My 1st Million At 33 – yes, you can do it too

Right before the Fed meeting, both precious metal stocks and the general markets are turning lower. The market is scared, and it should be. There are many dangerous under-currents beneath the surface of various markets, and they are not handled properly, all hell can break lose. In fact, since I started investing, I’ve never felt so SCARED as of now. Why? Many past capital market sins are coming home to roost at almost same time. Here are the dark clouds over the markets (many of which I have mentioned in previous posts):

1. Fannie Mae, the big elephant in the room: The full details of Fannie Mae accounting fraud will be revealed soon, possibly later in this year. If the whole truth is revealed, both $US and US bonds may react very negatively to the report. Despite that US treasury repeatedly states that GSE bonds are not insured by US government, the bond market is still pricing a preferential rate for GSE bonds.
2. Inflation starts to spiral out of control causing Fed to raise interest rates by too much, which in terms causing waves of deflation to come. Greenspan has “cheated death” by bluffing out of his way at the initial periods of 1 to 2 years where the energy price stays elevated. Afraid of crushing bond market, Greenspan never restored short term interest rate to a normal level by hiking interest rate at a much faster clip. Now Bernanke is receiving all the results from the past sins committed. Even the fudging of home owner equivalent rent is biting back hard on US Fed. At the time of housing prices going through roof, CPI was not showing any significant upticks. Now CPI is getting all what it deserved, having rents going up while the housing market slows down. Obviously, Fed cannot slap on its face, and correct the fudging of the CPI measurement, or else it will lose all the credibility if there is any left. This is putting Fed into a very tough position. Further increases in the short term interest rate will probably collapse the housing market. A terrible chain reactions will be started from this. GSE bonds will collapse because of increasing foreclosures and housing price deflation. All types of bond markets will go down along GSE bonds. That will in turn trigger further P/E ratio compression in the stock market. Massive selling in the US markets will speed up $US depreciation. It’s a total abyss if Fed raises interest rates too much. Obviously, that’s what the stock markets are currently afraid of. Under this scenario, there is not many places that one can hide. Even precious metal equities may be hit hard initially by the waves of selling on wall street, but eventually they will start to correlate to gold price which should be rising (after some delays most likely).
3. Fed is losing its credibility because Fed doesn’t raise interest rate enough to fight inflation. If Fed doesn’t raise interest rate as a show-off for being an inflation fighter, Fed won’t have much credibility. A stop in interest rate hikes probably will trigger gold to rise to new high. However, I believe that this is probably the preferred method for Fed. A rise in the gold price will not necessarily translate a heavy depreciation in the $US, as long as all other major countries cooperate in joint devaluation of all currencies. A rise in the gold price will not necessarily bring about an increase in oil price either, since gold is currently undervalued relative to oil. Besides, gold price is the easier commodity to be manipulated by central banks. As long as they control the rise in the gold price to a tamer posture, everything else will not go into a deflation mode. Obviously, once deflation starts, it can be very hard to put a stop, especially in this information and computer age, where millions & billions of dollars can transact in a very short time.

I believe that 5.5% on 30-year treasury bonds is the absolute line in sand before housing market goes tanking. As I have said previously, Fed forewarned the market two weeks before this meeting, and has normalized the inverted yield curve again to an almost flat 5.25%. A flat line means slowdown instead of recession, and that is Fed’s message to the stock market. However, for the next hike if it comes, I believe that the bond market will no longer conform to Fed’s wish, and will indicate a strong possibility of recession by an inverting yield curve. The message from bond market probably should be more correct than the Fed’s.

In case Fed either raises interest rate too much for the housing market and/or talks too tough to disappoint the stock market but pleasing $US currency market, Fed will probably begin cutting interest rates much sooner than anyone expects (possibly this year). It will be trying to reverse the speed of housing slowdown, and engineer a soft landing in housing market.

So if you have any money today to invest, what should you buy? I would suggest putting a little into precious metals, but not betting too much either. I think cash is slightly preferably at this point even than precious metals. We don’t know what Fed will be doing tomorrow. I personally will not venture a guess (except for a minimum of 0.25% hike which is baked into the cake). They may come out talk tough or soft, and that will influence the market dramatically. I’ve put 50% of my tradable cash into precious metals, and I won’t be buying much until either the stance from Fed is very clear, or that the precious metal market re-tests the low. I think deflation danger is very real, especially coming from a new Fed chief Bernanke who thinks inflation can be easily done through helicopter money. Well, yes and no. Bernanke can always engineer inflation, but probably not without a big deflation scar first if Bernanke is not thinking clearly. For now, I’m afraid that the deflation scar may hurt quite a bit. So having some cash for the uncertainty time is good. And if Bernanke panics to save economy from deflation, the next wave of inflation certainly will not be a walk in a park. It will be a walk in jungle, with different markets making fresh new lows or fresh new highs in the most unexpected ways, except to the correct position holders who endure and stand tough through ups & downs.

Let’s hope that Bernanke won’t be so stupid and too arrogant in thinking that he can do it all. Let’s hope that he will put a stop to the bleeding of stock market (before it’s too late) and commodity market. $US may fall some and maybe make fresh low, but at least it’s got some room right now, while the stock market has zero or negative room for continuance in the bull market trend.