In God We Trust All Others Pay Cash!

By Adam Lass, Editor, WaveStrength Options Weekly

Double your money on gold when China loses faith in U.S. debt

In the old days before children and small dogs had their own credit cards small merchants used to post hand-lettered signs beside the register stating that they would only accept greenbacks and cold coin.

If you wanted to pay for goods or services by check, you either had to be a long-term customer the counter clerk knew on sight, or have six different forms of ID (and even that was an iffy proposition if the store owner had been burned lately).

At first blush, personal checks and corporate bonds dont seem like they have much in common. The former is an item of personal convenience, while the latter is a long-term business relationship. But in the end, both are loans of one sort or another, based on the idea that one party can trust the other to pay up when the time comes.

Thats why, just prior to the explosion in credit cards, services sprang up that a merchant could call to see if a check writer was a notorious deadbeat. These services charged the merchant a nickel or two on every transaction, but the peace of mind was probably worth it.

Free Agents?

Bond investors have similar services available to them. Im sure youve heard the names: Standard & Poors Fitch Moodys these guys have been rating Wall Streets good faith and credit for 150-odd years. They are supposed to be the very image of probity, sober as judges, sound as, well, a banker.

Moodys (MCO: NYSE) stated in its 2005 annual report that this image is so important to them, it was in essence: the raw materials that support our business. The letter goes on at great length, bandying about such terms as independence, performance and transparency with abandon.

Unfortunately, the difference between those old check-guard services and these Wall Street credit rating outfits is who foots their bills. In the case of the latter, it is the very Wall Street outfits they are rating.

Broken Trust

It comes as no shock to any practicing cynic that Wall Streets own, bought and paid for, neglected to warn of the grand bankruptcy that was hurtling our way.

Sadly, many shareholders were not all that cynical, and having bit on hook, line and sinker as to the putative value of Americas banks and businesses based pretty much solely on the credit rating agencies word, and having lost a fortune doing so, took Moodys to court for a little old fashioned redressing.

Moodys answer (in court and over a stack of bibles?): Generalizations regarding integrity, independence, and risk management amount to no more than puffery As such, alleged misstatements of this nature are insufficient to sustain a claim under the securities laws.

I dont know how you feel when you read tripe like that, but I spit coffee out my nose when I first read it!

Downgraded!

Now that the horses are out of the barn, down the road and around the bend, the ratings agencies are sounding alarms all over the darn place. Now we are told that perhaps only five or six of Wall Streets most venerable institutions can be rated triple AAA.

And as of late last week, that list no longer includes Warren Buffetts Berkshire Hathaway (BRK-A: NYSE) and Jeffery Immelts General Electric (GE: NYSE).

In fact, many analysts suspect that by the time the dust settles, only the U.S. government will command the complete and total confidence required to attain AAA status. And if you ask the Chinese, even that may be in doubt.

Losing Faith

China is the number-one holder of U.S. Treasury debt, with about $1 trillion in bonds and some $2 trillion worth of reserves all told salted away. As such, they are starting to get just a little creeped out as to the direction their borrower is heading in.

In a rare press conference last Friday, Chinese Premier Wen Jiabao stated: We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. Frankly speaking, I do have some worries. Wen went on to implore that the U.S. maintain its good credit... honor its promises and... guarantee the safety of China's assets.

Some say that China is totally trapped in the soup with us, pointing to the fact that overall Chinese investment in U.S. government securities is actually up 40% over the past twelve months as China attempts to sop up the spillage all over trading room floors. The slightest hint of diversification could potentially result in the collapse of Chinas remaining holdings.

Sneaking Out the Back Door

In point of fact, China has been quietly diversifying every chance it gets. Back in July of 2008, state-owned banks like Bank of China and Bank of Communications began to sell off their holdings in Fannie Mae and Freddie Mac debt. And last September, China International Capital Corps Ha Jiming warned, officials have realized that its a bad idea to put all their eggs in one basket.

So now, now, when Premier Wen states before the entire world that China should aim to fend off risks as it diversifies its $1.95 trillion in foreign-exchange reserves and will safeguard its own interests, one suspects that he just might mean it.

Can you imagine what would happen to Mr. Obamas recovery package if China refuses to fund it? Okay, thats just horrifying, so lets just not.

The REAL Currency of Last Resort

Rather, lets imagine what Mr. Wen is truly looking for: In the bond world, reassurance is measured in interest paid. Increased risk requires increased bond rates. In essence, we as a country are being downgraded from triple-A just like Berkshire Hathaway and GE.

So whats your take away here? For starters, keep an eye out for rising T-note rates. Secondly, if the global safe haven isnt U.S. Treasuries and U.S. dollars any more, than what is it?

Gold, plain and simple. So look for the shiny stuff to spike precipitously as word of Chinese diversification spreads through the global market. I suggest that long positions in SPDR Gold Trust ETF (GLD: NYSE) are convenient, liquid and stand to gain dramatically from this shift.

A 30% increase by late summer or early fall is not out of the question. Proper deployment of call options could increase that gain threefold.