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China's Inflation Problem Looms Large 
By: Peter Schiff, CEO & Chief Global Strategist at Euro Pacific Capital

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The global economy has become so unbalanced that even government ministers who would normally have trouble explaining supply or demand clearly recognize that something has to give. To a very large extent the distortions are caused by China’s long-standing policy of pegging its currency, the yuan, to the U.S. dollar. But as China’s economy gains strength, and the American economy weakens, the cost and difficulty of maintaining the peg become ever greater, and eventually outweigh the benefits that the policy supposedly delivers to China. In the first few weeks of 2011 fresh evidence has arisen that shows just how difficult it has become for Beijing. 

Twenty years ago, China’s leaders decided to ditch the disaster of economic communism in favor of privatized, export-focused, industry. The plan largely worked. Over that time, China has arguably moved more people out of poverty in the shortest amount of time in the history of the planet. But somewhere along the way, China’s leaders became addicted to a game plan that outlived its usefulness. 

In order to maintain the peg, China must continually buy dollars on the open market. But the weaker the dollar gets, the more dollars China must buy. And with the U.S. Federal Reserve pulling out all the stops to create inflation and push down the dollar, Beijing’s task becomes nearly impossible. Last week, it was announced that China’s foreign exchange reserves, the amount of foreign currency held at its central bank (mostly in U.S. dollars), increased by a record $199 billion in 4th quarter 2010, to reach $2.85 trillion. These reserves currently account for a staggering 49% of China’s annual GDP (if the same proportional amount were held by the U.S., our measly $46 billion in reserves would have to increase 163 times to $7.5 trillion).

In order to buy these dollars, the Chinese central bank must print its own currency. In essence, China is adopting the Fed’s expansionary monetary policy. In the U.S. the inflationary impact of such a strategy is mitigated by our ability to export paper dollars in exchange for inexpensive Chinese imports. Although prices are rising here, they are not rising nearly as much as they would if we had to spend all this newly printed money on domestically produced goods. The big problem for China is that, unlike the U.S., the newly printed yuan are not exported, but remain in China bidding up consumer prices. As a result, inflation is becoming China’s dominant political issue.

It was recently announced that in November China’s consumer price index rose 5.1% from the same time a year earlier, with food prices rising more than 10%. As unrest builds, the Chinese government has unleashed a series of policies to address the symptoms of the disease while ignoring its root cause. 

The feeblest of these attempts is the imposition of price controls in many Chinese cities. But as President Nixon found out in the early 1970s, the laws of supply and demand cannot be suspended at will. The Chinese leaders realize this and have more recently implemented a raft of seemingly more sophisticated responses. 

Informed by the mistaken Keynesian economic principle that inflation is created by a strong economy rather than by an expanding money supply, China is hoping to solve its problems by restraining growth. To do this it has just raised interest rates and has moved to restrict bank lending.  

On Friday, the central bank said it will raise the share of deposits banks must keep on reserve by half a percentage point. This comes after six such increases last year (the fourth hike in just two months). On the interest rate front, the People’s Bank of China is mulling further rate increases, which many analysts expect to come in the first quarter. However, if these moves are not accompanied by a cessation of dollar purchases, they will do nothing to control inflation. 

This week, Chinese president Hu Jintao arrives for a summit in Washington, where he will get an earful from President Obama and Treasury Secretary Geithner about the importance of letting the yuan appreciate. On this point, the Administration actually has it right. But they fail, of course, to grasp the full implications of how a falling dollar and a rising yuan will hurt the U.S. economy. If the Chinese stop buying dollars, Americans will face higher prices and higher interest rates. If Geithner thinks we can take such changes in stride, he is in for a rude awakening. 

The real awakening will occur when China realizes that it has tethered its economy to an un-tethered currency. There are plenty of signs that many in the Chinese leadership are beginning to fully grasp the problem. 

For example, Zhou Qiren, an academic adviser to the People's Bank of China, said in an interview in the latest edition of China Reform Magazine that China should find a method of valuing the yuan that does not involve the printing of more yuan to maintain exchange rates stability. He argued that raising interest rates won't solve the fundamental problems behind inflation. To do that, China must control its money supply. I think he’s on to something.  

