CHINA PLUMMETED AGAIN

Remember the "must hold" 2,600 level for the Shanghai Composite? It just broke…

We began predicting lower prices for Chinese stocks back in April this year. As expected, they fell later that month and into May. And just weeks ago, we updated you on a vital number in this downtrend… the 2,600 level on the "Dow Industrials of China," the Shanghai Composite.

China is the world's largest exporter… so share prices of its biggest companies are important gauges of manufacturing activity. The Shanghai's 2,600 level is the area where it stopped falling and found a toehold. But on Tuesday, the Shanghai composite fell 4.3%, blew through 2,600, and closed at a 14-month low.

This is a bad sign for the global economic recovery. Stocks tend to "price in" what's coming a few months down the road. Considering Europe makes up about 20% of China's overseas sales (its largest market), we take the Shanghai's failure as a signal the global economic recovery is getting weaker… even "getting dead." If you still have money in the reflation trade, you need this index to rally.

U.S. is headed for one of the worst inflations in history

"It could never happen here"... That's the refrain we hear from our friends and colleagues. They say it after we've gone over all of the numbers involved in the government's financial position and explained our out-of-consensus view that the U.S. is not only heading toward a period of massive inflation, but such an outcome has long since ceased to be avoidable. People respond – "Oh, that could never happen here." – in the same way they repeat a catechism.

We don't think our view is shocking or even surprising. Much like with our GM analysis (we predicted bankruptcy as early as 2005), when you simply look at the numbers, the outcome is unavoidable.

And then there's history. Not a single brand of paper money has ever lasted. Or you might say, in all of recorded human history, gold remains undefeated. We expect that trend to continue. Likewise, we can't recall any nation that ever repaid its debts (in sound money) once they'd grown to 100% of GDP. And watching our neighbors "strategically" defaulting on their mortgages in record numbers, we see no reason to expect Americans will prove to be any more honest about their government's obligations.

Since America isn't the first powerful democracy to default through inflation, it may pay for investors to be familiar with the most famous such event...

In 1915, just after World War I began, you could exchange 4.2 German marks for one U.S. dollar – and that was when the U.S. dollar was still backed by gold. As you know, Germany lost the war. Its people were literally starving by the end, thanks to the British blockade. With no alternative except starvation and annihilation, Germany accepted an armistice that demanded $12.5 billion in reparations. The debt was equal to 100% of Germany's GDP prior to the war. At the time, the exchange rate stood at 65 marks to the dollar, a devaluation of roughly 95%. Most people believe Germany's hyperinflation was caused by this war debt. Not exactly.

After the war, Germany was broke... That's true. But the mark was cheap. It seemed like a terrific investment opportunity. Most people believed Germany would find a way to finance its debts. We imagine foreign investors at the time said, "Oh, hyperinflation could never happen in Germany..." And so speculators pumped another $2 billion of additional credit into Germany. Then came trouble. Germany's main creditor (France) refused to renegotiate the terms of the armistice. And the German people lost confidence in their own government. The people didn't want to pay the debts. Assassinations began to occur, most notably the murder of Walther Rathenau – the foreign minister. Investors lost confidence in the country. They abandoned the mark.

German prices rose fortyfold in 1922. The mark fell from 190 to 7,600 to the dollar. When Germany failed to make a foreign debt payment in 1923, 40,000 French and Belgian troops invaded. To appease its creditors, the German government printed more money. It issued 17 trillion marks in 1923 (compared to 1 trillion in 1922). By August 1923, a dollar was worth 620,000 marks. By early November 1923, the exchange rate hit 630 billion to one.

Could something like this happen in the U.S.? Not exactly. We doubt, for example, China will ever attempt to invade the U.S. to force debt repayment. But we think what will likely happen could easily be worse than Weimar Germany. You see, the mark wasn't the foundation of the world's economy. Today, more than 60% of all bank reserves around the world are U.S. Treasury obligations. As the U.S. continues to run massive annual deficits and as the Fed engages in "quantitative easing," the world's supply of money is growing, by large amounts. Sooner or later, people holding paper money of every variety, not just Uncle Sam's, will come to doubt its most important quality – the stability of its exchange value. The resulting massive inflation will not merely strike the U.S., but the entire world.

The powerful rally in U.S. Treasuries continues

Stocks plunged from Shanghai to New York, with the Standard & Poor’s 500 Index tumbling below its lowest closing level of the year, and Treasury two-year note yields slid to a record low on concern over weakening growth in China and a slump in U.S. consumer confidence.

The S&P 500 slid 2.6 percent to 1,046.95 at 2:18 p.m. in New York, its lowest on a closing basis since November 2009. The MSCI World Index of 24 developed nations lost 2.9 percent, while the Shanghai Composite Index tumbled 4.3 percent. The benchmark 2012 Treasury note yield slid as low as 0.5857 percent and the 10-year yield dipped below 3 percent for the first time in 14 months. Oil and copper slumped at least 3.4 percent.

“It’s ugly out there,” said James Paulsen, who helps oversee about $375 billion as chief investment strategist at Wells Capital Management in Minneapolis. “Consumers are pulling back. There’s concern about a China slowdown. We’re close to important technical levels on the S&P 500, with 1,040 being closely watched. It’s end of quarter, investors have to close their books and they are selling the stocks that did poorly.”

The tumble in global stocks began after the Conference Board said its leading economic index for China rose 0.3 percent in April, less than the 1.7 percent reported June 15. Losses accelerated after the same research group’s gauge of U.S. consumer confidence slumped to 52.9 in June, less than all 71 projections in a Bloomberg News survey of economists. The S&P 500 has tumbled 11 percent since the end of March, headed for its first quarterly loss in a year.

Jobs, Europe Concerns

Today’s data damaged investor confidence amid concern a Labor Department report July 2 will show the U.S. lost jobs for the first time this year, while European bank balance sheets come under heightened scrutiny as a lending facility from the region’s central bank expires.

The rate banks say they charge each other for three-month loans in euros rose to 0.688 percent in London, the highest in eight months, as institutions hoarded cash before the 12-month European Central Bank lending facility expires later this week.

European banks need to repay 442 billion euros ($540 billion) in 12-month loans to the ECB by July 1, the biggest amount ever awarded by the central bank. Demand for three-month cash from the ECB tomorrow will expose how much banks still rely on the central bank for funding, investors and economists said. The ECB will announce how much money banks have asked for at about 11:15 a.m. in Frankfurt.

‘Funding Pressures’

“Concerns about funding pressures are creeping in again,” said Alexander Titsch-Rivero, head of derivatives and structured products in Frankfurt at BHF-Bank AG, a German private bank. “Some banks seem to be concerned about the ECB’s 12-month loans expiring. Definitely some banks seem to have built up huge bond positions financed with this one-year ECB tender. Now you have a roll-over gap and that seems to make people nervous.”

The S&P 500, the benchmark gauge for U.S. stocks, retreated for the sixth time in seven days even after a report showed home prices in 20 U.S. cities rose in April from a year earlier as sales got a boost from a tax credit. The S&P/Case-Shiller index of property values climbed 3.8 percent from April 2009, the biggest year-over-year gain since September 2006. The gain topped the median forecast of economists in a Bloomberg survey.

All but five stocks in the S&P 500 fell, while 99 companies in the Nasdaq 100 Index were lower. Among 24 industry groups in the S&P 500, none had a loss smaller than 1.1 percent, according to data compiled by Bloomberg.

Dow Below 10,000

Boeing Co., Alcoa Inc. and Caterpillar Inc. tumbled at least 4.8 percent to lead losses in all 30 Dow Jones Industrial Average companies as the 30-stock gauge slid 260.05 points to 9,878.47, its first trip below 10,000 in more than two weeks.

