Of course we have the epic manipulation of the Fed to thank for this confusing scenario. It is artificially depressing bond yields to support the stock market, and yet that is not the whole story.

Foreign support

Foreign buyers do presently see dollar-denominated assets as something of a safe haven and are prepared to tolerate historically low returns on bonds for that percieved safety, or for that matter take a risk on US equities.

However, sooner or maybe later this conundrum has to be resolved. The stock market will not carry on rising indefinitely if a recession threatens to thump corporate profits hard. Those selling equities would then buy bonds and push the yield still lower.

Or is that what will happen? If you look at Spain and Italy you have pretty low stock markets with very high bond yields. Bond holders demand and get high yields because there is a rising risk of default as debt levels are so high.

Could the United States go the same way in a recession with stocks on the floor and bond prices decimated by very high yields? That tipping point in bonds could come very suddenly if history is any guide, and stocks would actually be the better investment in that scenario.

Or look at the United Arab Emirates. Majid Al Futtaim is about to issue bonds with a 5.8 per cent coupon, very low for a UAE private sector company, while at the same time the local stock markets are trading close to seven-year lows.

So both the UAE stock markets and bond markets are consistent in pointing to recessionary business conditions. Strange that really because business revived quite strongly in 2012, and both stocks and yields ought to be rising.

Let us stick to the US conundrum first. Transport data for January suggests the bond market is telling the correct story and that the US stock market is topping out for 2012.

Eurozone disaster

That is consistent with the horror stories from the eurozone about the return of the world’s largest economic bloc to recession in the fourth quarter. It is consistent with a Greek default and second global financial crisis.

And it would be consistent with UAE stock and bond markets indicating a renewed downturn in business activity this year.

Could it be that US stock market optimists are simply wrong and the bond market is correctly judging the future? Perhaps. But if so the US bond market is also in mortal danger and is no safe haven.

The ArabianMoney investment newsletter (click here) is advising its subscribers how to buy silver, gold, oil, even real estate to achieve maximum capital returns. These are hard assets, not paper like currency, stocks or bonds.

How serious can such a compact be when Greece and Portugal are signatories? Greece has never met a budget target in all its years in the European Union and Portuguese bond yields of 17.4 per cent yesterday suggest that it is the next Greece.

No deal

Indeed the main outcome of the summit was a failure to agee on how to plug Greece’s widening budget deficit. Finance ministers have pledged to deliver a plan by the end of the week so that Greece can receive aid to meet a 14.5 billion euro bond payment on March 20 and escape default.

Germany has apparently backed away from suggestions that a European Commissioner should oversee the Greek government. But the wider worry is now the contagion from Greece that is already happening, particularly in Portugal.

Portuguese 10-year bonds hit 17.4 per cent yesterday and two-year bonds 21 per cent, rates completely inconsistent with these instruments ever being repaid and pricing in 70 per cent plus default risk.

The claim by prime minister Pedro Passos Coelho that the debt is ‘perfectly sustainable’ is utter nonsense. Italian bond yields are back up above six per cent.

The next summit is from 1-2nd of March and will tackle the issue of raising the ceiling on the 500 billion European Stability Mechanism, unless of course the Greeks can throw another spanner in the works with a default and disorderly exit from the euro.

The unthinkable

That is still very much on the cards. It will do a lot more than give the Portuguese debt problems. It will destabilize the whole global financial system with the triggering of CDS insurance around the world.

Observers seem to forget how the Lehman tragedy gradually loomed on the horizon in 2007-8 and then turned into a disaster with nobody willing to prevent it.

Private sector debt holders can refuse to bailout Greece just as they decided against saving Lehman.

Then again international banks may prefer to call in the CDS insurance on their loans and leave the global banking system to pick up the tab. One can only imagine the arm twisting behind closed doors on this.

EU summit

EU leaders meet for yet another summit tonight in Brussels. It also appears that austerity measures now being demanded as a condition for the latest bailout package are proving just too much. A German proposal that a European Commissioner should approve fiscal policy would undermine ‘national identity and dignity’ said finance minister Evangelos Venizelos.

Too bad nobody considered that when they were stealing all the money from Europe in the first place. Greek membership of the European Union has been a long tale of obtaining money under false pretences to put it kindly.

But in the end it will likely be Greece that loses patience with the eurozone leaders and defaults on its huge debts, finally taking all the money it has borrowed without the means to repay it. Some might unkindly suggest that there was never any such intention in the first place. Greece has a long history as a serial defaulter.

The question then is whether the ECB president Mario Draghi has done enough to soften the blow of a Greek default with his stealth-QE expansion of credit to eurozone banks that started at the end of last year with $645 billion in new credit and may rise to almost $2 trillion this year.

Tim Congdon of International Monetary Research dubs this the ‘Draghi bazooka’ that will increase eurozone M3 money supply growth to five per cent by the middle of this year. But absorbing the Greek default – or if we are lucky a lesser orderly refinancing of the Greek debt with huge bank write-offs all the same – is going to need this cushion and more.

