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China Changing the Global Gold Market

While many investors have been distracted by the goings on in Europe, China has been making a dent in the global gold market by making it easier for investors to buy and invest in the yellow metal.

The goal: To dominate the global gold market and carve out a new role for its currency, the yuan.

China and other developing nations like India have been encouraging citizens to buy and hold physical gold, in forms ranging from jewelry and coins to bullion bars. China's aggressive promotion has pushed Chinese consumer demand for gold up 25% overall this year – much higher than the 7% global average.

World Gold Council (WGC) Far East Managing Director Albert Cheng, who predicted in March 2010 that Chinese gold demand would double by 2020, noted: "We now believe this doubling may, in fact, be achieved far sooner."

China is pushing gold because it wants the government and citizens to build financial reserves in assets stronger than the U.S. dollar, euro, and other weakening currencies. It also increases China's role in the precious metals market.

But there's another effect of this push for gold ownership: it's dislodging the dollar as the world's main reserve currency.

China's Gold Push Efforts

China's push for private gold ownership represents a major policy shift.

Chinese citizens were barred from owning physical gold under penalty of imprisonment until 2002. Since that policy was dropped and the Shanghai Gold Exchange opened, China has steadily stepped up efforts to encourage precious metal ownership.

The government now airs news programs on state-owned China Central Television describing how easy it is to buy and sell gold and silver. It also started its first gold vending machine, letting Chinese customers easily buy gold coins and bars using cash, debit cards and credit cards.

Current plans call for an additional 2,000 gold vending machines to come on line in the next two years. If they prove as successful as they did in Germany, where metals vending machines were first introduced, China's consumer gold demand will surge.

Chinese consumers turned off by the vending machines' high price mark-ups have another option – official government-operated "Mint Stores." Structured like a typical jewelry store, they feature specially minted bars in a variety of sizes. Mark-ups are minimal since each store has a Bloomberg screen tracking the current spot gold price, usually quoted in renminbi based on Shanghai trading, rather than in dollars on the London or New York market.

China also has encouraged more gold investment through new exchanges and yuan-denominated products.

The country on June 28 opened its first precious metals spot exchange. The South Rare Precious Metals Spot Exchange offers spot trading – as well as deferred and long-term electronic trades – in gold, silver, bismuth, indium and tellurium, with plans to add 13 other metal-related products. Chinese citizens can trade the metals through either direct margin accounts with the exchange, or through their banks and brokerage firms.

These efforts have increased Chinese consumers' gold interest, but it's the next development that will make China a major global player in gold trading.

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Three Doomsday Scenarios: What Happens If the Eurozone Breaks Up?

The time has come to confront an ugly truth: The possibility that the Eurozone will break up, or rather fall apart, is growing increasingly likely.

In fact, I'd say given recent developments in Italy the probability of a breakup is as high as 40%.

Indeed, if a country as small as Greece or Portugal were to default or abandon the euro, the effect on the Eurozone would be manageable. The debts of those countries are too small to make more than minor dents in the international financial system, and they represent too small a share of the Eurozone economy for their departure to have much impact.

The psychological effect of their departure would be considerable – if only because Eurozone leaders have expended so much money and effort to bail them out. However, devastated credibility among the major Eurozone leaders is more of a political problem than an economic one.

But now that the markets' focus has moved to Italy and Spain, the Eurozone is really in trouble.

Asking for Trouble

Part of the problem is that in arranging the partial write-down of Greek debt, authorities made it "voluntary," thereby avoiding triggering the $3.8 billion of Greek credit default swaps (CDS) outstanding. Of course, this caused a run on Italian, Spanish, and French debt, as banks that thought they were hedged through CDS have begun selling frantically, since their CDS may not protect them.

Honestly, how stupid can you get! I don't like CDS, but fiddling the system to invalidate them is just asking for trouble. And so far, the only effect has been a considerable increase in the likelihood of a Eurozone breakup.

Italy, Spain, and France are too big to bail out without the European Central Bank (ECB) simply printing euros and buying up those countries' debt. However, if the ECB adopted the latter approach, hyperinflation would almost certainly ensue. Furthermore, the ECB itself would quickly default, since its capital is only $14.6 billion (10.8 billion euros) – a pathetically small amount if it's to start arranging bailouts.

Of course, Europe's taxpayers could then bail out the ECB by lending the money needed to recapitalize the bank, but a moment's thought shows that the natural result of such a policy is ruin.