Tesla Motors Inc., the electric car company that hasn’t posted a profit, advanced as much as 19 percent after raising $226 million in the first initial public offering of a U.S. automaker in a half century.

All 10 industry groups in the MSCI World Index declined at least 1.8 percent, led by basic-materials producers and financial companies. The gauge has lost 10 percent this year. The MSCI Asia Pacific Index dropped 1.5 percent today as Japan’s unemployment rate unexpectedly increased.

The New York-based Conference Board cited a calculation error for the revision in its Chinese index. The research group’s outlook for the nation’s economy hasn’t been affected by the correction, said William Adams, the group’s resident economist in Beijing.

“Growth was not likely to accelerate in China, and in fact, a moderation is possible,” Adams said in a telephone interview. “This correction also supports the same view.”

Treasuries Rally

The yield on the 10-year Treasury security slid as much as 7 basis points to 2.95 percent, the lowest since April 2009. Treasuries have climbed 5.7 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. The 10-year Australian bond yield dropped nine basis points to 5.13 percent, and the yield on the 10-year German bund retreated three basis points to 2.55 percent.

Indicators of corporate bond risk in the U.S. and Europe rose. The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, climbed 5.53 basis points to a mid-price of 121.5 basis points as of 11:49 a.m. in New York, the highest since June 14, according to Markit Group Ltd. In London, the Markit iTraxx Europe Index of swaps on 125 companies with investment-grade ratings increased 8.74 to 133.27, the biggest rise since June 7, Markit prices show.

Yen, Dollar

The yen appreciated against all 16 major currencies and the dollar strengthened against 14 on demand for assets perceived to be the safest. Japan’s currency appreciated 1.7 percent to 107.89 per euro and touched 107.32 yen per euro, the strongest since November 2001.

Metals declined for the first time in four sessions on the London Metal Exchange, led by declines of more than 7 percent in zinc, nickel and lead. Copper fell 4.9 percent to $2.9375 a pound in New York, extending its decline this year to 13 percent. Oil for August delivery slumped 3.4 percent to $75.57 a barrel on the New York Mercantile Exchange.

The MSCI Emerging Markets Index fell 2.9 percent, the most since May 25, extending this year’s drop to 6.6 percent.

The Stoxx Europe 600 Index tumbled 3 percent as Rio Tinto Group, the world’s third-biggest mining company, plunged 6.4 percent on concern demand from China may weaken. BP Plc lost 1.7 percent in London, bringing its decline since an April explosion on the Deepwater Horizon rig to more than 50 percent.

The cost of insuring BP’s debt approached a record, with credit-default swaps increasing 3.5 basis points to 587.4, according to CMA DataVision, a London-based credit information provider. The contracts closed at an all-time high of 588.6 on June 25.

A HUGE MINING TREND IS REVERSING

The recent strength in gold mining shares is reversing a huge trend that's been in place since early 2009: "base-metal miners up, gold miners not so much."

For much of the past year, the mining firms that focus on copper, zinc, and nickel have far outperformed the mining firms focused on gold. Major copper miner Freeport-McMoRan, for instance, has gained as much as 180% since the March 2009 panic. Major gold miners Barrick and Newmont have gained less than 50% in the same time period. You can see the trend in today's chart, which tracks the ratio of Freeport shares vs. Newmont shares.

The rising trendline from early 2009 to early 2010 shows how the market favored Freeport over Newmont. This outperformance came from the "reflation trade"… Investors bet the government's giant E-Z-Credit program would stoke demand for all kinds of building materials, like copper.

Now have a look at the right side of the chart. You'll see folks are souring on the reflation trade… and they're starting to favor Newmont over Freeport. If you're of the mind that the global recovery is fake… and that debt problems will continue to send gold prices higher… you'll want to bet on this new "gold up, copper down" trend continuing.

Chinese stocks hammered overnight

The Conference Board revised its leading economic index for China to show the smallest gain in five months in April, in a release that contributed to the biggest sell-off in Chinese stocks in more than a month.

The gauge of the economy’s outlook compiled by the New York-based research group rose 0.3 percent, less than the 1.7 percent gain it reported June 15. The Conference Board said in an e-mailed statement that the previous reading contained a calculation error for floor space on which construction began.

Equities slumped in Asia and Europe as the prospect of a slowdown in the fastest-growing major economy fanned concern that the global recovery may weaken. With American consumers boosting their savings rates and European governments moving to cut spending and restrain fiscal deficits, emerging markets in Asia have led the rebound in the past year.

“We do see some moderation in growth in China, and in many ways that’s a welcome development” because the 11.9 percent annual gain in gross domestic product in the first quarter threatened overheating, said Brian Jackson, an emerging-markets strategist in Hong Kong at Royal Bank of Canada. At the same time, investors are concerned at the implications of slowing Chinese growth for the global economy, he said.

Jackson, who previously worked at the U.S. Federal Reserve and U.K. Treasury, predicts Chinese economic growth will slow to an 8 percent pace by year-end. He added that while the Conference Board’s index is dated, as other data have already been released for May, it provides a “useful” composite of indicators for the nation’s economy.

Stocks Drop

The Shanghai Composite Index lost 4.3 percent to 2,427.05 as of 4:25 p.m. local time. The MSCI Asia Pacific index dropped 1.4 percent and the Stoxx Europe 600 Index retreated 1.7 percent. China’s shares were also down as an impending sale of as much as $20.1 billion of Agricultural Bank of China Ltd. stock hurt investor sentiment, said Lu Zhengwei, a Shanghai-based economist at Industrial Bank Co.

The Conference Board’s index, published for the first time in May after four years of development, is designed to capture the outlook over the coming six months. It would have signaled China’s growth slowdown in 2008 and the recession of the late 1980s, according to William Adams, resident economist for the Conference Board in Beijing.

“This correction doesn’t affect our outlook for the Chinese economy,” Adams said in a telephone interview. “Growth was not likely to accelerate in China, and in fact, a moderation is possible. This correction also supports the same view.”

Property Market

Adams said at the time of the original release that new construction work, the key factor pushing up the indicator in April, may not continue to grow so quickly.

In the U.S., the Conference Board releases a benchmark gauge of consumer confidence. The reading for June is scheduled for later today, and is projected to fall for the first time since February, according to the median estimate in a Bloomberg News survey of economists.

American households boosted their savings rate to 4 percent last month, the highest level since September, underscoring a preference to rebuild wealth after home values tumbled the most since the 1930s during the recession.

The Commerce Department last week revised its first-quarter U.S. GDP growth estimate to 2.7 percent, from 3 percent previously, reflecting a smaller gain in consumer spending and a bigger trade gap.

Japan Weakens

Government figures today in Japan showed that the world’s second-largest economy is also slowing. Industrial production fell in May for the first time since February, the unemployment rate increased for a third month and household spending declined.

Today’s Conference Board revision for China showed that total floor space started in April dropped 0.1 percent, instead of the 1.3 percent gain originally reported.

China’s regulators have tightened rules for the property market in an effort to stem speculation and avert an asset bubble in the aftermath of a record credit expansion last year.

Premier Wen Jiabao’s government has also set a target to shrink new loans to 7.5 trillion yuan ($1.1 trillion) from 9.59 trillion last year. Officials have boosted requirements for the amount of money banks must hold as reserves, and used bill sales to withdraw cash from the financial system.

China this month committed to ending its fixed exchange rate peg to the dollar, another step that may cause the expansion to ease. The yuan had been held at 6.83 per dollar since July 2008 after a 21 percent gain the three prior years, in an effort to shield exporters from the global crisis.

Yuan Shift

The shift to a more flexible yuan will slow Chinese exports this year, adding to difficulties that include the European debt crisis and rising costs, Yu Jianhua, a Ministry of Commerce director general, told reporters in Toronto three days ago.

“The revision may have echoed existing market concern that China’s growth may slow later this year, though economic fundamentals are so far little affected by the European debt crisis,” said Lu at Industrial Bank.

