Well, Dear Reader, we’re here to tell you: America is in decline.

We can give it to you straight because we’re not running for public office. And if we were elected, we would immediately demand a recount.

Anyone who tells you America is not in decline is either running for office…or not paying attention.

In 1969, more than one out of every three dollars of income in the entire globe was earned in the US. That’s what the IMF’s World Economic Outlook tells us.

By 2000, that number had fallen…but not by much. The US still took home 31% of global income. But in the last 10 years, the US share has fallen hard — losing more than 7%. Now, only 23% of the world’s income is generated by the US.

Ten years ago, China’s economy measured about 1/8th the size of the US. Now, it is 41%. Another decade and it will be the biggest in the world. It is already bigger by several measures. And even if its growth declines to 7% a year, it will still surpass the US in a dozen years.

Hey, don’t take it personally. The entire developed world is in decline — with America leading them all down.

By 2050, according to a new study from HSBC, today’s emerging economies — as a whole — will be larger than Europe, America and Japan put together.

The New York Times reports:

The American economy’s reported 2.8 percent growth in the fourth quarter, at an annual rate, was seen as mildly encouraging. But it meant that over the previous 10 years, the economy had grown at a compound annual rate of just 1.7 percent. Until the current cycle, there had been no similar prolonged period of slow growth since the Depression.

The International Monetary Fund’s latest forecasts indicate that there is not likely to be a pickup in growth anytime soon, either in the United States or other large industrialized countries.

…if the fund’s forecasts of 1.8 percent real growth in 2012 and 2.2 percent in 2013 prove to be accurate, the 10-year American rate at the end of 2013 will have fallen to 1.5 percent… But it will still be a little above the 0.9 percent compound growth rate in the decade from 1929, the year the Depression began, to 1939.

For Britain, which endured a horrible decade in the 1970s that led to talk of the “British disease,” the previous postwar low, not shown in the charts, was in the 10 years ending in the second quarter of 1983, an annual rate of 0.95 percent. The figure for the 10 years through 2011 is 1.4 percent, but the I.M.F. predictions indicate the 2013 figure will fall to just 0.94 percent. The fund expects the British economy to grow by just 0.6 percent this year and by 2 percent in 2013.

The situation is even worse in Italy, where the fund expects the economy to contract by 2.2 percent this year and 0.6 percent the following year. If that happens, Italy’s economy will be smaller at the end of 2013 than it was 10 years earlier. The French economy is forecast to have grown at a 1 percent annual rate over the same 10-year period.

As the developed economies stagnate, the ‘emerging’ economies grow. Nineteen of the world’s top economies in 2050 will be those we regard as “emerging” today. China and India will hold the number 1 and number 3 spots, with the US sandwiched between them.

So far, we are just talking about numbers. Try to imagine a world in which today’s emerging markets have more economic power, and vastly more people, than today’s leaders. It is not just China and India who will be calling the shots, but Brazil, Turkey, Russia, Mexico and Indonesia too.

New technologies, new fashions, new ideas, new music, new cars, new movies…all are likely to come from countries where, today, Westerners are afraid to drink the water. Now, they are imitating us. Soon, we will be listening to pop Indian sitar music, eating doner kebabs and watching movies made in Jakarta.

Military power, too, is likely to shift to the growing economies. Like a body builder with a protein shake, they will use their increasing resources, human as well as material, to add muscle. But their muscle will be young, built with new technology and new techniques. America’s geriatric, expensive, bureaucracy-ridden, zombified military industry will be unable to match it.

It is one thing to talk nonsense to the voters. They love that kind of stuff. It flatters them. It comforts them.

But only a fool would believe it.

Which is what worries us. The candidates seem to think “declinism” is just a state of mind…and that economic and military success can be had by act of willpower.

“Decline,” writes Charles Krauthammer, “is a choice.”

And it’s a choice the candidates think they can avoid just by giving more money to America’s military industry.

“I will insist on a military so powerful no on would ever think of challenging it,” adds Mitt Romney.

But military spending is not a way to resist decline; it is a sign of it…and a cause of it. Osama bin Laden understood how it worked. By 2000, he had already brought one great empire, the Soviet Union, to its knees, luring it to spend money it didn’t have in a war it couldn’t win. He thought he could do the same to the US. So far, it looks as though he was right.

Lt. Col. Daniel L. Davis has been described as a “whistleblower.” He’s ratting out the military for failing in Afghanistan, just as Osama bin Laden predicted.

He doesn’t seem to understand. The military is not protecting the US in Afghanistan; there’s nothing to protect it against. Nor did it ever intend to “win” a war in Afghanistan. It never even identified what winning would mean or how it would know when it had won. This was always a zombie war, not a real war. Its purpose was only to transfer wealth and power to the military industry. In that sense, the war is a great success.

The Armed Forces Journal has the story:

Truth, lies and Afghanistan
How military leaders have let us down

By LT. COL. DANIEL L. DAVIS

I spent last year in Afghanistan, visiting and talking with US troops and their Afghan partners. My duties with the Army’s Rapid Equipping Force took me into every significant area where our soldiers engage the enemy. Over the course of 12 months, I covered more than 9,000 miles and talked, traveled and patrolled with troops in Kandahar, Kunar, Ghazni, Khost, Paktika, Kunduz, Balkh, Nangarhar and other provinces.

What I saw bore no resemblance to rosy official statements by US military leaders about conditions on the ground.

Entering this deployment, I was sincerely hoping to learn that the claims were true: that conditions in Afghanistan were improving, that the local government and military were progressing toward self-sufficiency. I did not need to witness dramatic improvements to be reassured, but merely hoped to see evidence of positive trends, to see companies or battalions produce even minimal but sustainable progress.

Instead, I witnessed the absence of success on virtually every level.

Regards,

Bill Bonner,
for The Daily Reckoning

When Emerging Markets Shape the Developed World originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

I’ve found many people are particularly energized about predicting a hard landing for China’s economy, but I believe the country is no sinking ship. China isn’t fast-approaching an iceberg in the dark of the night like the Titanic. Beijing has long been anticipating the ice chunks and subtly adjusting the rudder around inflation without steering the economic ship too far off course.

China’s government angled its vessel away from inflation by increasing the required reserve ratio (RRR) every month for the first six months of 2011 and raising interest rates three times. Once inflation was sufficiently under control, the country began to steer in a direction of growth again.

Recent results show how positive this easing has been. In its latest research this week, BCA Research reported that despite the policy tightening of 2011, the “most recent economic data out of China has all but confirmed that the economy remained incredibly resilient.”

