THOMAS NOGALES FINANCIAL, LLC / SouthWest Ranch Financial, LLC
December 2008 Update
The S&P500 is at 896 on 30-November-2008

This page can be linked to at   ( www.thomasnogales.com/emails/2008-12.htm ).

The Thomas Nogales Financial Market Alert Timing Model is out of the stock market. 

Year to date, the S&P500 index is down -37.7% and the TNF Balanced Portfolio is down -26.7% (with half the stock market risk.)

Here’s the year to date performance of the TNF Balanced Portfolio by asset class. This is the portfolio without market timing.

As of 11/30/08

Market Alert Model
The TNF core model is out of the stock market.

Year Ahead Timing Model
The YAT model is used to indicate periods of buy opportunities within the Market Alert Model’s timing cycle. The TNF Market Alert Model always trumps the YAT model. The YAT model is neutral.

Interest Rate Model
The TNF Interest Rate model is negative on interest rates and long bonds.  

Gold Model
The TNF Gold Model is positive on gold.

Stocks
In January the TNF Market Alert Model exited the stock market at 1366. It's now 34% lower. The damage in REITS and International has been even worse. On the positive side, the risk level of the S&P500 has declined over the past month. The market is overpriced but the downward potential is limited. I don't expect the market to drop below 800 for the time being.

Pay attention to the main page of the website. I frequently post a short comment there if something important comes up. I get emails from subscribers asking about more frequent updates and commentary. This all takes a lot of time to put together and I'm trying to keep it a free service. I'm not sure if many people are interested in weekly updates.

Bonds
The ten year treasury dropped under 3% on 11/28/08. That's amazing. Yields on corporate bonds declined month over month and munis dropped a bit too. It looks like the fear level is dropping. Is it a good time to buy corporate bonds? No. The economy will need to resize itself and that means bankruptcies. Smart bond pickers can do well in this environment but index buyers should stay away.

Gold
Gold is up but I don't see any signs of a price blow off ahead. Gold is always volatile and the recent price swings should be considered normal considering the circumstances. I consider gold an excellent hedge against a dollar decline but am not in the gold $4000 camp at this time. I think gold will do ok in 2009.

Remember, my models only forecast the direction of stocks, bonds, and gold and not a specific price point. Direction over the course of the in or out phase is all you need to profit from market timing.

World Financial Crisis
Reading the headline news around the world, many worry that we're in for a prolonged international monetary crisis that could turn into a Japanese "deflation" era. Japan was on its own for those years. The rest of the world did quite well. The major difference this time is the crisis is global and governments will coordinate a financial rescue. I do think they'll attempt to resolve it by massive spending.

It's said that the crisis originated in America with the bursting housing bubble which started a cascade of financial failures. It exposed the weaknesses in a system based on leveraged finance and excessive debt. That is all true. What's rarely discussed is how the housing price spike is really an event of the last five years. Prior to that house prices had increased slowly and really didn't take off until 2003. The same is true for the subprime loans that financed the housing bubble. It's also true for the lion's share of the cash-out financing that consumers used to increase their discretionary spending. What I'm saying is the consumer housing side of this mess is a recent phenomenon that didn't become enormous and extremely dangerous until recently.

We have to separate America's financial crisis into two components. They are distinct and unrelated.

First, there's the long term problem with social security and medicare. Medicare is out of control and there's no way we can afford to pay the bills coming due for the baby boomer generations health care. This problem is structural and solvable but nobody is going to like higher taxes and reduced benefits. Former Comptroller David Walker vigorously spoke all over the nation and warned congress for years about the coming cost explosion. Let's set this aside for now because it's not relevant to the lending crisis.

Second, is the housing bubble and the headline defaults ravaging the banking sector. We have to ask what caused the housing bubble. The answer is obvious; so obvious in fact that congress and George Bush don't want to discuss it and certainly don't want to take the blame but that's where the fault lies. The reason for this disaster is in government finance after 2001 - too much spending, too low interest rates and too many tax cuts. It all happened together and there was a reason for it. It was intentional and done to enable a broader policy plan. The policy plan was the cause and the financial collapse is the effect.

Excesses always exist in a free market economy but are regularly washed out with recessions and accompanying business failures. Alan Greenspan takes a lot of flack for using the Fed to prevent recessions thus extending bad finance and allowing trouble to build without a washout. That is certainly true after 2001. He worked with Bush and congress to abort the 2001 recession and the stock market decline. Lessening the impact of financial pain was Greenspan's usual method and everyone loved his expertise at smoothing out the business cycle. What happened after 2001 though went far, far beyond and pushed America and the world into recklessness. Why?

There is a reason for it and it's not the pat answer about having to spend money to fight terrorism after 9/11. That's pushing the blame onto a straw man - someone who can never be held responsible. It serves to misdirect investigation. For the answer, we have to look behind the veil of lies and confront the truth. This is a place few want to go because so much of the press and congress were part of enabling it. Many were duped so they have a defense.

The answer is really about the dollar and oil and the imminent danger posed by the approaching end of easy access to energy. Cheap petroleum energy fueled the world economy and made possible, for a short time, a rate of rapid economic growth. This enriched everyone to varying degrees and certainly pushed up the stock market and everyone's retirement accounts. A decline in world oil production is at hand. The dollar is the world reserve currency and that status is based on oil.

We're now at a point where not just the banks but governments are teetering on collapse as the back flow of bad finance threatens to tear down entire economies. If that happens, then the world financial system will have to re coalesce into a new form. By definition that means a move away from the dollar system and into something more diversified. Any change to the world order of dollar dominance changes not just economics but has geopolitical implications. It's also bad for your pocketbook. Unfortunately, it's going to happen, it is happening and can't be stopped. We're in the midst of a financial crisis but at the beginning of a new financial order. We're at the cusp of a transition from oil to other forms of energy. It doesn't have to end in disaster although it might.

I'm going to quickly step through some financial/dollar history to show where we've been and where we're going and present my opinion of likely outcomes. I'll try to remove my political opinions from the process as much as possible but will not hold back from criticism where warranted and truthful. Intelligent people will disagree with me on some points and that's ok.

