Why you should hold on to gold

What was the best-performing asset of 2008? The Japanese yen. The many funds that had borrowed money in yen to buy assets in other currencies, now sold those assets and bought back yen to pay down debt. This was the unwinding of the Great Yen Carry Trade.

Hard to believe though it is with all the huge volatility, the next best performer was gold, up about 6% on the year against the dollar, and a lot more against everything else from stocks to real estate.

Gold was down some 15% against the yen. But those who bought their gold with British pounds will be delighted. After a hedge-funding beating 30% gain in 2007, we saw a stupendous 44% rise in 2008. Gold broke out above £600 to all-time highs.

The case for a quick recovery

There is no debate that the U.S. economy is in terrible shape at the moment.

Nearly 2.6 million jobs were lost last year, with the majority of them coming in the final four months of the year. And some economists are forecasting as much as a 5% to 9% drop in economic activity during the fourth quarter, which could be the biggest drop in 50 years.

But some economists are starting to believe that there could be a much stronger and quicker recovery than is now widely expected.

They say that the sharp drop in production and inventories during this recession will force businesses that are now busy cutting back to quickly ramp up production once the economy starts to improve.

The crisis in financial and credit markets sparked by the Lehman Brothers bankruptcy in September caused businesses to slam the brakes on production much harder than justified by reduced demand alone, according to Joseph Carson, chief economist at AllianceBernstein.

“We were producing 2 million tons of steel a week prior to Lehman. Now we’re producing 880,000 a week,” Carson said. “The economy has slowed, but it has not fallen by half in the last three months. This kind of significant inventory liquidation is exactly why recoveries take place.”

Many also believe that the significant steps being taken by the Federal Reserve and Congress to spur the economy will kick in later this year. That stimulus, coupled with low energy prices, could cause a jump in economic activity.

A V-shaped recovery?

This kind of recovery is known as a V-shaped recovery, because a chart of economic activity would look like the letter V: a steep decline followed by a quick and strong turn around.

“Generally the sharper the recession, the sharper the recovery,” said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.

Achuthan said he is not yet ready to call the bottom of the current economic downturn. But he said his firm’s weekly index of leading economic indicators has been ticking higher in recent weeks, suggesting that the economy may finally be close to the bottom.

He added that when things start to show signs of improvement, the economy could well be helped by pent-up demand from consumers who sharply curtailed purchases in recent months.

“Consumers have been on strike,” he said. “They’ve been holding off buying things that they don’t absolutely have to have.”

Of course, hopes for a quick turnaround are still faint. There are many economists, including staffers at the Fed, who worry that there will be, at best, a modest pick-up in activity later this year and continued job losses continuing into 2010.

According to a plan released by the economic team of President-elect Obama over the weekend, the incoming administration believes the unemployment rate will continue to rise through the third quarter of this year, and top out at 8% — even if the economic stimulus plan it is proposing passes.

Or a U-shaped recovery?

And some economists who believe there will be a sharp recovery aren’t sure it will take place anytime soon.

“We’re eventually going to get a strong recovery. We just can’t forecast with any degree of certainty if it will be in the second half of the year,” said Ed Yardeni, president of Yardeni Research, an independent market research firm.

He added that the recovery could wind up looking more like a U, i.e. the economy hovers around the bottom for awhile, than a V.

Yardeni said everything will have to go right to bring any type of recovery in 2009, including quick passage of effective stimulus by Congress and an unfreezing of the credit markets.

He added there is some evidence of improvement in the economy, including narrowing credit spreads and lower mortgages rates. But it may be too little, too late for a turnaround this year.

“Right now there’s more going wrong than going right,” Yardeni said

Three Reasons Why Gold Moves Higher

In my mind, there is absolutely no reason that gold should still be sitting below $1,000.

Despite volatility that can cause short-term fear (such as that found in recent weeks), there are several reasons why the momentum points to higher prices in gold. I am concluding that we can all but ignore the typical “real world” supply-demand equation in favor of investment demand. The major catalysts I see for gold’s uptrend include:

1. Bullish trends in the gold options markets
2. The historical “gold-oil ratio” averages
3. Potential market-moving events to drive demand

Gold Options: Recently , options trading action pointed to levels upwards of $1,200 in the gold market. Bullion definitely has a chance to rally past these record-breaking levels, as a flurry of bets from out-of-the-money calls has a targeted range all the way up to $1,500 per ounce. After a recent fall in the commodity market, there has been strong volume on December $1,000 calls and spreads between $1,200 and $1,300. As gold options are currently dirt-cheap for traders, the trend in the options markets has higher gains on the radar.

Gold-Oil Ratio: One of the more interesting data points is the historical average gold-oil ratio which is at this point in time completely off the mark. If history proves an effective lesson, precious metals need to increase dramatically while oil needs to continue its decline. As we are sitting right now, gold would need to hit the $2,000 per ounce mark in order for the ratio to balance. Granted, this can be offset slightly with oil tailing off further; but the case for rising precious metals is evident.

