It’s been a wild ride this past year, but the markets are now on the upswing. Following a rough year where most of the markets dropped sharply, then stayed dull for a while, they’re finally headed higher. Most important, these are significant rises.

GOLD ON THE RISE

Gold, for instance, surged about $100 last month and, despite normal ups and downs, a renewed rise within its major bull market is clearly underway. This is being reinforced by the U.S. dollar, which is starting to break down, signaling that a bear market decline is just getting started. That is, the currency markets are up and so are commodities in general.

Stocks around the world have been generally moving up too. Bonds, however, are down significantly as long-interest rates head higher. At the same time, short-term rates keep falling (see Chart 1).

What does this mean?

First, it means that many of the major trends are changing. The U.S. dollar is going to fall further, while gold, silver and some of the strongest gold shares will continue to move higher. That’s also true of the major currencies, as well as the global stock markets. These should all do well in the months ahead, and probably beyond.

Second, the decline in the dollar is very important. It means that investors are beginning to feel safe again and they see no need to hold dollars as a safe haven, like they did before when the crisis was intensifying and people were running scared.

On the contrary, investors are coming to their senses. They see that this year’s budget deficit is going to reach about $2 trillion and the dollar can’t hold up under the weight of this large debt. Investors are returning to the fundamentals and they know that all of this easy money is going to result in inflation. That’s why bond prices are falling too because they’re very sensitive to inflation.

PLUNGING LIBOR RATE: A banking recovery sign

The Libor interest rate has plunged for a different reason. This rate has its pulse on the global banking system and when trouble became apparent to everyone, and things were at their worst, the Libor rate soared to near 6%. Now that it’s way below 1%, it’s telling us that the banking recovery will likely continue.

Remember, the markets tell the story. They always lead the economy. More important, the markets are now all in synch and they’re telling us the same thing. It’s a fascinating message and a fascinating time.

Stocks, for instance, have been moving up, signaling the economy is going to get better. The global stock markets are reinforcing this. The rise in commodities and gold is another indication that the worst is behind us, and so is the fact that silver is stronger than gold.

These markets are all pointing to no deflation ahead. In fact, by moving higher, the likelihood of a recovery is increasing, followed by eventual inflation downstream.

INFLATION / DEFLATION DEBATE

Meanwhile, the inflation-deflation debate rages on. Many are convinced that deflation and/or a depression is not only likely, it’s inevitable. The main reason why is due to the massive magnitude of the current crisis since it cannot be compared to most other crises or recessions, which pale in comparison.

While that’s true, the markets are saying something else. And we learned a long time ago to never underestimate the power of the markets. In other words, it would be foolish to ignore their message.

We humans have a tendency to hang onto our preconceived notions. That’s fine but it’s also important to keep an open mind, especially when it comes to the business of investing. Be flexible and regardless of what your personal future scenario is, don’t fight the market trends.

Keep in mind, markets will turn up when the general feeling is negative and skeptical. The news usually improves later, and all of the reasons why the markets are moving the way they are will become obvious with time.

REPERCUSSIONS STILL TO COME

There’s no question that this crisis has been the worst since the Great Depression and downright scary, which is something most of us have never experienced. The entire financial system was on the brink of disaster and an unprecedented amount of wealth was destroyed worldwide. The deflationists argue that this cannot improve so quickly and the worse is still coming. That could be true but if that’s what the future holds, it doesn’t look like it’s going to happen in the near future.

We’d be the first to agree that the fundamental problems are extremely serious but we also understand that the monetary response to these problems has been mind blowing. The amount of money involved is hard to grasp. This has not been a normal response to the crisis. It’s been overkill, so it’s quite possible that things will improve from here as an effect of this monetary overkill, at least for the time being.

As our friend Bill Bonner points out, “this monetary response has been three times more (adjusted to today’s dollars) than the U.S. spent to fight World War II. It is 12 times more (relative to GDP) than the total committed to fight the Great Depression.” That’s a lot of firepower and it certainly provides food for thought.

Plus, we’ve noticed that sentiment is beginning to change and that’s half the battle. We were recently in the U.S. and we were surprised to see people shopping, eating out and spending. That coincides with the strong rise in consumer confidence and it’s a huge change compared to just seven months ago when people were as gloomy as they could be.

Aside from better markets and a few signs the economy appears to be improving, we also recently saw an inflationary straw in the wind. Import prices soared at a 19% annualized rate. And while one month does not establish a trend, this is probably the first sign of what’s coming and it’s well worth watching.

WHEN CHINA TALKS, IT PAYS TO LISTEN

Then there’s China. Regardless of how you feel about China, you have to admit that they are money savvy. In less than half a generation they’ve transformed China from a poor rural country into one of the world’s richest and most powerful. This is simply amazing, so it pays to watch what China is doing.

Currently, China is concerned because it has too many dollars and U.S. bonds. China is also concerned that the Western monetary stimulus is going to trigger global inflation, along with weak bond markets and a falling dollar, so it’s taking action.

China is cutting back on their U.S. bond purchases and they’re buying gold in significant amounts. China has increased its gold reserves by an impressive 76% in the past six years. This is obviously to hedge against rising inflation and a weak dollar, which explains why China is also buying commodities.

As the Royal Bank of Canada recently reported, “China is stockpiling global commodities such as copper and iron ore as part of a reallocation, amid concern that the value of its dollar assets may decline. It’s part of an overall desire to decrease its exposure to dollar assets.”

China is also expanding all over the world. China is buying land in South America and Africa, other metals, and they’re building up their reserves of other currencies and bonds. While they’re at it, they’re spreading goodwill.

We’ve seen a small sample of this first hand here in Costa Rica. The Chinese are here and, for starters, they’re building a new, modern, soccer stadium. The Costa Ricans are happy since soccer is their passion and based on what we read, this is happening all over the world.

Like we said, the Chinese are savvy and they’re patient. They see what’s happening and they’re acting rather than reacting, which is what many other nations are doing. The bottom line… aside from watching the markets, we’d keep watching China too, and we’d continue buying gold.