The Dollar

A Quick History of the World's Reserve Currency

The Dollar 1873-1930s
America had a currency shortage after the Civil War and private currencies (bank notes) were issued by various banks all around the country. Bank failures and depressions were not uncommon. Silver was the coin of the realm. In 1873 the US dropped silver as a reserve metal and only used gold. By 1890 at least 90% of commercial transactions used bank checks for payments. Banking has always been a big business.

The modern Federal Reserve was founded in 1913 to stabilize the banking system. The modern Fed manages short term interest rates to slow or speed up credit to regulate the economic thermostat. We were on the gold standard back then. It was a cash and carry society for consumers. The nation was becoming a vast manufacturing power. Stocks were not owned by many people but were rather ownership certificates entitling the holder to the dividend flows from a business in exchange for providing capital to fund business activities. Dividends were the measure of a business much more so than today. Stock certificates were exchanged between banks and financiers and held as collateral and weren't feverishly traded like today. They were often bid up to extreme prices and would crash periodically. There were a couple major stock market crashes prior to 1929 where stocks were down for many years. The Great Depression started after 1929 and continued until WWII. Only in the 1920s did the public become more involved in stocks but even then to a very limited extent.

The gold standard required convertibility of notes to gold. All debts domestic and international could be paid in gold or a currency with gold convertibility. The depression required the government to print a lot of money to stimulate the economy so they called in all the gold coins to expand the money supply. (Today nothing is backed by gold so a confiscation is unlikely).

Various reasons are provided for why the Great Depression occurred but there were similar prolonged downturns prior to it. The word depression meant recession at that time and only later were the terms differentiated. In modern terminology a depression is much different from a recession and implies a near cessation of credit and business activity.

On the political side, Communism was a popular political ideology in the early twentieth century and an experiment in governance without kings and powerful financial interests running the show. It later was shown as unworkable because it wasn't compatible with human nature and stifled personal drive. Keep in mind, this wasn't widely understood until much later. It would take almost 75 years for communism to be abandoned but there was some wisdom in keeping bankers out of the power structure.

Key Dollar Point: Up to 1933 Americans used gold and silver for private transactions along with currency backed by gold. After 1933 the US currency was backed by silver for domestic transactions. Silver certificate notes (1928 - 1968) were used alongside silver coinage. The US dollar remained a gold backed currency for international trade.

The Dollar 1944 - 1980
In WWII, America and allies were victorious in turning back fascism. After the war it was necessary to hold communism in check while Europe and Japan rebuilt with enormous US financial aid and military protection. America may be criticized for many things but this was its finest hour and the goodwill created sustained international relations with Europe and Asia for two generations. America was seen as powerful, successful and determined and, most of all, deeply admired for its ideals. Of course, self interest was at play here but overall the post war era was a time of economic growth and increasing political stability. Politically, it evolved into a bi-polar world with Capitalism and Communism opposing each other.

In 1944 the Bretton Woods agreement was signed that designed modern monetary policy among nations. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold and the ability of the IMF to bridge temporary imbalances of payments. This created the unique situation whereby the United States dollar became the "reserve currency" for the nation-states which had signed the agreement. The world economy expanded and the dollar was used for commodity transactions and to settle international accounts.

The Western nations had a post war demographic bulge of young people and more population often introduces inflationary pressures into an economy. That combined with massive infrastructure projects in America like interstate highways, space programs, and the Vietnam war plus world wide military bases all cost a lot of money. So, we printed it. Monitization is the process of printing money in excess of the rate of GDP growth and devalues currency by causing inflation in prices. In monetization, the Federal Reserve bank buys bonds from the government and the Treasury now has the credit to print money as it pleases. The Fed is supposedly independent from the Treasury but it's a creation of Congress which authorizes the expenditures.

US inflation caused a breakdown of Bretton Woods in 1971 when other nations demanded payment in gold rather than currency. In the face of increasing strain, the Bretton Woods system collapsed in 1971, following the United States' suspension of convertibility from dollars to gold. The dollar declined against other currencies and the international financial system and use of credit entered a perilous period. Inflation expanded rapidly in the 1970s until the Fed under Paul Volcker raised interest rates to slow economic activity. It took years but eventually inflation slowed. Stock prices were very volatile in the 60s and 70s and rose little over the period. Inflation is ruinous for stock markets because rising short rates make dividend payments on stocks uncompetitive.

Silver coins were removed from circulation in the 1960s as the silver price rose above the coinage face value causing people to melt the coins. The US government ended the use of silver certificates in 1968 which were convertible into silver coin.

Without gold or silver backing, the dollar remained the world's reserve currency but was greatly weakened. The dollar continued to be used for pricing commodities. Since everyone needs oil, they also needed dollars to pay for oil. The dollar thus retained its reserve currency status after Bretton Woods collapsed. Nations need dollar reserves to buy oil. OPEC nations and others with large dollar holdings recycle those dollars into US government bonds and other assets.

Key Dollar Point: The US currency lost all gold backing in 1971. The dollar remained the world's de facto trade currency and was needed for oil transactions. Oil thus backed the dollar and soon the dollar was used for most commodity transactions. A complex system of dollar recycling keeps money flowing into the US.

The Dollar 1980 - 2000
Ronald Reagan became president while Volcker, an appointee of Jimmy Carter, was leading the inflation battle. Under Reagan, the US switched from monetizing money to issuing more debt via bonds. All major nations sell bonds and most run deficits. This system of expanding public spending works quite well as long as the rate of debt growth doesn't exceed the rate of economic growth. Prior to Reagan this financial rule was followed diligently. Reagan expanded the economy by issuing debt at a higher rate than GDP and this continued through the terms of George Bush and the first term of Bill Clinton. Our debt crisis has been growing for 25 years.

