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Happy New Year, and welcome to the January 2013 edition of my monthly Gold Letter.

 

In case you thought 2013 might be the year Washington got its act together, Congress reached another compromise to avoid having to pay its bills. Unfortunately, dodging the "fiscal cliff" will only make the real cliff steeper. That cliff, a dollar crisis, is waiting just down the road.

 

In my commentary this month, I analyze another factor that is bringing us closer to the real cliff: Japan's recent election. Instead of learning from US mistakes, the Japanese are using our playbook. New Prime Minister Shinzo Abe has pledged to inflate the yen to oblivion, and in doing so, will likely undermine the Japanese government's ability to keep subsidizing US Treasuries. Without Japan's support, the Federal Reserve will be the only major buyer - and when a government has to print money to buy the majority of its own bonds, the endgame looks bleak. 

 

The good news, of course, is that both avoiding the real fiscal cliff and the Japanese bond buying spree is bullish for gold and silver investors.  


Also in this issue: 
  • Dennis Miller of Casey Research explains why Treasury Inflation-Protected Securities (TIPS) aren't all they're cracked up to be.    

  • Lampoon the System shows the fiscal cliff deal for what it really is.  
  • My staff answers a frequent question about the investment merits of palladium.    
  • And, as always, we close with summaries of major news stories from the precious metals markets this past month.

To a profitable 2013,

 

Peter Schiff
CEO

Euro Pacific Precious Metals 

TREASURY'S LAST PILLAR CRUMBLES 

By Peter Schiff

Peter Schiff

With the return of Shinzo Abe and his Liberal Democratic Party to power in Japan, the market for US Treasuries may be losing its last external pillar of support. Re-elected on September 26th, Abe has quickly set a course for limitless inflation, saying Japan must "free itself from deflation and the strong yen." This is significant to the global economy as Japan is the largest foreign power left with a strong appetite for US Treasuries. If this demand falters, the Fed may be the only remaining buyer of new Treasury issuance.
 
 
Abe's Plan
 
This election marks Abe's second turn in the premier's seat. He first held the position from 2006 to 2007, when he abruptly resigned as the first of a string of unpopular one-year premierships. Notably, in the intervening time, the LDP lost its lower house majority to an opposition party for the first time since its formation in 1955. The victors, the Democratic Party of Japan, had been formed in 1998 on a platform of reducing corruption and making Japan more progressive.
 
Unfortunately, as we know from our past century of experience in America, progressivism is not the cure for an ailing economy. The DPJ was predictably unsuccessful at reining in the bureaucracy, but did manage to push through a damaging doubling of the national sales tax and additional entitlement spending.
 
Similarly to President Obama's 2008 election, the Japanese people were sold a lot of rhetoric about hope and change and, lacking any sincere alternatives, decided to give the new guys a shot. The results were equally disappointing on both sides of the Pacific. 
 
While American voters decided to throw good votes after bad in 2012, the Japanese preferred to return to the devil they know. The only problem is, he's still a devil.
 
Abe has essentially promised to return to the failed but feel-good policies of LDP government for the last 3 decades; namely, he will prop up failing industrial giants and attempt to print his way out of an economic slump.
 
Saving Grace or Pain in the $%&?
 
The yen hit a post-war high against the US dollar in 2011 and has remained strong. For sound-money enthusiasts, this has been cause for celebration. But for Keynesian demand-siders, it's a crisis.
 
Rather than attribute decades of sluggish growth to an interventionist industrial policy, Abe and his cadres are blaming the strong yen. In response, Abe has called for the Bank of Japan to target at least 3% inflation.
 
For some time, the only saving grace for Japanese citizens who are unable to find jobs or secure financing has been that prices have been stable or falling. Abe intends to rob them of that salve while doing nothing to address the underlying infection.
 
While some Americans may feel a self-interested sense of relief that one of the major dollar-alternatives is being undermined from within, they are misunderstanding the knock-on consequences of this move.
 