He also commented that the U.S. dollar, which became a substitute for gold as a result of the 1944 Breton Woods agreement, can no longer be serve as the anchor for world currencies. He further suggested that the yuan be linked to something  objective. It sounds to me like he’s talking about a certain yellow metal. 

The bottom line is that the Chinese are finally waking up. When the dollar was backed by gold, it was a reliable anchor. However, once that anchor was cast aside, the dollar was set adrift, and is no longer positioned to provide stability. For a while, even without gold, the strength of our economy and the competitiveness of our exports gave stability to the dollar, but those moorings have snapped.

For now the old guard in China still holds sway and the status quo remains intact. But new leaders are expected to be in place by 2014. When fresh hands take the wheel, we may finally see some meaningful change in the global monetary system.   

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After clicking the ad above, you will leave the Euro Pacific Capital website and be directed to the website of Euro Pacific Precious Metals, LLC. Neither Euro Pacific Capital nor any of its affiliates are responsible for the content of such website. Peter Schiff is CEO of Euro Pacific Capital, Inc. and CEO of Euro Pacific Precious Metals, LLC.

Precious metals are volatile, speculative, and high-risk investments. Physical ownership will not yield income. As with all investments, an investor should carefully consider his investment objectives and risk tolerance as well as any fees and/or expenses associated with such an investment before investing. The value of the investment will fall and rise. Investing in precious metals may not be suitable for all investors.

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Pricey Eats
By: Michael Pento, Senior Economist at Euro Pacific Capital

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From all accounts it appears that the world is in the early stages of a major leg up in food prices. The major macroeconomic trend will likely drive economic policy and the investment outlook for years to come. Although mainstream pundits like to focus on cyclical drivers like the weather, the real force behind the move is secular. The U.S. is leading the world in a pandemic of monetary inflation that is helping to cause commodity prices, food in particular, to skyrocket across the globe.

The Federal Reserve's monetary excess is currently being magnified by China's misguided currency peg policy. As the United States debases its currency through excess printing, China must follow suit. In order to maintain a consistent relative valuation, China must adopt the monetary policy of the United States.

Just last week, China announced that in the 4th Quarter 2010 its foreign currency reserves leapt by $199 billion to $2.85 trillion. The increase was much larger than economists expected, and suggests that China is printing as much as $2 billion worth of RMB per day in order to buy dollars to maintain the peg. The big problem is that China, with a booming economy, is adopting a monetary policy of an economy that is contracting. This is the perfect recipe for inflation.

And it's not just China that is enforcing a currency peg. Many other countries intervene in the forex market when they feel their currency has risen too high against the greenback.

For example, the Chilean currency gained 17% in value against the USD in just 7 months during 2010. The surging currency underscored the country's status as an emerging markets success story. But that condition abruptly ended last week when Chile's central bank pledged to intervene in the local currency market by increasing foreign currency reserves by $12 billion in 2011. After the announcement, the currency predictably dropped against the dollar and caused a major sell-off in Chilean equities.

The specious idea behind this action is that foreign governments believe that by keeping their currencies cheap they can bolster exports and maintain a strong economy. But a rising currency does not necessarily restrain exports. If those countries currently committed to pegs were to reverse course, their problems with local inflation could diminish. And those lower prices could offset to a certain degree the decreasing purchasing power experienced by the importers of those countries' domestic goods.

However many countries fail to understand this basic economic concept and fail to see the forest for the trees. By stubbornly clinging to the belief that a rising currency is bad for the economy, world economic leaders are helping to unleash a wave of inflation.