China remains the world’s fastest growing major economy, and the yuan decision was taken after the government concluded the rebound had “become more solidly based,” according to a June 20 People’s Bank of China statement.

Indicators for May showed that exports climbed 48.5 percent from a year before, helping yield a $19.5 billion trade surplus for the month. Inflation accelerated to an annual 3.1 percent pace in May, surpassing officials’ target for the full year, retail sales gains quickened to 18.7 percent and industrial production jumped 16.5 percent, government reports showed three weeks ago.

Lending Growth

Lending growth also exceeded economists’ estimates for last month. Banks extended 639.4 billion yuan ($94 billion) of new loans in May, compared with the median forecast of 600 billion in a Bloomberg News survey of economists.

The Conference Board’s coincident index for April, which is a measure of current economic activity, was unchanged from the release earlier this month. The coincident gauge increased 1.2 percent following a 0.4 percent increase in March.

The error for the leading index was “unfortunate where the group has tried to be as transparent as possible,” Adams said. The measure is based on data and surveys from the People’s Bank of China and the statistics bureau.

U.S. Treasury yields plummet to lowest level since 2009

Treasuries rallied, pushing the yield on the 10-year note to the lowest level since April 2009, on concern the economic recovery will remain slow.

U.S. debt gained as a report indicated inflation was contained last month and economists said the nonfarm payrolls report later this week will show employers eliminated 115,000 jobs in June. Group of 20 leaders said over the weekend that advanced economies plan to cut their deficits in half by 2013, allowing them to curb record bond sales.

“Economic growth for the balance of 2010 is going to be disappointing to a lot of people,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading in New York at Deutsche Bank AG’s private wealth management unit. “At the same time, inflation is benign. With the Fed on hold, maybe 3 percent on 10-year notes is not a bad trade for the next couple of months.”

The yield on the 10-year note decreased seven basis points, or 0.07 percentage point, to 3.04 percent at 2:16 p.m. in New York, according to BGCantor Market Data. It touched 3.03 percent, the lowest level since April 29, 2009. The price of the 3.5 percent security maturing in May 2020 gained 18/32, or $5.63 per $1,000 face amount, to 103 27/32.

Treasuries are the world’s third-best-performing government debt securities this quarter, having returned 4.05 percent, trailing 5.10 percent for Denmark and 4.32 percent for Britain, according to Bloomberg data.

Two-Year Note

The two-year note yield fell two basis points to 0.63 percent after earlier dropping to 0.62 percent, the lowest level since Nov. 27. The yield is approaching the record low of 0.6044 percent set Dec. 17, 2008, after the Federal Reserve cut its target for overnight lending to a range of zero to 0.25 percent.

The yield on the 10-year note will climb to 3.78 percent by year-end, according to the median estimate of 64 economists in a Bloomberg News survey. The yield on the 2-year note should increase to 1.32 percent, according to the median estimate in a separate survey.

The extra yield investors demand to hold 10-year notes over two-year securities, charted on the yield curve, fell today to 2.41 percentage points, the narrowest since May 26, when it touched 2.37 percentage points.

The yield curve plots the rates of bonds at different maturities, with a flatter curve reflecting increased demand for longer maturities from investors expecting lower economic growth and slower inflation.

‘Bull Flattener’

“The curve has gotten a bull flattener,” said Andy Richman, who oversees $10 billion as a strategist in Palm Beach, Florida, for SunTrust Banks Inc.’s private wealth management division. “The economic numbers are looking and coming in weaker than expected.”

Treasuries also rose as U.S. buyers sought longer-term securities to increase the duration of their portfolios to match their benchmarks at the end of the second quarter.

U.S. government debt extension increased by 0.06 years for July 1, compared with 0.09 years for June 1, according to Barclays Plc, one of 18 primary dealers that trade directly with the Fed. Duration measures how sensitive a bond’s price is to changes in yield.

Longer-term government debt was supported as a government report showed muted inflation.

The inflation gauge tied to spending patterns increased 1.9 percent from May 2009 after a 2 percent gain in the 12 months through April, the Commerce Department reported.

‘Room to Play’

“There was nothing in the data to disturb the trend of lower yields,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “The move toward that view has more room to play.”

The Fed said on June 23 at the conclusion of its two-day meeting that the recovery pace is “likely to be moderate for a time” and reiterated its commitment to an “extended period” of low borrowing costs.

A lower-than-expected 431,000 new jobs for the U.S. in May included a 411,000 jump in government hiring of temporary workers for the 2010 census, the Labor Department reported on June 4. The payrolls report for this month is due on July 2.

President Barack Obama said the goal set by the G-20 nations of cutting deficits reflects U.S. targets and takes into account the fiscal and economic needs of each country. The White House projects the U.S. shortfall will be a record of almost $1.6 trillion this year. U.S. marketable debt has climbed to an unprecedented $7.96 trillion.

Global bond returns may have nowhere to go but down after the best first half since 2005.

The benchmark 10-year Treasury note has returned 7.85 percent this year, including reinvested interest, leading global government bonds to a gain of 3.36 percent, according to Bank of America Merrill Lynch indexes. That’s the best start since the firm’s broadest sovereign debt index rose 3.77 percent in the first half of 2005.

Gold and silver could be on the verge of a monster rally

I believe we have recently added a much-needed element that will lead to much higher gold prices- boredom.

General gold sentiment amidst near-record prices is muted and reminiscent of sentiment last fall when we broke out to new highs, backtested the breakout, then rocket launched for 3 straight months. It was the type of move that was met with widespread suspicion as even gold bugs were calling for a return to $800-$900 gold.

Warren Buffett is dumping these stocks

The investing decisions of Warren Buffett are mimicked by investors worldwide.

Many value investors and market experts often look to Buffett for help in navigating the murky waters of investing. Buffett has built a fortune by taking advantage of opportunities when others have been fearful, and a lot can be learned by paying attention to his moves.

So what exactly has the Oracle of Omaha been up to?

Richard Russell: This is one of the biggest tops in stock market history

Richard Russell has grown very vocally bearish in recent months. Earlier this year, Russell warned that the stock market was once again becoming grossly overvalued despite its relentless new highs.

He has maintained that the bear market never ended and that the world is far too indebted to exit the bear market.

Merrill Lynch: The 3 big reasons gold and silver will soar

Merrill Lynch metals analysts maintain gold will hit a US$1,500 per ounce target by the end of next year as investor demand pushes gold prices higher.

In research published Monday, analysts Michael Widmer, Francisco Blanch, and Alex Tonks are predicting average gold price forecasts of US$1,200/oz this year, $1,350/oz in 2011, and $1,400/oz in 2012, up from $1110/oz, $1179/oz and $1109/oz. respectively.

"We also believe that silver has further upside and see prices averaging..."

Former CIA spy: War with Iran is imminent

Last week, Iran's opposition leaders Mir-Hossein Mousavi and Mehdi Karoubi canceled anti-government demonstrations timed to commemorate the anniversary of last year's disputed presidential election.

Secretary of the State Hillary Clinton called the cancellation "regrettable," but missed the larger point. The reform these two men offer is not what the majority of Iranians want: They want an end to the current Islamic regime.

CHART OF THE WEEK: THE GOLD STOCK DIVERGENCE CONTINUES…

This week's chart shows the continuation of a trend we highlighted early this month… the outperformance of gold stocks versus the general stock market.

Up until late April, shares of gold mining companies registered the same year-to-date gains as the benchmark S&P 500 index. But at the beginning of May – when the general market started to crack – gold stocks began diverging in performance from the market. It was an incredible display of strength for gold stocks to hold steady while folks sold stocks of all stripes to raise cash.