The Last Major Pillar
 
For the Treasury to continuing having successful auctions at current rock-bottom interest rates, someone has to be purchasing. A lot. 
 
Before 2008, most of the demand came from foreign central banks - especially China. Since the financial crisis began, China and many emerging market banks have dramatically reduced their purchases and even become net sellers. 
 
The deficit has been made up by the Federal Reserve, domestic personal and institutional investors, and a few foreign holdouts led by Japan. In fact, Japan is about to overtake China as the largest foreign holder of US government debt.
 
This is significant in that the other two sources of funding - Fed and US domestic - are essentially intertwined. The more Treasuries the Fed purchases, the higher inflation becomes, which harms the US economy even further, which leaves domestic funds less wealth to invest in Treasuries. In my view, the foreign influx of capital has been the key third pillar that has kept this vicious domestic cycle from playing out in full.
 
How It Crumbles
 
Prime Minister Abe's plan to devalue the yen could thus be disastrous for both US and Japanese government finances. As the yen devalues, Japanese domestic investors - who make up the bulk of owners of Japanese Government Bonds (JGBs) - will be under intense pressure to sell out and find higher yields elsewhere. 
 
This flight of capital will threaten Tokyo with default, so the likelihood is that the Bank of Japan will begin directly buying JGBs on an even larger scale (as our Fed has done since the financial crisis) instead of buying US Treasuries. They may even become net sellers of Treasuries in order to finance their bailout of Tokyo while controlling inflation.
 
This will, in turn, put tremendous pressure on US Treasury investors. As the outflows mount, the Fed will no doubt announce another program to buy Treasuries under the guise of promoting economic stability. If the Fed becomes the permanent crutch of the Treasury, we can expect inflation to get higher and higher - driving more and more investors out of Treasuries.
 
Decoupling Continues
 
It is clear that Washington and Tokyo are but two sides of the same coin. Japan's debt-to-GDP is about 212%, while the US has just crossed 100%. Both are highly dependent on domestic investor interest in government debt to keep the charade going, and neither have prospects of paying their debts without real write-downs for investors. 
 
Unfortunately, neither government is using the time before this real crash strikes to even attempt to shore up their positions. The platform of Shinzo Abe seems poised to undermine Japan's ability to continue subsidizing US government debt. Left without any significant external supports, Treasuries will be in an extremely weak position when attention shifts from the EU sovereign debt crisis to the our own tattered finances.
 
Fortunately, there are ways for investors to escape Abe and Obama's tandem cliff-dive. Recent data shows that China continues to build a viable alternative. The South Korean won and Taiwan dollar are now significantly more correlated to the movements of the yuan than the yen or the US dollar. These booming economies will sustain demand for commodities as they build real wealth. With the old statesmen of sovereign debt compromised, I expect the up-and-comers to continue to turn to gold and silver in droves.

  

Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Precious Metals.       

If you would like more information about Euro Pacific Precious Metals, click here. For the fastest service, call 1-888-GOLD-160.    
Another Wrong Turn 
Fiscal Cliff 1 of 2
Fiscal Cliff 2 of 2
(Click to enlarge)

Jon Pawelko publishes the web comic Lampoon The System to poke fun at insane economic policies and educate the public on sound economics.

Click here for more cartoons and information on his just-updated anthology book, available for only $12.
WHY TIPS WON'T PROTECT YOU FROM INFLATION
By Dennis Miller of Casey Research 
 
If the "World Snake-Oil Salesperson Society" had a hall of fame, good old Uncle Sam would be a charter member. When it comes to smooth-talking folks into buying debt instruments, he's the slickest around.

And Treasury Inflation-Protected Securities (TIPS) are one of his slickest gimmicks.

Here's how the federal government describes TIPS:
Treasury Inflation-Protected Securities (TIPS) are marketable securities whose principal is adjusted by changes in the Consumer Price Index. With inflation (a rise in the index), the principal increases. With deflation (a drop in the index), the principal decreases.