So what would a breakup of the Eurozone look like? Basically, there are three possibilities.

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Rising Government Bond Rates Push Eurozone Debt Crisis to the Precipice of Collapse

Rising government bond rates are making it increasingly costly for several key Eurozone nations to borrow money, stoking fears that the sovereign debt crisis has reached a critical stage.

Yields on 10-year Spanish Treasury bonds rose to 6.8% during yesterday's (Thursday's) auction – uncomfortably close to the 7% level at which many experts feel is unsustainable. When the 10-year bond yields of Portugal, Ireland, and Greece passed 7%, each was forced to seek a bailout.

Just last week the 10-year bond yields of Italy crossed the 7% threshold. Though yields dropped back below 7% after Italian Prime Minister Silvio Berlusconi stepped down, the respite proved short-lived. The Italian 10-year bond yield fell back to 6.84% yesterday but is expected to stay in the danger zone for the foreseeable future.

Perhaps more worrisome is the rise in French bond yields. While France is not one of the troubled PIIGS (Portugal, Ireland, Italy Greece and Spain), it has deep financial ties to those nations. French 10-year bonds now yield 3.64%, twice that of equivalent German bunds despite both nations having a top-tier AAA credit rating.

The cost of borrowing is rising even for nations that until now had been outside of the fray, like the Netherlands, Finland, and Austria.

"Momentum is building," Louise Cooper, market strategist at BGC Partners, told MarketWatch. "Ten-year French borrowing costs are now around [two percentage points] greater than Germany, Spanish borrowing costs are rocketing and 10-year Italian debt is yielding over 7%. The hurricane is approaching. Time to batten down the hatches."

Economic Damage

As the Eurozone debt crisis deepens, many analysts worry that the rising government bond rates could put the brakes on lending and lead to a credit crunch such as the one experienced during the 2008 financial crisis.

In the short term, however, the steady stream of scary news is taking a toll on the stock markets. The British FTSE 100 was down 1.58% and the French CAC 40 was down 1.78% yesterday, while the Dow Jones Industrial Average fell 134.79 points, or 1.13%.

"Investors keep thinking that the powers that be in Europe are getting in front of this – only to be disappointed when additional bad news emerges," observed Money Morning Capital Waves Strategist Shah Gilani. "That's why we're seeing these whipsaw trading patterns that are so frustrating to retail investors who've been schooled to buy and hold. The reality is that this will get much worse before it gets better."

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Three Psychological Stumbling Blocks That Kill Profits

Face it, the past 12 years have been horrible for most investors.

This is not necessarily because the markets have been rocky, but rather because the vast majority of investors are hardwired to do three things that kill returns.

You can blame Washington, the European Union, debt, high unemployment, or half a dozen other factors if you want to, but ultimately, the person responsible is the same one staring back at you from your bathroom mirror in the morning.

That's why understanding the bad habits you didn't know you had can be one of the quickest ways to improve your financial wealth.

Here's what I mean.

Dalbar, a Boston-based market research firm, produces annual research that compares the returns of stock and bond markets with those of individual investors. The latest, covering the 20-year period ended last year, shows that the Standard & Poor's 500 Index returned an annualized gain of 9.1%. That stands in sharp contrast with the measly 3.8% gain individual investors averaged over the same timeframe.

Fixed income investors didn't do any better. According to the Dalbar data, t hey gained a mere 1% a year versus an annualized return of 6.9% for the Barclay's Aggregate Bond Index.

In other words, investors' self-defeating decisions contributed to an underperformance that was 58% below what it could have been for stocks and 85.5% below what it could have been for bonds.

Why?

Three reasons: recency bias, herd behavior, and fear.

It's All About Perspective

Recency bias is what happens when short-term focus trumps long-term planning and execution.
It's what happens when somebody yells "fire" and everybody runs for the same exit at once despite having entered through any of half a dozen doors in the auditorium. Simply put, recency is recent knowledge that overrides longer-term thinking and memory.

This is why momentum trading works, for example, or the news channels seem to cover the same stocks at nearly the same time – because a huge number of people are focused on exactly the same companies simultaneously. Logically, they then become the subject of increased attention and tend to move more strongly or consistently.

The question of why is the subject of much debate among human behaviorists, but I chalk it up to the fact that human memories tend to focus on recent events more emotionally than they do longer-term plans that are put together with almost clinical detachment.