One significant data point is the sharp increase in money supply. After the country hit a low level of monthly money supply growth, the three-month change in M-2 money supply climbed to record levels during the final month of the year, says Greg Weldon of Weldon Financial. He says that money supply “pegged at +6.419 trillion, easily exceeding the previous record 3-month increase, seen at the peak of the global crisis, in March of 2009.

Easing in China is expected to continue through 2012, with ISI Group anticipating a potential RRR cut after Chinese New Year celebrations in February, then possibly again in April, June and August. Also, loans “have become more readily available in recent weeks,” says ISI. This should all be bullish for commodities, such as copper, oil and gold, and also trickle down to boost share prices of natural resources equities.

Chinese Copper Inventories Increase

Base metals were the laggards among commodities last year, with copper one of the worst performers, losing 21 percent.

Global consumption of copper increased only 4 percent in 2011, which is lower than the 10 percent growth in 2010, but higher than the decade-average of around 3 percent, says Macquarie Research. China’s consumption of copper—which makes up 40 percent of the global demand—was a primary reason for decreased consumption, as the country was drawing down on its own supply throughout the year.

This can’t continue forever, Macquarie says, adding that “demand made on new supply direct from producers would need to rise, with positive implications for prices.” Europe’s largest copper fabricator agrees with that sentiment, indicating that it anticipated China’s copper demand would be strong in 2012, according to Barclays.

A recent rise in copper imports is likely the result of restocking China’s depleted copper inventories. As is typical for China, after the metal fell in price last fall, the world’s largest buyer of the metal advantageously scooped up copper to replenish its cupboard, says Barclays Capital. As shown below, copper inventories into China reached a record low in 2011, but have sharply reversed recently.

An increase in copper demand places pressure on the supply side, which continues to experience shortfalls in mine output versus forecasts. These are caused by a variety of factors, such as weather, labor strikes, or simply a poor grade deposit. While Macquarie says there’s a possibility the world’s two largest copper mines, the Los Bronces mine in Indonesia and Peru’s Escondida mine, could deliver year-over-year increases in production, it concludes “it is highly unlikely that miners will succeed in delivering this level of additional output in total.”

While Chinese demand growth for commodities is not expected to be as robust as it has been historically, demand is expected to pick up throughout 2012. As confidence returns, Macquarie says there should be “a slow gradient of recovery in the near term before gathering pace into the mid-year.”

Increasing Reliance on Energy Imports

China’s rapid growth and increasing reliance on other countries for key resources has made a powerful case for commodities over the past several years. These three charts from BCA Research illustrate that once the country shifted from exporting to importing a commodity, there was no looking back.

You can see in all three how dramatically the energy balance has shifted to an ever-increasing dependence on imports. In each major commodity, after China began importing, growth took off.

China became a net importer of crude oil in 1994, and today, is the second-largest oil importer in the world. BCA forecasts the country is expected to surpass the U.S. as the largest oil importer in only a few years.

To obtain more natural gas, China spent years building massive pipelines to transport the commodity from Russia and other western Asian counties, and since 2006, natural gas imports have “gone vertical,” says BCA.

Coal, which accounts for the majority of total energy consumption in China has also been imported since 2008, and since that time, imports rose substantially.

Even with these imports, energy consumption is only a fraction of developed countries. The China story is just getting started: Urbanization just surpassed the 50-percent mark, hitting what I believe to be the pivotal moment that dramatically shifts buying patterns, driving an enormous demand for housing, consumer staples and durable goods. You ain’t seen nothing yet!

Happy Chinese New Year!

This weekend, the world’s largest annual migration takes place. Millions of people in China head home to celebrate Chinese New Year and welcome in the Year of the Dragon. U.S. Global Investors’ research analyst and Shanghai native Xian Liang recently talked about the significance of the dragon in Chinese culture:

“Unlike its western counterpart portrayed as evil, the Chinese dragon is an imaginary, mythical creature. Its body parts are from nine animals, including the horns of a deer, mouth of an ox, nose of a dog, trunk of a snake, and claws of an eagle. It has auspicious power because it can make itself invisible or visible at any time. It can both fly and swim. It makes clouds and rain. Because of these magnificent things, the dragon is associated with royal powers as well.”

After bounding through a tough Year of the Rabbit, we anticipate the Year of the Dragon will breathe fire back into Chinese markets in 2012. Kung hei fat choy!

Regards,

Frank Holmes,
for The Daily Reckoning

P.S. For more updates on global investing from me and the U.S. Global Investors team, visit my investment blog, Frank Talk.

It May Take a Dragon to Breathe Fire Into Markets originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

But the IMF did throw the euro (EUR) a bone this morning, saying that they will seek $1 trillion in an attempt to boost their resources to bail out countries (read Eurozone peripheral countries)… And… Germany had a great auction result this morning… So… The euro, which traded as low as 1.2734 overnight before the IMF statement, has gained back one full cent to 1.2834, as I write… Of course, by the time I get to the currency round-up that euro figure could be much different… Volatile times, for sure!

Look at that Aussie dollar (AUD)! Back to $1.04 and change this morning! WOW! This currency looked like it was headed for the slippery slope after the Reserve Bank of Australia (RBA) cut rates. I remember telling you then that the rate cut made no sense, but… With the markets’ pro-growth mentality, they just might look at the rate cut as a reason to reward the Aussie dollar… And slowly but surely the markets have done just that!

Overnight, The Aussie dollar got a boost from the news that the latest check on consumer confidence showed a rebound this month. The markets will look next to the Aussie Jobs report, which is due out today… And again the experts have forecast a rebound in Aussie job creation… If that holds true, the Aussie dollar should be able to maintain this 2 ½-month high versus the US dollar!

I know I talked briefly about this in the past, but… Could the Aussie dollar become a “safe haven” currency? Now that would be more like it, eh? A country with a trade surplus, narrowing debt, and “things” that other countries want! The problem is that the Aussie dollar can’t go toe to toe with regards to volume, with the majors of the US, UK and Japan… But if tiny little Switzerland can be regarded as a “safe haven” currency, then why not Aussie dollars?

OK… That’s my 30 seconds on the soap box, this morning… But even with me banging my fist on the podium, the markets won’t listen, and they’ll decide what a safe haven currency is in the end.

