— reporting from Rome, Italy

Does America want members of the 17 eurozone countries to go bankrupt one by one? If only a few went under, the American currency would win the currency wars and reaffirm itself as the reserve currency of the world.

If you were someone living outside the U.S., wouldn’t this sound like a “secret” strategy that could work? After all, are not all the major credit reporting agencies (that grant credit ratings to European countries) subsidiaries of major American corporations?

These are the suspicions I’m hearing from people here in Rome.

Let’s give the theory some further attention and you’ll be surprised at what we find…

When we look at the rising national debt of America, by the end of this decade, the debt-to-GDP ratio of the United States will surpass that of a number of European countries. Why, despite a never-ending rise in our total debt, are U.S. bonds not referred to as “junk” when so many other European countries, with better debt-to-GDP ratios than America, have their bonds considered junk?

On July 25, 2011, Moody’s Investors Services downgraded Greece’s sovereign credit rating by three notches to what is referred to as “Ca,” very risky.

In an ideal situation, here is what happens…

The American dollar is devalued over the next three to five years, so the U.S. is paying back its trillions of debt owed to foreigners with cheaper money.

The euro totally collapses over the next three to five years. With no euro, the greenback, although devalued, survives, as Europeans want American dollars, not Japanese yen or Chinese yuan.

Great idea, if you can pull off.

Under the scenario above, the snowball job of convincing two-thirds of world central banks that the U.S. dollar should be the reserve currency of those central banks continues.

But two problems arise…

Firstly, about 21% of the revenue generated by S&P 500 companies comes from Europe (according to Bloomberg). If the euro currency is devastated, the earnings of the major American companies will be as well, pushing stock prices lower.

Secondly, the rise in the price of gold bullion from $300.00 an ounce in 2002 to approximately $1,600 today is telling us a different story. There could be a new currency in town. Or, at the very least, there could be a new currency permanently tied to the price of gold.

Euro or no euro, American dollars partially backed by gold again…I easily see this in the cards. That’s the best advice on investing in gold or gold advice I can give.

What He Said:

“Any way you look at it; the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in PROFIT CONFIDENTIAL, August 27, 2007. “As for the stock market, it continues along its merry way oblivious to what is happening to homebuyers’ wealth. (Since 2005 I have been writing about how the real estate bust would be bigger than the boom.) In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed. History has a way of repeating itself.” Michael Lombardi in PROFIT CONFIDENTIAL, November 21, 2007. Dire predictions that came true.

Just imagine…

It’s 2012 and the world realizes the euro can’t make it as a currency. Greece, Portugal, Spain and Italy have all been repeatedly bailed out. Germany and France have had enough. They tell these weaker countries to get out of the euro or Germany or France will go it alone.

Meanwhile, in Canada, the air has finally been released from its overheated housing market and the economy is on shaky ground for the first time in almost 20 years. In the U.S., years of printing money are causing rapid inflation. Interest rates are rising, as investors want higher and higher returns from U.S. Treasuries. Debt has become a big problem for states and municipalities. The sovereign debt issues of Europe have crossed the Atlantic.

By late 2012/early 2013, countries around the world are in a race to devalue their currency. So they come up with any idea.

The central bankers of the G7, or maybe even the G20, meet to discuss an across-the-board devaluation of world currencies. But if massive currency devaluation is going to happen, what will be the reserve currency?

It can’t be gold, because there is not enough gold in the world to satisfy the reserve, even if the price is $3,000 by 2013. America joins China in making a new reserve currency composed of U.S. dollars and Chinese renminbi, 20% backed by gold.

Could this happen? Let’s put it this way: while I don’t have a crystal ball, I’ve seen stranger things happen. What I do know is that, sooner or later, something has to give with the euro and the greenback. That’s what the 10-year bull market in gold bullion has been telling those who listen.

Michael’s Personal Notes:

There is so much to say this morning, so much to write about. Fortunately, most of the action is happening outside the United States.

Moody’s Investors Service cut Portugal’s long-term government debt credit rating to junk status yesterday afternoon. Greece, Portugal, Spain, Italy…they are all in trouble. While just Greece and Portugal have “officially” had their credit ratings slashed, I predict Spain and Italy are next.

