These are some of my thoughts pertaining mostly to inflation and Gold, along with some supporting ideas and graphs. I would like you to read the whole thing, but if you are in a hurry, just read the parts in bold. These are just my thoughts and observations based on information available to the public. Feel free to poke holes anywhere you see them.

As inflation increases, the price of gold will rise relative to the ensuing weakness in the dollar and our purchasing power. Inflation will continue to increase, caused by the weakening dollar, and speculation on commodities which is based on scarcity.

Inflation (things becoming more expensive) will continue to increase due to the higher costs of doing business (energy/transportation, cost of inputs, wage increases, currency weakness) passed along to the consumer in order for companies and governments to maximize profits and protect themselves from failure. These cost increases that we are experiencing are due to the perceived weakness of the Dollar around the world, combined with the fear and the realities of scarcity of goods and resources in the future. Inflation is nothing more than the dollar weakening relative to the stable and intrinsic value of whatever that dollar is buying, combined with commodities fluctuating based on scarcity-based speculation. Rice is at a constant price if all I trade in is rice, and my supply remains the same. When the various currencies that my rice customers pay me with weaken, I will demand more of their currency for the same rice because I am afraid of the same weakness. Alternatively or concurrently, I can be worried about my rice supply in the future. So, when people around the world fear that there will be a scarcity of rice, or people don’t value the currency for some reason or another (trust/backing/guarantees, oversupply), the people who are buying rice with the least amount of money get hurt the most. So there are two core components of inflation; the strength of the currency based on both money supply and the credibility of the issuer, and scarcity. Buying rice in Swiss Francs, for example, is a much better trade off at the moment since those currencies are trusted and therefore stronger and more stable. Also, the swiss franc is still on the Gold Standard The scarcity component, however, always persists and is what makes things more expensive across the world, regardless of the strength of the currency used for commerce. Printing more money to fund financial bailouts, wars, and to fulfill preexisting obligations adds enormously to the problem. In April of 2006, the Fed stopped printing the M3 report - which essentially let us keep an eye on the printing press. (http://economistsview.typepad.com/economistsview/2005/11/not_so_transpar.html)

http://www.youtube.com/watch?v=GEm03U7eXTw&feature=related

This was 2006. Gold was at 634 when he gave that speech. It is at 926 now. I have attached a few charts. Notice how the price of gold took off after the dollar was unpegged. In reality, that is simply the dollar’s departure from value and the start of inflation based on too much money (liquidity) in the system. The level of money in the system is dictated by interest rates and cash flows; low rates means more liquidity, high rates sucks liquidity out of circulation. Lower interest rates allow banks to lend money with higher profit margins, and in today’s environment, this allows the banks to offset the rapidly increasing rate of defaulting loans, which make up part of the foundation of a gigantic system of questionably backed assets called derivatives. Derivative investments are complex IOUs which are assigned value based on the future performance of an underlying asset, index, or expected cash flow. They are used to secure borrowing and to insure investments against default (Credit Default Swaps). If assets backing these derivatives are not currently valued the same as they were when the the instrument was created, and/or the cash-flow of loans associated with the derivatives is compromised via defaulting debtors, then financial institutions have to conduct massive write-downs and accept billions in public and private funds in order to continue to fund their obligations. A significant portion of our financial system depends on this gigantic system of derivative debt (which are simply IOUs, held together by the creditworthiness and stability of the banks that broker and support the derivative instruments). If the trust in this gigantic system of debt is severely compromised, then the system can significantly stumble as was almost the case when Bear Stearns was rescued by the Fed and JP Morgan. Bear Stearns vouched for a certain percent of this derivatives market, and if they had gone bankrupt, in theory - the trillions in IOUs that they were obligated to back would have become further compromised, and a large part of the derivatives market could have unraveled. Lack of trust and credibility would have left the system unable to operate, and as it stands, the system can hardly value much of this debt. All of these writedowns by the banks are in an effort to make up debtors defaulting on their obligations for various reasons, and for the eroded value of pledged assets (real estate, other assets). ALL AGREEMENTS AND TRANSACTIONS ARE BASED ON THE TRUST THAT EACH PARTY WILL FULFILL THEIR STATED OBLIGATIONS. Trust has been the cornerstone of commerce since the beginning of time. This is the theory behind Ebay feedback system, and this is the theory behind the ratings agencies. We trusted companies like Moodys, S&P, Fitch, etc. to “rate” the likelihood of an investment defaulting. As it turns out, these agencies were unable to appropriately ascertain the real risk inherent to a multitude of complex financial instruments. This has significantly damaged the credibility of these agencies, as well as the ability of financial firms to sell these instruments. Once trust leaves the system, the system cannot continue to function without discounting cash flow instruments to adjust for the lowered trust. This is the same thing as discounting the dollar relative to the world. (derivatives info: http://en.wikipedia.org/wiki/Derivative_(finance) )