The relationship between TIPS and the Consumer Price Index affects both the sum you are paid when your TIPS matures and the amount of interest that a TIPS pays you every six months. TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases.

When a TIPS matures, you receive the adjusted principal or the original principal, whichever is greater. This provision protects you against deflation.
Sounds like a surefire winner, right? If inflation goes up you're protected, and if deflation occurs, you'll still earn interest on the original principal.

When TIPS were introduced in 1997, my broker suggested them to me. My response was, "Okay, I'm the lender, right? And the amount of the loan, the interest rate, and the time frame are fixed. The only variable is the size of the final principal payment based on the inflation rate determined by the Consumer Price Index (CPI), and the borrower gets to keep score? I don't think so!"

Let's look at the details. Both the interest and principal growth are taxed. If the government calculates the inflation and pays out a net 4%, the investor must pay federal income tax on the income. That sure seems like a guaranteed way not to keep up with inflation!

And the picture gets even worse in today's economic climate. The government's version of the inflation rate, which it uses to adjust the interest and principal payments, is currently 3% - but that's really a lowball estimate. In the last few decades, the government has significantly changed how it calculates inflation. Using the government's 1990 method, Shadowstats reports that the true inflation rate is really 6.2%, which is a much more realistic figure. If that's the case, the loss of buying power to inflation is even greater. Not only does the investor lose to inflation by being taxed on the income, he also loses because the true inflation rate is higher than the government's rate. This results in a final principal payment lower than the true inflation rate. I would call that a double-barreled loser!

The government has changed its method of calculating the many times, and I urge readers to visit John Williams' ShadowStats website to see how. He clearly explains why true inflation is much higher than the figures the government calculates and reports.

I recently spoke with John, and he believes many consumers are under the illusion that the CPI is based on a constant basket of goods, and that their respective price changes are measured over time. In his research, he outlines substitutions the CPI has made and the political significance of those changes.

In 1949, Benjamin Graham wrote an investment bible called The Intelligent Investor, and many pundits and advisors reference his work to justify their recommendations. Graham passed away before TIPS were introduced, but Jason Zweig has added some significant comments to the most recent publication of Graham's book, including a discussion on TIPS.

Because of the taxable nature of TIPS, Zweig suggests owning them inside an IRA or some other type of tax-sheltered account. He offers the following notes on TIPS:
In one easy package, you insure yourself against financial loss and the loss of purchasing power.

Either directly or through a fund, TIPS are the ideal substitute for the proportion of your retirement funds you would otherwise keep in cash.

For most investors, allocating at least 10% of your retirement assets to TIPS is an intelligent way to keep a portion of your money absolutely safe - and entirely beyond the reach of the long, invisible claws of inflation.
I would have agreed with the author when he wrote the book, but times have changed.

Most successful investors have a couple of things in common. First, they're not blinded by smokescreens and can see things as they really are. Second, they understand cause and effect. I suspect Graham, who had both of these qualities, would see TIPS for what they really are. When one applies these two principles to TIPS, a few conclusions become clear.
  • TIPS won't protect against inflation if they're not held in a tax-sheltered account.
  • If the government adjusts the principal of TIPS based on the inflation rate, the best an investor can hope for is to stay even with inflation.
  • If John Williams' inflation numbers are accurate, a TIPS investor risks losing a good portion of his life savings to the ravages of inflation.
Unfortunately, financial planners tend to perpetuate the myth that TIPS adequately protect against inflation. Recently, when I asked a Certified Financial Planner at a major brokerage firm how he protected his clients from the potential ravages of high inflation, he said he recommended TIPS. When I asked if they were doing anything else, he answered, "Not really." Several of my friends with managed accounts have also said their money managers "protect" them with TIPS.