The entire euro region, except for Germany, is in trouble. And I don’t want my readers to underestimate how fast those troubles could spread to North America.

From the other side of the globe, this morning, we get the news that China has raised its benchmark interest rate for the third time this year, as inflation is accelerating at its

fastest pace in China since the summer of 2008. (So much for the naysayers who said China was a bubble about to collapse.)

In China, a one-year deposit with the People’s Bank of China pays 3.5%. In the U.S., a one-year T-bill pays about one-twentieth of that, 0.17%. You really need to ask why foreigners would buy U.S. Treasuries. The answer: I believe they are buying less and less of them.

Whenever we hear news of another euro country facing sovereign debt issues, we see investors in those countries run to U.S. bonds as a safe haven. Between those buyers and the Fed, the demand for U.S. Treasuries continues…that’s until the world wakes up to America’s own sovereign debt problems.

Where the Market Stands; Where it’s Headed:

On May 20, 2011, my lead article in PROFIT CONFIDENTIAL was “Dow Jones 13,000; Why It Will Become Reality.” I’m sticking by that prediction for these simple reasons:

Monetary policy remains very accommodative. I believe the government and the Fed remain ready to do whatever it takes to stimulate further should the economy lapse back into recession. Yes, the economy is in trouble, but corporate America continues to churn out profits. The number of stock advisors bullish on the market is relatively low—there isn’t a lot of optimism in the marketplace, which is good for stocks.

After a correction that took the Dow Jones from 12,876 on May 2 to 11,875 on June 15, I believe the bear market rally is set to give us a final blow on the upside.

Please, don’t get me wrong. My opinion is that we are fully entrenched in a bear market that has yet to enter the dreaded Phase III. But I see this bear market luring more investors back into stocks before taking their money away again.

The Dow Jones Industrial Average opens this morning at 12,569, up 8.6% for 2011 and only 430 points away from the 13,000 target I discussed above.

What He Said:

“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour waits…people are spending in America today at an unbelievable clip. 1932, 1933… who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

I have to tell you, I thought it would be Spain. My thinking of the order in which the sovereign debt crisis would engulf Europe was first Greece, then Spain, then Italy.

But it looks like I was wrong. Italy, home of my favorite Italian wine, is next.

It all started on June 18 when Moody’s Investor Services said that it was weighing whether to cut Italy’s credit rating. Since then, government bond yields have been rising in Italy.

Italy has regained only a small fraction of the gross domestic product (GDP) growth it lost during the global recession (Italian GDP in the first quarter of 2011 rose only one-tenth of one percent over first-quarter 2010 GDP). Unemployment is high. Interest rates are rising and a sex-scandal-plagued Silvio Berlusconi is occupied with trying to maintain his position as Prime Minister as uncertainty over his capacity to govern rises.

Here’s why I believe the sovereign debt infection is spreading to Italy.

Yesterday, the shares of Italy’s forth largest bank, Unione di Banche Italiane, fell five percent to 3.63 euros—below what it had priced its shares in a one-billion euro rights offering it was trying to close yesterday.

The stock price of Italy’s largest bank, UniCredit, was down about nine percent yesterday. Intesa Sanpaolo, the country’s second largest bank, saw its stock price tumble seven percent yesterday.

When the stock prices of major banks fall so quickly, investor panic usually sets in. And that may be the situation in Italy right now. Moody’s Investor Services said Thursday that it may downgrade the credit rating of 13 large Italian banks.

It looks like the bond vigilantes are closing in on their next target. Poor euro; how will it ever get a break?

Michael’s Personal Notes:

What a day for the stock market Thursday…

First we had the International Energy Agency (IEA) announce that it would release 60 million barrels of oil into the marketplace. That pushed stock and commodity prices severely lower. Then Greece announced that it has struck an austerity deal, which brought stock prices back the other way.

Why the IEA is releasing so much oil is a mystery to me. I’ve read all the news reports last night and this morning, but I just don’t get it. This oil is being released from “emergency oil supplies.”

Some reports said the oil was being released to reduce the shortage of oil caused by loss of production in Libya. But the market reacted as if this was an oversupply situation. After all, Saudi Arabia is increasing its oil production to near record daily levels.