Money printing again

We also have to worry about the unintended consequences of money printing like this. There will be commodity price inflation and a whole new series of economic problems to handle with winners and losers this time around, not the saving of the whole system like in 2009. Good news for gold, silver and oil investors but nobody else.

The bankruptcy of Spanair, the Spanish regional airline last Friday may be a sign of the fall-out that is coming in the eurozone. Credit shrank by $120 billion in the eurozone in December, already worse than at anytime after the collapse of Lehman in October 2008 or the Great Depression of the 1930s.

A eurozone recession is baked in the cake. It is only a matter of how bad it gets.

It was a shame that there seemed to be such a limited Arab participation at Davos because the geopolitics of oil are likely to be a defining feature of the year ahead as well of course as the never ending eurozone crisis.

The organisers of the World Economic Forum might like to note that we get much better weather in Dubai at this time of year. The next issue of the ArabianMoney subscription-only newsletter is out tomorrow with more advice on investment opportunities for 2012, including silver, oil and Dubai real estate (click here).

This is the last video from Davos that we will be publishing this year and also about the most sobering. Rogoff is the co-author with Carmen Reinhart of the seminal book ‘This Time is Different’ that systematically reviewed all the major financial crises of human history and found that they seldom are different.

Self-delusion and over-optimism about the future are human character traits and the fundamental reasons why we are all doomed to repeat the errors of the past.

Worse than expected US new homes and GDP data explained the immediate fall. But the euphoria of the New Year seems to have largely evaporated on Wall Street.

Fed handout

For investors news that the Fed is to keep interest rates low for the next three years ought to be a cue to buy equities that have much higher dividends. Why then did they sit on their hands last week?

The headwinds blowing from Europe and Iran are to blame. Iran has threatened to stop selling oil to Europe as soon as this week in response to an embargo scheduled for July.

At the same time the Greek debt crisis is entering a final lose-lose phase. Banks are being required to make 80 per cent write-offs against privately held debt or trigger CDS insurance covering the full amount. Either is a huge and costly credit event.

The UK and eurozone are also about to enter a double-dip recession that started in Q4. Only a massive cash injection from the ECB before Christmas has prevented a meltdown in the regional banking sector with inter-bank lending still largely frozen up.

Safe haven?

The US stock market is benefiting as a comparative safe haven. But share volumes are very low and not at all consistent with a rising market. This lack of volume, momentum and high prices has led veteran market analyst Jo Granville to conclude that the Dow will fall 4,000 points this year (click here).

In the Gulf States the Dubai Financial Market gained more than five per cent last week and the Saudi Tadawul is also up 1.3 per cent in the past four days. Investors do not appear concerned about the local contagion from the European stand-off with Iran.

Stocks in the UAE in particular are rallying from very low levels, however, and confidence is extremely fragile. Bad news from the eurozone would quickly reverse the impact of good news from the Fed.

Facebook filing for its IPO next week will probably prove to be the classic top of the market event. Everybody wants it to happen even though the market direction is changing underneath them.

In theory holding rates low ought to encourage bond holders to exit this market. The return on this investment is negative after inflation, a guaranteed loser for capital holdings not a preserver of wealth unless you think the other options have even more downside.

Fear trade

It is a fear trade. Equities rallied very modestly on this news. In previous years stocks might have surged as the yield on equities is far higher than the yield on bonds, or at least still in positive territory.

But then stock markets around the world have lost their momentum and volumes. Famous market timer Jo Granville thinks the game is up and the Dow Jones will plunge 4,000 points this year (click here).

It is an extreme forecast but these are extreme times with the eurozone on the brink of tipping the world into a second global financial crisis and the Iranian dispute threatening $140 oil this summer according to the IMF.

Reason enough to be cautious. But as Dr Marc Faber continues to warn investors the US T-bond just has to be a long-term loser at these levels of interest rates. How long is the long-term? Is it beyond three years or within that timetable?

Certainly the Fed is preparing the market for QE3, a second round of electronic money printing which it is desperately keen to keep as a policy response to the imminent eurozone crisis.

But investors must surely scratch their heads. How much money can be pumped into the global economy before you get much higher inflation? Which asset classes will benefit from inflation and which lose? Bonds definitely look a loser, for how long can the Fed actually keep rates at these levels?

The Central Bank of Italy would love to keep its rates near zero but the market has long taken over, and low ECB rates mean nothing for Italian bonds. The ECB still has Germany as its benchmark and financial bulwark. The Fed has the heavily indebted United States.

Owning things

One thing is for certain, investors who own things will be OK. Inflation will be reflected in an increase in the value of things. Paper assets like money and stocks are another matter entirely. Money we know will be debased eventually and when it happens very quickly.

Share prices must reflect the profitability of the companies they represent. A world in recession will be a world of low profits and low share prices. That is most likely why easy money is starting to have less of an impact on stock markets. Investors are beginning to wake up and see it as a sign of bad times ahead, not a bed of roses.

