There is an interesting ongoing debate on inflation versus deflation at financialsense.com. This week was a debate between Mish and Daniel Amerman. Mish has been one of the most vocal deflationist before the stock market collapse, and he has nailed it correctly. Getting the big picture correct on inflation/deflation is probably the single most important thing for your financial portfolio (and I just cannot emphasize enough).

So do yourself a favor, and listen thru the 1+ hour of online radio. I was expecting simultaneous asset deflation and commodity deflation back in early 2008. That seems to be what Amerman is saying during his debate. However, with Mish, he is more of a total deflationist, although he also agrees with the fact that there is no way for USA to pay out all the entitlement/welfare programs at the current US dollar value. What Mish adds into the debate is the timing of the next inflation, and that he doesn’t believe in a general commodity inflation in a consumer retrenchment. I must say that I personally sides with Mish more than Amerman. Here are a couple of noted points from the debate:

1. Amerman is taking a long term view that USA may follow in the footstep of Roman/Argentine style of hyper-inflation or high inflation. Even if inflation is not that serious, it’s very true that back in 1970, USA went thru a period of high inflation, where real estate gained in nominal value, and many homeowners benefited from the reduction in the real inflation-adjusted value of the mortgage debt. There is no doubt in my opinion that Federal Reserve would like this ideal high-inflationary scenario to unfold, without getting into a hyper-inflationary scenario, where the economy and banking industry simply gets trashed. That was my primary reason of forecasting high inflation coming due to an impending collapse in real estate market back in 2006. Under a well-controlled but high inflation scenario, Fed can reflate the housing market, and therefore make the banking/mortgage industry to be whole again. However ideal (for Fed) this is, there is a very big problem. A reflation in housing market can only happen along with a wage inflation. And that is just NOT happening, due to global wage arbitrage from globalization, and high (and lasting) domestic unemployment rate. In fact, because of that, I think the likelihood for USA to follow Japanese style deflation is probably higher than most people realize.

2. Amerman keeps saying that for average Joe, the monetary inflation/deflation is much more important than asset deflation. I definitely agree with that. Mish tries to argue that there is also a price deflation besides asset deflation, while Amerman doesn’t believe in that. With certainty, commodity prices have gone thru some deflation. The notable example is the crude oil prices falling from $150 down to $40, and now back at $70. That is a lot of deflation in a short time. With my own day-to-day observation, it appears that most companies are holding the price levels as much as possible. However, the actual deflation creeps in through various means of promotions:
A. In grocery, I’m seeing tripling coupon values now. And there is a constant ad wars going on for promotional items.
B. In restaurants, I’m seeing more heavy distribution of coupons, and the serving size of dishes are REALLY getting bigger (at a small minority of restaurants). I have been surprised that ordering the same number of dishes now is leaving my family with more leftovers to take home.
C. For “monopoly” business, such as Disneyland tickets or Legos, prices are not falling at all. They have been rising. But promotions do seem to go on slightly more frequent than before. However, without promotions, I’m definitely paying 3% to 15% more on every Lego box that I’m buying for my children.
D. In government, taxes & fines are going up. And I don’t see any possibility that this trend will reverse itself.

From the above personal observation, I must conclude that most business are handling the deflationary pressure (due to less demand) via more promotions. They obviously wouldn’t back-roll the prices if they don’t need to. I don’t know if we will actually see a more pronounced deflated prices at the stores. But certainly, I think the majority of the savings from the commodity suppliers have NOT passed down to consumers yet. With this economic background, I think there will be some significant differences to your wallet whether you shop with coupons or not.
Furthermore, due to more business close-out and bankruptcy and lack of credit for new business to come in, there is LESS competition for the existing survivors. Less competition will simply mean higher prices going forward. This is the economic cycles at work here.

3. One of the most important thing to recognize in this debate is Mish’s point in including CREDIT for arguing a deflation. This is actually quite crucial. The destruction of credit has been much more relentless, relative to money printing at Fed. The money printing for stuffing the banks with good tier-1 reserve money truly came AFTER mortgage credit creation, not before. There is no ways for banks to lend out these newly minted money, since they know very well that their mortgage assets are still deteriorating at an alarming pace. This is the point that I was missing when I forecast high inflation in 2006 (at #1 above). Certainly, for much longer term, it still doesn’t change the fact that either US dollar or USA liability needs to get trashed. But the timing of such event is likely to get postponed first due to current unfolding of deflation.

