Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Keeping Track of Real Market Activity. In Paris, on Wednesday of last week, you could find French gold coins selling near the quoted spot price for gold. By Friday, that had changed. Buying the most recognizable and common French fractional coins in France today, you must pay 25% over the gold price. What a difference a day makes.

Rewind to last week and you’ll recall it was the Italian banks that were facing the scrutiny of the press and appeared to be in a critical state, not the French. This week, we discover that the man on the street knew something before the press was on to the topic – French banks are reeling so badly today that France, Belgium, Spain, and Italy banned short selling of the financial shares of those countries for 15 days. What else could they do, facing 16-20% price swings in those shares?

We find similar echoes this week on this side of the pond, with one-ounce Krugerrand premiums doubling overnight from $20 an ounce to $45 an ounce. Yet the price of gold has fallen from its peak of over $1800 to the mid $1700s. How can this be – that physical metal premiums on both sides of the pond are rising, even as the price of the metal is falling? This is when you can reflect on the differences between the world of paper and the world of physical metals.

Speaking of paper gold, CME changed the margin requirements on gold futures contracts this week (an increase of over 22% – the first of many increases, we suspect). There was no surprise at the price swoon that followed. However, the demand for the actual metal – versus merely a “future” opportunity to buy it – remained quite robust. Commodity trading advisors (CTAs) and hedge funds have been emphasizing physical metals over the last six months, as “counterparty risk” has returned to the forefront of everyone’s thinking. The pity, of course, is that counterparty risk is something we could have learned to manage by now, if regulators had cared about it.

Investment professionals typically neglect the core reasons to purchase the metals, unable to deal with the painful fact that they have missed a massive 10-year bull run. Individual investors, on the other hand, are insisting that the worst is not yet behind them. They continue to look for ways to protect themselves financially from the consequences, unintended or otherwise, of bad fiscal and monetary policies – even if it costs them a premium to do so. Granted, there are many who wouldn’t know what counterparty risk was if it approached them on the street and asked them the time, but the term is less important than the simple fact that they no longer trust the people whose skill and integrity (or lack thereof) determine the value of an investment.

In Paris during 1931 and 1932, US $20 gold pieces (the old one-ounce coins) commanded a market price of over $30 on the streets. What the people know is often more important than the conclusions concocted by Ph.D.s and investment professionals. Thousands of miles away, Parisians had a sense that we in the US were going to devalue by over 50%. Lo and behold, that is what materialized (65% was closer to the mark).

I share these anecdotes to encourage you to look past the obvious moves in the marketplace (and its sensational volatility). Listen instead to the subtle whispers of the store vendor, taxi driver, and restaurant waiter. Listen carefully, and ask lots of questions. Economic change is perceivable if we will but pay attention to the right indicators. Economists can play catch up and report on issues only after analyzing data from the past – events that have already occurred – such as the consumer confidence numbers this week (University of Michigan: 63 expected, 54.9 actual – the lowest levels since May 1980). Such analysis quantifies what you know already if you’ve been making your own observations.

Take the weekend and find a place to enjoy a cup of coffee or a quiet lunch, sitting, watching, listening, and talking to the people that know intuitively what is brewing. I’ll venture a guess that the café society, discussing politics and other issues of controversy, keeps its eyes and ears highly attuned to change. Like ’31, ’32, or even last week, let’s see what the REAL market is telling us.

You may not be in downtown Paris, but the word on the street is that you’ll probably need a little gold in the years ahead. Let’s see if the CME does us any more favors, battering the price for a short while and allowing us to make an attractive purchase.

2. Bond Market Ironies:  I have an abbreviated amount of time today, so this will be shorter than usual.

Economic weakness, whether present, future, actual, or perceived, is generating significant interest in Treasuries thus far, though any weakness at all may lead to a US government default.  However, the rally in bonds seems to be stimulating the economy to such an extent that stocks were allowed to rally off their lows for the week.  Rumors also had it that Goldman Sachs traders were playing with unlimited Fed dollars to boost the SPUs (S&P futures) all week, but, again, these were only rumors.

On the whole, stocks still gave up ground, with major indexes down an average of 1.8% for the week.  Bonds had a mixed week, but managed to grind out another gain with yields falling another 12 basis points.  However, commodities continue to revoke the Fed’s license to print – having given up very little technical ground in recent weeks, and still holding in bullish territory.  Real estate indexes jumped an average of 2.4% after their pummeling last week – responding more than others to the interim highs in bonds.

Economic indicators turned bullish. Again, we think this is due to rates only, and not organic growth.  Retail Sales came in as expected for the first time in a while, rising 0.5%, and initial jobless claims broke a personal best – falling below the previously unreachable 400K mark with a posting of 395K.  Wholesale and business inventories also fell more than expected, indicating consumer strength.

Overseas, one by one, countries are falling like dominoes to the “easy money” route to stabilization of their markets and economies.  The ECB is monetizing Italian and Spanish debt.  The UK has put interest rates on hold until 2013 (just like the Fed), and China is again pumping money into its banking system to stave off panic.  The Swiss have also proposed pegging their currency to the Euro in an effort to cure its “overvalued” state.  This may be easier said than done for the Swiss, since it involves closer relations to the ECB than citizens of Switzerland would prefer.

Lower rates might provide some breathing room for the markets at the moment, but this has merely put a band-aid on a gaping wound.  Stay tuned…

Best regards,

David McAlvany
President and CEO

David Burgess
VP Investment Management