It will be hard assets, things like real estate and precious metals that go up with and even beat inflation. Bonds will ultimately be a disaster and stock markets will likely collapse before them. Paper money will fare worst of all and that includes bonds.

The ArabianMoney monthly investment newsletter continues this commentary with actionable investment ideas that cannot be published on this website for legal reasons (subscribe here). The time to sort out your personal investment portfolio is now and not when disaster strikes but only you can take this responsibility.

Both gold and silver prices jumped sharply after the statement with gold now well above $1,700 and silver $33 an ounce. Mr Sinclair sees this as a major indicator of the quantity of money printing to come which will send the prices of precious metals much higher.

Important day

He told KingWorldNews.com: ‘Today is an important day. There are many days we talk but this is a mile-marker. What the Fed did today is they turned on the light of what will be QE to infinity. Today the light went on with regards to the intentions of the Fed. They did that for very specific reasons, we have troubles people can’t see and this is one of the ways out.’

Mr Sinclair reckons that this message is not going to be lost on any person or institution currently holding cash. The devaluation and debasement of the US dollar is being explicitly targeted by the Fed and they are putting a date on it.

‘I think you are going to see a very significant change amongst investors, corporations and companies with extra capital and people of the mainstream,’ he said. ‘You’re going to find gold being accepted as a hedge against what’s going on by entities, that up to now, you would think would be the last ones to be buying gold. How about someone like General Electric?

GE gold?

‘I used GE as an example because the principal of GE is a major advisor to the government. That would be the most unlikely thing for GE to buy gold. But don’t count it out. You are going to see a lot of things this year you thought at one time impossible, becoming reality.’

Mr Sinclair’s predictions on the gold price have been consistently accurate with the rare exception of the 2008-9 price correction, although that too only proved to be a bump on the road to higher prices. He sees gold prices heading north of $5,000 an ounce.

(For the full radio interview click here)

Nothing is actually decided at the World Economic Forum, rather like summits of European leaders. But Davos is always a good gauge of global opinion and business confidence about the future. Last year there was some optimism about the economic recovery.

Gloomy prognosis

2012 is a more gloomy prospect. The eurozone crisis is close to a denouement on the Greek debt mountain with unknown consequences. World Bank economists have warned this could be worse than Lehman in late 2008 in its contagion impact on the global banking system.

Then there is the mounting geopolitical issue of Iran and the new EU embargos on oil and other business activity. Lehman was not the only issue in 2008. Remember it was $147-a-barrel oil in July that year that pushed events over the edge.

US business executives we are told are feeling more upbeat about 2012 than their European counterparts or the Japanese for that matter whose economy is also close to a major implosion.

Where will the economic growth come from in 2012? Certainly not from the UK, Europe or Japan. China is also slowing down, although a hard landing is not widely forecast at present.

From the Gulf States? Not very likely with the military might of the world flexing its muscles for a possible conflict with Iran over the Strait of Hormuz.
Higher oil prices will help but not fully compensate.

Splendid isolation?

Indeed with large parts of the global economy either in recession or close to it the Americans are going to have to organize their own pre-election party. Can the USA grow in splendid isolation?

The danger of contagion is surely obvious. The USA is financier to the world and will suffer immediately from a blow-up in the eurozone banking system through loan guarantees, quite apart from the impact on earnings from its largest export market.

Besides the US national debt and deficits are still overpowering and growing, higher in fact than the eurozone. The temporary US mood of subdued optimism rests on very shaky foundations that are about to be shaken very hard.

The main reason for the current price gain appears to be speculation that the eurozone crisis is going to come to an orderly conclusion. That has shifted money back into the euro and yen and out of the dollar, boosting commodity prices like gold and silver.

Silver outperforms

Silver has behaved in its typically volatile fashion outperforming gold by a factor of two to the upside. Investors with longer memories will recall that this also works in reverse.

But can this recent price gain hold for precious metals? What if the optimism about the eurozone crisis resolution proves to be hubris? That has been the pattern now for almost two years: hopes of a resolution are suddenly dashed by a return to reality.

We are most probably going to see that again. The Greek private debt talks are in trouble, and even a satisfactory resolution means $150-200 billion in losses for European banks to absorb with France and the UK the biggest losers.

US banks have also vast cross guarantees of eurozone debt which are an instant contagion mechanism, so this problem will leap the Atlantic at the speed of electronic transmission. Nobody is too sure how even an orderly Greek debt rescheduling will impact on the global banking system.

Therefore we could well see the reversal of the return to the euro and yen and a shift back into the US dollar. That would be negative for gold and silver prices.

Wall Street crash

Then you also have to wonder about the stock market response. Would Wall Street take a hit? It seems inevitable and only yesterday ArabianMoney published a chart showing that a correction looked highly likely (click here).

If we do revisit the sell-off of 2008-9 then precious metals are unlikely to emerge unscathed, though as we have argued on this website before the fall in prices should be less dramatic because we have already seen the correction of last year.

So perhaps it is a bit early to break out the New Year champagne for investments in gold and silver though we are happy enough with our pick of the year (click here).