What does this mean? Several things; we have a lack of credibility in our financial system, and our financial system’s ability to repay obligations/debts it created has been compromised. We now have increasing inflation - along with a weakened dollar. Unemployment is up, and looks to be getting worse. All of this is occurring under the backdrop of a gigantic economic contraction, which is actually stagflation. I strongly feel that the price of Gold (and silver to a lesser extent) will remain a stable store of value, and keep pace with the global commodities we all use and need.

Can you imagine what the price of the dollar would be if all of the obligations of the US Government and the banking system were forced to convert back to our limited inventory of Gold? If trillions of dollars that are no longer highly valued are forced to reattach themselves to some official store of wealth (Gold, Silver), our dollar would go into the toilet. My suspicion is that if/when the Fed and US Gov. are forced to back the dollar to restore credibility and strength, they will pledge our own valued natural resources beyond just Gold. They will pledge that which is scarce and valued; metals, water, land, and our oil that we are so hesitant to tap into.

The Fed is stuck; they can’t raise rates to fix the weak dollar or the banking system may collapse, leading to a deeper crisis. They can’t lower rates or else the dollar’s slide will accelerate and hyperinflation will ensue. The pressure right now is on the Fed to raise rates.

http://www.youtube.com/watch?v=PoxlzPGIPt4 Fast forward to 1:45, Ron Paul earlier this year.

What is likely to happen with the markets is predictable and manageable. What is not predictable may change the thesis. The “Black Swan” theory. Can a Black Swan overcome financial forces of nature or delay what many consider the inevitable return to financial parity? Are Black Swans the tools of the Invisible Hand?

We know:
- We are in a period of both domestic and global contraction, projected to last for many years
- Stocks are valued on their projected ability to grow
- Commodities go up or down in value based on future fears of scarcity combined with relative the strength or weakness of the currency used to purchase the goods.
- The current rate of defaulting debt is increasing. It is not only a problem of sub-prime loans, it is also Alt-A loans, Prime loans, and the gigantic problem of Commercial loans which are beginning to default. If we truly dip into recession, there will be a snowball of defaults, including PRIME debt, due to severe economic stress amongst the middle and upper/middle class. Those with enough money to weather this potential storm, and those who plan ahead can mitigate the fallout.
- The system runs on trust. If trust was restored in the ability of borrowers to fulfill their debt obligations, the system would strengthen. In an economic contraction, this is not likely to happen. As such, economic return to intrinsic values could result from massive defaults in the banking system, and a re-valuation of assets.
- The derivatives system is potentially in a lot of trouble due to potential defaults it may not be able to support.

http://en.wikipedia.org/wiki/Black_swan_theory

http://plus.maths.org/issue14/features/smith/

We may also need to consider other factors to asset allocation beyond just sectors and styles. We may need to consider diversification by geographical location & banking system, various currencies, and physical stores of value. What is value but that which other people want? What is safety of capital but that which can only be preserved by the strongest and most viable financial systems?

Also:

from http://en.wikipedia.org/wiki/Money_supply

http://www.gutenberg.org/files/14811/14811-h/14811-h.htm#III Woodrow Wilson circa 1913, is amazing. Laws have been passed to protect people, but capitalism always wants to revert to its natural state of optimizing margins and efficient use of human capital.
The United States is a Corporation. http://www.law.cornell.edu/uscode/html/uscode28/usc_sec_28_00003002—-000-.html (BOTTOM, no. 15)

http://www.financialsense.com/fsu/editorials/trendsman/2008/0424.html Good Gold info & chart logic

Disclaimer: I might be wrong about everything contained in this post. Seek multiple opinions before making investment decisions.