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Weekend Edition

Porter's dire predictions are coming true
Saturday, July 30, 2011

Yes, it's for real. We've been wondering when the markets would wake up to the reality of the sovereign debt crisis. The day has come...
The action in the fixed-income markets on Friday verged on collapse. Yields on the world's benchmark sovereign debt – the U.S. 10-year Treasury bond – plummeted. Investors panicked and moved into the market, which is the world's most liquid market. Meanwhile, just about everything else in fixed income got killed. Mortgage REITs were briefly "no bid," for example. Annaly – the blue-chip mortgage REIT – was down more than 15% at the open. (I'll explain why in a moment.)
It was as if the world's fixed-income investors finally woke up and realized the world's economy has serious problems... which our politicians seem unable to address, let alone repair.
 The credit-ratings agency Standard & Poor's says there's a 50% chance it will downgrade America's credit rating from triple-A within the next 90 days. That's the same credit rating ol' Timmy Geithner said the U.S. would "never" lose just a few months ago. Most people believe these downgrades and the resulting problems (which we'll discuss in detail below) are being caused by the debt ceiling issue. They're not.
The downgrades, as S&P explains, are due to the funding needs of the U.S. government, combined with the growing size of our annual deficits relative to the growth of our economy, which remains moribund. I've written about these issues extensively in my newsletter, most recently in the May issue called, "The Day the Dollar Dies"...
... 61% of all the marketable Treasury debt held by the public will mature within four years. Thus, over the next four years, the U.S. Treasury must either repay or refinance more than $1 trillion in existing debt each year – not to mention additional deficit spending of at least $1.5 trillion. For us to avoid a default, the U.S. Treasury may have to borrow or refinance as much as $10 trillion in the next four years. That would double the amount of U.S. Treasury bonds currently trading in the world's markets.
 Looking just at these numbers and considering America's total debt load (public and private debts total nearly 400% of GDP), there's no question our sovereign debt rating should be cut... I'm not sure the U.S. is even an investment-grade credit.
That analysis includes a huge "but"... because thanks to the dollar's standing as the world's reserve currency, it is actually impossible for the U.S. to default unless it chooses to do so, through debt ceiling limits, etc. The real question, in my mind, isn't the sovereign rating. (And yes, I believe we will be downgraded whether or not the debt limit is increased.) The real question is, how long will our creditors and our trading partners continue to allow the dollar to dominate the world's banking system and commodity markets?
 My answer is, not for long. Not if the U.S. government continues to print money to pay for its own profligate spending. But how else will it finance a doubling of outstanding Treasury bonds in the next decade?
Over the next few months, I expect to see a repeat of the crisis of 2008 – but on a much bigger scale. This time, the credit problems coming to the surface aren't in the banks and the brokers. They're in the sovereigns – both in the U.S. and Europe. The only palatable political solution to this problem is  to print more money – colossal amounts of it. For now, investors remain willing to pile into U.S. Treasurys. But this crisis will only get worse until that trend reverses. The only way the U.S. government can avoid an actual default is to destroy the dollar. So that's what's going to happen. A downgrade is only the first step. But let me show you what that first step will mean...
 Here's the critical thing to understand. All around the world, the U.S. 10-year Treasury bond establishes the "risk-free" rate. That is, in just about any kind of fixed-income vehicle, market rates of interest are established by the current price and yield of the 10-year U.S. Treasury bond. Yes, matching duration bonds are normally used. If you're pricing a five-year mortgage, you'll use the five-year U.S. Treasury. But the fact is, the market is pricing the five-year Treasury bond by using the 10-year Treasury bond as the reference. The entire financial system uses the U.S. Treasury bond market as its foundation.
That's why whenever trouble arises and panic spreads, everyone buys Treasurys. If these bonds are no longer rated triple-A, the pricing of all other forms of financial instruments will suffer. Credit, in general, should become harder to get and more expensive because the entire system just got riskier. Think about it this way, if the safest part of the world's financial system is no longer safe, how much riskier did a bond that's three rungs down the ladder just become? We don't know, precisely. We only know "more risky" is the only logical answer.
 We saw what this means for leveraged financial holding companies on Friday when mortgage REITs got killed. Bloomberg's index of 32 mortgage REITs fell about 8.5% at the open because their cost of funding rose as investors abandoned the "repo" market and bought U.S. Treasurys. Investors are demanding higher prices to finance these mortgage books because many of the mortgages these companies hold are insured against principal loss by the U.S. Treasury. If those guarantees aren't triple-A anymore, funding those investments is going to cost more. (By the way, these risks are exactly why I urged my subscribers to sell Annaly at $17.82 for a 77% gain in May, and why we've added short positions in four major global financial firms – all of which are showing a profit.)
