Gold - the key to slashing government waste

How do governments compensate for the vast amounts of money they squander through inefficiency and incompetence? They simply create more - which would be impossible if we had an asset-backed currency.

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The first five trading days of this year have seen a rather nasty sell-off in stock markets worldwide. There is a widely-acknowledged link between what happens in the first five trading days, and the rest of the year. So are stocks doomed in 2008?

Let's look at the figures. A study of US markets has shown that in the last 36 up' Januarys (whenever the S&P rose in its first five days), it also rose for the year 31 times: that's 86% consistency. For the Dow Jones, meanwhile the consistency is about 73%.

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In the five times it did not happen, meaning when the S&P closed lower for the year despite starting the year on a high note, four of those years were extraordinarily bearish: 1966, 1973, 1990 and 2002.

So that's a pretty clear correlation in the up' years - what about the down' years?

When the S&P 500 rises in the first five trading days of the year, it's a pretty good bet that it'll end the year higher. However, when the first five days of the S&P 500 result in a decline, as has happened 22 times since 1950, the year-end results were split almost 50:50, sometimes up and sometimes down. So the good news is, this year's New Year slump doesn't mean stocks are destined to fall in 2008.

Of course, they're not safe either but while I am not overly bullish on stock markets in general, I do not think we are on the verge of a major crash. Though not particularly cheap, stocks are not horrendously overvalued either, as history shows they tend to be at major tops. (If it's horrendous overvaluations you're interested in, take a look at UK housing see MoneyWeek's recent property roundtable to learn how far house prices could fall: Are we heading for a house price crash?).

How the battle between inflation and deflation will hit markets

We are seeing a struggle between the inflationary policies of governments and central banks, as they inject vast amounts of liquidity into the system, and the deflationary, defensive stance of the private sector, as credit dries up and banks hoard cash and tighten lending.

This will undoubtedly make markets more volatile as sentiment swings from one extreme to another. But all that liquidity has to go somewhere, and much of it will end up in stocks. It would not surprise me to see new highs in the major global indices at some stage this year. Global government policy is highly inflationary and stock markets tend to go up under such pressures. In fact, the top-performing stock market in the world last year was, wait for it Zimbabwe!

I believe we are currently at the oversold end of the spectrum and short-term traders might consider going long but don't buy banks or builders. Junior mining companies remain cheap, but if gold corrects here, they will get cheaper. I recommend continuing to steadily buy in. They are still woefully lagging the performance of the underlying metal.

Elsewhere in the commodity sector, there is so much bullish talk about agricultural and soft commodities - indeed sugar looks like it is breaking out - that they feel a bit like uranium did this time last year. Let's hope for some similar action - but keep one eye on the exit.

Could gold-backed money cut government waste?

Elsewhere in the news, the papers are full of the Tories' new plans to clamp down on benefit fraud. The Welfare State is of course a supreme example of government hyper-inefficiency, wasting vast sums of money (a subject covered brilliantly in Matthew Elliott and Lee Rotherham's Bumper Book Of Government Waste' you can buy this at the MoneyWeek bookshop).

One of the ways governments compensate for their incompetence is simply to create more money to pay for it (see Northern Rock for example). This would not be possible if we had an asset-backed currency, because you cannot create tangible assets out of nothing. Gold imposes discipline; a discipline that those in power simply do not have.

If a politician here in Britain were to suggest a return to sound money as a cure for bloated-state-sponsored cock-ups, he would be laughed at. But as most people with an interest in India know, under British rule, the civil administration of the Raj was undertaken by a tiny corps, little more than 1,000-strong, of British and Indian civil servants: the Indian Civil Service, or ICS.

It was noted for its incorruptibility. Were these people really greater human beings than exist today? Perhaps, but unlikely. Did they work longer hours? Doubtful. Did they have computers and spreadsheets and printers and email? No. It is no coincidence that this streamlined government super-efficiency took place when the pound, the global reserve currency, was as good as gold.

Perhaps we should be taking more lessons from the past.

Turning to the wider markets

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Smith & Nephew leads FTSE into the black

In London, despite a late slide prompted by falls across the Atlantic, the FTSE 100 managed to end the day 20 points higher, at 6,356. Defensive stock Smith and Nephew, maker of medical devices, topped the leaderboard and was closely followed by pharmas GlaxoSmithKline and AstraZeneca, also in demand thanks to their defensive properties. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 added 42 points to end the day at 5,495. Media stocks led the way on news that President Sarkozy may ban advertising on public sector television, thereby boosting ad revenues in the private sector. In Frankfurt, the DAX-30 added 32 points to close at 7,849.

On Wall Street, the Dow Jones gave up an early 100 point lead before plunging 238 points to close at 12,589. Mortgage lender Countrywide led the index lower with a 17.2% falon fears that it may file for bankruptcy. The tech-rich Nasdaq was down 58 points at 2,440. And the S&P 500 was down 25 points, at 1,390.

In Asia, the Japanese Nikkei added 70 points to close at 14,599 as bargain-hunters stepped in following recent falls. And in Hong Kong, the Hang Seng was up 502 points, at 27,615.

M&S shares plunge on poor Christmas sales

Crude oil futures continued to climb this morning, and were last trading at $95.66 a barrel. In London, Brent spot was at $95.56.

Spot gold hit a new record high of $891.40 this morning, beating yesterday's new high of $881.10. And silver had risen to $15.95 an ounce.

Turning to forex, the pound was last trading at 1.9644 against the dollar and 1.3348 against the euro. And the dollar was at 0.6793 against the euro and 109.3 against the Japanese yen.

And in London this morning, shares in Marks and Spencer tumbled by as much as 18% - their biggest fall in 19 years - after the retailer announced an unexpected 2.2% fall in revenue over the Christmas period.

Finally, our recommended article for today...

Have stockmarkets set a losing pattern for the year?

- John Robson and Andrew Selsby think that the January barometer - that what happens in January is indicative of the year as a whole - is pretty flawed. However, some of the more reliable indicators around suggest that this year it could be proved right. To read their latest views on what to expect from stockmarkets in 2008, read: Have stockmarkets set a losing pattern for the year?

Do you really understand your investments?

- Anxiety about money is exceeded only by that for antisocial behaviour, immigration and terrorism, and it's especially high amongst the young. Tom Bulford suggests three ways to soothe our collective financial fears - starting with an end to jargon - here: Do you really understand your investments?