There are obviously some political motives behind the scenes here…so I’ll just leave it at that.

But for investors, I see opportunity. Gold bullion was down over $30.00 per ounce yesterday. I haven’t seen that kind of downside movement on gold for months.

But when I looked at my gold stocks, I noticed that they closed Thursday at the same level they closed Tuesday. Gold stocks holding steady while the yellow metal falls in price?

As I have been writing for a few weeks now, the share prices of gold exploration and development companies are forming a base here. Yesterday’s sharp pullback in gold bullion’s price was a good indication that the gold stock prices are near their bottom. If this was two months ago, and gold was down $30.00 an ounce, gold stock prices would have pivoted downward quickly.

Where the Market Stands; Where it’s Headed:

Let them release 60 million barrels of oil, let Greece and Italy fall. It doesn’t matter to this bear market rally. No matter how bad the news gets, the market continues to trade above its 200-day moving average—a big technical positive for stocks.

Stocks love to climb a “wall of worry.” And we seem to have plenty of that around lately. I’m sticking with my guns: The bear market rally that started in March 2009, although tired and long-in-the-tooth, still has life left in it.

What He Said:

“What group of stocks is next to fall in light of the softening U.S. housing market? The stocks of companies that sell retail products to the American consumer, I believe, are next on the hit list. Many retail stocks are already reporting soft sales. In my opinion, they haven’t seen anything yet in respect to weaker sales.” Michael Lombardi in PROFIT CONFIDENTIAL, August 30, 2006. According to the Dow Jones Retail Index, retail stocks fell 42% from the fall of 2006 through March 2009.

While perusing weekend financial press, I could barely smother a chuckle. Again the economists and various experts are puzzled over how something relatively small, and thus presumed insignificant, can threaten to bring down an entire institution. The first time this question arose three years ago, it was the U.S. subprime mortgage mess that had almost choked the global economy to death. This time it is tiny Ireland with a population of less than five million that is threatening the survival of the entire Eurozone.

Things are rarely simple just because their size causes the assumption of insignificance, but poor Ireland is merely the latest catalyst to a much larger issue that has been the root cause of most of the economic misery of the past two years: bankers’ greed. Unlike Greece, Ireland’s government did not bring its citizens to ruin. It was the lenders who had overextended themselves, lending irresponsibly to everyone and anyone asking for a loan, completely ignoring even the most blatantly obvious risk flags.

This has been debated long and hard: the reckless abandon of risk management on the global level, as well as how wild lending is even possible after the fall of Lehman Brothers. Most have thought the issue of risk management, or lack thereof, resolved. Only, the problem with reactive measures is that they cannot erase what has happened before or the fact that there are no easy and fast fixes of systemic problems.

The systemic problem that has obviously been systematically ignored is that Eurozone lenders, just like the U.S. subprime lenders, have enjoyed lax supervision for so long that losing perspective was easy. The problem was further exacerbated by the fact that the Eurozone has attempted one economy and one interest rate without accounting for the impact of separate tax regimes and the vastly different spending habits of citizens of individual European Union (EU) members.

A comparison between Ireland and Germany provides for a quick litmus test. Germans are well aware that their industry has matured and that, as a behemoth, it cannot move fast. That is why Germans would rather save than spend. The Irish, in contrast, love to go on fancy shopping sprees, courtesy of the cheap euro, regardless of whether they can actually afford them or not. In the end, Ireland’s government, although not directly guilty, other than perhaps by being willfully blind, had to ask for the EU’s help to rescue its irresponsible banks. Making things exponentially worse is the fact that Ireland’s bailout and relying on short-term loans could export its crisis to other vulnerable states in the Eurozone. The trouble not just with the Eurozone but the entire global economy is that everything is so interconnected, so a single stone thrown into the pond can have powerful ripple effects.

Perhaps the German chancellor Angela Merkel is onto something more than a “share the pain” lesson with her propositions to inflict some of the pain on future sovereign debt-holders, and not only taxpayers, and certainly not only the German ones. This seems to be a case of simple mathematics. It does not seem likely that either Greece or Ireland can continue financing themselves without robust economic recovery and without increasing their revenues through taxation, neither of which is forthcoming or easy. So how will they pay off the bailouts and continue to attend to their long-term debt?

