For more than a year, the “recovery” bounce in the stock market has refused to give up. The indexes have recovered more than 50% of what was lost. Technically, they look pretty good. What’s more, the S&P sells at more than 21 times normalized earnings, according to Robert Shiller’s latest tally. It seems like nothing can stop stocks now.

Then there’s the Treasury market. Overall, yields remain remarkably low. It is almost as if Treasury buyers are unaware that they are being asked to finance the biggest increase in sovereign debt ever. It doesn’t seem to matter either that many of the applicants for money will be incapable of repaying it. Several sovereign debtors, including the US, have already reached the “point of no return,” according to professors Rogoff and Reinhard.

Still, the financial press is optimistic. Economists are irrationally confident. Investors and advisors are overwhelmingly bullish. And the American public seems willing to add a trillion-dollar health-care program to its burdens – a sign of remarkable faith in the nation’s prospects.

So, let’s go back and reexamine our basic position. Is this really the “Great Correction” that we think it is?

If there is one lesson we’ve learned over the years, it is that we need to be patient. Things that have to happen generally do, sooner or later. You just have to wait. And when they happen, they generally happen much faster than you expected. Even when you’ve been expecting something for years, it can come and go before you realize what is going on.

You get used to being wrong…or at least premature. You wait. You watch. You think the time has come…and then: whoops…not yet. Pretty soon, you are overcome by anticipation fatigue. Then when the real thing finally does start to happen you don’t believe it. You wait to be sure…you hesitate…and then it’s over!

Just what am I waiting for? I’m anticipating more evidence of this Great Correction, including another big swing down in the real price of stocks, bonds and commodities…further deterioration in the real estate market…a falloff in consumer spending…and a higher savings rate.

I’m also expecting higher yields from government debt…and a dangerous intensification of financial problems in both the private and public sectors. If I’m right, those things must happen eventually. So far, we’re still waiting.

But this week the long-awaited turnaround in the bond market may have begun. Rates are rising along the entire yield curve, especially at the long end. “The bond market is now very close to saying, ‘We’ve had enough,’” predicts the octogenarian stock market technician, Richard Russell. The 30-year T-bond’s recent decisive move above 4.80% marks the end of a 25-year bull market in bonds, says Russell. Rates will be moving higher from here.

Investors are starting to tune into how sovereign debt works. And they’re starting to realize that even governments can default. In fact, almost all of them do default eventually. Yes, even governments whose debts are denominated in their own currencies default. And even when they have the power to print the currency themselves.

How could that be? Well, it is very simple and worth spending a little time on. I want to make two points:

First, governments will usually choose to default on their debt rather than risk hyperinflation of their currencies. Second, when they reach a “point of no return” they have no choice. They cannot cut back spending. Because even the most drastic cutbacks will not do the job. That would simply result in lower tax receipts and an even bigger deficit. At a certain point, the multiplier effect becomes the divider effect.

I’ve made the point many times that democracy seems hell-bent on self-destruction. America’s founding fathers noticed many years ago that when people realized that they could vote themselves money from the public treasury, democracy would be doomed.

Most people presume that if a politician offers benefits, “someone else” will pay for it somehow, someday. In practice, the money doesn’t come from additional taxes. Taxes are already, at least theoretically, at their optimal level. Higher tax rates produce lower economic activity, which lowers tax receipts. So instead of raising taxes, governments borrow the money. Then sovereign debt loads become larger and larger until, as Greece has recently discovered, they are impossible to carry.

America also has public sector debt problems – of about equal measure to Europe – and she has huge private sector debt problems as well. For the moment, the skies over the American financial markets are clear. But out at sea a hurricane is spinning faster and faster. There is a huge wave of debt defaults/foreclosures in the private sector that will hit the markets soon. This wave, combined with record borrowing from the US government, is bound to push up bond yields…making it harder than ever to get needed funding.

The situation with the US government is more complicated than it is with private borrowers – or even with Greece or California. The federal government can print money. But it, too, is ultimately at the mercy of the bond market. Last year Uncle Sam borrowed $2.1 trillion. This year it will borrow $2.4 trillion. Without this money, US government spending would have to come to a halt. The US counts on lenders. It needs lenders. Without them it would be forced to make cuts equal to about 10% of GDP. Think you’ve got de-leveraging now? Just imagine what that would do.