So… Chris (and thanks, Chris!) brought you the news on all the downgrades by the ratings agencies… Should that have all been done long ago, though? I don’t know why anyone pays attention to what these agencies have to say any longer…

Here’s a prime example… S&P lowered the AAA rating of the US last August, right? Well, let’s see… Since then the yield on the 10-year, which is the bell ringer for bonds, yield has gone from 2.82% to 1.85%… So, just to explain bonds for those new to class… With bonds, yield and price have an inverse relationship… So, when the yield goes down, like it has for the past six months, the price goes up, which makes the bond more expensive. And to make a bond price go up, and yield to go down, the bond has to be bought by the truck load… Which, makes you wonder if anyone cared that S&P cut the US rating… Doesn’t it?

It’s nice to see the Chinese renminbi (CNY) on the currency appreciation tracks again. I did a ton of reading on my mini-break, and a lot of it was on China… (The US and Eurozone too!) And what I read reinforced my thoughts that China is working to remove the dollar standard. But it will be a long process. And it looks as though Russia is now joining China’s move away from having their trade terms settled in dollars, but signing currency swap agreements.

Look, folks… I know that some of you think I get enjoyment from telling you these things, but that doesn’t have one iota of truth to it… Having these countries sign currency swap agreements to remove dollars from the terms of trade is a BIG DEAL! And will eventually lead to the dollar being removed as the reserve currency of the world… Which means we can’t run up deficits like we do, print money like we do, and live like we do, because everything, and I mean everything will cost more…

We could have avoided what looks like is just down the road a bit… But our leaders chose not to… They, instead, chose to fund every program known to mankind, and borrow money to pay for it. I warned and warned about the deficit spending, and what it would do to not only our purchasing power, but our national security… And now, it’s led to this… I shake my head in disgust, and think about what could have been… But, if you don’t think having the reserve currency of the world is important, then take a look at the UK after WWII… They had to devalue their currency twice! And talk about a dark, depressing, drag on an economy!

OK… That talk can go on for hours (and has), but, as I said, it’s nice to see China back on the currency appreciation tracks… That was also very nice to see such a strong fourth quarter GDP number of +8.9%… Moderation… Not collapse… Remember who told you that many months ago, and many times since…

Don’t forget that the Singapore dollar (SGD) follows the renminbi… So, if the Chinese are ready to begin another round of currency appreciation versus the dollar, the Sing dollar will move along with the renminbi…

While I’m here in Asia… I will remind everyone that Asia is where I see the majority of economic growth this year… The emerging markets will have some, but Asia will have the most. So, I like most Asian countries outside of Japan… And here’s something that will make you bang you fist on the table… 28% of high-tech manufacturing jobs left the US from 2000 to 2010… That’s equal to 687,000 jobs…

The expansion of science and engineering capabilities in China and its neighbors are really making things difficult for the US president’s mandate to improve exports…

Here’s the thing, folks… When the president got up in front of the nation and said that the US would improve exports by “X”, what was he thinking? I’ll tell you… A weaker dollar, and a stronger renminbi…

And here’s a glimpse into that thought process… Remember when St. Louis Fed President Bullard, was asked if the rounds of quantitative easing (QE) were successful, one of his answers was: The dollar depreciated…

And those rounds of QE… The Fed told us that they were doing them to inflate the economy and produce jobs… When in reality, QE was done to weaken the dollar, to help meet the president’s mandate… I’ve always told you that the government wants and needs a cheaper dollar…

You had better stop there, Chuck…

Gold has had a nice run so far this year… With the low for the year (yes, I know we’re only 18 days into the month) coming on January 3… $1,566.25 … Gold has added about $90 to its price since January 3…

As the dollar, euro, pound sterling (GBP), and franc (CHF) fail to attract investment, those dollars head to gold… And as long as Japan keeps their interest rates at zero, there’s no reason to buy a currency that, according to Jim O’Neil from Goldman Sachs, is 25% overvalued… So, those investors turn to gold too…

And look at that Brazilian real (BRL)… Beaten down, and sent to the woodshed for more beatings, the Brazilian real proves to be resilient… Crazy moves in this currency, folks… And like I’ve always told you, only money from the “speculative investments” portion of your investment portfolio should be used here… And, and iron stomach to handle all the volatility… But in the end, remember… Brazil needs to attract a boatload of investments and cash to fund the infrastructure projects for the World Cup and Olympics that are coming to Brazil…

OK… It’s economic data dump day… PPI (wholesale inflation), the TIC Flows, and two of my faves, Industrial Production and Capacity Utilization, will all print today. The only two I really care about are IP and Cap U… Both should see slight improvements in December over November results… The TIC Flows have pushed the markets to become comfortably numb, which is a real shame.

Then there was this… A reader sent a note to Chris yesterday chastising him for calling out US Treasury Secretary Geithner… He said that we are “almost constant in anti-Obama administration political spin. Greenspan was the one calling the shots in those days not Geithner.”

OK… First of all, political spin is not what we do here… We call them as we see them, just like we did with Bush’s $500 billion budget deficits… But let me spell something out for this reader about Geithner… He was the head of the NY Fed, the lead Fed Bank and the one responsible for regulation… The NY Fed failed miserably… They had the regulations, but not the will to enforce them… And as I said, Geithner was the head of that bank… That’s what Chris and I talk about… Which is NOT anti-Obama administration spin…

To recap… We did have a currency rally going on when I arrived this morning, but it has since backed off. The currencies rallied on news that the IMF was going to seek $1 trillion for a rescue fund. Germany and the IMF lowered their 2012 economic growth forecasts. And Germany had a very successful bond auction this morning. And it’s a data dump day…

Chuck Butler
for The Daily Reckoning

Do Investors Pay Attention To Ratings Agencies? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

One of the big questions of the year is whether China blows up or not. Hard landing or soft? When will the clock strike midnight on the Chinese? Things are slowing down, and it feels like it’s getting late.

But first, why does this matter? China matters because China is big. If this were 1980 — when China’s economy was about one-seventh the size of the US’s economy, no one would care. Today, the appetite China has for raw materials is no secret, and is one of the main reasons why miners and oilmen are flush with cash. So if you invest in miners and oil companies, then the answer to the hard landing question decides the fate of your portfolio.

For some ideas on this front, I turned to my friend Ben Simpfendorfer, founder of the Hong Kong-based Silk Road Associates (and author of an excellent book, The New Silk Road). He also writes a very good letter focused on China called China Insider. Ben speaks both Mandarin and Arabic and has traveled extensively in Asia and the Middle East. As such, he has an inside look on two cultures that few Westerners will ever see.