And the more extreme the events or the news, the sharper our short-term focus becomes.

That's why, according to "Mood Matters," a book by Dr. John Casti, one of the world's leading thinkers on the science of complexity, "bombshell events are assimilated almost immediately into the prevailing [social] mood" where as longer-term cycles bear almost no witness to gradual change.

If that doesn't make sense, think about what happened on 9/11. Most of the world's major markets bottomed within minutes of each other on short-term panic and emotion. Then, when trading resumed days later, they began to climb almost in sync as highly localized events once again faded into the longer-term fabric of our world.

And that brings me to herding.

The Herd Mentality

We'd rather be wrong in a group than right individually so the vast majority of investors tend to make decisions, and mistakes, together en masse.

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Five Companies to Avoid Until the Eurozone Debt Crisis is Over

U.S. companies with significant exposure to Europe will take a profit hit regardless of how the Eurozone debt crisis shakes out.

The financial strain of Europe's efforts to avert default among its troubled members – Portugal, Italy, Ireland, Greece and Spain (PIIGS) – has set the Eurozone on course for a recession even if its efforts succeed.

Yesterday (Thursday) the European Commission dropped its forecast for growth in the Eurozone to just 0.5% from its previous estimate of 1.8% in May. The commission blamed austerity measures, which were aimed at lowering budget deficits, but ended up eroding investment and consumer confidence.

"The probability of a more protracted period of stagnation is high," said Marco Buti, head of the commission's economics division. "And, given the unusually high uncertainty around key policy decisions, a deep and prolonged recession complemented by continued market turmoil cannot be excluded."

Falling consumer demand has already begun to affect the bottom lines of many U.S. companies that derive large portions of their revenue from the Eurozone bloc.

"In light of cutbacks in government spending, tax increases and waning business confidence, there already has been some [company] commentary on slipping appliances, bearings and heavy-duty trucks demand," Citigroup equities analyst Tobias Levkovich told MarketWatch. "In many respects, these early remarks are a worrisome sign."

For example, General Motors Co. (NYSE: GM) on Wednesday said the debt crisis would prevent it from breaking even in Europe this year. And Rockwell Automation Inc. (NYSE: ROK) on Tuesday warned of declining capital spending in Europe next year.

Although sales to Europe account for only 10% of revenue for the Standard & Poor's 500 as a group, several sectors have far more exposure to the Eurozone.

The auto sector derives 27.6% of its sales from Europe, followed by the food, beverage and tobacco sector at 22%, the materials sector at 19.8%, the consumer durables and apparel sector at 16.2% and capital goods at 16.4%.

"Europe is a major component to the U.S. economic engine and it is a concern," Howard Silverblatt, an analyst with S&P Indices, told MarketWatch. Silverblatt noted that while a European recession may not necessarily take down the U.S. economy, "it has an impact that will move stocks."

Here are five U.S. stocks that have significant exposure to Europe and leveraged balance sheets high – making them risky investments until Europe gets back on its feet:

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Rising Wages in China Good for Glocals, But Few Jobs Coming Back

Although some economists have predicted that steeply rising wages in China would bring some jobs back to the United States, the biggest winners will be the large multinational companies operating in China.

Last week the Guangdong province, where many of China's factories are concentrated, announced a 20% increase to the minimum wage. Combined with two earlier hikes in April and July, the total increase over the past 10 months is a startling 42%.

And with an eye toward booting domestic consumption, the government plans to keep the raises coming – on average 20% a year through 2015.

That extra money will get spent with domestic Chinese businesses as well as U.S. corporations with a strong presence in China – such as McDonald's Corp. (NYSE: MCD) – but is dramatically raising costs for Chinese manufacturers.

Between the wage increases and slumping global demand, the Federation of Hong Kong Industries warned on Tuesday that as many as one-third of Hong Kong's 50,000 factories could downsize or close by the end of the year.

As China's competitive advantage in wages erodes, some analysts have predicted a wave of jobs returning to the United States from China. A recent study by the Boston Consulting Group (BCG) forecast a return of 2 million to 3 million jobs by 2020.

But Money Morning Chief Investment Strategist Keith Fitz-Gerald doubts any repatriation of jobs will be quite so massive.