Many financial planners simply take all of a client's financial information and plug it into the company computer, which then produces a report outlining a suggested financial strategy. If the person writing the computer program plugged TIPS into the formula, that's among the items a final report may suggest. If your planner insists that any of your money should be invested in TIPS, I would certainly ask for a solid explanation.

In my opinion, TIPS do the opposite of what they're supposed to do. With inflation on the rise and some creative accounting on the part of the scorekeeper, I think TIPS are a terrible investment. I urge every reader to do his own due diligence. Questioning financial planners and money managers may lead to some stressful conversations, but the risk of losing a large portion of your nest egg to inflation warrants taking the time to educate yourself by demanding answers.

Many friends have asked me what they should invest in to protect themselves against inflation. Unfortunately, they're looking for an easy answer that doesn't exist. Only a combination of investments can accomplish the goal.

Many readers may remember an entertainer named Alex Karras who also played professional football for the Detroit Lions. At the time, the Lions had a terrific defensive team and a horrible offense. When a reporter asked Karras for his prediction on the upcoming season, he replied, "I predict we will play to a lot of scoreless ties!"

If you're heavily invested in TIPS, a scoreless tie is the best you can hope for. We have much higher aspirations.

How I Realized the Government Lies about Broccoli

As a kid, I was led to believe the federal government was close to God. If a report came out from the government or even Walter Cronkite, no one considered questioning its authenticity. It was fact.

But somewhere in my 20s, I actually started to think for myself a bit more and question certain things, including the government and its messages.

It all started with a headline-making government report. Apparently if I didn't eat broccoli - I mean at least two big helpings each week - I was certain to die of cancer by the end of the decade. Now, I hate broccoli. I hate the taste of it, the smell of it, and even the idea of having to eat it to survive. I began to suspect something was fishy.

Shortly thereafter, there was a big editorial about Washington lobbyists corrupting America. I looked down the list and sure enough, there was a big broccoli lobby. Bingo! The broccoli lobby had corrupted the research process in the US. It bought and paid for the study that published the data indicating I had to eat two big helpings a week to avoid an early deathbed. Wasn't it that same broccoli lobby that paid someone to dump truckloads of broccoli on the White House lawn when Bush the First was president?

That was a traumatic day for me, realizing that the federal government could be paid to educate the public about something that wasn't true... particularly regarding broccoli.

I've finally concluded that any government that will lie to its constituents about big things like broccoli will think nothing of lying to them about little things like unemployment numbers, the inflation rate, nuclear weapons in Iraq, or the Vietnam War. Once it gets comfortable lying about the big stuff, the little ones come easy.

 

An active international lecturer for 40 years, Dennis Miller wrote several books on sales and sales management. He was a contributor to the American Management Association and is a former US Marine and a member of the Mensa Society. Early in his career, he was an adjunct professor at Northwestern University.
 
In 1995, Dennis undertook a serious study of investing, devoting many hours a day to reading and speaking with investment managers, authors, analysts, and anyone who could broaden his knowledge of investing. Sixteen years later, Dennis' book Retirement Reboot was born, as well as his monthly newsletter, Money Forever. Click here to learn more and subscribe.
QUESTIONS FROM OUR CUSTOMERS 
 
What Are The Benefits of Owning Physical Palladium?

Along with platinum, rhodium, ruthenium, iridium, and osmium, palladium is known as a platinum group metal (PGM). All of these metals share similar properties and are often found together in nature. However, there are critical differences that determine the relative industrial utility and market price of the different PGMs.

 

Because all the PGMs are very rare and difficult to mine, the markets for these metals are much thinner than for gold and silver. In fact, platinum and palladium are the only ones commonly bought and sold. They do not trade on futures markets and are mainly bought by industry and investors in physical bullion.

 

Like platinum, palladium is an integral part of catalytic converters, which clean toxic vehicle emissions. This use accounted for 71% of palladium's global consumption demand in 2011, followed by the electronics industry with 16% of global consumption, the dental industry with 7%, and the remaining split between jewelry, investment, and chemical industries.