Typically, food prices are more volatile than prices for finished goods. It is there that this new wave of inflation is first manifested. Unfortunately, this means that the poorer people around the world, who pay a higher percentage of their income for food, will bear the brunt of the pain. A quick look at some alarming movements in food prices should give you a sense of how bad things are getting:

• Sugar was up 25% in 2010.
• Corn and wheat were up 53% and 49% respectively in 2010.
• Soybeans were up 28% in 2010.
• In December, the U.N.'s Food Price Index, which covers dairy products, meat, sugar, cereals and oilseeds, jumped an alarming 4.2% from the previous month. In so doing the Index passed the previous peak set in June 2008.
• India's food price inflation rose to a one-year high of more than 18% according to data released in early January. Rising food and energy prices in India have convinced many analysts that the Indian central bank will raise rates later this month.
• In China, food prices rose 11.7% from January to November 2010. In response, several cities have implemented direct controls to limit food price increases and the central government has vowed to eliminate speculation in the country's commodities markets.

Of course, global currency depreciation has also caused other commodity prices to rise. Food production is extremely energy intensive, and $90 per barrel oil has helped push food prices to new all-time highs.

The surging cost of fertilizer, driven in large part by U.S. ethanol policy, is also adding another driver to rising food costs. According to the EPA, ethanol sales in the United States are expected to rise to 13.9 billion gallons in 2011 from 12.95 billion gallons in 2010. The agency is requiring that renewable sources account for at least 8 percent of motor fuels sold in 2011. Congress is requiring that U.S. annual ethanol production increase to 36 billion gallons by 2022. With nearly 40 percent of the U.S. corn crop currently diverted to ethanol, the demand for fertilizer is likely to increase substantially. 

Prices are already on the move. Mosaic, one of the country's largest fertilizer corporations, sold diammonium phosphate for $461 a metric ton in the fourth quarter, up 61 percent from a year earlier.

Admittedly, there are other non-inflationary factors that are boosting global food prices. For instance, poor weather conditions in major exporting countries across the globe have significantly curtailed harvests and expectations. And alongside bad weather in Australia, Europe, North America ,and Argentina, rising Asian demand is at the heart of the spike. China, for example, is expected to buy 60 percent of globally traded soybeans in 2011/12, which is double its percentage of four years ago.

But the genesis of soaring food costs lies at the feet of Ben Bernanke and his desire to re-ignite inflation domestically. However, countries like India and China have already started to reverse the inflationary effect of linking their currencies to the USD and are raising banks' reserve requirements and interest rates. Contrast those actions with those of our Fed chairman who has repeatedly stated that inflation in the U.S. is far too low. We can only hope Mr. Bernanke repents from his love affair with inflation before food riots land on U.S. soil.

In the meantime U.S. investors can help mitigate their exposure to rising food costs by perhaps looking to invest in those firms whose financial performance improves with rising food prices.

Michael Pento is Senior Economist with Euro Pacific Capital. Opinions expressed are those of the writer.

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Investment Opportunity

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This company is a large cap, foreign-based, international agribusiness selling seeds and crop protection pesticides. It also engages in plant and crop research.

The company sells products that help produce and grow corn, wheat, soybeans, and other fruits and vegetables. Pesticides make up the bulk of its revenue, with seed sales accounting for about a quarter of overall company sales. About 45% of its seed business comes from corn and wheat.

While acreage under farm management has increased over time, the main driver of crop production has been increasing yield. With an increasing world population there is a need for more crops on existing farmlands. Yield must increase to help meet rising demand.

The US Department of Agriculture depicts this information via the following graph:

Source: USDA, 2009. Basket: Corn, soybean, wheat, rice.

Companies such as this one, that help increase yield per acre, are well-positioned to benefit from rising food prices.

Source: Google Finance, Jan 2008 -Jan 2011.

Risks:

• Raw materials the company uses could rise in price.
• Reduction in the prices of crops, whether due to overproduction or to government price ceilings, could cause a reduction in demand for the company’s product.
• Crop damage like a flood, drought, or killer frost could prevent farmers from using the company’s products, lowering revenue.

INTERNATIONAL INVESTING MAY NOT BE SUITABLE FOR ALL INVESTORS. 

CLICK HERE TO RECEIVE MORE INFORMATION ABOUT THIS COMPANY, AND TO SEE IF IT IS SUITABLE FOR YOUR INVESTMENT OBJECTIVES AND RISK TOLERANCE, OR CALL 1-800-727-7922 TO SPEAK TO AN INVESTMENT CONSULTANT.

Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. There can be no guarantees of success in pursuing any of the strategies we recommend, or that any of the specific companies will gain in value. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. Euro Pacific has not independently verified the information supplied by the company, and cannot make any representations as to its accuracy. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

Why don't we provide the company name?
Under FINRA Rule 2310, broker-dealers are required to make sure that every investment recommendation is suitable for each client's unique investment objectives and risk tolerance. The company overviews provided here are meant to give an indication of the type of recommendations a Euro Pacific Investment Consultant may make, depending upon your unique investment goals, risk tolerance, and profile. If you have questions about the companies described in this report, or think they may be suitable for your portfolio, please call (800) 727-7922 and a Euro Pacific Investment Consultant will assist you, with no obligation to purchase from us.

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Sifting Through the Wreckage of China Small Caps
By: Crocker Coulson, President of CCG Investor Relations

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After global stock markets have risen steadily for almost two years, many investors may have concluded that promising stocks with very low valuations are a thing of the past. But it would surprise many to know that some of the lowest valuations can be found in China, one of the world's fastest growing economies.

Based on the performance of a few recent Chinese tech IPOs, Chinese stocks have an unearned reputation for trading at sky high valuations. Online retailer Mecox Lane commands a nosebleed price earnings ratio of 65 - and that is after seeing its share price cut in half in the wake of a disastrous Q3 earnings report released just a few weeks after going public. Mecox Lane now has a raft of class action law suits alleging it grossly misrepresented its prospects during the IPO process.

Youku.com, otherwise known as China's YouTube, and E-Commerce firm China DangDang sport market caps of $3.6 billion and $2.1 billion respectively, despite the fact that both have never earned a dime of profits. We have seen this movie before, and it often ends in tears.

With all this froth in the China space, it is puzzling that there is simultaneously a number of very solid Chinese companies in growing market sectors, that are growing revenues at 50% to 100% a year, but which are trading at less than 8 times next year's projected earnings. It is becoming a tale of two markets.

A few common threads run through these types of modestly valued firms; small cap status, inclusion in less visible industrial or agriculture sectors, and sole listing on a U.S. exchange.  (For two examples currently included in Euro Pacific's stock offerings, please see below.)

Since the spring of 2010 there have been a series of short-seller attacks that in some cases uncovered fraudulent accounting at U.S. listed small cap Chinese stocks. The most recent and visible of these was a company called RINO International, which had traded as high as $32 dollars on the NASDAQ, giving it a market cap of nearly a billion dollars. On November 10th of 2010 an amateur research firm called Muddy Waters came out with a strong sell rating, claiming that the company's revenue was massively overstated and several of its customers were fictitious. Within ten days of the report's publication, RINO's auditor confirmed many of these allegations. RINO's shares now change hands on the pink sheets at $4 per share.

Following the RINO case, the Wall Street Journal reported that the SEC was investigating Chinese companies that had gone public through reverse mergers in which Chinese operating companies merge with a publicly traded U.S. "shell" company with no operations. Such transactions have been used since about 2005 by Chinese companies looking to raise funds and go public quickly. While a significant proportion of these reverse mergers have been successful for companies and investors, many have turned out to be scams. However, the storm of bad publicity that have surrounded the public blow ups by RINO, Duoyuan Printing Fuqi International, and China Northeast Petroleum has caused a number of mutual funds to dump their entire holdings of former reverse merger stocks and sent skittish retail investors running for the sidelines.

So how is an investor to sort through the wreckage of the China small caps and pick out the potential huge wins from the next train wreck? Given the risks, investors may want to try and pick out the names that are of institutional quality, meaning those stocks that the large mutual funds and hedge funds would be willing to scoop up if market sentiment on this group turns. Here are characteristics that generally make a company appealing to institutional investors:

Big Four Accounting - Given all the blow ups of companies audited by smaller U.S. accounting firms, the new mantra among mutual funds is "Big Four or out the door." No fund manager wants to have to explain to his investors why he or she took a chance on a company with a no-name auditor. So look for companies that either have Big Four auditors or have announced they are making the move.