"Wishful Thinking'

"That's wishful thinking on the part of Westerners," said Fitz-Gerald, who operates The New China Trader service for the Money Map Press, who noted that "labor rates are still very, very low" in China.

Although Fitz-Gerald said a few "industries with little value-added" could see the return of some jobs to the United States as a result of China's rising wages, other factors will restrain a mass migration of jobs across the Pacific.

Despite reports of major labor shortages in the eastern coastal parts of China, Fitz-Gerald said there remains "vast undeveloped low-wage areas ripe for industrial expansion" in the western provinces of China.

"They have a 50-year initiative called the "Go-West' program that is designed to push labor from the eastern regions to the western ones," Fitz-Gerald said. "If the jobs are pushed west, there will be no great exodus of jobs from China."

The majority of jobs that do leave China, he said, will probably go to areas with even cheaper labor, such as Indonesia, Thailand, Vietnam and Mexico.

"That should make U.S. manufacturers very nervous," Fitz-Gerald said of Chinese jobs moving to Mexico. "The Chinese would be building stuff on our back doorstep."

With a factory just across the U.S. border, a Chinese manufacturer would save a lot of time and money on shipping.

"They could become even more competitive than they are now," Fitz-Gerald said.

Read More…

Stalling German Economy Will Throw Gasoline on Eurozone Debt Fire

Germany's economy is slowing dramatically, an unwelcome turn of events that will put even more strain on existing fractures in the European Union (EU) as it struggles to cope with its ongoing sovereign debt crisis.

Last month a consortium of eight leading economic institutes slashed their forecast for German economic growth in 2012 by more than half, from 2% to 0.8%.

That decision was validated yesterday (Monday) when Germany reported a 2.7% drop in industrial production for September. That's the biggest drop since February 2009, and triple the decline that analysts had expected.

Worse, such a decline will make it even tougher for Germany, which has supplied the bulk of the bailout money that's prevented the Greek debt crisis from triggering a global financial meltdown, to play the role of hero in the European debt crisis.

"This is very, very serious on a lot of levels," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "If Germany drops into recession the pressure on German banks will be extreme."

Fitz-Gerald said that the banks, as well as the German people, most likely would want to "bring their money home" to address Germany's own economic needs.

Of course, the loss of its greatest benefactor will have dire consequences for the Eurozone.

Fitz-Gerald thinks the situation could even reach a point where Germany would opt out of the common euro currency to save itself.

"Everyone's been talking about Greece leaving the euro," Fitz-Gerald said. "But Germany leaving is a real possibility, depending on how bad it gets. It's no longer inconceivable."

Catching the Contagion

Germany's economy is faltering mainly because of the problems plaguing its Eurozone partners. A report last week showed that orders for German industrial goods from other Eurozone members fell 12.1% in September following a 1.4% drop in August.

"German industry has finally caught the crisis virus," Carsten Brzeski, an economist in Brussels for ING Groep NV (NYSE ADR: ING), wrote in a research note. "The financial turmoil and the economic slowdown in other Eurozone countries have obviously spoiled the appetite for goods made in Germany."

Many economists now are worried that the entire Eurozone is heading into a recession, which will make it harder for countries like Germany and France to help struggling Portugal, Ireland, Italy, Greece and Spain (PIIGS).

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MF Global Bankruptcy Exposes Vulnerability of U.S. Banks to Eurozone Debt Crisis

The bankruptcy of MF Global Holdings (NYSE: MF) was a distressing signal to investors that it is possible for U.S. financial institutions to fall victim to the Eurozone debt crisis.

MF Global filed for Chapter 11 bankruptcy Monday after credit downgrades led to margin calls on some of the $6.3 billion in Eurozone sovereign debt the bank held. The position was five-times MF Global's equity.

Although the major U.S. banks have less exposure relative to available capital, their many tendrils in Europe – particularly to European banks – will inevitably drag them into any financial meltdown in the Eurozone.

Even the U.S. banks' estimated direct exposure to the troubled European nations of Portugal, Ireland, Italy, Greece and Spain (PIIGS) is disturbingly high – equal to nearly 5% of total U.S. banking assets, according to the Congressional Research Service (CRS).

And according to the Bank for International Settlements (BIS), U.S. banks actually increased their exposure to PIIGS debt by 20% over the first six months of 2011.

But the greatest risk is the multiple links most large U.S. banks have to their European counterparts – many of which hold a great deal of PIIGS debt.