As you can see from this week's "performance chart," the big gold stock fund (GDX) is up 20% in the past three months (the black line). The general market, on the other hand, is down 7.5% during the same time (the blue line).

As gold miners enjoy the robust economics of selling gold for over $1,100 per ounce, expect this trend of gold stock outperformance to continue.

How China's GIANT gold accumulation plan works

We are now used to China sourcing huge volumes of metals from external sources to drive its industrial machine forwards, but the latest announcement from Coeur d'Alene Mines on its deal to have its gold concentrates purchased and processed by China's largest gold producer suggests that precious metals are on China's vast shopping list too.

China is already the world's largest gold miner.

Richard Russell: A market disaster is approaching

The bear keeps torturing the majority. If only the authorities could straighten out the oil problem, the housing problem and the unemployment problem, everything would be fine. But the market is not interested in current problems, it is looking ahead to the disaster that we will see in late 2010...

Holding stocks here is a sure ticket to a smaller bank account. People cannot take it into their psyches that this is the resumption of one of [history's] great bear markets. Our salvation is bullion gold. The gold mining stocks are also doing beautifully.

Congress passes "diluted" financial reform bill

Legislation to overhaul financial regulation will help curb risk-taking and boost capital buffers. What it won’t do is fundamentally reshape Wall Street’s biggest banks or prevent another crisis, analysts said.

A deal reached by members of a House and Senate conference early this morning diluted provisions from the tougher Senate bill, limiting rather than prohibiting the ability of federally insured banks to trade derivatives and invest in hedge funds or private equity funds.

Banks “dodged a bullet,” said Raj Date, executive director for Cambridge Winter Inc.’s center for financial institutions policy and a former Deutsche Bank AG executive. “This has to be a net positive.”

Hashed out almost two years after the worst financial crisis since the Great Depression, the legislation shepherded by Senate Banking Committee Chairman Christopher Dodd and House Financial Services Chairman Barney Frank places limits on potentially risky activities such as proprietary trading or over-the-counter derivatives and gives regulators new powers to seize and wind down large, complex institutions if needed.

The overhaul, which still requires approval from the full Congress, won’t shrink banks deemed “too big to fail,” leaving largely intact a U.S. financial industry dominated by six companies with a combined $9.4 trillion of assets. The changes also do little to solve the danger posed by leveraged companies reliant on fickle markets for funding, which can evaporate in a panic like the one that spread in late 2008.

‘Fig Leaf’

The Standard & Poor’s 500 Financials Index, whose 79 companies include JPMorgan Chase & Co. and Goldman Sachs Group Inc., rose 1.4 percent at 1:02 p.m. in New York.

The legislation is “largely a fig leaf,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. “Given where we were when this got started, I’d have to imagine the Wall Street firms are pretty happy.”

Banks avoided drastic curbs on their highly profitable derivatives businesses. Lenders including JPMorgan and Citigroup Inc. will be required to move less than 10 percent of the derivatives in their deposit-taking banks to a broker-dealer division during the next two years, which may require additional capital.

Goldman Sachs and Morgan Stanley, which were the two biggest U.S. securities firms before converting to banks in September 2008, won’t be as affected because they kept most of their derivatives in their broker-dealer units.

‘Pennies’ of Dilution

“There’s going to be some adaptation, but I don’t think there’s going to be any colossal impact,” said Benjamin Wallace, an analyst at Grimes & Co. in Westborough, Massachusetts, which manages $900 million and holds stakes in Bank of America Corp., JPMorgan and Wells Fargo & Co. Derivatives rules mean “there’s going to be a capital raise, but the analysis we’ve seen suggests we’re talking in the pennies in terms of dilution” of earnings per share.

Senator Blanche Lincoln, a Democrat from Arkansas, had originally advocated forbidding banks that receive federal support such as deposit insurance from trading swaps, a rule that could have required banks to spin off those businesses.

The final agreement provides a number of exemptions: Banks can continue trading derivatives used to hedge their risks and can keep trading interest-rate and foreign-exchange contracts. Banks will have up to two years to move other types of derivatives, such as credit default swaps that aren’t standard enough to be cleared through a central counterparty, into a separately capitalized subsidiary.

97% of Market

U.S. commercial banks held derivatives with a notional value of $216.5 trillion in the first quarter, of which 92 percent were interest-rate or foreign-exchange derivatives, according to the Office of the Comptroller of the Currency. The five U.S. banks with the biggest holdings of derivatives -- JPMorgan, Goldman Sachs, Bank of America, Citigroup and Wells Fargo -- hold $209 trillion, or 97 percent of the total, the OCC said.

The rules are “nowhere as bad as what the banks might have feared as recently as a week ago,” Bill Winters, the London- based former co-chief executive officer of JPMorgan’s investment bank, told Bloomberg Television today. “Banks have pretty much factored in already the idea that most derivatives will have to be cleared through a central clearing counterparty. Not a huge surprise and probably not a huge cost either.”

Volcker Rule

Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather. They include credit-default swaps, which act like insurance for investors in case a debt issuer can’t repay.

Swaps sold by American International Group Inc. that later went sour helped push the insurer to the brink of bankruptcy and triggered a $182 billion federal bailout of the New York-based company during the near collapse of the financial system in 2008.

Another portion of the legislation that was amended in the final conference was the so-called Volcker rule, named after Paul Volcker, the former Federal Reserve chairman who championed it. Originally the rule would have prevented any systemically important bank holding company from engaging in proprietary trading, or bets with its own money, as well as investing its own capital in hedge funds or private-equity funds. Goldman Sachs executives have estimated that about 10 percent of the firm’s annual revenue comes from proprietary trading.

3% Rule

In the final version, the banks will be allowed to provide no more than 3 percent of a fund’s equity, and will be limited to investing up to 3 percent of the bank’s Tier 1 capital in hedge funds or private equity funds. That represents a ceiling of about $3.9 billion for JPMorgan, $3.6 billion for Citigroup and $2.1 billion for Goldman Sachs, according to the companies’ latest quarterly reports.

“I don’t think it will have any impact at all on most banks,” Winters said of the amended Volcker rule. “It’s a pragmatic solution that will result in the banks having no big issues.”

While the rule has been watered down, it still represents an important change in direction for a financial industry that had been allocating a larger and larger portion of capital over the last decade to making bets and investments with their own money, said James Ellman, president of San Francisco-based hedge fund Seacliff Capital LLC, which specializes in financial industry stocks.

‘Casino’ Must Go

“You’re going to be taking out of the banks areas of investing that every 10 years or so, at certain points in the cycle, tend to have dramatic losses,” Ellman said. “Effectively you’re telling the system: We have to take the casino out of the utility.”

While Ellman said the legislation will help to make the financial system safer, he added that “it won’t satisfy anybody who wanted really strict additional regulation of banks.”

The new version of the Volcker rule also incorporates changes proposed by Democratic Senators Jeff Merkley of Oregon and Carl Levin of Michigan that aim to curb conflicts of interest by preventing firms that underwrite an asset-backed security from placing bets against the investment. In April, Levin presided over a hearing in which Goldman Sachs executives were accused of betting against some of the same collateralized debt obligations that they underwrote; the executives responded by saying they were acting as market-makers.

Market-Based Funding

While requirements for an increase in capital will provide banks with a bigger cushion to absorb losses, the legislation does little to reduce banks’ dependence on the markets to finance their balance sheets. It was that market-based funding that made firms like Goldman Sachs and Morgan Stanley vulnerable to the panic that spread in 2008.

“Something has to be put in place to cause banks to have deposit-based liabilities and not market-based liabilities,” Grimes & Co.’s Wallace said.

The effects of the legislation won’t be seen for several years as new regulations are drafted and implemented, analysts said. New international capital requirements under consideration by the Basel Committee on Banking Supervision, which could be implemented by the end of 2011, will also be important.