The US economy expanded at a very fast rate driven by public spending and a robust consumer market due to the huge baby boom generation. Spending patterns by age groups is well understood and is used extensively in product marketing and financial planning. The government introduced the widespread use of IRA and 401k plans for retirement saving and this pulled the public into the stock market. The greatest stock market boom in US history ensued. The Fed managed interest rates to keep the engine going. Treasury Secretary Robert Rubin recognized the danger of debt expansion and reined it in during Clinton's second term. He slowed the rate of debt growth to below the rate of GDP growth. This was possible because of the enormous tax revenues generated from booming business activity and taxes on stock market gains and not because of superior economic management. At the time, some in the government predicted forward budget surpluses of trillions of dollars in the new millennium but this was overly optimistic. The stock market soon stumbled as government spending declined and by 2001 stocks were falling quickly as the economy entered a recession.

The 2001 recession would have cleansed the system of excesses if it had been allowed to continue. It wasn't. More on that later.

Let's step back a bit. After 1971 the dollar was essentially backed by oil. In the 1950s the theory of a predictable rate of oil depletion of established oil wells was developed by a Shell geoscientist named King Hubbert. He accurately predicted that American oil production would peak in 1975. This knowledge was successfully applied to other oil producing areas around the world. By the late 90s geologists were certain that some Middle East countries were approaching a production peak and a downturn was going to occur in various areas around the world. This became a strategic concern for the military because it could lead to resource wars.

Policy makers were aware of three key facts by the 1990s.
1. Oil production was peaking worldwide and oil would become much more expensive unless production could be expanded in new areas with large reserves. US offshore supplies are insignificant contributors due to their low production rate. Oil shale and tar sands are very expensive to develop and only feasible at much higher oil prices. It's important to understand the difference between oil reserves and the flow capability of an oil well. You can have a very large reserve capacity but a very low flow rate (or pumping rate). Thus tar sands are a large reserve but have a very low flow rate. The flow rate depends on the type of reserve, it's age and the geology.
2 . The continued use of the US dollar as the world reserve currency is dependent on its use as the trade vehicle for oil since the dollar is no longer linked to gold or silver. A decline in oil production and a switch to alternative energy sources would diminish the role of the dollar in international trade and thus America's ability to project power and issue debt in its own currency.
3. Large oil reserves of high quality existed in Iraq and Iran. Natural gas and heavy oil existed in the Caspian Sea nations.

America has a key role in expanding the rule of democracy and its military power serves to keep the forces of chaos on a leash. This fact is very significant. The end of the petro dollar era would mean the dollar's dominance would wane. This fact is of vital importance for understanding what followed after 2000.

Key Dollar Point: The US dollar has been backed by oil since 1971 and not gold or silver. Oil is the lubricant of commerce in the modern era. Oil depletion (Peak Oil) and/or alternative energy sources weaken the dollar standard.

The Dollar 2000-2008: The Bush Years
The world financial system is based on the petro dollar and a US military dominance that allows the expansion of Western values broadly called "democracy". Democracy was the counterweight to communism and the rule of kings. The US protects the militarily weak Persian Gulf oil producers in exchange for them accepting dollars for oil. Thus all nations that import oil must have dollars and hold dollar reserves. Oil is the key to understanding the military events of the last several years. It's why the 6th Fleet is in the Mediterranean and why we're at war in the Middle East.

The Iraq war is the result of energy policy decisions within the US government. Global oil demand has been growing steadily and oil supplies were peaking. In his second week in office George W. Bush created the task force, officially known as the National Energy Policy Development Group (NEPDG) with Dick Cheney as chairman. The discussions of this group were held in secret and haven't been released to this day.

The energy problem facing the US were clear and the leadership had a choice. They could transition to alternative energy but this would be very expensive and cause a decline in economic growth with grave risks for the dollar and American power. Shifting to alternatives at that time (late 90s) was a problem because, if the cost of oil remained low, competitors would have a cost advantage. China uses a lot of carbon energy because it's a major manufacturer. America, however, has off shored much of its manufacturing so it would be possible to move gradually away from oil. As an example, France is very nuclear and Germany is moving rapidly to solar. A shift to solar is very doable and cost competitive at a higher oil price. A transition would take a long time. A decision had to be made on what path to pursue.

A decision was made not to take the path of alternative energy but to bring in large oil reserves with big flow rates onto the world market thus gaining time for an energy transition. This would preserve the dollar standard as long as possible. The Bush administration made a decision that the oil must continue to flow or the US economy and Democracy would be at risk. The large remaining reserves with a potential for high flow rates existed in hostile areas and it would require military action to bring that oil to market.

There were three large sources of carbon energy.
1. Iraq has 10% of world's know oil reserves of oil and it's very high quality.
2. Iran has 9% of world's know oil reserves.

Oil production in both countries is very low due to poor infrastructure. Neither country would allow the major oil companies in. Iran was a target in the War on Terror because they refused to take dollars for oil and demanded Euros - a threat to the dollar. Both regimes were hostile to the US and hated each other and hated OPEC and Western values. Both were repressive by Western standards. Iraq paid death awards to suicide killers of Israelis. Iran had ambitions for regional leadership.

3. Another source of energy was the Caspian Sea area which had large reserves of natural gas and heavy oil. The US decided it could run pipelines from the Caspian Sea countries through Afghanistan. This would set up a confrontation with Russia which was intent on dominating the area.

The decision was made to go for it. Saddam Hussein could be knocked off with a military assault. Iran is a much bigger country with a homogeneous population. The people largely dislike the religious leadership but are very nationalistic. The best way to undermine Iran was through subversion and inciting the people against the leadership. Another concern with Iran was its nuclear ambitions. In the Caspian region, the Afghans have a long history of fighting invaders relentlessly but the US figured they could be subdued. Iran lies between Iraq and Afghanistan so US forces in both countries would intimidate Iran - so they thought. Iran hated the Taliban and likely would not provide military assistance to them.

Starting oil wars would have been politically impossible during a severe US recession. The US economy was slowing rapidly in 2000 and the stock market was falling by 2001. The Bush people cut taxes and doubled the national debt to overwhelm the recessionary forces. This action went against prudent fiscal management. Paul Volcker and Robert Rubin both published op-ed pieces in major papers warning of the economic fallout and possible disaster. Smart people foresaw the economic danger of massive spending plus tax cuts but their voices were drowned out in the zeal to go to war after the attacks of 9/11. It is totally wrong to say the present economic problems were not foreseen.