I admire his work for these reasons, and also because he is critical and thoughtful about China’s prospects, whereas many others are either unfailingly sunny or permanently apocalyptic.

In his latest letter, which just hit my inbox this morning, Ben addresses the very question I open with: hard landing or not?

“I expect no hard landing in 2012,” Ben writes. As for 2013-15, Ben is much more bearish. As with any prediction, though, the reasoning is more important (and more interesting) than the conclusion. The key is to understand that China still has a lot of spending power. Let’s take a look…

“China could afford to go on another debt binge in the event that the economy appears to slow abruptly,” Ben writes. “Sure, it has implications for medium-term growth (and I’ll get to that in a moment), but the ability to continue borrowing, or further relax fiscal and monetary policy, does rule out the risks of a hard landing in 2012.”

In the past, China was able to skirt the financial crisis because it simply commanded its state-owned banks and state-owned firms to embark on big projects. It has the firepower to continue to do so in 2012. One place it will certainly focus on is housing. Housing prices are falling nationally. But housing markets are intensely local. You should be suspicious of attempts to aggregate them. Ben appreciates this.

“A look at major city clusters around the country shows that property sales have collapsed in areas centered on Beijing, Shanghai and Hangzhou,” he writes, “even as they remain steady in places such as Chongqing, Hefei and Shenyang.”

Ben continues:

“My own experience — traveling through nearly a dozen second-tier cities over the past six months — echoes the data, with some cities clearly about to suffer a horrible property crash even as others look more balanced owing to less supply, but also a stronger local domestic economy (typically the coastal provinces) that is less reliant on fiscal stimulus.”

As to that stimulus, China’s government plans to build 7 million public housing units annually over the next five years. This is a big increase from the 3 million units China’s state-owned units built in the years 2008-10. And it’s also a lot bigger than the 5 million units the private sector created over that time.

But think what this means. It’s an artificial stimulus. Its goal is mainly to keep people working. However, the market itself clearly does not support such an increase. Ben peels back some of the numbers on the profits earned by builders.

The five large state-owned firms earn profit margins of only 8%, according to data compiled by SouFun (a leading real estate data provider). This compares with 15-25% profit margins for private companies in recent years. I’m taking these at face value, though my suspicion is that the data overstate the profitability of the public firms.

You know, though, how economics works. As profit margins shrink, this is the market’s signal that the capital is perhaps best used elsewhere. Governments can ignore this signal, at least in the short term. But private firms cannot. They must serve the wishes of consumers or they will go out of business eventually. They also have owners who will see that the profits no longer compensate for the risks. They will pull back. And this is what’s happened.

This next chart is telling. It shows you the number of units built each year by private and public firms. You can see the big jump in public construction, which was part of China’s stimulus plan. But look at that blue line. It’s leveled out and declined last year:

“In effect,” Ben sums up, “the shift toward construction of more public housing implies that state-owned firms, operating at smaller margins, will capture an ever-larger share of economic activity…at the expense of the more-dynamic private sector.”

So more and more of China’s economy becomes dependent on government spending. We know that such government spending leads to bridges to nowhere. Or, in China’s case, empty office buildings, empty condo towers, empty malls and, indeed, empty cities. That’s a big problem — but it’s probably not a 2012 story.

Ben concludes: “Whether because of chances that a property crash is limited to certain parts of the country, or because of China’s ability to pump more credit into the economy, the odds are that 2012 turns out to be surprisingly dull, with the economy slowing, but still growing at above an 8% rate…”

It’s also an election year in China. Senior leadership will change in China in late 2012. All the more reason to expect massive spending from government coffers to keep the spell unbroken, if only for another year.

The time frame just beyond 2012 is the problem. Maybe the government spends so much that it produces reasonable-looking economic numbers and keeps people employed, but the resulting economic growth would have been a fantasy. Economies exist only to satisfy human wants and needs. They do not exist to produce numbers that look good in economic reports. China’s economy will have failed, just as other state-directed economies have failed, in its essential task of serving consumers. It becomes, then, an expensive fiction. China’s coffers, as rich as they appear, are also not inexhaustible. All of this means there is an inevitable quality to the collapse here, though the timing is hard to call.

At least for 2012, it seems investors can count on China coming to the table with its usual gusto to spend money. But the clock is ticking and midnight approaches.

Regards,

Chris Mayer
for The Daily Reckoning

China’s Cinderella Story originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

GlobalPost expects its correspondents to live in the countries they write about. Co-founder Charles Sennott put together a correspondent’s field guide with key points he expects his writers to live by. No. 1 on the list is simple: “Be there.”

I love this idea. I am also mindful of its wisdom in my own investing adventures. (This is why I rack up a lot of frequent-flier miles.) There is no substitute for being there.

Today, I’m in Nicaragua. It’s morning here as I write you from a palm-fringed house perched on a bluff overlooking a gorgeous stretch of beach at Rancho Santana. Before I visited Nicaragua for the first time, it was simply a place on a map. It was an abstraction. If anything, it was a set of received ideas — bits gleaned from other people, reflecting all the biases you’d expect.

Now Nicaragua means something very specific. It is a house with a pool surrounded by coconut trees. It’s green mountains and white surf and ocean breezes. It’s a warm pile of rice and beans and fried plantains. It’s friendly people and good times.

I was here with a group of readers over the weekend. They were looking at possibly buying real estate here. That is an idea that many people back home in the US would think a bit nutty. Back home, Nicaragua often means something that has little to do with the substance of what it actually is. Nicaragua means Sandinistas. It means Ortega. It conveys a vague sense of menace. To invest here would seem insane.

But the ground truth is different.

On Saturday, Joel Bowman and I delivered the first presentations ever made at the brand-new clubhouse in Rancho Santana. It was a very low-key affair. (I gave my talk in bare feet.) My task was to provide some macro context for Nicaragua. Some of the ideas I included in my talk are below, based on my own ground truth.

The big thing everyone thinks of first is el presidente, Daniel Ortega. Business people and investors in Nicaragua have no particular love for Ortega as far as I can tell. But they also believe he has been good for investors. He has provided tax breaks, carved out free-trade zones and boosted infrastructure investment.

It’s not an ideal free market, of course, but it’s now functionally superior as such to many other markets investors might rank offhand as better. The proof is in the pudding. Hear it from Carlos Pellas Chamorro, the richest man in Nicaragua. He is the controlling shareholder of Grupo Pellas, which has an oar in seemingly every boat: sugar, rum, banking, media, insurance and more.