Investors and analysts including Optique Capital Management’s William Fitzpatrick said bank stock prices have already factored in any likely reduction in revenue from the changes.

“Profitability is indeed going to take a hit and we’re going to see more stringent capital requirements,” said Fitzpatrick at Milwaukee-based Optique, which oversees about $800 million including stock in Bank of America, Goldman Sachs and JPMorgan. “The changes are most certainly necessary. They can certainly lead to a more stable and predictable earnings stream.”

Still, he added, “this doesn’t remove all of the elements of financial distress that could lead to some of the challenges we had in 2008.”

Jim Rogers: Inflation risks are "extremely serious"

Investor Jim Rogers, chairman of Rogers Holdings, said the threat of inflation is “extremely serious” and the world is in an ongoing bear market for financial assets.

Rogers, who predicted the start of the global commodities rally in 1999, is betting on a decline in stocks and gains in commodities, he said today in an interview with Bloomberg-UTV in Mumbai. He’s also bought up the euro and the U.S. dollar and said agricultural commodities are “extremely cheap” on an historical basis.

The Federal Reserve this week said Europe’s debt crisis may hinder growth in the U.S., the world’s largest economy. Global stock markets have plunged amid the fallout from the European crisis, which saw euro nations and the International Monetary Fund back up Greece with an almost $1 trillion bailout.

“The world has an ongoing economic problem which has not yet been resolved yet,” Rogers said today. “I don’t think the best place for people to invest is in stocks.”

Asian stocks dropped the most in nearly three weeks today on disappointing sales and earnings forecasts by U.S. companies. The MSCI World Index of the largest companies has lost about 13 percent of its value from a more than two-year high in April.

“I am still concerned about debt around the world,” Rogers said. “I am not terribly optimistic about the world economy partially, largely, because of the gigantic debts which have built up.”

Rogers said he’s not optimistic about the euro or the U.S. dollar in the “long term.” Sugar and silver are cheap on an historical basis, Rogers said.

China's real estate bubble is reaching epic proportions

Yu Jiang looks into the front window at his two-bedroom apartment in the center of Kangbashi, in China’s Inner Mongolia, and says he may buy another. The place has been empty for three years, as are as many as 90 percent of the units near it.

Designed for 300,000 people, Kangbashi, the new urban center of Ordos prefecture west of Beijing, may have only 28,000 residents, Bank of America-Merrill Lynch said in a May 10 note. Standard Chartered Bank called it “the Dubai of northern China” for its vacant skyscrapers and more than 1.1 trillion yuan ($161 billion) worth of new public buildings and local wealth.

Unlike in Dubai, where home prices have fallen more than 50 percent since mid-2008, buyers are still piling into Chinese housing. Yu says he sees no reason why the threefold gain on his investment shouldn’t grow.

“The future of Kangbashi is bright,” said Yu, 52, who runs a house-decoration business. “Government offices have moved here so the economy will develop well. Prices will rise.”

Investors are stockpiling empty apartments because there are few alternative investments, undermining government efforts to deflate a property bubble, said Patrick Chovanec, an associate professor at Tsinghua University in Beijing.

“Money is being dumped into property because there are no alternatives,” said Chovanec, adviser and former vice president of the Hong Kong venture capital firm Asia Mezzanine Capital Group. “Policy makers are nibbling around the edges of the core problem.”

Loans Curbed

A recovery in the stock market may encourage some investors to switch to equities, which were boosted this week after the central bank indicated it would let the yuan appreciate. That would leave developers with unsold projects and may cause loan defaults.

Although the government has restricted pre-sales by developers and curbed loans on third-home purchases, average property prices in China have risen more than 10 percent from a year earlier for four straight months.

Policy makers are considering a property tax in some cities to increase the cost of holding empty homes. About 50 percent of apartments are bought with cash, said Glenn Maguire, chief Asia- Pacific economist at Societe Generale SA in Hong Kong.

Fund managers James Chanos and Marc Faber, Citigroup Inc. economists Willem Buiter and Shen Minggao, and Harvard University professor Kenneth Rogoff are among those who have warned of a crash in China if the government can’t stop the property bubble. Buiter and Shen say it may take three years for the boom to bust while Faber says it could happen within a year.

‘Pretty Horrendous’

The result will be “pretty horrendous,” slashing economic growth to less than 5 percent over two years and saddling banks with more than $400 billion in bad loans, said Jim Walker, chief economist at Hong Kong-based Asianomics Ltd. and former chief economist at CLSA Asia-Pacific Markets, in an interview.

Banks are at risk because they often use land as collateral for loans from developers. A 50 percent fall in property prices would mean the loans are no longer covered by the land’s value, calling into question “the solvency of the entire banking system,” Chovanec wrote in a blog in January.

The nation’s 13.6 trillion yuan ($2 trillion) of new loans in the past 17 months, bigger than the economies of South Korea, Taiwan and Hong Kong combined, is “unprecedented in 400 years of economic history,” said London-based hedge fund manager Hugh Hendry, co-founder of Eclectica Asset Management, which manages $420 million.

Risks associated with home mortgages are growing and a “chain effect” may appear in real-estate development loans, the China Banking Regulatory Commission said June 15 in its annual report. The Beijing-based regulator told lenders to report their real-estate risk by the end of this month.

Prices Rising

Chinese investors have few appealing options. Capital controls prevent citizens from investing overseas; bank deposits yield 2.25 percent, less than the 3.1 percent rise in May’s consumer price inflation.

China’s wealthy switched their focus to property in 2007 because of the stock market’s poor performance, said Rupert Hoogewerf, founder of the Shanghai-based Hurun Report, a luxury publishing and events group. The Shanghai Composite Index has slumped 59 percent since peaking at 6,092 points on Oct. 16, 2007.

“The underlying sources of the property bubble remain,” said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong. “Savings deposits for households and corporates combined are worth 146 percent of GDP and earn 2.25 percent and are trapped inside the country. Equities have performed poorly, while the bond market is underdeveloped.”

Financial Holdings

Few places illustrate the boom in wealth and lack of investment opportunities better than Ordos, population 1.5 million. Demand for coal from the desert region to fuel China’s factories has boosted the area’s gross domestic product by an average 25 percent for the past decade, said Lu Ting, an economist with Bank of America-Merrill Lynch in Hong Kong. Coal contributes more than half of Ordos’s GDP, he said.

“Ordos has basically been bought up by miners who have got plenty of cash,” said Hurun’s Hoogewerf. “They’re buying up the properties, not living in them themselves, and basically just sitting on them.”

Construction of Kangbashi new town, 560 kilometers (348 miles) from the capital, began in 2004 and the Ordos government moved most of its offices there in 2006 from Dongsheng, a 40- minute drive away. With few shops, restaurants and other amenities in the new city, most government workers still prefer to live in Dongsheng and commute.

Theater and Arts

That hasn’t stopped the government from investing more than 1.1 trillion yuan in Kangbashi on buildings that include the 502 million-yuan Great Theater of Ordos, the 362 million-yuan Ordos National Theater, and the 318 million-yuan Ordos Culture and Art Center, according to the Ordos government’s website.

Government efforts to slow the real-estate market have had some effect. Bank lending fell 31 percent to 4 trillion yuan in the first five months from a year earlier as the government raised banks’ minimum reserve requirements three times.

That helped curb housing sales in Beijing, Shanghai and Shenzhen, the nation’s wealthiest cities, which fell as much as 70 percent in May from the previous month, the official Shanghai Securities News reported.

Most Attractive?

The decline had little effect on property prices, which rose 12.4 percent in May from a year earlier, the second-fastest pace on record after April’s 12.8 percent gain, the statistics bureau said on June 10. On a monthly basis, values advanced 0.2 percent in May.

Citigroup’s Markus Rosgen and Elaine Chu said in a May 31 note that the 30 percent decline in a gauge of property stocks in the first five months of this year made the sector the most attractive in China.