Prior to 2000, the regulatory weaknesses in the US financial system were a smoldering bunch of twigs. The doubling of US national debt after 2001 was done to prevent a recession and to reverse a stock market decline. It was a "bet the farm" action but a prerequisite to enabling the warfare based strategic energy objective. To expand the economy, interest rates were lowered to historically low levels and and then $5 trillion dollars was spent. These actions threw gasoline on the smoldering twigs as vast amounts of money and credit entered the system. These actions created the housing bubble, the subprime bubble and pulled up the stock market and employment. The dollar lost 40% of its value after 2000 as deficits soared but the stock market took off in 2003 fueled by low interest rates. The TNF Stock Market Timing Model gave a buy signal with the S&P500 at 828 in March of 2003.

This is where I'll step lightly but won't shy away from controversy. The events of 9/11 present many unanswered questions. Thousands of Americans died. For the first time in history, a steel structure would collapse in totality due to a fire. Stunningly, on 911, it happened to three buildings - an event that over 500 experienced architects and engineers and many firefighters believe must be questioned. These professionals are part of the 911 Truth Movement and they demand an honest investigation into what happened. Some of them call it a 2nd Reichstag Fire but critics dismiss such statements as conspiracy insanity. They say there's no proof of a 'false flag ' operation and the timing may have been simply fortuitous for the war planners. Whatever the truth, the events of 2001 helped set the stage for the War on Terror and Coalition of the Willing. The money spigots were opened and war plans were set in motion. Congress approved the Iraq war despite no evidence linking Hussein to 9/11 terrorism and despite warnings from CIA insiders and the British (Downing Street Memos) that the intelligence was flawed and contrived. This was an oil war.

Running the show was a shadowy mix of oil company interests, far right politicos, corporations, and pro Israel policy makers who all had different end objectives but saw a common path to achieving them. I'm not implying that they were individually involved in anything other than greed or patriotic zeal. The core group was the Project For a New American Century (PNAC) which has a charter and signatories that included top officials in government leadership roles (Dick Cheney, Don Rumsfeld, Jeb Bush and many others including influential people in the media and business). The PNAC agenda was implemented when Bush took office.

The Project for the New American Century (PNAC) was an American neo conservative think tank based in Washington, D.C., co-founded in early 1997 as a non-profit educational organization by William Kristol and Robert Kagan. The PNAC's stated goal is "to promote American global leadership."[1] Fundamental to the PNAC are the views that "American leadership is both good for America and good for the world" and support for "a Reaganite policy of military strength and moral clarity."[2] Critics claim that it has exerted strong influence on high-level U.S. government officials in the administration of U.S. President George W. Bush and strongly affected the George Bush administration's development of military and foreign policies, especially involving national security and the Iraq War. - Source: http://en.wikipedia.org/wiki/Project_for_the_New_American_Century

The core objective was the idea of a Pax Americana with US power circling the globe and allowing no military competitors. They believed this was possible because the fall of the Soviet Union meant the end of the bipolar power structure and America was the lone superpower. They had a window of time to circle the wagons around the globe to retain US dominance. The scale and the audacity of the plan now appears ludicrous for many reasons.

Key Dollar Point: Oil depletion threatened a weakening of the dollar. Without gold or silver backing, only oil backed the world's reserve currency. The oil wars would bring more oil onto the market, crush countries that wouldn't cooperate and thereby extend the petro dollar era. US military dominance would enforce and protect oil flows.

The Dollar: 2008
The wars are winding down but the bills and the consequences are hitting home. Our national debt was doubled since 2001 and will limit our policy responses to the new recession. The US probably can't borrow enough overseas to beat back this mammoth recession. Cash to support economic stimulus packages will either be printed or perhaps will be taken from the military budget. Either action will cause a contraction in US influence.

The Iraq insurgency will stay in check knowing America's military will relinquish control of the country and turn it over to the government and the religious factions. Iraq has signed oil deals have with major Western firms and non-Western nations but the the Iraqi government, if it survives, will manage the flows.

Were the wars worth it? Less Iraq oil is being produced now than in 2003. The Iran overthrow didn't work because the population didn't turn against the religious oligarchy thus leaving the religious leadership in a stronger position. The Afghanistan war has failed because the Russians managed to maintain control of the nations around the Caspian. The nations have committed to Russian oil pipelines rather than the US plan and the Russian slap down of Georgia went without a response. That tells the story. Thus the Taliban are emboldened. Even the future Iraq oil flow is doubtful unless the country is stabilized. So, the wars have been a failure because the strategic objective was not met.

In my opinion, the Bush Energy Wars were short sighted and had little chance for a long term payoff because oil depletion would trump whatever they did. It wasn't possible to win because you can't defeat geological science with an army. It was pure folly from start to finish and a pipedream pursued by ideologues with fantasies of empire. Their actions have taken our nation to the brink of ruin. Bush isn't alone in the blame. Congress is corrupted by the campaign contribution system and went along with Bush because he was willing to spend public money. My perspective may sound harsh but, after a careful study of the events, I don't see any support for the idea of a benign or intelligent strategy.

As it is, the US must now maintain a military presence in Iraq and Afghanistan in order to stabilize the regions and prevent retaliatory genocides against locals who cooperated with the US military. If things don't stabilize then tens of thousands and perhaps millions of muslims who cooperated with the US will be allowed to emigrate to America. The US is currently creating huge lists of names of Iraqi refugees in Jordan and other countries who are eligible for emigration to America. I know an official directly involved in the process. These people will not assimilate well and could be a source of future major problems here at home. Simply ask anyone from England or France about their waves of muslim immigrants.

As of November 2008, the leading economic indicators are plunging at the fastest rate on record. We have a new president. We're back to where we were in 2001 but with a much worse financial situation. We can't spend our way out of this mess like in 2001. In a way we're lucky that the world is now is in a global economic contraction because it buys time since less oil will be used. It won't last. The dollar has risen strongly against most world currencies as asset contractions have spread globally and caused money to rush to the perceived safety of the greenback. Stock markets are down 50% in many countries.