Industry Leadership - Most professional money managers like to own companies that are leaders within their market sector, or at the very least in the top three. China's government is actively promoting consolidation in dozens of industries in order to build companies capable of competing on a global stage and promote energy efficiency and technology focus. Look for sector leaders.

Exposure to Domestic Consumption - China's government has also made a policy decision to steer its economy away from low value-added export industries and towards domestic consumption. The Chinese population still has one of the highest savings rates in the world at 43.5%, reflecting decades of economic uncertainty and the absence of any social safety net.

Chinese policy makers are putting a healthcare scheme in place and encouraging higher spending on appliances, vacations, automobiles and a range of other goods and services. When those 1.4 billion wallets start to open up, watch out! Fund managers love consumer plays right now and so should you.

Fire sale prices of companies with screaming growth rates, high profit margins and leading industry positions won't last forever. Assembling a small portfolio of these names could be a very smart New Year's resolution for 2011.

Crocker Coulson is president of CCG Investor Relations, the largest provider of investor relations consulting services to Chinese companies listed in the U.S. CCG represents Yongye, China Valves and Gulf Resources and receives fees and in some cases warrants in exchange for services. The views expressed in this article do not constitute investment advice and any investor should perform adequate due diligence and/or consult their professional investment advisor before investing in any of the securities mentioned in this article.

Crocker Coulson and CCG Investor Relations are not affiliated with Euro Pacific Capital, Inc. The views expressed in this article are those of the author and may or may not reflect those of Euro Pacific Capital. Euro Pacific Capital does not guarantee the accuracy and completeness of third party authored content.

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Modestly Valued U.S. Listed Chinese Firms Offered by Euro Pacific Capital

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North Dakota Gushes

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In a past newsletter we had mentioned a variety of energy investments in companies involved in the Bakken oil field that stretches from the northern plain states in the U.S. (North and South Dakota, and Montana) to southern Manitoba and Saskatchewan in Canada. We believe that this massive field could offer the most important sources of continental energy for many years to come. Our latest special report on Canadian Oil trusts also referred to companies active in the Bakken.

Recent reports coming from North Dakota, a state that sits in the middle of the Bakken field, confirm our earlier optimistic prognosis for the region. Investors should take notice.

On January 2, the Associated Press reported that North Dakota government and industry officials announced that the state contains more than twice the amount of oil previously estimated and that the state's already record crude production will double within the decade. This suggests that in just a few years North Dakota could surpass California and Alaska in oil production to become the No. 2 oil producing state, trailing only Texas.

North Dakota is currently pumping about 350,000 barrels of crude per day and is on pace to have produced about 110 million barrels in 2010, up from 79.7 million last year and more than double the amount produced less than three years ago. The increase is partially due to advances in drilling technology that have cut the amount of time needed to complete a well from 65 days in 2008 to about 25 days. More accurate mapping, GPS-assisted drilling techniques, and more efficient uses of hydraulic fracturing (fracking), are also big factors that explain North Dakota’s ascendance.

Companies that drill for oil in the region, provide geological, logistical or technological services, or help transport the energy to population centers throughout North America, should be well-positioned to profit from the bounty. 

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Gone Fission

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There are few things more essential for human life than fuel. As we move further into the 21st century, and add billions more energy craving humans to the planet, the need to create heat and power will only increase. As reserves of fossil fuels inevitably deplete, or become more expensive in relative terms, other sources of energy will necessarily become a bigger slice of the energy pie. There is widespread agreement among energy analysts that nuclear energy will become an increasingly large component of the global energy mix. Uranium, a relatively rare metal, is the key ingredient to make nuclear power. Like other mineral commodities, uranium deposits need to be found and dug out of the earth. The companies that accomplish this task could be poised for a bright future.

Today, 31 nations representing two-thirds of humanity use nuclear power to produce about 14% of global electricity. Nuclear energy produces 75% of the electricity used by France. The figures are lower, but still very significant, for most other developed nations where nuclear delivers 24% of the electricity on average. In the U.S. nuclear power plants create 20% of electricity, which is as much as natural, and second only to coal which produces 45%. Despite the best efforts of environmentalists, it appears nuclear is here to stay and likely will play a prominent role in moving towards a cleaner economy.