Demand for housing in China will withstand government bank lending curbs, and further declines in the nation’s property stocks may be an opportunity to buy the shares, Mark Mobius, who oversees about $34 billion in emerging market funds as Templeton Asset Management Ltd.’s Singapore-based chairman, said in answer to e-mailed questions April 21.

The EPH China Fund hadn’t owned property stocks until late May, when valuations fell below historical averages, prompting it to buy Shenzhen-based China Vanke Co., the nation’s biggest publicly traded property developer, and Evergrande Real Estate Group Ltd., said Russell Hoss, who manages the $59-million fund from Newport Beach, California.

Smaller Declines

“We want to own developers with good balance sheets, good brands, limited cash outlays and with exposure to second and third tier cities,” said Hoss. Whereas prices may fall 25 percent in cities such as Beijing and Shanghai, declines in second- and third-tier cities may be only 10 percent, he said.

Policy makers’ tolerance for property price declines is no more than 30 percent for “fear of too much economic weakness,” said Shen Minggao, Citigroup’s Hong Kong-based chief economist for Greater China. If China’s 8 percent growth target for this year is “challenged,” policies to cool property may be softened or “even reversed,” said Shen.

Property investment contributed almost 11 percent of China’s GDP directly last year and Shen estimates that with the spillover effect into other industries, the total contribution is double that.

Kangbashi’s construction boom shows no signs of slowing. In the Yu Ying Yipin area on Min Fu Road, Lian Bang Group is building five 13-story apartment blocks. Opposite, Sheng Da Group has 12 17-story residential towers nearing completion.

About 100 meters further along the road, site clearing is under way for what Ordos-based developer Elion Resources Group- billboard says is a 156,537 square meter project with 26 apartment blocks capable of housing 3,530 people.

“You can’t address a bubble by preventing people from owning two apartments,” said Michael Pettis, a finance professor at Peking University in Beijing and former head of emerging markets at Bear Stearns & Cos. “The money has to go somewhere.”

Gold giant Newmont just broke out to an important new high

The market is catching on to the idea I presented in back in May... the idea of higher gold prices in large-cap gold miners.

To recap, shares in big gold mining companies have been a disappointment for the past four years. While gold has more than doubled in price during that time, most big gold miners have barely made any gains... Some, like industry giant Newmont Mining (NEM), have moved sideways.

BET ON INTEREST RATES? NO THANKS.

Today's chart proves once again betting on higher interest rates is a hard dollar…

Once or twice a year, we remind readers that there are much greener "trading pastures" in the market than making the popular bet on higher interest rates. As Steve pointed out years ago, realtors are the world's worst interest rate forecasters… but they're just barely worse than market gurus and Wall Street analysts who predict where interest rates are headed.

Below is the past seven years of the yield on the benchmark 10-year U.S. Treasury note. This is the most widely followed interest rate in the world… the rate used to set mortgages and car loans.

As you can see from the right side of the chart, the yield recently plummeted below 3.25%… to around the level it was at in 2003 and 2008. Concerns of a slowing economy caused the decline.

We're sure some short-term traders out there are able to make money on interest rate gyrations. But for the majority of folks, it's far easier to profit from things you look at from a value standpoint… like buying cheap oil… buying cheap gold stocks… shorting expensive real estate… buying cheap Asian stocks… and buying blown out natural gas. Leave the interest rate bets to the realtors!

The euro bailout could be failing

So much for that Greek bailout plan. Greek CDS are now back at fresh all time highs as the market seems set on not only testing the EU's rescue resolve, but determined to get a fresh new bailout plan entirely.

At last check CDS was just shy of 1,000 bps.

The immediate catalyst is a Fitch report that says Greece risk has gone up and...

World's central banks: Gold could be the most important asset to own for the next 25 years

Almost a quarter of central banks believe gold will become the most important reserve asset in the next 25 years, according to an annual poll by UBS.

The result highlights the sea-change in attitudes in the official sector towards the yellow metal.

For two decades central banks were net sellers of gold but that trend has reversed as...

Top Austrian bank: "Gold is the optimal investment in both deflation and inflation"

The central question of whether the next few years will be dominated by inflation or deflation still remains unanswered.

In periods of inflation, tangible assets are the preferred asset class, whereas in times of deflation, cash is king. Gold is liquid, divisible, indestructible, and can be easily transported.

It has a worldwide market and there is no default risk associated with it.

Gulf DISASTER: Federal agency says BP spill could cost over $1 trillion

Bad news concerning the Gulf oil disaster continues to come from WMR's federal government sources in the Federal Emergency Management Agency (FEMA) and the US Army Corps of Engineers. Emergency planners are dealing with a prospective "dead zone" within a 200 mile radius from the Deepwater Horizon disaster datum in the Gulf.

A looming environmental and population displacement disaster is brewing in the Gulf.

New Australian prime minister scraps plans for mining tax

Julia Gillard began her job as Australia’s first female prime minister by promising to smooth relations with mining, its biggest industry.

The 48-year-old Wales-born lawyer took office today after ousting Kevin Rudd, whose slump in opinion polls threatened to make their Labor Party the nation’s first one-term government in 80 years. Rudd stepped down rather than face a party vote.

Gillard moved to fix two of Rudd’s most unpopular decisions by pledging to revive the carbon-trading system he shelved in April and agreeing to open negotiations with the mining industry on a proposed tax increase that had sparked widespread protests among companies, workers and politicians, including members of Rudd’s own party.

“The change of leadership will mark a major change in the management style of the government,” said Paul Brennan, senior economist at Citigroup Inc. in Sydney. “The change of leadership may increase the government’s chances of being re- elected.”

Gillard’s ascension to the nation’s top job was welcomed by BHP Billiton Ltd., Rio Tinto Group and Fortescue Metals Group Ltd., which had led the fight against the 40 percent so-called super-profits tax. Melbourne-based BHP, the world’s biggest mining company, said in a statement it was “encouraged” by the appointment and will suspend its advertising against the proposed tax.

Rising Shares

Investors also bet Gillard will compromise on the tax, which had accelerated Rudd’s slump in approval polls. BHP shares rose 1.3 percent in Sydney trading, Perth-based Fortescue gained 2.5 percent and London-based Rio added 1.7 percent. They later slid in London trading.

“Gillard has launched her leadership with a conciliatory tone toward the mining industry,” said Roland Randall, vice president of research and strategy at TD Securities in Singapore. “As a new leader, she can compromise without loss of face.”

Gillard said at the press conference that she will call an election within the coming months, “throw open” her doors to talks with mining companies and make climate change a central plank of her election platform.

“It is as disappointing to me as it is to millions of Australians that we don’t have a price on carbon,” she said. “If elected as prime minister I will re-prosecute the case for a carbon price.”

Parliamentary Career

Gillard’s political career got off to a stuttering start. After failing in three attempts to win Labor endorsement to stand for parliament, she took a job as chief of staff to Victorian state opposition leader John Brumby.

She finally won endorsement for the Labor Party in 1998, winning the Melbourne seat of Lalor. In opposition, she served as the party’s spokeswoman on health, squaring off against the Liberal Party’s Tony Abbott.

Now, the two will face off in the coming election. The 52- year-old Abbott, a former Rhodes scholar and priest trainee, was elected leader of the Liberal Party in December, after overthrowing Malcolm Turnbull.

When Rudd, 52, ran for the Labor leadership in 2006, he enlisted Gillard as his deputy. The pair led Labor to a landslide victory in November 2007, ending John Howard’s almost 12 years in power.

Gillard joins powerful female politicians such as New South Wales state premier Kristina Keneally, Queensland state leader Anna Bligh and deputy opposition leader Julie Bishop.

