains

by: Emmet Kodesh

The DOW was up 175 points yesterday, the S&P is back at 1516 after Monday's stomach - churning drop. The NASDAQ has added back above 3160 but it is not good. The renewed surge has been thrilling but I hope you're on the local. The last two sessions were prodded to climb and stimulants are wearing down the horse. Caveat Emptor.

If you have followed my suggestions that you limit precious metals and miners to 10-20% of your holdings, underweight fixed income and continue to "nibble" at this bull, you should be glad. If your holdings are allocated more than 10% (heaven forfend more than 20%) to precious metals and miners you are pained at the continuing losses and perhaps wishing you were fully invested in equities. The indices and the climate do not support repose, but stay calm. While I would love to see an endless series of triple-digit green days, it won't happen in the emerald city. This is an euphoric calm before the storm. Stay steady on and as I wrote, keep an eye on the exits and have a clear path to them.

Ben Davies of Hinde Capital writes this week of an approaching period of socio-economic anarchy brought on by an unprecedented disjunction between prices and underlying values. The period of "monetary singularity" he envisions will boost gold, and technology will enable its use as money. He and others see Central Bankers faced with maintaining "ultra-loose" credit and stimulus policies "or resign themselves to collapse to the current monetary system." The latter is the more likely outcome, as today's $5 billion POMO ("permanent open market operation") stimulus by the NY Fed plus Secretary Bernanke's reassurances to the Senate Banking and House Finance Committees on Tuesday and Wednesday lifted the markets.

While Chairman Bernanke insisted that he would keep inflation below 2%, Michael Pento reiterated in his Wednesday podcast the warning he has been sounding for months: that given unprecedented levels of debt creation ($7 trillion in five years) America is heading either for "hyperinflation or a deflationary depression." Pento affirmed a point I have made several times that "those in bond funds are going to see their savings destroyed." Please underweight this asset class and / or be ready to shift to cash or physical asset metals.

As to inflation, by now you should be familiar with the metrics and studies of economist John Williams, who reminds all and sundry that the U-6 unemployment rate has been around 15% for several years almost tracking the debt creation supposed to cure it. The actual workforce participation rate is 50% worse. Liquidity injections harm the situation they claim to mend. Artificially depressed credit encourages acquisitions like the recent one of Heinz by Berkshire Hathaway (BRK.A, BRK.B) which lead to layoffs. Transfer of electronic credits from the Fed to the Treasury and back do nothing to create jobs on Main Street.

Job loss or diminished working hours and income also result from Health Insurance mandates. It is a vicious circle for, as Williams notes, our economy runs largely on citizen-consumer spending. But most of us are de-leveraging debt, necessarily so. Thus the deflationary spiral that Fed stimulus purports to redress. The merry-go-round gets giddy.

Aside from stimulating the asset prices in unnatural ways, it sometimes seems that Federal stimulus programs aim to suppress precious metals prices. This is the view, among many observers of Jim Sinclair. With fifty years' experience in the markets and in metals and mining exploration and development, Sinclair suggests that those who manipulated the LIBOR (London Interbank Offered Rate) do similar magic with gold even as more nations adopt it as a de facto currency or press, as does Germany to southern European states to have it serve as collateral for further loans. Sinclair suggests that by March 01 this will initiate a V-shaped recovery for precious metals prices. His long-term thesis coheres with views of Ben Davies, Williams, Jim Rogers and others. This re-balancing of values makes sense but is hardly certain.

Proponents of trend trading like Jonas Elmerraji continue to point to the S&P (NYSEARCA:SPY) up-channel and make the bullish case. This week he stresses Financials (XLF), Health Care (NYSEARCA:VHT) and Industrials (DIA, VIS, RGI). The channel is there but the bottom is soft and shifty. Perhaps more significant currency - gold trends are highlighted by Kevin Wides. His charts show the pound breaking down against the dollar, dropping through trendline support at $1.53 toward $1.32 with a corresponding rise in gold from its neckline, made for 16 months to GBP 1600/oz. Corresponding dollar weakness would see gold rise to $1800 and then $2300/oz. He makes a plausible case that aligns in many ways with Pento's, but the conditionals in the form of government intervention in markets haunt predictions and undermine the respective economies. With 60% of world reserves still held in dollars, a breakdown in America will rock global markets.

The takeaways are simple and more urgent than ever: cautiously increase your participation in this stimulus-dependent market and have an exit strategy ready. Be prepared to go into cash and physical metals. The markets now have increased volatility from political gridlock and underlying economic weakness. By the end of the third quarter, the internal contradictions are likely to assert themselves forcefully. While the degree of Central Bank intervention in markets argues against significant increases in one's precious metals allocations, this is not time to lessen a minimal 10% position. If you change it, raise it a bit via physical silver (NYSEARCA:PSLV) or Gold (NYSEARCA:PHYS). The Gold ETF (NYSEARCA:GLD) and its silver counterpart (NYSEARCA:SLV) invite limited buys at their depressed levels.

The fundamentals as well as initiatives by China, Russia, Germany and others suggest a new currency system backed largely by gold and commodities than by increasingly unsteady fiat currencies. Be ready to benefit from this ongoing move. Consider it a hedge against this quarter's unsteady market euphoria.

Disclosure: I am long PSL, PSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.