"America is a land of economic marvels: No one saves money, but everyone spends it. Consumers buy things with money they don't have... but never seem to run out. Home prices skyrocket... even though the majority of Americans can't afford one. Bull markets flourish on Wall Street, even though the average stock sells for 35 times earnings. Commodity prices soar, yet the inflation rate barely budges.

And most incredibly of all, the dollar's value collapses, but foreigners still buy billions of dollars worth of Treasury bonds every month. Will America's delicious economic fantasy ever end?"

Eric Fry, The Daily Reckoning

If you read the first issue of this new newsletter, then you know what this newsletter is about. If you did not, you may want to catch up before reading this issue: First Issue.

To see where things are headed is critical to form a view on where to invest. I will focus on the US exclusively for now, since the global economy is highly dependent on what happens there. I will then show the GCC investor what it means for him.

Keep in mind as you see the charts below that in 1945, the US produced more goods than the rest of the world combined, it was still one of the world's largest oil exporters, it was virtually debt free and produced a large annual balance of payments surplus, it had very friendly relations with the entire Arab world and the average American Citizen was a net saver.

It has been said that the face of Helen of Troy launched a thousand ships and that a picture is worth a thousand words. Let’s see if the picture of the US economy, shown in the charts below, helps launch a thousand sell orders!

Let’s start with how much the US government collects and spends.

So, the US government has been living beyond its means for quite a while now. Apart from the blip of surpluses during the internet mania, the last time the US government had a surplus for three consecutive years was during 1947-1949.

That’s a long free lunch!

And here’s the result…

That is a debt burden of over US$ 24,000 for every man, woman and child, just at the Federal level! And at current levels, it adds over $1,700 to this burden annually.

The Financial Times reported in May 2003 that a study was commissioned by Paul O’Neill, the Treasury Secretary at the time. Conducted by Jagadeesh Gokhale, an economist with the Cleveland Federal Reserve and Kent Smetters, an economist at the Wharton School of the University of Pennsylvania, the study concluded that the government’s total ‘financial imbalance’ (future obligations less future revenue) could be as high as $ 44.2 trillion. It’s only $ 7 trillion now.

And this is just at the Federal level. Most of the States are currently running deficits, many of them being record deficits. It is estimated that total credit market debt (including Federal, state, corporate, household, and mortgage debt) exceeds 300% of US GDP. The last time it was anywhere close? Just before the 1929 stock market collapse, when it peaked at 270%.

That was the domestic picture. How are the Americans doing in terms of trading with the rest of the world?

Again, we see sustained imbalances over a prolonged period.

What should normally be required to balance this gap is a constantly weakening US dollar. But as we can see, the dollar has held up nicely until recently.

Source: US Federal Reserve

The dollar trended down from 1985 to 1995 due to the trade and budget deficits. This then reversed as capital flooded into US equity and bond markets during the boom times. But continuing deficit and trade imbalances have put the dollar under pressure again. A breach of 80 on this index is very dangerous for the US $.

Here is what I believe is happening. The US has turned from being a net producer of goods to a net consumer (and therefore, from being a strong creditworthy powerhouse to the largest debtor in the history of the planet), with an addiction to a lifestyle that is not sustainable under globalisation.

The scale of job losses and economic uncertainty in the US is reflected in the following chart:

Source: American Bankruptcy Institute

As the US economy sputters and there are no further interest rate and tax cut stimuli of substance to come for the middle class consumer, US $ weakness has benefited the price of gold.

The chart above shows average monthly prices, with gold hitting an inter-month high of $ 875 in 1980. It then fell into a 20 year bear market, from which it has emerged in the last two years.

Here is what Alan Greenspan (Chairman of the Federal Reserve) said in an article he wrote titled Economic Freedom and Gold:

“Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.”