Feet on the Floor

“I’m aware I’m the first woman to sit in this role but I didn’t set out to crash my head against any glass ceilings,” she said today. “I keep my feet on the floor.”

Gillard said she grew up in a “hard-working family” that taught her people should be rewarded for their efforts. Today, she restated her goal that every child should be able to access a quality education, a pledge including in her maiden speech to parliament in 1998.

Her parents, John and Moira, who moved to Australia in 1966 to escape the cold Welsh winters that frequently left their four-year-old daughter with bronchial pneumonia, watched from their home in Adelaide as Gillard was sworn in Australia’s 27th prime minister.

“When I see Julia we’ll probably both cuddle and probably shed a tear or two, we are very proud,” her father John said in a phone interview today. “We’re very proud of her.”

School Cheers

About 100 children at Adelaide’s Unley High School Resource Center today cheered as they watched the swearing-in. Gillard graduated in 1978 with an A for Chemistry and English and B+ for Physics, Economics and Mathematics, principal Susan Cameron said as she read from Gillard’s report card.

“She studied hard and the students today were gripped by the coverage of this exciting day,” Cameron said in an interview.

Gillard studied at the University of Adelaide and Melbourne University where she graduated in 1986 with degrees in arts and law. She then joined law firm Slater & Gordon in Werribee, Victoria in 1990, practicing industrial law. The firm now has a meeting room named after her in its Melbourne office.

“She argued with the same charm and humor we see in her style today,” said Carol Johnson, who was in student politics with Gillard at Adelaide. “We knew she’d go far but we didn’t think she’d go this far this quickly.”

Gillard’s partner, Tim Mathieson, a hair stylist who works on her flame-red bob, congratulated Gillard today with a hug and a kiss as she was sworn in at Government House.

Gillard has had to fight criticism she wasn’t qualified to be a leader because she didn’t have children. Liberal Senator Bill Heffernan had to apologize for saying in May 2007 that Gillard was unfit to be deputy prime minister because she was “deliberately barren.”

“You’re either working at this intense high level or you’re having kids,” Gillard responded in an interview then with the Australian Broadcasting Corp.

George Soros: Germany could cause the euro to collapse

German's budget-savings policy risks destroying the European project and a collapse of the euro cannot be ruled out, billionaire investor George Soros said in a newspaper interview released on Wednesday.

"German policy is a danger for Europe, it could destroy the European project," he told German weekly Die Zeit.

Soros, who earned $1 billion in 1992 by betting against the British pound, added that he "could not rule out a collapse of the euro."

"If the Germans don't change their policy..."

China will soon be the world's largest importer of this essential energy commodity

China is set to overtake Japan as the world’s largest importer of thermal coal as soon as this year, only three years after China became a net importer of the mineral used to fire power stations, according to an emerging industry consensus.

The speed at which Chinese coal imports are growing is surprising.

THE BREAKDOWN IN HOME DEPOT IS GETTING WORSE

Remember the "dangerous breakdown" we noted in Home Depot (HD) shares? It's getting worse…

To recap, we keep Home Depot shares on our watch list for one big reason: It's America's largest chain of home improvement stores… which makes its share price and profits rise and fall along with spending on the American dream. If the Depot's share price is tanking, it's a bad omen.

Driven by the huge government "goosing" of the housing market, HD shares soared off their March 2009 bottom into the mid $30s. But several weeks ago, we highlighted how HD shares broke their uptrend to hit their lowest low in two months. This weakness has come on massive trading volume as traders fled the "housing trade."

On Tuesday, HD continued its horrid summer performance and struck its lowest low in four months. And again, the weakness came on big trading volume. If Home Depot continues this downtrend, it's a strong sign the government goosing is wearing off. We've no doubt the geniuses in Washington, D.C. will order up a fresh boondoggle to fight this trend.

New home sales plunge to lowest level on record

Purchases of new homes in the U.S. fell in May to a record low as a tax credit expired, showing the market remains dependent on government support.

Sales collapsed a record 33 percent to an annual pace of 300,000 last month from April, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down.

Stocks dropped and Treasuries rose as the report added to signs of weakness in the economy after a decline in retail sales and a slowdown in private job growth. A lack of inflation and concern over jobs and housing are among reasons Federal Reserve policy makers today are likely to renew a pledge to keep interest rates near zero for an “extended period.”

“May was a bad month for the economy,” J. Alfred Broaddus, former Richmond Fed president, said in an interview on Bloomberg Television’s “In Business With Margaret Brennan.” When the Fed releases its policy statement today, its language on the economy will be “markedly more pessimistic,” he said.

The Standard & Poor’s 500 Index fell 0.6 percent to 1,089.27 at 10:39 a.m. in New York. The S&P Supercomposite Homebuilder Index decreased 0.4 percent. The yield on the 10- year Treasury note fell to 3.11 percent from 3.17 percent late yesterday.

Exceeds Drop Projected

Sales were projected to drop 19 percent to a 410,000 annual pace, according to median estimate of 76 economists surveyed by Bloomberg News. Forecasts ranged from 300,000 to 530,000. The government revised April’s purchase rate down to 446,000 from a previously reported 504,000.

The median sales price decreased 9.6 percent from the same month last year, to $200,900, today’s report showed.

Purchases dropped in all four U.S. regions last month, led by a record 53 percent drop in the West.

The supply of homes at the current sales rate jumped to 8.5 month’s worth, from 5.8 months in April. There were 213,000 new houses on the market at the end of May, the fewest since 1970.

A report yesterday showed sales of previously owned homes unexpectedly fell in May, adding to concern the retrenchment following the end of the tax incentive will be deeper than anticipated. Existing house purchases, calculated when a contract closes, dropped to a 5.66 million annual rate, the National Association of Realtors said.

New-home sales are considered a more timely barometer of the market than purchases of previously owned homes, which account for about 90 percent of the housing market.

Housing Slump

Other data show the market is starting to stumble. Housing starts in May declined by the most since March 2009, and building permits, a sign of future construction, fell to a one- year low, data from the Commerce Department showed. The National Association of Home Builders/Wells Fargo confidence index for June fell by the most since November 2008.

The number of mortgage applications filed to purchase houses dropped this month to the lowest level since 1997, according to data from the Mortgage Bankers Association.

The Standard & Poor’s Supercomposite Homebuilder Index, which includes Toll Brothers Inc. and Lennar Corp., has dropped 28 percent since reaching a 19-month high on May 3. The broader S&P 500 Index is down 10 percent from April 23’s 19-month peak.

Builders are also concerned that the Gulf oil spill and European debt crisis are hurting buyer confidence. Toll, the largest U.S. luxury homebuilder, said deposits have been running 20 percent behind the year-earlier period the past three weeks.

Consumer Outlook

“Concerns about the financial crisis in Europe and escalating regional political tensions, coupled with worries about the oil spill in the Gulf of Mexico and its effects on the economy and the environment have negatively impacted the outlook of American consumers,” Joel H. Rassman, chief financial officer at Horsham, Pennsylvania-based Toll, said in a June 16 statement.

Hovnanian Enterprises Inc., the largest homebuilder in New Jersey, said orders fell 17 percent in the quarter ended April 30 from a year earlier, and contract signings slowed in May, indicating the tax credit helped pull some sales forward.

This startling announcement could have huge implications on your taxes

Yesterday in the UK, something happened that has significant implications for us all.

Old western economies are clearly losing their dominance. Particularly in Europe, the costs of broken pension plans and entitlement programs are bankrupting entire economies.

Yet, national governments continue to perversely borrow and consume; politicians have been acting like degenerate gamblers, borrowing money from anyone they could, blowing it all on terrible bets, borrowing more money to make even worse bets, and actually expecting different results.

Something needs to change... and it appears that Britain is the first major western government to face the music. As such, British Chancellor of the Exchequer George Osborne unveiled yesterday what has been touted as 'emergency' budget austerity.

