US equities look set to question their own over-valuation this earnings season...

EARNINGS SEASON began on Wall Street last week and it's nearly as miserable as the gale blowing through St. Kilda on this grey and British-like Monday morning, writes Dan Denning in Melbourne for the Daily Reckoning Australia.

The Dow Jones fell a neat and tidy 100 points on Friday and most of the major indices fell by at least one percent. Finance and tech – in the form of JP Morgan and Intel – were the two big earnings disappointers. There will be more, we argue, because the last two quarters of 2009 corporate earnings looked good compared to the free-fall quarters of 2008. But that improvement has run out of stimulus and momentum. The US labor market still sucks, to use a scientific term. And stocks are beginning to express their doubts.

It would be a natural time for stocks to object to their own valuations. US investors were sitting on a 62% rally in stocks since the March lows of 2009. Hmm. That sounds more than vaguely like a 61% Fibonacci retracement. This leads us to the obvious question:

Has the March 2009 rally topped out?

More earnings results from IBM, Citigroup, Bank of America, Morgan Stanley, and Starbucks could confirm that reversal this week. Or not. We will just have to see. Not that the power of US earnings reports compels Australian stocks to follow the US lead. It's a different market here, with different business conditions, and closer trading ties to China. But how will corporate earnings travel this year? It may not matter, honestly, given that Price/Earning Ratios are already so high.

Closely related for Aussie stocks, the price of iron ore is on the up and up. The spot price, according to Metals Bulletin, is around $135 a tonne, which is a lot higher than the annual contract price of $61 per tonne. Some analysts are already calling for a 30-50% rise in the 2010 contract price.

If that happened, it would obviously be a big boost to earnings for the iron ore majors. But would it be enough to justify current valuations? The more speculative play would be the juniors, although those have also had a pretty good run since March already. Besides, Bloomberg reports that the Brazilian ore giant Vale is grabbing market share from Rio Tinto and BHP Billiton. Bloomberg says Chinese steel production is driving ore demand to a record 1 billion tonnes this year. Vale claims it can expand production faster than its Aussie rivals, and is set to grab 28% of the ore market.

The 2007 crash wasn't preceded by any signs or evidence of a correction, of course. Whereas today, on the other hand, we have two solid years of mediocrity from which share prices, or at least earnings, can possibly recover. Possibly. But as we've been saying all along, in a credit depression, corporate cash flows will revert to historic means. There will be fewer profits in the economy as economic activity adjusts to lower levels of credit and loan growth.

That doesn't mean there aren't good businesses with growing profits to invest in. But you probably won't find them in the finance, technology, insurance, and media sectors like you could over the last twenty years. You'll have to do more research and take more risk. The good news is that this will cause more and more investors to give up on stocks as an asset class. When no one wants them, then you'll have a real buy signal.

Until then, we creep along in this petty pace from day to day. A great Money Migration is underway. And this could be the year it leads to a serious strain in the finances of the Western Welfare States. You'll want to own fewer stocks, more cash, and more Gold Bullion in preparation.

An outlier? How about a Republican winning a Senate seat in Massachusetts? We have no recollection of the last time a Republican actually won a Senate seat in that state. There've been some close races in the past. But it looks like State Senator Scott Brown is giving Democratic attorney general Martha Coakely all she can handle and more.

CNBC ring-master Jim Cramer says a Brown win on Tuesday will trigger a huge rally. Cramer says investors will celebrate the "Pelosi Politburo Emasculation". He's referring to Nancy Pelosi, the female Speaker of the House of Representatives from the People's Republik of California. Cramer reckons a repudiation of Coakley is the high red-tide mark in America's "spread-the-wealth" Federal policy.

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The consensus view on Gold vs. Dollars misreads the deep trends...

IT AS BECOME clear that the media and many institutional analysts are going to keep talking the Dollar up despite the lack of fundamental reasons, writes Julian Phillips of the Gold Forecaster.

We feel that you will benefit most from a look at what lies ahead for the Dollar and its fundamentals and what could take it higher, if it does rise.

The main reason a rally in the Dollar is being promoted is because it is due for a rally. The same is being touted for the Pound Sterling. It is certainly true that a price never moves in a straight line. It is also true that investors, buyers and sellers must see trade around all levels to ensure they are balanced and accept price levels as convincing. When the market sees a price 'spike' you can be sure that sellers will turn up to bring it down. The only time it stays there is when buyers and sellers feel that, that price is justified by them both.

However, please note that the price of the Dollar is the main fulcrum of the currency world, a currency, unlike a share that is traded by an exchange. So its price doesn't move by buyers dominating one day and sellers the next. It stays in balance most of the time. That is why its fall from $1.23 to $1.51 per Euro has been gradual. If it rises it is because of a distinct reason similar to a change of tide. So the concept of "just a rally" would not end the bull market for gold.