Is the dollar a refuge? Not really. It's of value because you need it to buy commodities but that could change. I don't believe the dollar is at risk of an immediate collapse because the petro dollar standard remains in place for now. But, change is coming. The world economic conferences like the recent G20 are really about stabilizing world finance and the role of the dollar.

That brings us to the present. America has lost a lot of credibility and the world financial system is in chaos. The transition to a new financial system is already underway. The dollar is certain to be less dominant. The United States must present a realistic plan for its own financial stability and a rational for why the dollar should continue as the world's reserve currency. Obama has assembled a competent financial team and many have roots in the Clinton administration. This is very symbolic to foreign leaderships because Clinton was well liked overseas and pursued balanced budgets. Symbolism is a good and will buy Obama time. In the meantime, it's possible some nation or a group of nations will reject dollar dominance and restore regional economic stability and set a pattern for others to follow. This could happen by adopting gold or silver backing for a trade currency or more likely a weighted currency system based on GDP combined with metrics for debt burden and measures of financial stability.

Private investors have to assess the likelihood of Obama stabilizing the US economy and how that will impact the dollar. This is a crucial decision because a dollar decline from the loss of reserve currency status will impact your purchasing power.

The first order of business for the world is to stop the plunge in asset prices and to stabilize economies. This means money printing and debt liquidation on a massive scale. It will likely be inflationary but hopefully not a runaway inflation.

Key Dollar Point: The oil wars have failed. The dollar's future role will depends more on how well we manage our domestic finances. Obama's economic team are top notch money people and they understand what is a stake. This means massive cuts to future entitlements, lots of new spending and a likely contraction of the military budget.

The Dollar: 2009 and Forward
The US has over $10 trillion in national debt. The Fed may monetize US debt if the economic crisis doesn't improve. That would normally be the kiss of death for a currency. These are not normal times. The whole western world is in trouble and they will all inflate in unison to save their banks and push up house prices and keep people employed. Asia has weaker currencies and immature regulatory agencies but a stronger economic base. Currency volatility will continue as a new equilibrium is reached after the crisis stage. However, at some point, some nations will break the pact.

I spoke last week with two gold dealers. A dealer in Phoenix told me that the spot price for gold is fiction. You don't buy or sell gold at that price. I called a large New York dealer. He said they are paying 2-3% over spot for gold coins and selling for about 9% over but have no gold inventory. There is a multi-week wait for gold coins but fractional Eagles are coming in and Vienna Philharmonics. Most of the gold demand is coming from Europe where people are panicked about the Euro possibly failing. So, you see, it's not just Americans who are worried.

The Perth Mint in Australia has decided to suspend selling gold coins. Australia is a major gold producer but is overwhelmed with orders.

With nations around the world printing money, negative interest rates, and a financial crisis it appears the a bubble could move into precious metals if inflation rises. Obama has stated they will ignore deficits and do whatever it takes to stabilize things. Folks, that means money printing. How much more clear can they make it. Since you can't buy coins, buying GLD may be a good option because it can be traded easily. There's no bubble like a gold rush so be careful. My Gold Model remains on the buy side.

Gold won't really take off until the general public gets involved. That has not yet happened and won't until they become fearful about rising domestic inflation. They'll buy gold high and will hold too long. Should a prudent investor buy gold at $800? Yes, but only in the context of a balanced and well timed investment mix. Don't bet the farm ever on one thing.

Key Dollar Point: The world must stabilize their economies or find a way to disengage from the dollar. Obama may have about one year. Gold is real money no matter what anyone says. If gold rises that means the currency system is not working. The dollar will not collapse if America regains financial control but our debt levels make that doubtful. Even if coordinated national efforts stabilized the economy, the dollar will weaken in the future as the globe shifts to alternative energy. The dollar will remain a player but not THE player in the new system.

Deflation?
Readers know I don't buy into the long term deflation scenario. The consensus is for deflation for the next decade. There's lots of talk of a depression with falling prices. We may get a depression but I don't think it will be deflationary. I might be wrong.

I fail to see how that outcome is likely in fiat currency world. You can believe the deflation story if you want but think about it a bit. Simple common sense reveals that there's no limit to how much money they can print. They said they will spend money and ignore the deficit - that's the exact words. The nation is deep in debt and all our debts domestic and foreign are denominated in dollars so what's to stop them? They have a printing press and three shifts of workers to run it. Why don't you believe them? Do you need a personal phone call from Obama?

This shows how deeply the deflation psychology has taken hold. The press and celebrity economists are begging the government to spend money to re inflate the system and that's exactly what we'll get. Once convinced of the need for massive fiscal spending programs the public will tolerate inflation as a necessary evil. This psychology will allow the re inflation to run longer and stronger thus raising house prices and ending the credit crisis - that's the theory. The other major economies around the globe are all on board. It will be a global re inflation. Inflation is like heroin - once you get the high it takes a long slow withdrawal to permanently get off it. That may be tough to engineer.

Low interest rates and huge forward deficit spending in nations around the world will support gold. Gold requires two criteria to advance in price. It needs a crisis of some kind and very low real interest rates. Fighting deflation means currency printing and that's bullish for gold. Failing to beat deflation means a move away from the dollar as other nations act to protect themselves. That's bullish for gold.

Deflation only makes sense in a world where a gold backed currency limits money printing or a currency is punished via linkages to other currencies via fixed exchange rates.

The evidence points to a changing financial system. Less dollar dominance means rising prices for necessary imported goods and commodities. If America reforms its financial system the dollar could become stronger relative to some other currencies if they get weaker. That can't be ruled out. For investors, holding only cash in a portfolio may mean less short term volatility but a broader mix of assets is the better long term play. The important thing is to build your portfolio one asset class at a time and when assets present good value.