Not without miracles. Germany wants future holders of the Eurozone’s sovereign debt to take haircuts in case of defaults when buying the risky treasury bonds of countries such as Greece, Ireland or Portugal. Who would buy such bonds, considering the excess of risks that accompanies them? Perhaps only speculators could show some interest, but at exorbitantly high costs of borrowing. Eventually, when houses of cards start collapsing, stronger players in the Eurozone might finally “see” what Germany has been harping about for months and expel those who cannot afford their EU membership, leading to the Eurozone’s potentially unavoidable shrinking. Perhaps this is Merkel’s ultimate goal, perhaps it is not, but it should certainly give the Eurozone and the rest of the world pause.

The sovereign debt issue has to be put to bed for stock prices to really accelerate in a meaningful way. It may take fourth-quarter earnings season to get investors distracted from the issue, but it has to be dealt with in order for equities to begin a sustainable new trend. This is a lingering issue and will remain a significant risk to global capital markets over the next few years. Governments just have too much debt and large, annual deficits for any investor to disregard the issue. Someday it will become a currency breaking event if not dealt with.

In this equity market, it’s pretty clear that China is running the show now. By this I mean that domestic and foreign equity markets are trading off China’s economic data. That country’s stream of news is now a leading factor shaping domestic investor sentiment and it’s now affecting day-to-day trading action.

One of the things we have to keep in mind as investors is that the stock market always likes to speculate on the future. This means that stock prices can go up, even when unemployment goes up or housing prices go down. This is what’s happening right now. The key going forward is corporate earnings and the outlook for corporate earnings in 2011. Currently, the outlook is quite favorable and many large-cap businesses cited improving business conditions in the third quarter.

In the absence of earnings reports, the market does tend to overemphasize other news, because it has no choice. But, the most important news we can go on as investors is what corporations say about their businesses. The investing marketplace is a fickle bunch and memories are very short. Domestically, all you really have to do is listen to what the railroad companies are saying and you’ll have a great sense as to the current state of things.

The stock market can experience solid near-term uptrends in an environment that’s full of confidence-sapping investment risk. There’s a reason why individual investor participation is low in equities and it’s that there’s no real certainty to go on. There’s no defined trend to latch onto (other than gold) and individual investors are rightly sitting on the sidelines.

In the majority of cases, all the action that European leaders have taken to get a handle on the sovereign debt crisis has been met with selling by large, institutional investors. I wouldn’t be surprised at all that a whole new set of rules is created over the next few years to govern the euro currency and a new central bank for the entire block. Without it, the currency may very well come apart and create havoc in global capital markets.

It’s comedy hour again in Europe.

This morning, we wake to news that, according to Eurostat, the European Community’s statistics office, Greece’s debt has been revised to 127% of GDP. Ireland is being pushed to accept a bailout from the European Economic Community. Some key government people in Italy quit this morning amid cries for Prime Minister Berlusconi to quit.

Given what is happening in Europe, is it any wonder the greenback rallied two percent on Friday?

No breaking news from Spain and Portugal today, but there is enough bad news coming out of Greece, Ireland and Italy to keep the euro under pressure. (As a side note: I would not be surprised to eventually see Germany leave the euro and head back to its own currency.)

Looking at the securities issued by the governments of the troubled European countries, their bonds yield between 7.0% and 8.5%. In the U.S., a country that I believe in the long term is headed down the same path as some of the debt-ridden European countries, investors are buying U.S. government five-year bonds for a yield of only 1.46%.

In the same way I couldn’t understand why investors were jumping into NASDAQ stocks in late 1999, I can’t understand why people are willing to buy U.S. Treasuries today at such paltry returns, given the financial condition of the issuer. (We all know what happened to the NASDAQ 100. The index is still down 50% 10 years later.)

But cracks are starting to show in the lining of U.S. bonds. The yields on five-year U.S. Treasuries have been rising for two weeks straight now.

