Money and Markets

Dear Colleen,

It's very early Monday morning, and I just got back from a short walk outside.

South Florida's sunrise is still two hours away, and there's no moonlight. So it's pitch black, difficult to see anything beyond a few feet ahead.

But 850 miles to the north-northeast, the darkness engulfing the Federal Reserve Board in Washington -- especially its Chairman, Ben Bernanke -- seems far greater.

Raging inflation is on his doorstep, but he can't see it. The numbers are staring him in the face, but he refuses to acknowledge the dangers.

This is not a new phenomenon. We saw the same blindness afflict Fed Chairman Arthur F. Burns in the early 1970s. And we saw it again in Fed Chairman G. William Miller in the late 1970s.

Both men presided over massive increases in money supply and big declines in the U.S. dollar. Both ignored the obvious signs of inflation until it was too late. Now, Fed Chairman Bernanke is doing the same, paying no attention to history.

Perhaps no one has shown him this chart of surging commodity prices.

The chart demonstrates -- unambiguously and without bias -- that the next wave of inflation could be among the biggest of all.

In particular, three waves of price surges stand out vividly:

1. In the early 1970s, the Reuters CRB Index, representing a broad range of commodities, doubled -- from an index of 100 to around 200.

The primary cause: Energy prices going through the roof.

The consequence: Soaring inflation.

2. In the late 1970s, commodity prices jumped again, this time from the 200 level to about 330.

The primary cause: Energy prices going through the roof.

The consequence: Soaring inflation.

3. Now it's happening all over again, but much worse.

The latest rise in commodity prices is even greater than the two surges of the 1970s: The Reuters CRB Index has more than doubled, from 186 at the end of October of 2001 to 386 at the end of last month.

The primary cause: Energy prices going through the roof!

The likely consequence: Soaring inflation!

And that's based exclusively on the commodity price rises we've witness so far.

It does not take into consideration the new surges that are still in the making, driven by the rampant demand from China and India.

Nor does it consider the elephant in the room ...

The Next Big Wave of War

Just five years ago, there were no wars in the oil-rich Persian Gulf or the Middle East. Nor were there any wars in nearby regions that could impact them. None.

Now, there are four:

War #1. Afghanistan, heating up dramatically in recent months, with a major resurgence of the Taliban.

War #2. Iraq, sinking rapidly into a full-scale civil war, now claiming at least 100 lives each day.

War #3. Gaza and West Bank, suddenly transformed from a low-level rebellion into an all-out conflict.

War #4. Lebanon, just starting to explode, with shocking new surprises on the near horizon.

Are these four wars the last? I certainly hope so. But right now, I see the real possibility of several more:

Possible War #5
Iran vs. the U.S.
or Israel

Israel is already at war with Iran's protégées -- the Hezbollah of Lebanon, the group I've been warning you about for many months.

Indeed, last year, I told you about the direct link between Hezbollah and Iran's special al Quds Force, which, in turn, is under the direct auspices of Iran's Revolutionary Guard.

I explained why these forces are far greater threats to the West than al Qaeda. And I told you it was only a matter of time before they attacked.

That's what's just happened in Lebanon. And now, you don't need me to connect the dots for you. You can do it yourself:

• The U.S. is the chief arms supplier and financial backer of Israel.
• Israel is at war with Hezbollah.
• Hezbollah gets its weapons and financing mostly from Iran.
• Ergo, indirectly, the U.S. is already at war with Iran.

If there were no other source of conflict between the U.S. and Iran, it could be more easily. But never forget:

- Iran and the U.S. have had no diplomatic relations since Iranian students stormed the U.S. embassy in Tehran a quarter-century ago.

- Iran's agents have been pouring into Iraq, training and arming Shiite militias, establishing alliances both inside and outside the government.

- Iran has just thumbed its nose at the U.S. and Europe, refusing to budge in its drive to become a nuclear power.

- Iran is poised to resupply Hezbollah and quickly replenish its missiles destroyed in recent days.

Now, with all these conflicts converging in one time and place, Larry's forecast of a war with Iran, the first I heard from any analyst anywhere, seems closer than ever to reality.

Possible War #6
Syria vs. the U.S. or Israel

The U.S. has had Syria on its radar screen since the beginning of the Iraq war, accusing its leaders of complicity in the Iraqi insurgency.

The U.S. and the West have accused Syria's top leaders of assassinating Lebanon's former prime minister Rafiq Hariri, with a U.N. investigation into the murder still ongoing.

The U.S. has charged that Syria is also a major backer of the terrorist Hezbollah.

The U.S. is further angered by Syria's emerging alliance with Iran. And just yesterday, Bush administration officials said they are seeking ways to separate the two countries. If they can't, the implication is that Syria could also be a target.

Most ominous of all, Syria's information minister has just declared that if Israeli ground troops approach its border, it will enter the conflict, a serious widening of the war with untold consequences for both sides.

Possible War #7
Turkey vs. Kurdistan

In my last report, I explained the immediate consequence of a civil war in Iraq: The emergence of a new independent Kurdish nation in the northwest -- Iraqi Kurdistan.

The big problem: In that scenario, Turkey has vowed to invade Iraq with its own ground troops.

Reason: About half of all Kurds live in Turkey, numbering some 15 million. And for over 85 years, they have rebelled unsuccessfully to create their own nation.

The Turkish government will do virtually anything suppress any further rebellions. And the formation of an independent Kurdistan on their Eastern border is their most feared threat. They will not let it happen.

To most Americans, all this may seem irrelevant. But nothing could be further from the facts. Turkey is a member of NATO. And for the first time, two NATO nations -- the U.S. and Turkey -- would be on opposite sides.