 When you apply the same kind of thinking across the financial system, you begin to get an idea of why the world's economy is probably heading for trouble. The cost of financing is going up – for corporations, homebuyers, and governments. Sooner or later, this will spark renewed efforts at the Federal Reserve to monetize our debts. But when it turns on the presses this time, we expect our creditors and trading partners to revolt. Gold and silver will soar. Financial stocks will plummet. You've been warned...
 As you probably know, I've been warning about a collapse in sovereign debts since at least December 2008. I call these problems "the End of America," because I believe the inevitable outcome will be the loss of the U.S. dollar's status as the world's reserve currency. (That clearly hasn't happened yet – investors are still flocking to the Treasury market in this crisis.)
The stage for this crisis was set during the financial crisis of 2008. And I don't believe it will be over until these debts are either written off or monetized away by the Fed through inflation. Until that happens, we'll be dealing with a world of far greater financial uncertainty. Your primary goal as an investor right now should be to simply retain your purchasing power. How can you do that?
 The basic ways to defend yourself from the government's efforts to monetize our debt are pretty simple: Hold 10%-20% of your assets in the form of gold and/or silver. That's your best protection against the government. Holding your liquid (cash) savings in better currencies – like the Swiss franc, the Canadian dollar, etc. – is a good idea, too. (Everbank can help you do this, by the way.)
Investing in hard commodities is also a good bet. But you have to buy these stocks during periods when the market becomes temporarily convinced the Fed won't print any more money. We might reach a good point for these purchases in three or four months, as the U.S. economy will continue to slow, stoking fears of deflation.
There's one other good way to protect yourself from these risks: Use the volatility to make a lot of money, safely...
 You might have heard how Dr. David Eifrig, who was a former proprietary trader for Goldman Sachs, has amassed a perfect track record for us since launching his trading service – Retirement Trader. It's been phenomenal to watch what he's accomplished and to hear about the impact he's made in the lives of our subscribers.
Doc doesn't trade options like most people. Instead of trying to make big gains in risky stocks, Doc goes after modest gains in safe stocks. But he does so consistently, month after month. That's why he hasn't had a single losing trade since we launched his Retirement Trader advisory in April 2010. Not one. Making profitable trades is always good for your account, but I believe it's critical for you to do so now. Let me explain why.
 To make money safely in the options market, you MUST have volatility. It's the market's volatility that makes options prices go way up – frequently to absurd levels. That gives you the big spreads you need between puts and calls to make a lot of money safely.
I realize this probably sounds like Greek to most of you. But trust me, Doc is a phenomenal teacher. And he'll show you exactly what to do and what to watch out for – one simple step at a time. If you can learn from Doc how to make an extra 5%-8% per month using safe options strategies, you will be able to turn this crisis into the best year of your investing life. And I know that's what many of our subscribers will do, because we did the same thing back in late 2008 and early 2009 with my Put Strategy Report. It was Doc who taught me most of what I know about options. And he can show you the same secrets.
 Here's my best advice: Put Doc's strategies in your investment arsenal now so as this crisis heats up and volatility goes higher and higher, you'll be prepared to trade and profit. I know if you take us up on this offer, you'll be a subscriber for life. So we're offering a huge discount on Doc's service through Monday. Try a subscription this weekend and you'll save $1,000. More importantly, I know you'll earn your subscription fee back with the first trade you make. Given Doc's track record, I'm convinced it will be profitable.
 One more thing... I know 99% of the people reading this e-mail will never take the time (or spend the money) to learn how to trade options safely and earn consistent profits month after month. But think about this for one second before you decide it's not for you. Most investors are focused on whether or not stocks are going up or down. Lately, they've been going down, which means most people are losing money. But if you were following Doc's safe options strategies already, you'd be paying far more attention to this chart...
Volatility in the Options Market Since May 
It shows the pricing of volatility in the options market. When this chart goes up – especially when it crosses 25 or 30 – folks make a killing in safe options. If you don't know how to make these trades, you're missing a big opportunity – the best opportunity right now in the markets, in my opinion. Click here to learn more about Doc's Retirement Trader strategies.
Good investing,
Porter Stansberry

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