Financial Sense Blog

The recent jawboning between the US and their Chinese counterparts is not only being played out on the diplomatic front (with Treasury Secretary Geithner making a house call) but also in the financial markets. The bump in rates by China, instead of allowing their currency to “freer” float certainly confused investors’; however the reaction to a reduction in liquidity was very certain: sell risk assets.

As all investors and traders are aware, investor sentiment is a ‘contrary’ indicator, always at high levels of bullishness and complacency at rally and market tops, and at extreme levels of bearishness and fear at market bottoms.

On Tuesday, the U.S. stock market suffered its worst day in two months. The recent volatility in the market continues to breed uncertainty among sheepish investors who are still in capital preservation mode. In this brief commentary, I want to explain some of the reasons behind the recent volatility as well as discuss some of the buying opportunities that I see ahead.

With the Fed’s near promise to implement the second round of quantitative easing, stocks, commodities, and precious metals have experienced sharp rallies relative to the July 2010 lows. The rallies have occurred despite questionable fundamentals, especially related to employment and housing. The Fed’s plan to devalue the U.S. dollar has helped spark rallies in gold, silver, copper, stocks, and commodity-related currencies, such as the Australian and Canadian dollars. If the U.S. dollar were to stage a countertrend rally, then risk assets may experience corrections from their recent overbought states.

Joseph Stiglitz is a Columbia University Professor and a Nobel Prize-winning economist. He extolled the wisdom of Keynesianism on Bloomberg yesterday.

While the US economy continues to weaken (see my recent commentary: Don't Doubt the Double-Dip), many foreign economies continue to experience solid -- even spectacular -- economic growth. When the global economic crisis began in 2008, many forecasters doubted that the world economy could return to growth without the US consumer. But the world is learning what Peter Schiff has long predicted: that the US consumer is a drag on the world economy, not an engine for growth.

Investors should continue to hold gold for long-term investment. It will move to $1500 and then higher. Traders sell spikes and buy dips. Gold-related news: South Korea decided this week to increase the percentage of gold in their investment portfolio these purchases could be substantial. China continues to buy gold.

Finally and with the greatest of reluctance – the US government has begun the defense of the US economy. This essential and long overdue defense is likely to be extremely painful for US investors, precisely because it is so long overdue. To return strength to a US economy mired in growthless depression requires an extraordinary action – the Federal Reserve and US government are openly going after the value of the US dollar.

Many mortgage lenders lacking the reserves to buy back mortgages which will likely be put back to them by bondholders. This is the latest development in what may end with a second string of bank failures resulting from misconduct and fraud.

Today’s bounce was not much of a surprise for several reasons… •Overall trend is up, one day sell offs are generally profit taking •Panic selling on the NYSE tipped us off that the market was oversold •I don’t think they will let the market fall before the November election •Intermediate cycle is turning up this week, 3 weeks of upward momentum…