Oil Prices
The world's economies consume a lot oil even under poor business conditions so I don't expect oil prices to stay at $50. The IEA just completed a worldwide survey to gauge oil depletion and the results were stunning. The truth about depletion is finally coming out now that the Bush Energy Wars are ending. They say that established oil fields have an average annual decline rate of 9.1%. Even if new fields are discovered the rate of world production decline will drop annually to 6.4% at best. This means higher oil prices. A world economy hammered by rising oil prices and financial losses doesn't bode well for business conditions.

"Earlier this year, The IEA promised to actually do a thorough bottom-up evaluation of the world’s oil supply rather than continue to base its future projections of oil production on anticipated demand. The London Financial Times has published excerpts from a leaked draft of the report. According to the Times, the report will say the natural annual rate of output decline will be 9.1 percent. Even huge investments in additional supply will only result in reducing the annual rate of output decline will be 6.4 percent. Depletion will become even more acute as prices fall and investment decisions are delayed.

A new report from a UK business-sponsored peak oil group says that the risk from falling oil production in coming years is greater than the threat posed by terrorism or the short-term impacts of climate change. The task force found Chris Skrebowski’s scenario “highly probable.” Skrebowski, consulting editor of Petroleum Review, projects that global oil production will peak in the period 2011-2013 and then decline steadily, with non-conventional sources such as tar sands failing to fill the gap in time to avoid a serious energy crunch. He also warns that supplies could collapse if a handful of huge, long-established oil fields go into terminal decline simultaneously." - Source: Goal1 Coalition

The Bush wars have delayed a move to alternative energy. The $5 trillion in deficit dollars spent since 2001 could have been productively applied to the vast infrastructure spending necessary to spread new technologies across the nation. We're in big trouble.

The petro dollar system is doomed to weaken over the next decade and that has implications for the value of the dollar.

Longer term, the role of oil will define the influence of the dollar. Oil production will be in decline and this is certain because of the geological science. The dollar's role as a world standard of exchange will be increasingly dependent on our nation's economic stability and ability to manage domestic financial issues. In other words, the dollar will be more like all the other currencies in the world.

China
I'm not sanguine about China. Reports I've read indicate widespread layoffs in the major cities. Look how Detroit gets slammed when auto sales slow down - the city's been in a 20 year recession. China is the world's Detroit and the Western slowdown is roiling China. I have great doubts that China will shrug this off with only a few percentage points off its growth rate.

I sat in disbelief reading today’s Shenzhen local paper stating that some 9,000 of the 45,000 factories in the cities of Guangzhou, Dongguan and Shenzhen are expected to close down in the next three months according to the Dongguan City Association of Enterprises with Foreign Investment estimates. Those closures would see up to 2.7 million jobs cut as overseas demand for consumer goods and clothes fades, that’s more than 50,000+ a day if you believe official figures, which I do not, and I believe number is actually higher. The association says that, by end of January, demand will shrink by 30 per cent, and these are just mainland factories. The Federation of Hong Kong Industries said that about 25 per cent of the 70,000 Hong Kong-owned companies in southern China "could go to the wall by the end of January". Yet on the very next page I read an article quoting the Ministry of Commerce as stating “Although it is likely to cause a decline in China's external demand, our stock market and financial system will not be fundamentally affected.” - Source Story at 321Energy.com

China has a conundrum. They need rapid growth to employ the people pouring into the urban areas. Unemployment is socially disruptive and a threat to the regime. On the other hand, the nation is horribly polluted from oil and coal use. The ground water system is over-utilized and 90% of the surface water is polluted. On its present path of development the country is becoming unlivable.

Earnings Lies and Pie on the Face
On financial sites I'm reading how the stock market is such a great deal and we should buy. What they're saying is that Operating Earnings ($89) have a PE of 10 and stocks are poised to bounce back up from depressed levels. This BS harkens back to the bubble days of the 90's. Reported Earnings ($48) means the PE is actually at 18. What's the difference between the two? Operating Earnings add back interest and taxes and other deductions to the bottom line. This supposedly gives a more accurate picture of profitability. Suuurrre it does. It's also the number they can easily manipulate to scam the shareholders and it's what executive bonuses are based on. Reported Earnings are what they must report to the government and are, in my opinion, more representative of real additions to working capital and asset values.

Another argument I hear is how dividend yields are improving so the stock market is cheap. It's true, yields are rising as stock prices fall but not many dividend pay outs are rising. In this market you have to carefully examine a firm's ability to continue dividend payments. Many firms will freeze or cut dividends before this recession is over. In fact, dividends are being cut at the fastest rate since 1958.

I've stated before that this market may not hit bottom until the real PE of the market is under 10. That can be accomplished two ways. Earnings can rise and stocks don't go up or stock prices fall. It depends on psychology and the speed of an economic recovery.

Subscriber Denise B. sent me a very funny and insulting article published in the Asia Times about Obama's economic team. It also discusses how the genius endowment managers at major universities have fallen flat on their faces. Harvard and Yale looked great for years because of their investments in private equity, commodities, and hedge funds. They shunned traditional stock and bond investments. In 2008 it all went down hill.

A case in point is the reported implosion of the Harvard and Yale endowments. For years, these giant funds were held up as proof that superior intelligence was the ticket to excess returns. During the 10 years through 2007, Harvard and Yale produced compound annual returns of 15% and 17.8% respectively, far better than the market, the average endowment or the average hedge funds - only to blow up in 2008 by frightful proportions not yet released. According to a recent study [1], the "super endowments" sailed past their peers by loading up real estate, commodities, and "private equity", precisely the sectors that underwent necrosis this year. Private equity is the subprime version of corporate finance, acquiring non-public companies with a minimum down payment and the maximum of debt.

David Swenson, the legendary manager of the Yale Endowment, learned one trick: buy on dips in the equity market with all the borrowed money he could get. The alumni network on Wall Street made sure that the university endowments were first in line for the hottest deals. That worked until 2008. We do not know how far the private equity holdings of Harvard and Yale have fallen, but the traded equity price of the Blackstone Group, a leading private equity firm, is a fair gauge. It is down from its $35 initial offering last year to only $4.65 today, a drop of 87%. - Source: Asia Times Obama's one-trick wizards

I own Swenson's book "Unconventional Success" and in it he suggests a portfolio heavily allocated to stocks but admits to using private equity for Yale. I had no idea of the extent that various schools were up to their necks in illiquid investments.