There are 441 working nuclear power plants around the world, including 104 in the United States. Another 58 plants are under construction with an additional 500 being either planned or proposed in both developed and developing nations over the next 20 years. This expected growth is underscored by escalating nuclear power programs in China, Russia, India and the U.K.

The price of uranium, which is driven by a more complex set of factors than those typically governing other energy prices, has shown particular volatility over the years. Starting off the new millennium at about $6 per lb., the spot price for uranium gradually rose through 2005 to about $20 per lb. In 2006 the price really began to climb, ultimately peaking in mid-2007 at a stratospheric $136 per lb. As the 2008 crash began working its way through the system, the spot price for uranium got hit hard, falling back to the $40 per lb. range by mid-2010. In the last six months it has since rebounded back to $60 per lb.

Source: Infomine.com Jan 2001 - Jan 2011.

Although this kind of short term volatility is sufficient to both repel risk adverse investors and attract those looking for a quick gain, it is the long term outlook for uranium that gets our attention.

The overall demand for uranium is expected to rise substantially over the next few decades. The number of active reactors worldwide is expected to double over the next 20 years. The World Nuclear Association's authoritative forecast of uranium demand is expecting a 50% increase by 2020 and a 100% increase by 2030, with China and India being major new customers.

On the supply side, we have actually witnessed a decline in mine production since the 1980's. The current supply of uranium is well below the average demand levels that we have seen since 1985. In order to meet this projected demand, worldwide production is scheduled to rise from 124 million lbs. in 2009 to 220 million lbs. by 2015. These projections ignore the usual headaches associated with mining, such as technical problems, weather, and other issues that can easily put the brakes on a mine's overall production.

Although some investors looking to play this trend would be willing to speculate on small exploration companies, we feel more comfortable with the proven producers. One company in particular that attracts our attention is a sizable miner, which accounts for more than 16% of world production from its mines in Canada and the U.S. The company is currently reporting more than 480 million pounds of proven reserves. The company also owns premier land positions in the world's most promising areas for potential new uranium discoveries. Although the stock has shown significant upside movement since July we do not feel that the upward potential is over.

Source: Google Finance. Jan 2001 - Jan 2011.

As we can see from the above chart, this company's share price correlates nicely with the price movements in uranium. As with precious metals and other widely traded commodities, uranium appears to be caught up in the general upward momentum of commodities in general. As Bernanke continues to run his printing presses, markets naturally will respond by raising the prices of the raw materials of those staple materials needed for everyday life. This company should make a solid long term addition to any growth-oriented portfolio.

Risks:

• Like all commodities, uranium prices are subject to extreme fluctuations. Significant drops in prices will negatively impact uranium mining companies.
• Nuclear power is highly dependent on regulatory approval and political support. As a result, the market for uranium involves more political risk than most commodities.

INTERNATIONAL INVESTING MAY NOT BE SUITABLE FOR ALL INVESTORS. 

CLICK HERE TO RECEIVE MORE INFORMATION ABOUT THIS COMPANY, AND TO SEE IF IT IS SUITABLE FOR YOUR INVESTMENT OBJECTIVES AND RISK TOLERANCE, OR CALL 1-800-727-7922 TO SPEAK TO AN INVESTMENT CONSULTANT.

Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. There can be no guarantees of success in pursuing any of the strategies we recommend, or that any of the specific companies will gain in value. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. Euro Pacific has not independently verified the information supplied by the company, and cannot make any representations as to its accuracy. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

Why don't we provide the company name?
Under FINRA Rule 2310, broker-dealers are required to make sure that every investment recommendation is suitable for each client's unique investment objectives and risk tolerance. The company overviews provided here are meant to give an indication of the type of recommendations a Euro Pacific Investment Consultant may make, depending upon your unique investment goals, risk tolerance, and profile. If you have questions about the companies described in this report, or think they may be suitable for your portfolio, please call (800) 727-7922 and a Euro Pacific Investment Consultant will assist you, with no obligation to purchase from us.

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