A reporter once asked him if open and free markets really work in Nicaragua. He said:

“Open and free markets work everywhere when you let them. Of course, there are many obstacles in Nicaragua, as in all emerging nations… Many sophisticated foreign investors like Citibank, GE, Grupo Roble, Cemex, America Movil, Telefonica, PriceSmart, Wal-Mart, Cargill and many others have invested large sums of money in Nicaragua, obtaining very attractive returns.”

Those of us who have been down here have known these things for years. Only recently, though, has the ground truth started to seep into the mainstream press.

Still, most Americans would be surprised to learn Nicaragua is the second safest country in Central America, behind only Costa Rica. Or that the World Bank ranks it as the easiest country in Central America, Panama excepted, in which to start a new business. Or that in “ease of doing business,” Nicaragua ranks well ahead of such perennial darlings as Brazil or India — or even neighboring Costa Rica. A recent IMF report said that Nicaragua was the Central American country that best protected investors’ rights.

There are always uncertainties. But sometimes I think people almost reflexively assume that a foreign place has greater risks than back home simply because they overlook — or have grown complacent — about the risks they’ve lived with for so long.

Realities, too, can change. Places can go bad, like overripe fruit. But they can also re-emerge. In this way, the investor’s chore (or pleasure) is clear: to stay informed, to always seek out and gather fresh insights, to revise opinions accordingly so they do not grow stale and cost you a lot of money.

Great opportunities in markets often emerge simply because investors are relying on old assumptions or on ideas posed by people who have never checked things out up close. There is then an opportunity to get in at good prices and wait for the rest of the world to catch on.

This is always important, but the idea of ground truth seems it will be more important in 2012, as a number of big questions linger unanswered in 2011: What is the fate of the EU? Who will be the US president after the 2012 elections? Will gold get back to $2,000 an ounce? Will the US Treasury bond bubble pop? Will the BRIC countries slow further in 2012 or reverse course? Can commodities rally in the face of tepid economic growth?

It feels like 2012 will be an important year, maybe even a pivotal one, in the changes it could bring. Those who rely on ground truth have a better shot of ferreting out opportunities as the world changes than those who don’t.

So here’s to finding more ground truth in 2012!

Regards,

Chris Mayer
for The Daily Reckoning

The Importance of “Ground Truth” originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

For several months, the major trend in the financial markets has been no trend at all. Just static. During the last four months, for example, the Dow Jones Industrial Average has delivered an astonishingly large number of 100-point days. But on a net basis, the Dow hasn’t budged over that timeframe.

Since July 27th, the Dow has traded up or down more than 100 points on two out of every three trading days. Furthermore, many of those 100-point days were actually 200-, 300- or 400-point trading days! (As recently as June and July, hundred-point days were relatively rare — only about one day in three).

Despite all those gut-wrenching 100-point days, however, the Dow is still hanging around the 12,000 level — right where it was at the end of July. Clearly, volatility is a bull market, even if stocks are not.

The euro zone probably deserves most of the blame for this fruitless, directionless volatility. One moment, the euro seems destined to blow apart. The next moment, the European leadership announces some sort of crowd-pleasing rescue effort…and then a few moments after that, the crowd’s pleasure dissipates as the crowd begins to doubt that the latest rescue plan will actually rescue anything. Lots of static…no clear signals.

The only clear signals that seem to be making their way through the static are the one’s we’d rather not hear — kind of like the Mariachi music that sometimes pierces the static along Route 66.

For starters, Emerging Market stocks have been sliding for months — a phenomenon that often portends slowing economic growth worldwide.

Additionally, most of the recent economic reports from around the globe suggest the Emerging Markets may be on to something. In other words, they aren’t falling for nuthin’.

“Manufacturing activity is contracting across Europe and most of Asia,” Reuters reports. “China’s official purchasing managers’ index (PMI) showed factory activity shrank in November for the first time in nearly three years, while a similar PMI showed Indian factory growth slowed close to stall speed.”

Meanwhile, Reuters continues, “The final euro zone manufacturing PMI was confirmed at 46.4, its weakest level in two years, with factory activity in both of its biggest economies, Germany and France, weakening. The UK factory PMI fell to 47.6 in November, its lowest since June 2009, further evidence that Britain’s economy is in dangerous territory.”

So far, the US economy — like its stock market — has continued plodding along. Nothing great, but nothing horrible either. That’s good news, relatively speaking. But resilient is not the same thing as bullet-proof. And as Dan Amoss, editor of the Strategic Short Report, recently observed, the resilient US economy may be succumbing to the sluggish conditions that surround it.

“The Economic Cycle Research Institute (ECRI), one of the few reliable economic forecasting firms, still shows that the US economy is slowing from its prior growth rate,” Dan observes. “The nearby chart shows the ECRI Weekly Leading Index (in blue, left scale) and the growth rate of this index (in red, right scale).”

“Since the end of October, the WLI growth rate has stopped dropping quite so rapidly, from -10% to a recent -7%. One might describe the US economy as resilient, yet this resilience in US economic data isn’t consistent with what we see from the rest of the global economy. Something doesn’t add up.”

In other words, caution remains the watchword. A prospective “Santa Claus Rally” notwithstanding, US stocks remain acutely vulnerable to a European Union that is struggling to hold itself together and a global economy that is struggling to grow.

Eric Fry
for The Daily Reckoning

US Markets are Relatively Stagnant Despite Bursts of Volatility originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

That’s the curious thing about water. There always seems to be either too much of it or not enough. What follows is another look at my favorite commodity and the opportunities of investing in it.

At breakfast at the Raffles in Phnom Penh, I read a story about how Levi Strauss is trying to minimize its water use. A pair of blue jeans will consume over 900 gallons of water in its lifetime. That includes everything from the water to irrigate the cotton crop to multiple washings of the jeans.

The pressure is mounting on Levi, and other companies, to reduce their water footprint. Miners, food companies, tobacco companies and beverage makers all face pressure to use less water. In many places where they operate — such as India or China or Africa — fresh water is in short supply. This forces a re-examination of everything — from favoring drought-resistant crops to creating new ways to sanitize things.

Companies are also looking to use all of this to their advantage in marketing. Imagine idyllic farms in India with a smiling farmer using new efficient irrigation methods financed by Levi Strauss. However it may reflect reality, such an ad would appeal to the feel-good consumers of today.