Possible War #8
India vs. Pakistan

Since their independence from Brittan after World War II, India and Pakistan have gone to war four times: in 1947, 1965, 1971 and as recently as 1999.

Until recently, these two South Asian nuclear powers were engaged in a peace process which seemed to be moving forward.

But the terrorist blasts in Mumbai this month have dealt a severe blow to peace. India obliquely blames Pakistan for the attacks. Pakistan blames domestic Indian terrorists.

The governments on both sides want the peace process to continue. But the extremists on both sides want to derail the process, cause chaos and precipitate another war.

And unfortunately, if the pattern in Iraq and Lebanon is any indication, the extremists have a reasonable chance of succeeding.

Most of Middle East,
Persian Gulf and
South Asia

Peering further into the future, if these wars cannot be prevented, the conflict is likely to spread to other neighboring Muslim nations, also rich in oil and natural resources.

That includes Turkmenistan, Uzbekistan and Kazakhstan to the North ... Saudi Arabia and Yemen to the south ... plus Jordan, sandwiched in between Iraq and Israel.

All told, the conflicts could cover an area twice the size of Europe, with triple the population.

This is very serious. And the inevitable financial consequences can be best summarized in one single word -- inflation.

These wars can only bring more debts, more deficit spending and more money-pumping by central banks around the world to help finance their armies.

And it means far broader threats to the supply of commodities than heretofore debated or imagined.

Look. These war-prone regions represent the overwhelming bulk of the world's oil reserves.

Just in the Middle East alone, their oil reserves are over seven times greater than those of the next largest sources.

Plus the region has some of the largest deposits of natural gas, magnesium, tin, uranium, coal, iron, copper, zinc and gold.

Never before has there been a greater reliance by the world's fastest growing economies on these resources! And never before have I seen a greater threat to these supplies. That explosive combination is a classic precursor to raging inflation.

I pray Lebanon and Israel will not wage an all-out war. I pray the raging civil war in Iraq will not split the country into three. I hope Iran, Syria, Turkey and Saudi Arabia will not be dragged further into the conflicts.

But even in the best-case scenario, the commodity price surge we've seen so far is already enough to spur much more inflation.

That means more interest-rate hikes, despite anything Ben Bernanke may say.

It means more plunges in interest-sensitive stocks, despite any near-term rallies.

And it means you need to take firm action to protect yourself against the fall-out. My recommendations ...

First, Keep a Big Portion of Your
Money Safe, in U.S. Treasury Bills

Treasury bills offer four major advantages:

Advantage #1. No principal risk. As long as you can wait the three months until maturity, you're guaranteed a 100% return of your principal plus interest. Moreover, this guarantee is based on a direct guarantee by the U.S. Treasury Department, still the highest rated institution in the world today.

Advantage #2. Exempt from local and state income taxes. This is a significant -- but little known -- advantage that Treasury bills offer, which CDs and other bank accounts do not offer.

Advantage #3. Extremely liquid. If you want to sell your Treasury bills before maturity, you can do so in a very active, highly liquid secondary market. And with a Treasury-only money fund, you can move even more swiftly.

Advantage #4. Rising yields. Each time the Fed raises its rates, your yield goes up promptly. You're never locked in to old, lower rates. And right now, the T-bill rate has risen to the point where it covers the loss in purchasing power that you suffer with consumer price inflation.

The most efficient way to buy Treasury bills is through a Treasury-only money market fund.

You can withdraw your money at any time via wire transfer. You can write checks against your money fund shares and continue earning interest until the checks clear. Plus, in comparison to banking fees, the fees charged by most money funds are far lower.

Our favorite Treasury-only money funds, in alphabetical order, are:

American Century Capital Preservation Fund (CPFXX; 800-345-2021)
Dreyfus 100% U.S. Treasury Fund (DUSXX; 800-645-6561)
Fidelity Spartan U.S. Treasury Fund (FDLXX; 800-544-8888)
USGI U.S. Treasury Securities Cash Fund (USTXX; 800-873-8637)
Vanguard Treasury MMF (VMPXX; 800-662-7447)
Weiss Treasury Only Money Fund (WEOXX; 800-430-9617)

Second, Put Some of
Your Money in Gold

If you've been following our gold and gold stock recommendations, your profits should already be impressive. And you have the potential to repeat the performance -- or better -- even if you start right now.

Consider streetTRACKS Gold Trust (GLD). This is the large, widely-traded exchange-traded fund (ETF) that tracks the price of gold bullion.

Until this ETF was available for purchase in U.S. markets, the only way you could directly invest in the yellow metal was by buying gold bars or gold coins, incurring annoying storage and insurance costs. Now, however, you can effectively buy or sell gold just like you buy or sell any major stock. The price of GLD is set to one tenth of the price of an ounce of gold bullion.

Third, Maintain a Stake
In Energy Investments

There are also quite a few exchange-traded funds that are dedicated to the energy sector:

Oil Service HOLDRs (OIH) focuses on companies that provide drilling, well site management and related products or services for the industry. It's the second-largest among the six energy ETFs, with a total market capitalization of over $1.74 billion.

SPDR Energy (XLE) invests primarily in energy companies that develop or produce crude oil and natural gas. With a market capitalization of over $2.6 billion, it's the largest and most liquid of the energy ETFs.

PowerShares Wilder Clean Energy (PBW) is quite different from the other two, focusing on alternative energy. It's based on the WilderHill Clean Energy Index -- typically renewable sources of energy and technologies. The fund is still small but growing nicely.

This gives you several alternatives. Plus, it should give you a good balance between safety and inflation protection.

Good luck and God bless!