"Given that U.S. banks have an estimated loan exposure to German and Frenchbanks in excess of $1.2 trillion and direct exposure to the PIIGS valued at $641billion, a collapse of a major European bank could produce similar problems inU.S. institutions," a CRS research report said earlier this month.

Of course, the major banks say their exposure to the Eurozone debt crisis is much lower because they've bought credit-default swaps (CDS) to hedge their positions. Credit-default swaps are essentially insurance policies that pay off in the event of a default.

Unfortunately, this same strategy was one of the root causes of the 2008 financial crisis involving American International Group (NYSE: AIG) and Lehman Bros.

"Risk isn't going to evaporate through these trades," Frederick Cannon, director of research at investment bank Keefe, Bruyette & Woods Inc., told Bloomberg News. "The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who's ultimately going to pay for the losses?"

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Spain's Economic Crisis Shows the Eurozone Can't Escape its Debt Trap

Fresh evidence of Spain's deepening economic crisis has revived fears about that nation's ability to dig out of its sovereign debt problems, and illustrates why the Eurozone debt crisis is likely to drag on for years.

Spain's gross domestic product (GDP) was flat in the third quarter, the country's central bank said yesterday (Monday). That follows anemic growth of 0.4% in the first quarter and 0.2% in the second quarter.

Even more troubling is the nation's unemployment rate, which rose to 22.6% in September – the highest in the Eurozone.

As one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain), Spain has been trying to wrestle down its high sovereign debt with austerity measures. Unfortunately, those measures are driving the Spanish economy toward recession, which is making it impossible for the government to hit its budget deficit reduction targets.

"It will be very difficult to meet the deficit goals without additional austerity, which might push the economy back into recession," Ben May, a European economist atCapital EconomicsinLondon, told Bloomberg News. May thinks Spanish unemployment could go as high as 25%.

Each of the PIIGS faces the same cycle of futility – economy-killing austerity measures that erode the nations' ability to cope with their debt issues, necessitating even deeper austerity measures.

But without the economic growth to create the wealth to cope with the budget deficits, the Eurozone debt crisis will gobble the PIIGS up one by one.

Like Greece

In Greece's case, its faltering economy led to a series of bailouts from the European Commission (EC), the International Monetary Fund (IMF) and the European Central Bank (ECB), to avoid default.

But the Greek economy is among the Eurozone's smallest. If the other PIIGS, particularly Italy and Spain, descend to where Greece has fallen, there won't be enough money to rescue them.

"Unless European economies outgrow their deficits, the chance of rolling bailouts working is slim to none," said Money Morning Capital Wave Strategist Shah Gilani.

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This Birthday Is Nothing to Celebrate

The world's 7 billionth person is likely to be born today (Monday).

However, this birthday isn't something to celebrate.

Since the global population passed 6 billion only in late 1999, we've added more than 80 million people each year on average. And the environmental footprint of those people is expanding rapidly as emerging market populations modernize.

The planet may be able to accommodate these extra people and their consumption – but then again, it may not.

And if it can't, the drain on our planet's resources could harm us all.

So we'd better find a way to reduce population growth – fast.

Of course, if you think I'm about to propose something along the lines of China's one-child policy, you couldn't be more wrong.

We have economic means of population control that are neither coercive nor costly. And the sooner we implement them, the better.

A Disaster in the Making

When Thomas Malthus warned of overpopulation in 1798, the global population was approaching 1 billion – a level it reached in 1804. It had grown in the previous three centuries from 500 million in 1500. Thus, if the gradually increasing prosperity of 1500-1800 had continued – without the Industrial Revolution increasing world production capacity artificially – it would have reached 1.62 billion by 2011.

There is a very good case to be made that 1.62 billion is today's natural population, and that the growth since 1800 is artificial, caused by the Industrial Revolution removing previous limits on production. At that level, almost all serious environmental problems would go away. Even if all 1.62 billion of the world's inhabitants enjoyed Western living standards, the global warming and pollution effects of their output would be easily absorbed by the planetary ecosphere.

Around 2004, U.N. population projections had us reaching a population of 8 billion by 2027, then peaking at around 9.3 billion just before 2050 and declining slowly thereafter. Alas, the latest projections are not so sanguine. They have no peak in population this side of 2100, with population passing 10 billion and reaching 10.12 billion in 2100.

At this level, an environmental disaster is very likely.

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