The one part of the story that caught my eye was on a 15-acre cotton farm some 90 miles west of Mumbai. The farmer uses drip irrigation, a method of delivering water and fertilizer piped through veins spread over his fields. It’s vastly more efficient than flood plain irrigation, as the water gets right where it needs to go. There are also fewer weeds and less need for power, a not small consideration in a country in which periodic blackouts, however brief, are as common as flies. The farmer reports his water use is down 70% since using drip irrigation.

A group called the Better Cotton Initiative installed the irrigation equipment. The founders are a group of organizations and retailers, including Gap, Ikea and Adidas. Ikea hopes to use only “better cotton” by 2015. Adidas promises to do so by 2018. You can see how this is appealing to the companies.

There was a time when US companies didn’t really want to know what went on in their factories overseas. That time has passed, probably for the better. In an age when any competitive edge can be a difference-maker, why not try to gain an edge in customers’ minds this way and do some good for the world in the process?

The market is saying it approves. Early research indicates customers like to think they are changing the world for the better. Products that meet that need will enjoy an edge over those that don’t.

Given all of this, I think it is a profitable exercise to think about what kinds of companies benefit in such a world. What kinds of companies enable such a world? As it turns out, there are plenty of them.

Water is a $500 billion industry. You could break that into two giant buckets.

The first is water infrastructure. These include the water utilities — some 250,000 of them globally. These are necessary assets of vital importance wherever they are. They absorb a steady amount of spending that tends to be pretty resilient, regardless of what’s going on in the economy. Population growth drives the creation of new utilities every year. See the chart below on US water and sewer construction spending.

If anything, we’ve underinvested in these facilities over time, leading to leaky pipes and contaminated water. There will be a lot of pressure here to gain efficiencies.

The second big bucket is applied water. You can think of this as irrigation and industrial water uses (such as those used in the manufacturing process). Irrigation is a big one, representing some 70% of applied water use.

Emerging markets play a big role in all of this. Just over the next five years, China alone will spend nearly $50 billion on water, mostly on water treatment systems and flood control projects. In India, there are plans for 30-plus power plants by 2017 — all of which will use heavy amounts of water for cooling. India also has large irrigation projects on the docket, which will divert rivers and soak parched farmland. In Africa, where mining companies are busy cracking open the earth to get at much-sought goodies, there will be a great need to manage the water use of these projects.

As you can see, water touches almost everything — from energy and mining to basic food production and manufacturing. You want to talk about shale gas and the great revolution in American energy? Well, water management is going to play a big role there — testing it, filtering it, recycling it. You want to talk about feeding 9 billion people by 2050? We’re going to need to manage our water assets more intelligently. You want to talk about technology? New smart phones, computers and lifesaving drugs? All of the companies that make these things use tremendous amounts of water. And they need the water to be pure and meet strict standards.

The beauty of water as an investment theme is that “inevitables” power these trends. There is really no way to get around it. If you think about the pressures applied by population growth and urbanization, you can readily see how important efficiency and sustainability will be.

You don’t have to get a lot of things right, either. You don’t need to know what the world’s favored energy source will be in the future — coal, natural gas, nuclear or alternative energy — it doesn’t matter. They all use water, and lots of it.

Water was the key theme that kicked off my Mayer’s Special Situations newsletter in the summer of 2006. The original Blue Gold Portfolio unveiled five stocks with exposure to powerful trends emerging in water — the need to purify it, preserve it and move it. That portfolio delivered an 87% return in its first year and has been a solid winner ever since. We’ve added names since then and over time have sold off some or watched them get bought out. Now only two stocks remain, both part of the original set.

Water remains one of my most favorite investment sectors.

Regards,

Chris Mayer,
for The Daily Reckoning

Water – Still Blue Gold originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

As most folks are probably aware, Bangkok has been under a deluge. Floodwaters engulfed the place and brought everyday life and commerce to a halt.

A local contact here in Bangkok warned me not to come. But I went anyway…

I arrived at the airport, which was mostly empty. There was hardly any traffic on the streets. When I got to the hotel, it was a little eerie seeing the sandbag defenses up around the hotel. In fact, most buildings had sandbags around them in case the floodwaters broke through. And when I walked in the hotel lobby, I was greeted by name. “Welcome, you must be Mr. Mayer.”

I must’ve been the only nut checking in that night!

Tens of thousands have already fled Bangkok. The floods, too, have certainly affected the flow of travelers here. Some foreign governments have advised their citizens not to go to Bangkok. Tourism numbers are down. Business meetings have been cancelled.

As a result, hotel vacancies are up. The Wall Street Journal reported that the Shangri-La Hotel had an occupancy rate of only 30%, compared with the 70-90% rate the hotel usually enjoys this time of year. I’m sure that’s typical.

As Bangkok is about 40% of Thailand’s economy, what happens in Bangkok is important to Thailand. The floods were the big topic of conversation everywhere I went. Bangkok has been hit with a number of business-stopping events in recent years. There was a military coup in 2005, protests that closed the airport in 2008 and more protests in 2010 that left 90 dead. (Some say this unrest is likely economic, whatever the political motives offered. The average manufacturing wage in Thailand is about $250 a month, compared with $400 in China. 10 years ago, the countries’ relative positions were the other way around.) The floods add to the list.

You might be surprised at the global impact of these floods. Thailand is the world’s second-largest producer of disk drives, for instance, at about 40% of global supply. Western Digital is particularly hard hit, with 60% of its production in Thailand. Key suppliers to the industry are also submerged in water. Nidec, for instance, has a 75% share of the motor market for disk drives. Its Thai plants are about one-third of production.

As a result, components are scarce, and the prices of disk drives are up about 20% since the floods began.

Japanese companies, in particular, rely on Thailand as an offshore production base. Toyota and Honda have plants in Thailand (and so does Ford). Both will have to scale back their global production of vehicles because of shortages of Thai-made parts. These facilities are literally underwater.

My first meeting in Bangkok was at the Spice Market at the Four Seasons. It was empty during what would normally be a busy lunch hour. I met with Lan, a Cambodian-born Thai of Chinese descent, who worked in the brokerage business for more than 20 years. (Lan is on “permanent sabbatical” now, she tells me.)

She gave me a good overview of the scene here, besides giving me a crash course in Thai cuisine. Lan brought up the historical curiosity of Thai independence. By dint of diplomatic skill and luck, Thailand has never been occupied. Unlike other nations of Southeast Asia, the colonial powers never ruled it.

I’m not sure what this means in practical terms. Lan thought it important enough to mention and said it may account for the relative enduring openness of the Thai economy to foreigners. Thais don’t have the baggage associated with the legacy of colonialism.