In 1971, anyone could take one oz. of gold and freely sell it the US government for $ 35,and vice versa. Today, if we divide the total US $ estimated to be circulating in the US and abroad (16 trillion), by the total amount of gold estimated to be held in the US national stock (256 millions ozs.), one oz. of gold is equivalent to $ 62,500.

This does not mean gold is worth that much, it shows how much paper (fiat) currency has been printed and cheapened compared to gold, which cannot be produced by government decision.

In fact, the #1 business hardcover best seller on the New York Times list is “Financial Reckoning” by Bill Bonner, which portends serious financial crises in the years ahead.

Can this malaise be turned around? Perhaps, if either the US starts to live within its means or it manages to grow its way out of trouble.

But, as Robert Rubin, the former US Treasury Secretary put it, “our political system lost its willingness to take the very difficult path of maintaining financial discipline”.

And the engines for growth (a strong capital base and a fully employed, well paid labour force) have moved elsewhere in the world.

What does this mean for the Gulf investor? If you believe that the global economy is at a major turning point, then let us turn to Yoggi Berra for guidance, who said: If you come to a fork in the road, take it!

Ok, so Yoggi was a bit obscure there but here's what I see happening. The US $ is likely to keep falling, with occasional rallies. As the US economy disappoints, the stock markets may well correct to more realistic valuations. The value of assets linked to the US $ will fall.

As China continues to grow into becoming the next economic giant, it is consuming vast quantities of commodities, such as copper, zinc, nickel, etc.

Base and precious metals prices have hit multi-year highs and companies that had stagnated due to low commodity prices in the last few years are producing healthy profits and enhanced stock market valuations.

Gold and other precious metals are natural beneficiaries of this turmoil. The US$ has been the world’s reserve currency since World War 2, but it is now the largest debtor nation in history, and continues to run the largest deficits in its history.

As the US $ continues to decline, people want to hold assets in real money. But the Gulf currencies are tied to the US $. The Euro and Yen have benefited from cash flowing out of the US$, but the underlying economies are anemic at best.

Real estate in Europe and the Gulf has appreciated on the basis of this liquidity but the best performing asset classes in the last two years have been precious and base metals and other resource commodities, such as oil and gas.

Gold now hovers around $ 400, having hit 15-year highs in December 2003 and is ready to test its highs during the 1980s.

As gold has breached the key psychological level of $ 400, institutional interest in mining companies continues to grow. Deutsch Bank is calling for gold to hit $450 by the end of 2004.

A manager at the Abu Dhabi Investment Authority (ADIA) told columnist Thom Calandra of CBSMarketwatch that he expected gold to hit $ 550 “sooner rather than later”.

Canada is one of the four Big producers of minerals in the world. It is in the top 5 producers for gold, platinum, diamonds, nickel, copper and numerous other metals. In addition, Canadian companies explore for metals globally, making it a dominant player in this industry, alongwith South Africa, Australia and the US.

The total market capitalisation of all gold companies is estimated at US$ 150 billion. It is miniscule relative to global bond markets (estimated at over $ 40 trillion), foreign currency and global equity markets.

Investment in Canadian companies in the resource sector is something that many investors in the GCC and elsewhere should seriously consider. Using on-line trading and full service brokerages in Canada, investors in the Gulf can participate easily and cost-effectively using the information I will provide on this industry.

Institutional interest, particularly from the US and Europe, is very strong now in Canada. At the gold show in Toronto on March 10, there were over 10,000 attendees, where you would not have seen more than 500 people 4 years ago.

I will begin to provide you information in future newsletters about how to invest in Canada, companies that you might consider investing in, trading tips and strategies, and other sources of useful information.

Richard Russell, who is a 43 year veteran of Wall Street and publishes the well-regarded Dow Jones Letters, has become very bearish on the US markets. He is predicting that the Dow Jones Index and the price of gold will cross…at 3000!!!

As more money flows into the gold and other precious metals sector, there is a potential for truly astounding returns for stocks in this sector, because it is relatively small. This will provide opportunities to create (and enhance) fortunes.