Why Practicing Caution Best Strategy for Investors These Days

Written by Michael Lombardi, Profit Confidential

Economic conditions in the global economy are taking a quick turn in the wrong way!

Consider the Purchasing Managers’ Index (PMI) of the U.S. economy tracked by the Institute of Supply Management. Last month it contracted for the first time since November of 2012 and only the second time since July of 2009!

The PMI registered 49.0 in May, compared to 50.7 in April. (Source: Institute of Supply Management, June 3, 2013.) Any reading below 50 suggests the manufacturing sector is experiencing a contraction.

But it’s not just the U.S. economy that’s experiencing a contraction in manufacturing (and affirming the possibility of an economic slowdown). China, the second-biggest hub in the global economy, is seeing the same. In May, the Chinese PMI also showed contraction. The HSBC China Manufacturing PMI registered at 49.2 in May, compared to 50.4 in April. (Source: Markit, June 3, 2013.) Again, any reading below 50 suggests a contraction in the manufacturing sector-which happens to be China’s biggest industry.

Germany, the fourth-biggest producer in the global economy, has been seeing its manufacturing sector contract for some time now. The German PMI registered below 50 in May, the same month the International Monetary Fund slashed the country’s growth outlook in half! The German economy is expected to grow by only 0.3% this year, compared to 0.6% in its previous forecast. (Source: Wall Street Journal, June 3, 2013.)

All of this shouldn’t come as a surprise to Profit Confidential readers. I have been harping on about this issue in these pages for some time now: the global economy is on the brink of an economic slowdown.

Warning: We have a significant amount of information pouring in each day suggesting an economic slowdown in the global economy is pacing faster. Remember, the U.S. economy is very reactive to the global economy, and the direction of the economic trajectory and the stock market are highly dependent on it.

Unfortunately, to fix these softening economies, central banks in the global economy have taken the same approach as the Federal Reserve and the Bank of Japan-lower interest rates and print more money.

Dear reader, the problem in the global economy is that demand is anemic; printing more paper money doesn’t create demand.

Being cautious is the best investment strategy right now.

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Michael’s Personal Notes:

As economic conditions in the U.S. and the global economy deteriorate, and as central banks around the world print more money in their misguided attempts to spur growth, more and more analysts are saying that gold bullion‘s best days are behind it. Their reasoning: the economy is improving, the Fed will cut back on its monetary stimulus, the worst is behind us, and there’s no more crisis, so there’s no more reason for gold to rise – this is the exact opposite of what I’m saying!

The gold bears fail to realize there are fundamental forces at play behind the gold bullion bull market.

Central banks around the world are looking at gold bullion as an alternative to the currencies they hold in their reserves. It is well documented in these pages how major central banks like the ones from Russia and Turkey continue to buy gold bullion.

Then there is the central bank of China. Its official reserve reached a value of $3.44 trillion in the first quarter of 2013-similar to the size of Germany’s economy. China increased its reserve by $128 billion in the first quarter, making it the biggest increase in reserve since the second quarter of 2011. (Source: Financial Times, April 11, 2013.) My bet is that most of that reserve is in U.S. dollars, which China would desperately like to get rid of.

With that said, China doesn’t have as much gold bullion to back its reserves as countries like the U.S., Germany, and France have. As a matter of fact, the Chinese central bank only holds 1.6% of its reserves in gold bullion, compared to 75.6% for the U.S. and 72.0% for Germany. (Source: World Gold Council, May 2013.)

To bring its total gold bullion holdings to 10% of its reserves, the central bank of China would need to allocate about $344 billion of its reserves to buy gold bullion.

Add strong demand from countries like India to the fact that China needs to increase its gold reserves, and the fundamental demand behind gold bullion is clear. According to the World Gold Council’s estimates, demand for gold bullion in India is expected to jump 150% by the end of June as compared to last year. (Source: Wall Street Journal, June 3, 2013.)

The amount of gold bullion and silver imported in India reached $7.5 billion in April – more than double the amount from a year earlier. The Indian government has increased its import tax from two percent to six percent in a matter of just 1.5 years to curb demand. (Source: Wall Street Journal, May 20, 2013.)

The demand for gold bullion is as strong as ever.

What He Said:

According to Michael Lombardi in Profit Confidential, January 10, 2008, [WCI Communities, the largest U.S. luxury home builder, filed for Chapter 11 protection on August 4, 2008]:

“Home-building in the U.S. will enter a quasi depression state in 2008 and the construction industry will make 2008 a record year for pink slips. I predict a major homebuilder will go bankrupt in 2008.”