When the Dollar rises, gold traders on New York's Comex exchange sell gold in such a related manner as to try to establish a direct link between the Euro and gold. Silver follows. Of late we have seen that relationship broken and then followed again. As the Gold Price has risen it has also risen against the Euro, thus de-coupling from the Dollar. But the actions of short-term traders keep returning to the day-to-day moves of the Dollar against the Euro, perpetuating the belief that when the Dollar rises against the Euro, the Gold Price falls.

When the Euro was first issued it held roughly a 1:1 relationship to the US Dollar. Each Euro now trades at $1.4254, a rise in the Euro of 42.5% this decade. In that time gold has gone from $275 to more than $1200 an ounce, an increase of 440%. So do we now expect the Gold Price to move in line with the Euro? Why should it?

The Eurozone and the US are at similar levels of development, their economies are moving in a similar path. The Dollar and the Euro are paper currencies are of a similar structure and reliant on similarly driven central banks. They have the same economic and currency goals. They are relatively inter-dependent. What will ail the one will ail the other. Hence the rise of one against the other is similar to a race where one runner is slightly ahead of the other. They are in the same race and the performance of one is not detrimental to the other. But the Gold Price is in an entirely different race, going a different way, moved by different drivers. We believe that this Euro/Dollar and Gold/Dollar ratio will fall away over time, just as in the past the oil to Gold Price ratio fell away.

Of far greater pertinence is the attitude of Dollar surplus holders to the US currency. These Asian, Arab and Russian banks are caught in a cleft stick, knowing that if they sold their Dollar surpluses they would inflict losses on themselves in the process of undermining not just the US but the global economy. But each of these surplus holders is also in a different position regarding the Dollar. All of them are caught in the cleft stick, but in this they will react in different ways.

Opec oil producers are dependent on the United States for the security of their sovereignty. The House of Saud dare not reject pricing crude oil in Dollars, or they would lose the physical protection of the US, as would all those western and northern countries of the Persian Gulf. So they can only influence the Dollar oil price through energy supplies, ameliorating the state of the currency's value. However, this may be changing as a new Gulf currency may be used to price oil. If this does happen, then a major nail will have been driven into the coffin of the Dollar as the global reserve currency.

Russia needs to maximize oil income to keep itself economically sound. So it will accept the Yuan from China but won't reject Dollar payments from other countries. It is diversifying reserves as far as it can without damaging the Dollar exchange rate (such as the Gold Price, for instance), and would love to jettison the US currency, but for the sake of the value of its reserves and the stability of the world's currency markets, including the Ruble market, it won't. As one Treasury Official said, the Dollar may be our currency, but it's your problem.

China is stuck with around $3 trillion in its reserves, firmly snared in the Dollar trap. It is unhappy with this and is diversifying as far as it can (including into gold). Its unshakeable answer is to peg the Yuan to the Dollar and reap the benefits of sucking manufacturing out of the United States and selling it cheap goods, which are the first to be bought in a recovery. There will be no loosening of the "peg" until the problem of China's Dollar reserves are solved. It is therefore turning the disadvantage into an advantage, bleeding the United States of its strength. By doing this, the advantage of a weakening Dollar to the States is neutralized.

President Obama's visit to China simply demonstrated that the Chinese were not prepared to budge on this. However, the Chinese did concede that they would not dump their Dollars on the market. This would cause such disarray globally that the Dollar would collapse, but so may the global economy.

Euro-dependent countries, in contrast, will move with the Euro. But most other nations will similarly attempt to absorb the weakening Dollar, and where this hurts them too much, will attempt competitive devaluations to keep some stability in their exchange rate with the No.1 reserve currency, should their trade levels with the States require it.

Overall, therefore, the world will continue to accept the Dollar but to some extent diversify into gold to "counter the swings in the Dollar" as the German Bundesbank put it in 2008.

Domestically, consumers in the States are more aware than ever of the buying power of the Dollar in their shops. As their disposable income rises they will spend it on cheaper goods that meet the same needs as more expensive items, usually home produced. It will only be when the US imposes tariffs on Chinese goods that this will change. At the moment this is unlikely. If it does happen, expect similar barriers to be set up for US goods entering China. With China moving to economic self-sufficiency, it is becoming less vulnerable to dropping exports or potential tariff barriers.

In short, we believe that as the US recovery accelerates, imports will grow rapidly, further increasing the US trade deficit and thus undermining the exchange rate of the Dollar on international foreign exchanges once again. We have seen it do so many times and so expect it to do so not just again, but eventually to be weaned off this relationship as short-term traders are made to suffer because of holding to it.

With the global economy struggling to recover and with so many dangers laying ahead, each one of them threatening uncertainty, instability and with international tensions growing, it is clear to most that the Gold Price is rising against all of these worries. It is not rising because of a falling Dollar. It will not fall, we believe, except short-term, against a rising Dollar. It would therefore be wrong to isolate the Dollar as the reason why the gold price either rises or falls, but it will continue to be the reason why the media in general records such rises and falls, because it is easy and story-worthy to do so.

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