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Market Watch

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  • | 5:00 a.m. March 2, 2011
  • Longboat Key
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The market remains overpriced. There is no reason to be invested in either the stock market or the bond market. Bonds pay little. And the 12-month demand for cash for bond refinancing and for financing new bonds issued to cover current government deficits is so great that interest rates must rise. When interest rates rise, bond prices go down. There is no reason to believe that bonds won’t crash exactly as they did in the 1980s.

The safest investments today are cash and gold and silver. Cash will give the investor flexibility when opportunities finally arise. Gold and silver are in long-term bull markets. Gold and silver are particularly good investments in an environment like today’s. As leading currencies such as the euro and the dollar continue to decrease in value, gold and silver are going up in price.

Gold and silver have a monetary history of 5,000 years. No paper currency (called “fiat money”) like ours has survived more than an average of 40 years. Thirty-nine years ago, when President Nixon closed the gold window and refused to redeem dollars for gold, the U.S. became a fiat currency nation. There was nothing backing the dollar of a commodity nature (gold, silver, etc.) as required by the Constitution.

Without an anchor such as gold and silver on a currency, history points out that politicians will do with it as our politicians are doing today. They will ruin the nation’s currency with war, debts and welfare growth. 

The market is up 700 points this year, about 6%. With only two months of our current calendar year gone, the market is increasing at the rate of about 30% annually. What could be better than this? 

There is no fundamental reason for the market to be at these levels. The latest round of quantitative easing has put cash in broker’s hands. This has caused speculation. Speculative trading has caused the market to go up in value. 

Additionally, there is a market for high-grade stocks because of the fear of pending inflation. Companies such as Abbott Labs, Coca-Cola, Johnson and Johnson, and Sysco Corp. that are A-plus-rated stocks that pay good dividends are seen as “hedges” against currency inflation because they operate all over the world in every currency. 

The general market, however, is not priced for gains — it’s priced for losses. A good barometer is the dividend yield on the Dow Jones Industrial Average. The annual dividends paid on the Dow the last 12 months were $288, representing a 2.35% yield on a Dow price of 12,268 points. The average Dow dividend yield over the years is 4.3%. If the market were selling at only the average Dow yield of 4.3%, instead of 12,268 points, the Dow would be priced at 6,699 points. That is 45% less than it is selling for currently. As the math shows, the market is in a posture to potentially hurt investors badly.
How does the Fed actually “finance” government debt?

1. The Fed prints $1.6 billion of new money (this year’s expected deficit);

2. The Fed gives cash to the U.S. government which uses the cash to pay bills;

3. The Fed sells the U.S. government-issued bonds to banks. The notes, most likely, are 10-year notes that pay 3.5% annually to the investor;

4. The bank lacks the cash to buy, let’s say $10 billion of these new notes, so the Fed “loans” the banks short-term money at a cost of .5% annually;

5. The bank pays the Fed annually at the rate of .5% ($50 million annually for a $10 billion loan). The bank “makes” $350 million on the $10 billion investment in treasury bonds. With some fancy computer entries, and no investment risk, the bank books a $300 million profit;

6. Although the public does not generally realize this, the Fed and the U.S. government are doing this to rebuild banks’ liquidity. Although these are only “paper profits,” the interest costs get paid annually by the U.S. government. The U.S. government can’t afford the interest payments, so it borrows the interest payments from the Fed (see No. 1 above and start cycle again).

With gold and silver up so much over the last 10 years, many Wall Street and business journal articles are saying gold and silver are in a true bubble. These articles suggest gold and silver are set up for a significant decrease in price. 

The last time we went into almost any business district in any city in this country and saw people holding up signs all over the place saying that “we buy gold” was in the early ’80s. Why?

The answer is that there are so many U.S. dollars out there around the world that are no longer considered a “store of value.” Countries, and individuals, holding dollars want to trade them in on something that has lasting value. The dollar’s rapid decrease in value has increased demand for gold and silver. There is no evidence that this trend will stop.

The largest purchasers of gold in the world are China and India, respectfully. They are purchasing gold and silver because they hold so many dollars in their reserves. They do not trust the dollar to maintain its value. 

If gave two grandchildren $10,000 each, which grandchild would be better off in 10 years: the one to whom was given $10,000 in gold and silver or the child to whom was given a $10,000 check? (If any grandchildren out there are reading this, lobby for the $10,000 in gold and silver.)

In 10 years gold has gone from under $300 an ounce to $1,400, an increase of more than 450%. Silver is up much more than that. The U.S. dollar, however, has lost 21% of its purchasing power. Stocks are overpriced, bonds are heading south, and gold and silver continues to go up. Cash pays little, but it “feels good.” 

The cautious investor will stay with “feel-good” cash. Adding to gold and silver investments is wise if one feels there will be continuous future increases in federal debt levels. Increases in the price of gold and silver occur as the country’s debts increase. As U.S. debts increase, the purchasing power of the dollar decreases. Simple math indicates the bull market in gold and silver has a long way to go.

Caveat emptor.

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.




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