World Events: Certain market moving world events could lead to a staggering demand for gold, adding yet another catalyst to the bullish playbook. With the possibility of domestic & international economic disaster, a strong threat of inflation around the world, the potential catastrophic war between Israel & Iran and even flailing currency markets, any one of these deal-breaker events could cause a sharp jerk upwards in the gold markets. Investors betting on the world’s furthered economic demise are moving all the chips on the table toward the precious metals markets.

Predictions & Opinion

In my mind, there is absolutely no reason that gold should still be sitting below $1,000. I am calling for $1,150 an ounce by the first quarter of 2009. With commodity levels headed back toward $900, I feel that a rebound in precious metal markets is imminent despite the occasional bear market rally on flailing oil prices. If you can stand the volatile short-term movements in the market, gold bulls may soon be rewarded.

The 2009 economy and your wallet

The new president’s first job will be to repair a badly broken economy. Here’s how he’ll take on the four biggest challenges – and what that means for you.

Under normal circumstances, the election of Barack Obama would have meant a lot for your wallet. As a candidate, Obama promised to shift the burden of taxes toward the affluent, get health coverage to the uninsured and slap tougher regulations on financial products.

But these aren’t normal circumstances. Major financial institutions have disappeared virtually overnight. American automakers are now in danger of doing the same. Retirement funds are drying up and job losses have skyrocketed.

Forget “change you can believe in” – this is change you hope that Obama can keep up with. The new president and the Democrat-controlled Congress have more to do, and will spend more taxpayer money, than almost anyone would have expected a few months ago.

“The recession train has left the station,” says Harvard University’s Kenneth Rogoff, former chief economist at the International Monetary Fund. “This is about trying to prevent it from driving off a cliff.”

So can the new crew head off a crash? Let’s take a close look at what to expect from the government in 2009 and at how that changes your own financial game plan.

Challenge No. 1: The bottomless housing pit

One in 10 mortgages is either in foreclosure or delinquent on payments. That’s costing the rest of us big-time: If two houses on your street go into foreclosure, you can shave 10% off the value of your house, says Mesirow Financial economist Diane Swonk. The home-equity bonfire has eliminated an easy source of credit – a heavy drag on an economy that has depended on consumer spending for 71% of GDP.

What to expect from Obama: Obama will be under intense pressure from both left and right to expand Washington’s footprint in the housing market. That’s because none of the efforts so far have had much impact. The Hope for Homeowners program, which offers banks a government guarantee in exchange for reducing the principal on mortgages, has led to just a few hundred loan modifications.

One reason: Many mortgages are serviced by firms that don’t actually own the debt. Those servicers have less incentive to act – and may fear lawsuits from far-flung investors holding bits and pieces of the mortgage. “It’s been like using a paper cup to bail out a sinking ship,” says Mark Zandi, chief economist of Moody’s Economy.com and a former McCain adviser. “We need some real big buckets.”

What would bigger buckets look like? First, Obama can attack the slump in demand. The administration might pull the trigger on a proposal from the current Treasury team to finance new mortgages at rates as low as 4.5%.

To stanch foreclosures, Obama wants new bankruptcy rules that would allow judges to modify some mortgages. Many Democrats also back a plan from Sheila Bair, current head of the Federal Deposit Insurance Corporation. The government would offer a deal: If the lender lowers the mortgage payment, Uncle Sam will pick up 50% of the losses if the borrower ultimately defaults. This might require a law to shield servicers from investor lawsuits. The FDIC estimates that this could stop 1.5 million foreclosures, at a cost to taxpayers of about $24 billion.

Some voters will find this hard to swallow. Bair’s program pays out to homeowners and financial players who made bad bets, while the rest of us keep living in the houses we could actually afford. And there’s an argument that home prices have to find their natural bottom. But many economists worry that the market will overshoot on the way down just as it did on the way up. “We could be looking at a death spiral in prices if the rate of foreclosures isn’t reduced,” says Nariman Behravesh, chief economist at Global Insight.

Even if intervention works, things will be ugly. “You can’t stop the correction that is still required to offset the speculative excesses of the bubble,” says economist Jared Bernstein, an adviser to Obama’s campaign. “That correction is going to continue through 2009.”

Your strategy if you’re a seller: Obama has no quick fix. If you must sell now, move fast and be realistic. Undercut asking prices in your neighborhood, using the (lower) prices actually paid as a guide, advises Gabriel Bedoya of the real estate firm Corcoran Group. “It’s a much better gauge of what people are willing to pay,” he says.

Your strategy if you’re a buyer: No hurry. But don’t fret about trying to pick the bottom – you can get a house at a good price now if you are willing to stay put. In 2009, houses will be more affordable than they have been in a decade, according to research by UBS. And thanks to a Federal Reserve rate-cutting spree, 30-year mortgages are at an all-time low.

Your strategy if you’re staying put: Whatever Obama does, the Fed’s rate push makes this a good time to look at refinancing.