Dear member,

A resolution, of some degree, to the Fiscal Cliff will likely occur before year end, if not immediately in January. Furthermore, increasing the debt ceiling is a foregone conclusion and should result in a significant rise in precious metal prices. With these two issues out of the way, the low interest rate, stimulus heavy environment, led by the Fed, should usher in a period (3-6 months) of more stable and predictable economic news. In this week's Volume we aim to bridge the gap between central bank actions and your personal investment strategy heading into 2013.

More than two years ago, on September 8th 2010, the Bank of Canada (BOC) increased its target for its overnight lending rate from 0.75 to 1.00. It has stayed at 1% since then. The next interest rate announcement is January 23rd and in all likelihood, nothing will change.

Why the BOC Lending Rate will Remain at 1%

The greatest influence on Canada's monetary and economic policies are derived from the economic activities of its largest trading partner, the United States. With over 50% of Canada's trade occurring with the US, we are talking about hundreds of billions of dollars in annual GDP between the two nations.

The Federal Reserve has recently vowed to maintain interest rates at record low levels until unemployment drops below 6.5% or there is evidence of increased inflation. The Fed had previously guaranteed rates near 0% until mid 2015, but now it is saying rates will stay at these levels until unemployment drops to 6.5%. It could take several years to hit that employment target (much past 2015) and the Fed is well aware. This strategy adopted by the Fed has major implications for the BOC and its monetary decisions moving forward.

Because of the Fed's prolonged strategy of cheap money, the US economy is now addicted to low interest rates. Barring extreme inflation, it will be very difficult for the Fed to raise rates much at all in the coming years, unless it wants to create a recession or potentially worse. With the unemployment rate still flirting with 8% and no signs of any significant inflation (according to the Fed's calculations) or robust activity from the US economy, rates will remain at exceptionally low levels.

Recent reports show that both the headline and core PCE inflation remain comfortably below the Fed's goal of 2% (at 1.7% and 1.6%, respectively), while the unemployment rate remains unacceptably high at 7.7%. Furthermore, this unemployment rate is simply inaccurate as tens of millions of Americans have either given up looking for a job or are now working reduced hours. The shrinking labour pool is the only reason the unemployment rate was diminished slightly in the months leading up to Obama's re-election.

No Choice

The Bank of Canada has no choice but to maintain rates at rock bottom levels or risk derailing its own fragile economic recovery. The Loonie is continuing to perform well against the USD even with Canada's key lending rate at 1%. Could you imagine what would happen if the Bank of Canada began raising rates? Trade with the US would slow, the Loonie would rise much further and corporations would be crying out, begging Ottawa to slash rates in order to prevent layoffs.

Loonie vs. Dollar

source: BMO Capital Markets

The Impact of a Strong Currency

source: BMO Capital Markets

Every country wants a strong currency, but when your big competitors or biggest trading partner is devaluing its currency, it can be deadly for exports and GDP. The Canadian dollar was above par as of this writing and it continues to hamper trade between Canada and the US - as seen in the above Auto Industry chart.

These types of charts foreshadow the pressure Canada's central bankers are facing. If you think Canada can excel and prosper with a Loonie trading significantly above par, think again.

The Fed Raises the Ante

The US government and the Federal Reserve are flat out taking the route of inflation in order to avoid bankruptcy. The US Treasury Secretary recommended completely doing away with the debt ceiling. Forecasters are predicting that in 2013 the Federal Reserve will buy upwards of 90% of all new US issued debt!

Bernanke proved us all right on Wednesday when he announced the Fed will make additional asset purchases after Operation Twist expires. He announced that the Federal Reserve will buy $85 billion per month in mortgages and Treasury bonds to stimulate the US economy and keep borrowing rates at all-time lows.

A survey of 18 primary dealers, reported by Bloomberg, believe the government will reduce net sales of all Treasury securities by $250 billion in 2013, from the $1.2 trillion of bills, notes and bonds issued in fiscal 2012 ended Sept. 30. However, in reality, it is highly unlikely to happen given the country's stagnant economic growth. It is particularly unlikely when the Fed enables out of control spending by the government by purchasing 90% of all its new debt...

The Fed, in its efforts to boost growth, will add roughly $45 billion of Treasuries a month to the $40 billion in mortgage debt it's currently purchasing. At $85 billion per month in bond or mortgage asset purchases, this would effectively absorb roughly 90 percent of net new dollar-denominated fixed-income assets. The Fed is not only the largest buyer in the US Treasury market, but in reality, is the only significant participant.

$85 billion might not sound like a huge sum in this modern era of monetary recklessness, but when looked at over time, we are talking about over $1 trillion being added to the Fed's balance sheet in the next year. The Fed's balance sheet currently sits at $2.8 trillion. This is a hugely aggressive stance the Fed has taken and is extremely dangerous. The Fed has run out of short-term bonds to sell and is now buying long-term government bonds to maintain low interest rates. The Fed will continue to buy $40 billion in long-term mortgages as well. It is getting desperate and will clearly stop at nothing in its attempt to stimulate the economy, but more importantly, keep rates low and prevent a complete collapse.

If rates rise, it is game over as hundreds of billions will be owed in interest alone on the US debt, which has rocketed through $16.3 trillion and is now bumping up to the debt ceiling (yet again).

The Fed has to keep interest rates low or close to 0% in order to allow its balance sheet to expand by the cheapest means necessary. This is forcing countries to take on more debt in order to maintain a competitively valued currency. This is another reason we are seeing record central bank purchases of gold in 2012.

Focusing Back on Canada

The Bank of Canada recently reported that Canadian exports are expected to pick up gradually, but continue to be restrained by weak foreign demand and ongoing competitiveness challenges. 'Competitiveness challenges' is code for explaining the side effects of a strong Loonie. Challenges outlined include the persistent strength of the Canadian dollar, which is being influenced by safe haven flows and spillovers from global monetary policy. This is yet another reason why the BOC has its hands tied and will not raise rates.

In regard to inflation, the risk remains muted. The Bank of Canada reported that both total and core inflation are expected to increase and return to 2 percent over the course of the next 12 months. This is expected to happen as the economy gradually absorbs the current small degree of slack, the growth of labour compensation remains moderate and inflation expectations stay well-anchored.

The Bank of Canada also stated that, "Over time, some modest withdrawal of monetary policy stimulus will likely be required, consistent with achieving the 2 percent inflation target. The timing and degree of any such withdrawal will be weighed carefully against global and domestic developments, including the evolution of imbalances in the household sector."

This tells us that money, both in the US and Canada, will remain cheap and accessible to those with appropriate credit. At some point this period of uncertainty will be replaced with one of inflation fear - which will result in a significant market rally across the resource sector, especially in the beaten down juniors.

There is an inflation monster brewing at the Federal Reserve and before long it is going to break out, potentially leading precious metals to new all-time highs.

We have taken meetings over the last several weeks with some stellar management teams, involved in previous buyouts, to find out what they are working on in 2013. These management teams have raised several million dollars over the last couple months as they look to make 2013 a banner year. And given their track record, it's no surprise they were able to raise significant amounts of capital in this market while many others can't. Aligning ourselves with past winners actively engaged in advancing projects and innovative technology is our primary goal for the coming year. With the current, low valuations within the junior market, we are anxious to get things rolling in 2013 and introduce you to some of our findings. There are some great opportunities out there.

All the best with your investments,

PINNACLEDIGEST.COM