Portfolio Allocation - A Possible Asset Mix
Since the US dollar dominated financial system is in trouble, you can understand why some smart people advise against holding everything in dollars. Warren Buffett is putting all his money into stocks. He's warning about future inflation. He says holding cash will be a big loser over the next ten years. Believe him! Others are holding foreign stocks that pay dividends plus a position in gold. This theory figures that economies with natural resources and good finances will be net winners under a new financial system. Australia and Canada are considered likely beneficiaries. Foreign and US stocks have all done badly so timing these moves is critical.

The key is not to get stuck only with dollars if the music stops. One morning you may wake up to learn of a new financial system where the dollar still has a position but is no longer ruling the roost. There won't be any early warning. If that happens, you have to own stuff. In the meantime, a portfolio mix of gold, TIPS, cash and eventually stocks will be very volatile. Sorry, but holding only cash in US dollars is probably the riskiest thing you can do.

Personally, I intend to invest in four areas. Cash, gold, stocks and bonds. I intend to be very cautious until evidence gives me more confidence.

TIPS: I discussed this asset class last month in great detail. This idea here is that a dollar decline would be very inflationary as imported goods and oil would be more costly leading to price inflation. TIPS are indexed to inflation and would protect purchasing power. If you don't feel comfortable with TIPS then hold a short term bond fund invested in treasuries like VBISX.

Gold: I think bullion would be a big winner if the dollar dropped and will likely be in demand by national treasuries and individuals for many years to come. A large position in gold is not unreasonable and should be held as coins in your personal possession in a safe deposit box. Do not store a significant amount of gold at home. I don't believe the US government will confiscate precious metals. One subscriber wrote to say he's planning to move his gold to Switzerland where he travels. I prefer gold over silver because silver is more of an industrial metal. A case can be made for silver too.

Stocks: At some point, equities will be a good value but not yet. Buffett likes stocks that pay a dividend. Foreign stocks paying a dividend and are more leveraged against the dollar but foreigners tend to cut the dividend payout quickly unlike US firms. However, dividend cuts will come in droves if this recession continues beyond 2009. A good financial rating isn't a guarantee of a steady dividend.

The stock market has been tough on dividend stocks too as can be seen comparing SPY (SP500) to VIG (Vanguard Dividend Appreciation ETF).

Most people should wait until the whole market bottoms before buying a dividend fund. The TNF Market Timing Model will likely catch this turning point.

Cash: Currency on hand in a money market fund is needed to pay expenses and to take advantage of opportunity. There will be lots of opportunity in real estate in the years ahead plus deals on goods people will be forced to sell.

For now, a balanced portfolio mix consisting of cash, inflation indexed bonds, stocks and gold isn't a bad idea. I've preached this idea before. Most investment advisors would say this is much too conservative. It may be cautious but I'm talking short term.

I believe it's a big mistake to put all your money in one basket. Nobody knows for sure how things will work out. A balanced mix of assets combined with market timing is the best approach. This assumes we buy when things are cheap and sell when expensive with no frantic trading in between.

It Won't Ever Be The Same
America isn't going back to the good old days. The aging US population will never spend like before. You can't put boiled pasta back into a box.

Obama will stimulate the economy. He may even send a debit card to you every month that must be spent within 90 days. He'll give you money and he'll give you inflation. One will go with the other. At the very least, this country is vastly over retailed and has too much office space in many areas. The economic contraction will continue until it all hits a point of equilibrium scaled for the nation's savings and demographics.

The stock market will at some point offer compelling values. I would love to buy stocks right now to fill out my portfolio but it's too early. Many people including retirees who need income will move into stocks early out of desperation or after reading a magazine article by an expert. This is how the bear gets its three squares a day. Be patient. This market will not run away from you.

The dollar is defined by it's reserve currency status because its the major petro currency. Any move away from that status is reason for concern.

I do not expect a dollar collapse because there is nothing strong enough to entirely take the dollar's place. I do expect rising inflation eventually as the world works together to stabilize things. Everyone is on board and that includes China which has much to lose from instability. There will be a transition to a new global currency system.

TIPS are probably the best bond class for the average investor to hold. However, if the Obama team fails to stabilize US finances, we could see a bond rating reset of US sovereign debt causing much higher rates on US treasuries. Rising rates are very bad for bond holders. Ask anyone who has owned municipal bonds and corporates in the last six months.

TIPS protect against inflation but might not do well if treasury rates rose due to a cut in our sovereign bond rating.

The world economy will be under great stress for many years. People are too optimistic about an economic recovery. The prosperity of the last twenty years was a sham and only possible because of cheap oil and debt expansion. The real economy is something quite a bit smaller. Many nations benefited during the expansion phase and the contraction phase will be brutal for them. I have to believe that US strategic planners understand this. The risks of war will increase in the future at the same time that budget cutters will be looking at the military.

Dollar Summation
1. The dollar's days as the world reserve currency will come to a slow end under the best of circumstances. The dollar will not collapse but could drop relative to other currencies if the world switches to a currency basket for buying oil. A switch is not punitive and makes sense considering the globalized world economy.
2. The US must act immediately to stabilize its revenue and expenditure streams or risk a cut to its sovereign debt rating and a certain currency decline. This means Obama must trim medicare, restructure the health care system, increase taxes and reduce military spending. The government will spend big for the next couple years so debt stabilization is out the window near term. Obama will most likely present an action plan showing large short term spending increases and long term entitlement cuts.
3. Inflation will be higher in the future on a global basis. Deflation is very unlikely in a fiat money world. A deflationary depression is possible if the US does a lot of things wrong which it hopefully won't.
4. Demographics will prevent a return to a 1990's style economy. Forward growth will be much lower. Therefore, stock prices will struggle. Demographics are much worse in many other nations and especially in Russia and parts of Europe.
5. The failure of Bush's energy wars will have long term effects. The US military will have to contract for financial reasons and this increases the international risk of warfare over natural resources. The Somali piracy is an example of a regional authority breakdown.
6. It's possible the US may try another folly - increasing the immigration rate to bolster the demographic/economic base. This action would be culturally destabilizing.