It’s easy to buy Thai stocks, for instance, and the Thai stock market is interesting on several levels. In that respect, my timing is good. Later in the afternoon, I got a bird’s-eye view from Andrew Stotz, a strategist at Kim Eng Securities. He had a neat way of presenting his ideas on the Thai market and its stocks in a flipbook publication that he puts out monthly, called Stotz Stocks.

The gist of his latest view is that Thai stocks are attractive at about 11 times earnings, with low debt, hefty dividends (near 4% yield) and healthy returns on equity (around 20%). Those are the averages. A little stock picking, of course, can you get you even more enticing goods.

Plus, foreign ownership of Thai stocks is down to where it was in 2009, at around 35%. This may be a contrarian indicator, as foreign investors owned 41% of the market before the crash in 2008. And contrary to the Western world, Thailand has low debt levels. No sovereign debt crisis here!

According to Stotz, historically, Thai stocks do well from this 9-12 price-earnings ratio range, with an 18% return in the year following and an 11% annual return over five years. A blunt instrument to play Thai stocks is the MSCI Thailand Index Fund (THD). (I’ll have a more-targeted play in your next letter.) Thailand has been through worse crises before and has always rebounded.

So as bad as the flood appears, I am inclined to think this, too, will pass. It seems a temporary setback for Thailand’s markets, which, like bamboo, bends but does not break from the stresses put on it.

Needless to say, the Bangkok I saw on my visit was not typical. But I am glad I lingered in the city anyway. It was supposed to be just a stopover on my way to Cambodia and Vietnam. But thanks to Lan, my contact and new friend, I had a productive time there that included one fantastic meeting that turned up what may well be the best idea of the trip.

Regards,

Chris Mayer,
for The Daily Reckoning

Thailand: 7,500 Miles From Greece…and Loving It! originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

“Come on, we’re in markets. Let’s flip for it.”

Well, how could I resist that? Everyone in markets — from careful investor to highflying speculator — learns to live with chance, and even to relish it. It’s part of the thrill of markets (and life); you just never know how things might play out.

So we flipped. I called heads. Heads it was. And Frank Holmes paid for dinner.

Frank is the CEO and chief investment officer of US Global Investors (NASDAQ:GROW), which is a mutual fund company with a slate of award-winning funds. He’s a well-traveled investor, too, and we swapped stories of our travels. He told me about a recent trip to Sri Lanka, where his firm was looking at palm oil plantations.

We met at Cookshop in Chelsea, Manhattan — a restaurant that favors seasonally available and locally sourced ingredients prepared simply. (We had the excellent split-roasted chicken, cooked over a wood fire. Worth a visit if you are in the area.) We had a great conversation that ranged over seemingly everything.

One of the things we talked about was S-curves, which is kind of the “House Specialty” at US Global. Holmes explained what this macro scenario is and why his firm relentlessly seeks them out. Take a look at the chart below, which shows you a generic curve. The main thing here is to invest in the middle part of the curve, when growth accelerates.

It’s a simple idea, which is part of its appeal. And there are many historical examples — in population growth, oil consumption and demand for cars, among many other things. It’s loosely based on an idea by economist Simon Kuznets, who found long cycles (around 20 years) of boom times around an increase in infrastructure spending.

One historical example is the US interstate highway system in the 1950s. The highway system created a much more mobile society and had a profound effect on businesses. Think about what it meant for truckers, retailers and managing inventories. Travel time between Cleveland and New York City, for example, declined by a third. But the highways also produced brand new opportunities that did not exist previously. New motels, gas stations and restaurants sprang up across the entire country.

“We try to take a look at this model and look at emerging countries and go back and forth in history and try to identify where they are on this S-curve,” Frank said.

What’s driving the big S-curves of today’s economy? Population growth is one thing. It took over a century for world population to move from 1 billion to 2 billion (from roughly 1805-1927), but only 40 years to go from 3 billion to 6 billion (from 1960-2000).

“What’s significant here is that in the 1970s, the world’s population was half of what it is today,” Frank pointed out. “China and India had no global footprints then.” Russia was behind the Iron Curtain. Today, they are embracing an infrastructure build-out that will be as dramatic in effect as the interstate highway system was for the US.

You will find we’re in the middle of similar demand curves today in cars, electricity, steel, oil and more…

Frank made some interesting points about cars. In developing markets, most people pay for cars with cash. “Loyalty for car buyers in the US and Europe is not to the car buyers,” Frank said, “but to who will give them the money, because over 90% of all cars have a note against them. But in Africa…it is a cash trade.” That leaves them less sensitive to global financial markets. So in 2008, when the world was falling apart, Nigeria actually had positive growth. So did Mozambique. These were predominantly cash economies.

Another way to get at the S-curve model is to think of water. It can be a solid, liquid or gas. There is a temperature at which dramatic things happen. “The same thing happens with demographics, consumption or GDP per capita,” Frank maintained. There is a certain point at which dramatic changes take place and put you on the steeply sloped part of the S-curve.

Government policy drives a lot in this analysis, and Frank mentioned it often. Government is a precursor to change. “China has gone from a communist country to a socialist country that’s slowly moving toward capitalism,” he said. The S-curve in China began with Deng Xiaoping and the opening up of China. The largest real estate transfer in the world was when China gave citizens plots of land. “This was very significant,” Frank notes, “even though these leases are for 40-60 years, because it’s a transfer of wealth, which the Chinese are able to borrow against, sell and trade.”

Greater freedoms led to the creation of a rising middle class. Today, China has the second-largest number of billionaires in the world. “These are not oligarchs, like in Russia” Frank pointed out. “These are people that are basically getting Pizza Huts.” They are entrepreneurs, starting businesses and growing them. “What happens when you get 60 million people making $100,000 a year? What does it change?”

It changes a lot. It means a lot of people want air conditioners and cars and homes. It means a lot more coal and steel and metals. The power of TV and the Internet helps fuel this desire. “Everyone in the world wants what we have. They can see it. And they want that dream. They are willing to work 60, 70 hours a week to get that,” Frank explained. “They are not out picketing on Wall Street.”

So how does this tie back into making money in markets around the world?

US Global starts with a comparison between the E-7 and G-7 countries (essentially, the big emerging markets versus the big developed markets). The E-7 countries have half the world’s population, but only 20% of the world’s output. The G-7 is the opposite.