Going back the “joke” Euro countries…

How the wheel is working could not be clearer. The euro falls in value on poor economic news coming out of Europe, the U.S. dollar rallies, and gold goes down in price. This is what the “joke” European countries have to do with gold. And this exactly what happened on Friday. The euro got whacked, the U.S. dollar rallied two percent and gold bullion fell two percent in price.

At some point, it will not matter what the news is in Europe. The U.S. will have its own comedy running and its currency will weaken on its own without help from Europe. An ever-increasing money supply and no real effort to put the brakes on government spending can only lead to higher U.S. domestic interest rates and a weaker greenback.

As has been the case for the past 10 years, I see any weakness in the price of gold bullion as an opportunity to further accumulate the metal.

Michael’s Personal Notes:

As demand for General Motors Co.’s public offering is stronger than was expected (it looks like GM will be a public company again in about a week), we get news that foreigners will end up owning about 16% of GM once the shares start listing.

The U.S. and Canadian governments took a gamble with public money and funded GM through its bankruptcy to the tune of $50.0 billion. The government will get a good portion of that $50.0 billion back when GM is listed. And this year, GM will return to an annual profit after five consecutive years of losses.

As with many of this country’s great assets, foreigners are continuing to buy them up, as the balance of power moves from the west to the east. America stopped being the biggest auto market years ago. China is not only the world’s biggest market for cars today; it is also the fastest growing market.

The shift of power from the west to east continues…and there is really very little that can be done about it. All great empires eventually fall, and with the fall, their currencies erode. This is the zest of what we are seeing with the deteriorating condition of the greenback today.

Where the Market Stands, Where it’s Headed:

Investors are getting nervous. It’s been about a week that stocks have stopped rallying. Relax, I say. A week’s worth of trading does not make a new trend.

Up 14% since the end of August, the stock market was due for either a correction or some profit-taking, or maybe both. In reality, the market has not corrected on the downside by much yet, and this is what I’m really looking for. Will we get a meaningful correction in stock prices here or not? I have yet to see it.

Until proven otherwise, I see the bear market rally in stocks that started in March of 2009 intact.

What He Said:

“Overbuilt, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, April 3, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008, long before anyone else

It wasn’t too long ago that global investors were sending stock prices lower based on debt concerns in Europe. This very real issue hasn’t gone away; it’s only begun to be addressed by politicians, and there’s a lot more work to do. Now the issue is affecting Ireland, and it’s my strong feeling that we cannot ignore this risk to your investments.

If the commodity price cycle is going to be the big story this decade, then debt/currency issues will be the biggest threat to global financial stability. It’s a boring subject for most people, but sovereign debt (including the U.S.) has the very real potential to create significant currency instability going forward. Major currency changes are already afloat. In the past, big currency fluctuations have proven throughout history to wreak havoc on investor pocketbooks.

It was only back in August that sentiment among equity investors was so bad that not even the best corporate event could shake institutions into buying shares. Now, everything seems rosy again thanks to our good friends in the money printing business. This is a false sense of long-term security.

I don’t want to be in the business of predicting the stock market as a whole. The action is the action. There’s no right value for an equity security or an entire market, so why go around worrying about it. All the numbers do is reflect the perception of value at a given point in time. Being one who’s usually fully invested, I’ve ridden the same rollercoaster that most people have. But, I’ve also learned over the years that investment risk is just as important as the potential return on your investments. In this market, a good dose of protection is a worthy strategy.

Everyone in the equity speculation business has a short memory, with both winners and losers. Once in a while, a big risk can sit stewing and then come back to bite everyone in the “you-know-where.” I think that big risk is sovereign debt and it has the potential to break the euro in two and create a serious tidal wave of negative sentiment in all capital markets. It’s something that equity speculators need to keep in the back of their minds if they’re thinking about jumping on the current bandwagon in stocks.

It isn’t fun thinking about risk. It’s way more fun to think about potential return. But, with the right assets in your portfolio, you can mitigate risk to a significant degree. From my perspective, we’re in a bull market for commodities, not equities. I can’t predict where the broader market is going to go over the next couple of years, but I do know that I want to hedge my bets and own real things like gold and fertilizer. It’s a back-to-basics investment strategy that reflects the fundamentals in this new age of austerity.