Cheap and plentiful oil enabled fast world economic growth for the last fifty years. It's over. Personal debt enabled fast domestic growth and high stock prices. It's over. Government debt pulled the economy out of the 2001 recession and it can't happen again.

If you understand the dynamics and geology of oil, it's clear we're at a critical point for worldwide prosperity and we must successfully transition to alternative energy.

Currencies rise if they're in demand. Years ago, currencies were safe to hold if backed by gold or silver. Then came the age of fixed exchange rates where overnight revaluations introduced a lot more risk but pegs kept things orderly. All the world's currencies have broken their links to gold and silver and currencies now float in the open market. Only the dollar remains a required holding for those who must buy oil. If that link breaks, the dollar will have no legitimate claim to reserve status. The manic spending, the deficits and the wars since 2000 were an attempt to continue the Dollar Era in the declining age of oil.

Is the dollar topping?
I believe the panic phase of the credit crisis is behind us and the mad rush into the dollar could be over. I'd wait for stronger evidence before moving out of the dollar but below are some charts that provide some early information.

Gold (GLD) has moved sideways and recently moved up through its 50 day moving average. It will probably drop back into the 700s but it appears to be making headway.

The Euro is steadying. Maybe all those wealthy Europeans rushing into gold can calm down a bit now.

Oil as measured by USO is still way down and isn't showing much strength against the dollar.

The Next Six Months
This economy is extremely treacherous. Unfortunately the primary trend remains down. I see no indications that the US economy is improving - none whatsoever. The employment situation is deteriorating and the leading indicators for the economy are absolutely dreadful. It's far too early to talk of a bull market in stocks. Conserve cash and be very cautious but don't pass up opportunities because of fear. This recession will be worse than 1974 but I'm not ready to say we'll have a Depression. I can't see that far ahead. I do accept it as a possibility. In this video, Robert Shiller of Yale compares today to the depression and notes the similarities. This guy is thoughtful and not the type to speak loosely so pay attention. On the other hand, the Economic Cycle Research Institute tracks data going back to the 1920s and, although economic indicators are plunging, it's not as bad as what happens prior to a depression. They say we'll have a bad recession.

On the whole, I'm not positive about the next year but will jump into the stock market when my model says buy. Sitting in cash is not the answer for the long term. I would advise people to pay down debt and cut expenses to the bone. Drive an older, paid off car. It's good to own your home free and clear but for many people that will not be possible. If you have a large mortgage on your house, do not pay it off with savings. The government may have to reduce everyone's mortgage at some point.

The government will have to resort to untried and controversial measures to prevent a widespread, death spiral deflation that could run for many years. Deflation is very difficult to break once it sets in. The most likely option is monetization of public and private debt. In other words, simply printing money without selling bonds and getting money into the hands of everyone. I know that sounds outrageous but it might come to that - we'll have to wait and see. This would cause the dollar to drop. Other nations will resent it and that event could precipitate the move to a currency basket for international trade and oil purchases.

The political situation for America is of concern. The Bush years have hurt goodwill and confidence in America's leadership. The Obama team has maybe the next year to show progress on the nation's finances but will be fighting headwinds. Our national debt is too high and there's too many places needing money. I believe everyone should own some gold at this point and not because I think you're going to get rich from it. There's the very real possibility of a large dollar decline in the future but it's not a certainty. We will have a huge spending program enacted that could go on for years. When you print money like that it seems impossible for the dollar's purchasing power to increase.

I expect the government to spend big on infrastructure and especially in alternative energy development. The smartest thing America can do is to transition to a clean energy infrastructure and the rest of the world should do the same. Many in Europe are already on board. A balanced and clean energy system will not be confrontational.

I make no claim for being able to predict asset prices other than the ones I follow. My models have done an excellent job of forecasting the stock market, gold, and warning of the danger in bonds. I do think my timing models will find opportunity as this all evolves but the windows for action will open and close quickly. If my models signal a buy or sell you must pay close attention and act promptly. I believe there will be several opportunities to make short term trades in the S&P500 as the market bounces off valuation bottoms. In fact, I almost sent out a BUY alert when the S&P500 closed at 752 on 11/20/08 but held back because I usually use the Friday close for market timing signals.

I think I'll send out alerts inter week when my stock model signals a temporary bottom but you must act promptly when my model says sell. Even delaying two days could be too long. If you don't want to trade, then stay out until the general economy improves and earnings start to rise.

Other News
I've decided it's time to change things a bit. I'm going to change the name of my LLC to Southwest Ranch Financial. It's time to upgrade my image.

First some history. I can see the Sierra Madre mountain range in Mexico from my back patio but that's as Spanish as I get. The surname Nogales is a nom de plume and an anagram of Gleason. It's also the name of Arizona and Mexican towns not too far from my ranchette. The towns are situated across the border from each other. The sleepy US town is a ranching community in the high desert. The Mexican town last month had 10 drug war murders in one afternoon with hand grenades tossed at the police. A friend of ours works for US Immigration and he says it's perfectly safe to shop on the Mexican side if you exit the town before noon - before the criminals wake up.

Living in the high desert means nice temperatures and plenty of wild critters. Roadrunners, tarantulas, quail, hawks and coyotes are everyday neighbors and go about their business generally unconcerned with humans. A couple weeks ago this big fellow strolled past my back patio and then parked himself on the driveway apron. I always have a camera ready.

Best Regards,
Thomas Nogales Financial, LLC / SouthWest Ranch Financial, LLC     (www.thomasnogales.com)
Tom Gleason, Manager & Researcher

Author of: How To Invest If You Can't Afford To Lose (Free download on the TNF website)
Tom Gleason has degrees in finance and information systems. He's worked as a bullion dealer, fraud investigator, real estate appraiser and financial analyst.

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