Frank looks for certain things, like a favorable tax policy or an infrastructure spending plan. “We create a relative valuation model to see where shifts are happening around the world,” he said. With this view, US Global can also plot other countries and compare them to the G-7 and E-7 framework so that he remains in the most favorable situations.

There are many interesting insights that come from such work. For instance, Frank’s plotted out the infrastructure spending plans of the E-7. It’s a huge amount of money — some $6 trillion over the next three years alone — that will fuel commodity demand. He mentioned China’s high-speed rail as something that “will change everything.” Again, the highway analogy comes to mind. The rail system will span 24,000 miles and link up 240 cities and 700 million people. Think of all the trade that will unlock, just as with the US highway system, only on a much bigger scale.

The final proof for these things is, as they say, in the eating. In searching for S-curves, Frank and his team have uncovered many gems to put up the kind of performance numbers they have. US Global Investors was an early investor in the new Colombia, for instance. It seeded Pacific Rubiales at 25 cents per share. Today, it’s C$22 per share and has been as high as C$35 per share.

Finding gems like that makes it all worth it. If you had put $10,000 with Frank’s Global Resources Fund in 2000, you’d have nearly $60,000 today. And that was during a rough decade for stocks. (If you had put the $10,000 in the S&P 500, you’d have about $11,000 today.) This goes to show you — if you can get past the noise and paralyzing fear, there are plenty of opportunities out there in all kinds of markets.

Regards,

Chris Mayer,
for The Daily Reckoning

Winning Ideas in a Losing Market originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Increases in demand from China and India have driven a 7.5 percent increase in demand for gold jewelry during the first half of the year despite a 25 percent increase in the price, according to a report released this week from GFMS. However, much of India’s potential gold demand remains untapped.

Toussaint highlighted an interesting fact: Of the roughly 800 tons of gold imported to India each year, only the top 40 percent of Indian households purchase all of the country’s gold, says Toussaint. The other 60 percent of Indians, who may have the same adoration for gold and celebrate Ramadan and Diwali, historically may not have had access to purchase gold. This large population represents a huge untapped market. To fulfill demand, the WGC has created a program with Indian post offices to distribute coins and small pieces of gold. Toussaint says right now there are 700 post offices in the rural areas servicing 90,000 customers and he expects that number to grow. This market is worth pursuing based on McKinsey’s research that a “huge wealth creation wave” is developing in India. As Toussaint puts it, “if purchase patterns continue, we will see from 2005 to 2025, a four times larger gold market in India.”

This is a fascinating idea because very few entities other than the post office have the network and infrastructure necessary to reach beneath the surface of the world’s largest gold market.

India may be the world’s largest gold market, but in China, gold buying has become so significant that the country has become the fastest-growing market for gold jewelry in the world. Not only are Chinese purchasing increasing amounts of gold, they prefer pure 24-carat gold. This high-quality gold is given to celebrate special occasions, such as birthdays, and purchased for a bride at her wedding. In 2010, 6.6 million brides will make gold a part of their ritual as the yellow metal signifies the importance of a long-term relationship, says the WGC website.

While jewelry represents a large percentage of gold purchases in the country, Chinese can also purchase gold at their local bank. WGC formed a partnership with the Industrial and Commercial Bank of China (ICBC Bank), the largest bank by deposits in the world. They began offering a “Gold Accumulation Plan” that lets investors buy and accumulate small portions of gold over time. Similar to a bank account, people participating have access to the underlying gold or the cash value at any point. Since it was launched in December 2010 through this summer, the ICBC has an estimated 1.7 million accounts, with an accumulation of more than 12,000 kilograms of gold.

After India and China led the global demand for gold, accounting for 52 percent of 2010 tonnage, the GFMS says the two Asian countries have “continued impressive growth” this year. Gold buying in India jumped 38 percent during the second quarter alone. GFMS reported China’s gold purchases jumped 90 percent on a year-over-year basis through June. This is a follow up to the 75 percent increase in gold demand the country experienced last year.

This share tops all of North America, which accounts for 8 percent, Europe and Russia, which account for 13 percent, and even the Middle East and Turkey, which together account for 12 percent. North American gold demand fell 12 percent during the first half of 2011 due to the slumping U.S. economy and rising prices.

David Lamb, the WGC’s managing director for jewelry, recently told Reuters there is a “significant tidal shift to the Asian markets, to India and China in particular, and gold rising upwards and disappearing from the mass merchandising in the West.”

Central Banks Load Up on Gold

Demand for gold isn’t only coming from the residents of China and India. There’s been a huge sentiment shift among central banks as well. Toussaint noted how, after many years of selling, central banks have become net buyers of gold. He says, “Western Central banks have essentially shut the tap off, and the vast majority of the buying is coming from Eastern central banks.”

In just the first half of this year, official sector purchases are up three-fold over the 2010 total to 216 tons, accord to the GFMS report. GFMS says the rise is largely due to low sales levels from Central Bank Gold Agreement (CBGA) signatories and the International Monetary Fund (IMF) completing its sales program at the end of 2010. In addition, other countries have gobbled up gold in an effort to diversify reserves away from the U.S. dollar. Scotia Capital estimates central banks’ total purchases of gold will reach 248 tons by year-end.

Some of the big buyers have been Mexico (whose central bank purchased roughly 100 tons of gold earlier this year), Korea (purchased 25 tons in June), Thailand (purchased nearly 19 tons in June) and Russia (which has purchased over 50 tons of gold from its domestic market year-to-date).

Toussaint says Eastern central banks are “catching up with the rest of the world” because their current allocation is tiny right now. However, whenever the WGC discusses these buying habits with the central banks of Korea, Taiwan and other Asian countries, they consistently say that they are interested in gold, and looking to hold it over the long-term. In other words, he says, this is not a “knee-jerk reaction to the direction of the dollar.”

GFMS also believes that this could be just the beginning. In a release announcing the report, Philip Klapwijk, Global Head of Metals Analytics at GFMS, said, “we are in essence in chapter three of the central bank story—we’ve left behind a period of heavy net sales, then a short period of neutrality and we’re now in a new environment of heavy buying.”

Regards,

Frank  Holmes,
for The  Daily Reckoning

P.S. This only scratches the surface of what was covered during the webcast. We discussed much more than China, India and central bank gold demand. If you missed it the first time, you can listen to the entire presentation at your leisure here. Find out the reasons we don’t believe gold is in a bubble, the economic factors affecting how gold is valued, and how our culture and emotions shape the gold-investing landscape. It’s great insight for the serious gold investor.

Perfect Storm Creates Tidal Wave of Gold Demand originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.