"Forget it, he's rolling."

I had the opportunity recently to exchange emails with one of the more grounded economists around. He is a regular on business television, and one of the few who saw the problems of the past decade coming. Currently, he also happens to fall in the camp of the disinflationists/deflationists.

My question to him was why (for so many), inflation implies economic growth, while deflation need imply slowdown. (Actually, I think I know the answer to the second half of the query, but more I was curious why inflation must mean more robust recovery.) The answer I got was that it's hard to raise prices when demand is weak and running below aggregate supply. Pretty straightforward. Add to that, it seems that most people rely on CPI as the basis for determining whether inflation exists. CPI is running very low these days (and the economy just so happened to hit a few speed bumps lately, calling into question the recovery that gets touted all the time). Case closed, I guess.

But, as others have aptly and eloquently pointed out before, CPI is a massively manipulated number. The two main problems: hedonics and the exclusion of food and energy prices from its calculation. A lot of folks, including the above-referenced economist (who I have tremendous respect for), see CPI as the canary in the coal mine. As long as it goes down, we should expect deflation generally, and lower treasury yields specifically.

Nevertheless, I operate with a different mind set. I think we could have inflation in the midst of a sputtering economy. I think interest rates are destined to rise (just don't ask me when exactly). And when they do, life for most average Americans will get that much tougher. If inflation is really about demand, couldn't we have a scenario where the price of food and energy go up painfully, since those are two key inputs of daily life that we can't go without (all while CPI happily continues along). I know people like to dismiss grocery store inflation like it's some sort of joke, but how isn't it relevant to the conversation? Still, getting past that point for a minute, my instinct is that the agonies of inflation won't be experienced simply at the corner deli.

I read a great interview recently with Terry Coxon (of Casey Research) in which he articulated a fundamental premise: increasing the money supply eventually leads to inflation. That's just the way it works. I guess it doesn't have to, but it's the inevitable consequence of relying on the Federal Reserve. (The next time they catch a bubble before it forms, it will be a first.) To expect them to know when to sop up liquidity is an exercise in futility. Practically, when you have irresponsible monetary (and fiscal) policy, the easy money that results is going to go somewhere. We already saw its impact on the real estate market, and before that how it effected the tech sector. We have an election coming up this Fall, and if you don't think the Fed (with a little tap on the shoulder and encouragement from Barry, Tim, Nancy, etc.) is going to accommodate, you're not paying attention. Money printing, QE2, whatever you want to call it, it's coming. And it will lead to more bubbles and bigger problems down the road.

And not to go off on a tangent, but what of gold? Isn't that a canary? If we are to believe that deflation is the trend, why is gold in the midst of a convincing secular bull market (one that everyone likes to dismiss as a bubble, by the way - I think that's called irony).

So, given that it's now become too late to tell this story quickly, here's where the rubber meets the road. I think that where we are seeing the most obvious inflation is in the US Treasury market (ahh, now I get the reference to Animal House). We are seeing a steady and increasing march towards the fixed income market, in particular to the promises of Uncle Sam. And like real estate, where cap rates became silly, treasury rates are headed towards numbers that cause a head scratch. And when the unwind comes, it won't be because the economy has gotten back on its feet, it will be because the U.S. is like every other country that has been irresponsible with its spending. In the end, buyers of its debt are going to demand to be compensated. And we'll be able to look around and enjoy 10%+ unemployment all at the same time.

And with that, who did I borrow this soap box from again...

Something other than gold

Thus far, the sum and substance of my investing ideas on this blog is the belief that gold and related stocks are the way to position one's portfolio going forward. As I have written, moneyprinting is the dominant theme, which means a true currency, outside the grips of central bankers, is the easiest and most obvious way to preserve wealth.

Nevertheless, there is one company out there that I happen to be a fan of: Microsoft. I think they are positioned to do very well over the next year or two, and I have taken a position through LEAPS, specifically the Jan 2012 30s. The company had very strong earnings last week, beating on both the top and bottom line, and is poised to continue on that path.

With the LEAPS, my gut tells me I have a double or triple in store. Granted, it is always a risk to use options, as they can expire worthless and you lose out on any dividends. Still, I think the LEAPS are pretty cheap right now and probably represent the stop loss I would consider if I owned the stock outright.

The Price of Gold in China...

This past Thursday, one of the spec gold stocks that I own was the subject of a takeover offer. The largest shareholder (representing ~50% of the voting interests) gave its blessing to the deal, suggesting it is likely to go through. I decided to sell my stock that day, and while the return was not quite as outsized as I had originally anticipated, I am happy to make money in this market (considering the headwinds that I believe lie ahead).

The other moral to this story was that (I think) this episode is the start of a trend in the precious metals space. Gold will flourish in this market, whether you believe in inflation or deflation. It is a true monetary asset, one that has an inelastic supply and which the central banks of the world cannot debase at the first whiff of trouble. Therefore, small companies that hold the promise of gold in the ground will get gobbled up by larger mining concerns. It is why I have tried to build a portion of my portfolio around such companies. Will all of my choices work out? I'm optimistic, but probably not. Nevertheless, it is worth the time and effort to look at these companies. Because even though the company mentioned above did not give me what I was hoping for, it still gave me over 50% in about 8 months. I'll gladly take that as much as I can.

No sugarcoating

So, Lebron picked Miami. I always thought he was a longshot to come to NY, but now we have certainty -- what was thought to be a perfect union, was nothing more than a media creation mixed with plenty of false hope. I like Amare Stoudemire. I think the David Lee sign-n-trade netted some solid pieces. But, in the end, trading draft picks and throwing away the past two years didn't amount to all it could have been.

At the same time, the free agency period became an absolute circus. I think the hour long special to rip Cleveland's heart out was a disgrace. With ego and bravado like that, how could he have picked any place BUT New York!

Still, we did learn something about him -- enough to make me question whether he was the guy to bring the Knicks back. For all the hype and attention he has received, the otherworldy ability, in truth he's not the man. By signing with Miami, he conceded defeat. At the age of 25, he decided to pick the easy path. While the great ones embrace the challenge, Lebron folded. I have no doubt that the Heat will win a title, but I bet far fewer than most are anticipating. Because for all the talent, we know what to expect when times get tough. All sizzle, no spice. The throne has been renounced.

Where from here

I've been watching the markets lately and feel that reality is finally starting to set in. In a world where we saw an 80% rally off the lows, it felt like there was a disconnect between the euphoria of the markets and the realities on the ground. So, with a "correction" since April that continues on, I am expecting more of the same. Not that anything goes in a straight line, but to borrow from David Rosenberg, rallies at this point should be rented and not owned.

So, how am I approaching this? As mentioned before, I am a big proponent of gold. The only policy solution in place is money printing, and gold will benefit as the only monetary asset that can't be debased at the push of a button. Along those lines, stocks that would be perceived beneficiaries of money printing should also be considered - for me, selectively, businesses that deal in the precious metals space.

On a final note, Diego Forlan and Uruguay were eliminated from the World Cup today, leaving three teams who I don't really root for. I think Spain is the eventual victor.

Until next time.