 

Because of strengthening automobile and electronics demand in emerging economies and labor unrest in South African mines, palladium hit a nine-month high at the end of December as some predict a shortfall in the new year. The mining supply is limited, with Russia and South Africa accounting for about 80% of annual global output. Though it has risen 300% since its recent low in 2009, palladium remains 46% below its record high.

 

For those willing to accept higher volatility in return for potentially outsized returns, palladium remains an attractive option that fits into Peter Schiff's overall investment thesis.

 

Euro Pacific Precious Metals offers 1-ounce palladium Maple Leaf coins issued by the Canadian government. The US Mint does not currently offer a palladium product, though it was authorized to do so by law in 2010. A study has been completed and may lead to the product being issued as early as this year, which is expected by some analysts to drive significant additional investment demand.

 

If your looking do diversify your precious metal holdings, call our Precious Metals Specialists to discuss if palladium is right for you: 1-888-GOLD-160 (1-888-465-3160)

THIS MONTH IN GOLD

American Eagle Gold Coin Sales Skyrocket

Financial Times / CNBC - November saw a 131% increase of US American Eagle gold coins sales, the highest rate in two years. The rush started right after the re-election of President Barack Obama, indicating that many investors have lost faith in a near-term solution to the United States' ailing finances. The increase in physical bullion sales did not translate into higher gold spot prices due to institutional capital leaving gold ETFs and other derivative investments. Read Full Article>>

 

China Frees Up Gold Market

The Wall Street Journal - In December, the Chinese government began to allow interbank gold trading for the first time. This is just the beginning of the CCP's plan to compete with London's liquid gold market and attract more foreign investors to the Chinese economy. Jeremy East, global head of metals trading at Standard Chartered PLC, remarked "From [China's] perspective, gold is seen as currency, and the government is slowly releasing controls on currency." China is the world's largest gold producer and one of the top gold consumers. Read Full Article>>

 

Gold Execs: Yellow Metal Rising in 2013

The Vancouver Sun - PricewaterhouseCoopers' Gold Price Report found that 80% of gold mining executives expect the price of gold to rise in 2013. New demand from central banks is key to this forecast, as many have shifted from net-sellers to net-buyers of the yellow metal. Mining executives have to be more accurate than most in their forecasts in order to properly anticipate demand for future projects. Thus, this bullish endorsement carries significant weight in the investment community. Read Full Article>>

 

Morgan Stanley: Gold & Silver Far from Peak

Bloomberg - Morgan Stanley projects gold and silver to outperform other raw products in 2013. Rising prices will be spurred by low real interest rates, central bank buying, and continued global economic uncertainty. While other analysts predict the end of gold's super-cycle, Morgan Stanley's report claims this viewpoint is "too simplistic." They go on, "Commodities are cyclical but the elasticity of supply and demand, as well as the length of the cycle, vary significantly." In other words, the gold train won't run forever - but it still has a lot of steam left. Read Full Article>>

 

Japanese Pensions Invest in Gold

The Wall Street Journal - Several Japanese pension funds have begun to invest in gold for the first time. With Prime Minister Shinzo Abe calling for unlimited quantitative easing from the Bank of Japan, funds are seeking safety from inflation in gold. Traditional Japanese pension funds rely heavily on foreign and domestic bonds, which were traditionally considered foolproof, but are now seen as vulnerable to credit downgrades and other shocks. "By diversifying currencies, we aim to reduce risks associated with them," said Yoshi Kiguchi, the chief investment officer of Okayama Metal & Machinery Pension Fund, which began buying gold as an alternate currency in March.
Read Full Article>> 

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In This Issue
Treasury's Last Pillar Crumbles
- Peter Schiff
Another Wrong Turn
- Lampoon the System
The Problem with TIPS
- Dennis Miller
Questions From Our Customers
This Month in Gold
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