Overall I tend to agree with Mish who is blasting every hyper-inflationist out there. I don’t know whether the debate really puts an end to hyper-inflation, but I do think that Japanese-style deflation may be with us for at least a couple of years. However, Mish view obviously doesn’t jibe with the current optimism on Wallstreet and global stock markets. Just be careful holding equities. When the game is up, no one is going to ring a bell to remind you that the top is behind you.

The strength in this market rally has been beyond amazing. Now I’m fearing that all sectors are going to make a last parabolic hurray before taking a correction, with energy sector (especially natural gas) making a quick catch-up.

My net worth has been undergoing dramatic changes as market rallies further. I have benefited greatly from the high-tech and mining sector advances, while hurting badly in my cross-hedges in the financials and general stock market, not to mention my high cash position in $US dollar is dropping against all other currencies by day. Every component is going to the extreme (big gain or big loss), and I am not entirely sure which positions I should be trimming.

It looks like S&P500 is going to visit 1100 first before correction. However, I have bailed out most of my small positions in the general stock markets months ago back in May to July timeframe.

This week is an option expiry week. Looks like it may be the same story again, with shorts being forced to cover.

The US dollar still holds the key to this market. As soon as it reverses back up, safety bet will be in order, meaning that all anti-dollar bets & stock markets will retreat. However, with both Euro and gold breaking new high overnight right now, I assume that tomorrow will be the same again, with an upward bias.

Just some of my market observations.

1. Let’s start with the easier ones. Time to sell gold? NO WAY. In fact, I will be buying more if there is a 50% pullback from any short-term high that is being established. I didn’t buy more nor sell my positions. My patience is certainly paying off.

2. Stock markets continue to be very strong. The technical picture just doesn’t match up with the fundamentals. Many people believe that stock market is a predictor of the economy. Quite often that is true, but correlation simply does not mean causation. If the stock market is that smart, then we wouldn’t have a sudden fall from financial crisis at all, almost coincident along with the actual economy. The fact is that stock market is our joint front-running guesses. I expect the stock market to eventually “catch down” with the actual economy. But there are more hopeless optimists than I can ever beat up. My hedges from short positions are heavily in red, bringing 2% substantial losses of my net worth. However, I continue to hold my hedges (but may terminate hedges at any time).

3. US dollar is breaking support. If 77/76 is broken, then it would visit 70, most likely. This is probably the most crucial indicators for both gold and stock markets. Based on euro, and gold/silver ratio, it appears that this is probably what will unfold (which means that gold will go much higher, while stock markets will continue to go up). I kind of refuse to believe it, but markets know better.

4. Natural gas has fallen some 80% from peak of $13.69 down to $2.41. It reflected an over-supply and a weak economy. If the economy is turning around, natural gas must go up. So far natural gas has NOT confirmed an economic turn-around. Regardless, one thing is for sure. It won’t go down to zero. Is it a good time to buy UNG or natural gas producers or natural gas futures? I won’t bet on it, but I think the risk should be relatively low.

I continue to be investing fairly conservatively (probably over-conservatively by any measure). The uncertainties in the stock markets are still too great for any long term investment. And the worst potential volatility actually comes from currency markets. One should continue to stay extremely alert. Stop loss orders are advisable.

HongKong is going to keep its own gold in the newly built vault. When the party that keeps your “money” (in gold) can be insolvent, there is no guarantee that you will get your “money” back. I don’t know whether this news has anything to do with the two days of the vertical rise in precious metal & mining stocks.

The best way to buy gold is simply buying physical gold, and keep them yourself. Such process can be dangerous and susceptible to theft, but in my opinion, it is far better to have these banking thieves and liars taking possession of your gold. The same is true for silver.

I have looked over the prospectus for GLD, SLV, SIVR. There is also an upcoming SGOL to compete against GLD. All of the prospectus have extremely limited legal rights for your purchased shares in their trust. Most of the time, your legal rights stop at the Trustee. Trustee can deal with Custodian, but not sub-custodians who may keep your gold/silver. It is extremely difficult legally to recover your gold/silver through layers of legal non-protections down to sub-custodians. And guess what, at every level, from Trustee, Custodian, down to Sub-custodians, all of them are big banks which can become insolvent in the event of derivative crisis.

The primary reason to buy gold/silver is to have “insurance” against financial calamity. Leaving your gold/silver to these big banks who have recently gone to the brink of failures defeats the sole purpose of buying gold/silver. You won’t know who may go belly up, shorting nakedly in gold/silver futures, until some bank really fails.