Financial Storm Rising

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THE GATHERING STORMby Paul TustainAugust 28, 2007

"...Only a lack of imagination can have allowed professional investors to suddenly think of the US Dollar as today's quality refuge..."
ONCE EVERYONE gets back from vacation and starts to focus on what's really going on, we may be in for a torrid few months in the financial markets.
I believe the current lull in gold prices could offer a good opportunity to defend yourself before the real trouble begins.

Since the end of June there has been huge damage done to the finances of hundreds of organizations worldwide. But much of this pain is still hidden inside investment funds holding obscure financial instruments which are now unmarketable.
Too many investment professionals have been backing the same short-odds gamble â€" residential housing â€" and the aggressive financial arrangements they set up are unraveling a little more every day.

The underlying problem of non-paying US mortgage debt is getting worse, not better, but this fact is being forgotten in the current rate-cut induced rally in shares and bonds. Short of organized double-digit inflation I don't believe there is a force capable of halting the slide in subprime US property prices.

On top of that, we still have the extended pain of increasing rates hitting more US home-buyers as their "teaser" deals end. Data compiled by Inside Mortgage Finance and Lehman Brothers say this trend has barely begun. It won't peak until the end of summer next year.
The world's largest financial organizations have already taken big hits â€" quietly, for the moment â€" but the collapse of the subprime sector really is hurting, and we are seeing things that just shouldn't happen in a well-ordered financial world.

Fund managers are not producing credible fund valuations; they have frozen values using old prices, and are forbidding the normal result, which is investors piling through the exits.
No-one can price mortgage-backed derivatives at the moment, and no-one really knows how the underwriters of credit default swaps are pricing the insurance time-bomb they're sitting on. These horrible investments are in many cases worth nothing, and in the case of credit-default swaps, less than nothing.

The current lull might prove an opportunity for the prospective gold buyer. Gold has not yet moved up; in fact, it has dipped a little as stretched investment funds have sold whatever they can to raise cash and reduce their margin calls.

Nor can any serious comment on the gathering storm fail to remark on the apparent "flight to quality" which on Monday last week saw US Treasury bonds put in their strongest day since Black Monday 1987.

US Treasury bonds are part of the fast-growing and utterly irredeemable $9 trillion public debt now outstanding in the United States. The US trade deficit was also on record-breaking form again last month. Only a few short weeks ago these dreadful statistics drove the US Dollar to record lows against a basket of major world currencies.

Only a lack of imagination would allow investors to think suddenly of the US Dollar as today's "quality" refuge. Any respite for the Dollar will surely be temporary; indeed, the bounce we saw during the sharpest stock-market losses so far may have simply been short-covering by Dollar bears (of which there are plenty) rather than fresh buying of “quality�.
Everything that has just happened in fact makes things worse for the US currency. At the heart of this current crisis lies the bubble in poor-quality US home loans. It is US consumers who are being pinched; it is the return on invested US Dollars which is now being cut.
Lower US rates on the back of America's weakening domestic economy will re-kindle a Dollar slide in due course. So the current lull may offer only a brief window, in which fewer, stronger Dollars buy more gold than they soon will.

And amid the storm now gathering in the broader financial markets, I believe gold could offer a serious defense against both volatility and losses in stocks, bonds and the US Dollar.© 2007 Paul Tustain

Neither the TSP Strategy group, nor individual members including myself, are licensed or authorized to provide investment advice. Any statements made herein merely reflect the personal opinions of the individual group member. Please make your own investment decisions based upon your personal circumstances.