Osborne's budget cuts deep. It hits the elderly, it hits low income workers, it hits single mothers, it hits business owners and investors... it even hits the Queen, who will see her multimillion pound salary frozen for several years.

To give credit where credit is due, Osborne should be commended for looking his nation in the face, speaking about a very grim reality, and being candid about the tough sacrifices that everyone will have to make.

But here's the scary part, and what we need to learn from:

While there was significant talk in Osborne's speech about spending cuts, most line items have yet to be fully determined. What they are absolutely clear about, though, are the tax changes.

Britain's VAT, for example, will increase from 17.5% to 20%. Many personal income tax rates will rise as well, particularly for high income earners. These changes will be phased in gradually... except for one.

Osborne announced that Britain's capital gains tax will increase from 18% to 28% for higher income earners. Yet unlike the other changes which are phased in over time, capital gains tax change occurs IMMEDIATELY.

There is a serious lesson here: governments have the power and willingness to make major changes overnight. With the stroke of a pen, they can impose capital controls, higher taxes, gold forfeiture, confiscation of retirement savings, or anything else they can dream up.

Britain's emergency budget underscores this point even more, and reminds those of us who aren't in the UK that we need to prepare NOW. Why? Because other countries won't be far behind, including the United States.

At a certain point, President Obama will be forced by circumstance to look the American people in the eye and ask them to sacrifice... and pay higher taxes effective immediately.

Also, it's likely that the US government will get its hands on private retirement savings some day soon... there's about $5 trillion out there, and at some point that they'll mandate a portion of all managed retirement accounts to be held in the 'safety' of US Treasuries.

I can't stress this enough-- proper financial planning should be an integral part of your multiple flag strategy.

To protect yourself from overnight tax hikes, this means using existing, legitimate tax shelters. US tax code, for example, provides a means for people to set aside tax-deferred savings for retirement through an IRA or 401(k).

Most of these entities, though, are unfortunately engineered to generate profits for the financial institution who manages the account, rather than the individual who is busting his butt every day to save for retirement.

The best solution that protects your savings from rising tax rates and government confiscation is to hold your investments in an Open Opportunity IRA structure.

Similar to a regular IRA, an Open Opportunity IRA allows you to generate tax-deferred (or tax-free) returns on your savings. Unlike a regular IRA, this structure gives you complete control and flexibility to do what you want with your retirement savings-- like planting multiple flags overseas.

With an Open Opportunity IRA structure, you can buy foreign property, store gold overseas, establish an offshore bank account... as well as invest in all the other instruments that you might already be investing in right now with your retirements savings.

The big difference? It's nearly impossible for the government to get their hands on it. And if you start investing through this tax deferred structure, you won't wake up one morning to higher tax rates that will pummel your investment returns... which is exactly what happened in the UK this morning.

This is one of the biggest no-brainers for US taxpayers... even if you're just starting out, establishing one of these structures provides a long-term solution to generate tax-deferred or tax-free savings as you make contributions over time.

Terry Coxon is a leading expert in this industry; he's authored numerous books on tax and personal finance issues, and his latest e-book is one that you should absolutely own.

In Unleash Your IRA, Terry explains the real magic behind these structures-- how to set one up, how to protect yourself and your assets, and all the amazing things you can do while still following the tax rules.

I strongly urge you to take action now... continuing to kick the can down the road is a very dangerous course of action given all the warning signs around us.

Apple's huge rally could be trouble for new investors

The 38-fold surge in Apple Inc. shares that drove the iPhone seller past Microsoft Corp.’s market value means the company may be “too big to succeed,” according to research from Rob Arnott.

Research Affiliates LLC found that since 1953, shares of the biggest Standard & Poor’s 500 Index company in an industry trailed the average stock by 2.4 percent a year in the next decade. The CHART OF THE DAY shows the market value of Apple, whose stock rallied to $270.17 yesterday from $7.17 at the end of 2002, passed Redmond, Washington-based Microsoft’s in May following the introduction of the iPad tablet computer.

Apple, based in Cupertino, California, has increased net income seven straight years, following the release of the iPod music player in 2001 and the iPhone in 2007. The IPad came out in April, and Apple is forecast to report record profit of $12.4 billion in the fiscal year ending in September, according to the average of 28 analyst estimates in a Bloomberg survey.

“For investors, ‘top dog’ status is dismayingly unattractive,” wrote Arnott, founder of Newport Beach, California-based Research Affiliates, which oversees about $50 billion. “When you’re No. 1, you have a bright target painted on your back. Competitors are gunning for you. Politicians and pundits are gunning for you. Far from a problem of ‘too big to fail,’ companies can become ‘too big to succeed.’”

Apple’s shares were worth $245.8 billion as of yesterday’s close, compared with $227.4 billion for Microsoft. Apple trails only Exxon Mobil Corp., which at $296.6 billion is the biggest U.S. company.

This country could see a huge boost from China's thirst for oil

China is a force to be reckoned with in the international oil market.

It is today the world's second-largest oil consumer, after the mighty U.S. And an increasing amount of China's oil use is being supplied by imports. In 2009, China's import crude volume exceeded domestic production for the first time ever.

This means the Chinese are looking abroad for more oil. China's national oil companies have been extremely active in buying.

Porter Stansberry: China could cause a big increase in interest rates

It was a good day to be back in the office, after a week in Europe... because events seem to be unfolding according to our expectations. China has decided to allow its currency to appreciate. As long-time readers know, we hold a simple view of the world. We expect as the Fed creates more dollars, the exchange value of paper money will decline. You might say we believe the printing press is more powerful than the mortgage defaults, if only because its work can be accomplished faster and without limit. The government's decision to bail out the banks, Fannie, Freddie, AIG, etc. will cause commodity prices to rise. Most foreign currencies will rise too, but perhaps not the euro, which seems poised to print even more money than the Fed.

Unsustainable trends – like America's trade deficit with China – can't go on forever, but they can last a very long time. China's currency peg, which has been in place since 1994, allowed America's trade deficit to grow without limit. It also allowed the Federal Reserve to export our domestic inflation to the Chinese market and its nearly endless supply of labor. Now, finally, these trends seem to be reversing. From now on, increasing demand for Chinese goods will result in higher prices as the yuan appreciates.

What does all of this mean to you? We offer a warning: The move on China's currency presages a big increase in interest rates. China's central bank controlled its exchange rate by selling yuan and buying Treasury bonds. As the country allows the yuan to rise, it will undoubtedly buy fewer Treasuries. The U.S. Treasury, meanwhile, will be selling record amounts of bonds as it attempts to raise nearly $4 trillion in the next 12 months to extend maturing debts and finance OBAMA!'s record deficits.

One other point to consider about a stronger yuan... It should allow China to purchase more commodities, which, along with a corresponding weaker dollar, should cause commodity prices to rise substantially. That's why crude oil jumped nearly 2% on the news. Freeport-McMoRan, the world's largest copper miner, gained 6%.

And finally... we know the world's central bankers are now facing an even bigger quandary. U.S. dollars might not have been the best currency in the world, but at least they were good for buying things in China. Now... they might not be so good at that anymore. If you were a central banker, what would you do? The central banks of Russia, the Philippines, Kazakhstan, and Venezuela are all buying gold, the World Gold Council said on Friday. Also, Saudi Arabia's gold reserves more than doubled to 323 tons from 143 tons in March. The WGC said the revision was due to an accounting adjustment. We know accountants can get creative, but hiding nearly 200 tons of gold takes talent. With gold trading at all-time highs, we're seeing nearly every central bank add to its reserves...

It doesn't seem like that long ago (2006) when people looked at us as if we had three eyes when we warned the U.S. dollar standard was on the verge of collapse. Now, it seems more and more inevitable each day. We sure hope you started buying gold and silver back then.