The Madness of Crowds: How to Play Bonds, China, and Gold in 2012

I read Charles Mackay's 1841 classic, "Extraordinary Popular Delusions and the Madness of Crowds" long before it ever became fashionable. Even so, when you think about it, 2011 must set some kind of record. As investors, that means we need to decide whether this madness will continue in 2012 and which direction to take. Take the madness in the bond world, for instance. Long-term bonds of a country with an out-of-control budget deficit and a worrying trade deficit are currently yielding 1.6% below inflation. In other words, year after year, investors are willing to pay 1.6% of their capital to hold them. On top of that, investors have been so keen on this miserable asset in 2011 they have bid up its price by no less than 26%. Conversely, China is revolutionizing the world economy. Year after year, China puts up growth rates of 8% or more, and the latest data suggest that will continue throughout 2012. What's more, Chinese stocks stand on a bargain-basement price-to-earnings (P/E) ratio of less than 8-times earnings. Yet, in 2011, investors shunned these bargains, giving the Chinese market a pathetic return of minus-22%.