Typically, of course, government bond buyers don’t cut off a lender altogether. They merely demand a higher rate of interest to offset what they see as an increased level of risk. The higher interest rate adds to the borrower’s cost – increasing his deficit and forcing him to borrow more.

This is where it gets interesting. You might say that a government can “print its way out” – it can just print the money it needs rather than borrowing it. But what would happen if the US chose to print $2 trillion this year? It would risk hyperinflation. Lenders would run for cover. Prices would shoot up. The damage to the economy would be severe…so severe that only governments under extreme pressure – think Weimar Germany or Mugabe’s Zimbabwe – are willing to risk it. Instead, they try to muddle through, as Greece is doing now – promising budget cuts, making special financing deals and pushing up the rate of inflation a bit, but not so high as to cause panic in the bond market.

See, as long as the bond market permits it, debt levels continue to grow. But at some point – the point of no return – a government can no longer save itself from disaster. How does that work? Well, when deficit/debt levels are too high, the cuts necessary to bring the budget back in balance are so great that they squeeze the economy hard, reducing output and decreasing government’s tax revenues.

In this case, the government cannot escape. It has to print money. Or default. Most often, it will choose default, because it is the less painful solution. Either way, the government finds that it will be cut off from the bond market. Hyperinflation is merely an additional and unnecessary aggravation. (That said, I agree with Nassim Taleb, that hyperinflation remains an underestimated black swan risk.)

The underlying story of the economy has not changed. We are in a Great Correction. We don’t know exactly what it is correcting…but it looks as though it will at least reduce some of the leverage that has been added to American and British households over the last 60 years.

So far, the process is tentative…and unsure of itself. From a peak of 96% of household income in 2007 debt has fallen to…94%! The drop is so small that it makes you wonder if it is a trend at all. But if it is, it has a long way to go. Ten years ago – at the peak of the dot-com bubble – household leverage was only 70% of income. At the present rate it will take another 24 years to get back to 1999 levels.

Albert Edwards of Societe General has examined the non-financial leverage in the system. There is excess leverage of about 60% of GDP, he says. He calculates it will take a decade of “Japan-like pain” to eliminate it.

Either way, you’re talking about a long process of getting back to “normal.”

The Great Correction is also what is keeping housing and unemployment down. When the banks aren’t adding to the nation’s credit, you just can’t expect many new jobs or many new house sales.

Nothing has changed in the last week – except we have moved one week closer to whatever crisis lies ahead.

Bill Bonner
for The Daily Reckoning

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning .

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I’m a contrarian. When everyone loves gold, I hate it. When everyone hates the dollar, I love it. I called for a top in gold and silver and by inference, a bottom in the dollar, at the end of November 2009. I was immediately battered to death with criticism, threats and a public keelhauling by one of the manipulation crowd. The level of venom made it obvious to me that I was right. And of course, I was.

I won’t get bombarded this time, I’m telling people what they want to hear. And that’s a shame because people’s reactions are what tell me when I am right or not. I see the dollar getting toppy.

Gold has been interesting. It was really getting carried away and was a classic example of irrational exuberance by the 1st of December and screaming to correct but very few people saw it. The permabulls were calling it a Commercial Signal Failure. I don’t know what that means and I suspect they don’t either. They just made it up. They call it a Commercial Signal Failure every time gold hits a top. But they were screaming “Buy, buy.” I’d love to know how much money they lost their followers this time.

All markets, bear or bull, have regular corrections. Gold and silver are no exceptions. Gold had a perfectly normal and predictable correction. Gold is no more manipulated than any other financial market. Gold shares peaked in early December at the same time as gold. Gold shares are still exceptionally cheap in historical terms given that the POG is still very high. Any gold company that can’t make a lot of money at $1100 gold needs to be raising moose.

I think a top in the dollar is at hand. I’m not even sure it’s correct to say the dollar went up, in reality, the Euro went down. But as many problems as the Euro has, the British Pound and US dollar are going to crater as well. It’s just that in the race to the bottom, the Euro has on a temporary basis been going down faster.

I think gold has pretty much finished its correction, the permabulls are all muttering to themselves about manipulation. That’s always a good sign for gold. Gold shares are historically cheap, as cheap as they were in 2001 and 2002 with far lower prices for gold and silver. The number of visitors to our site is a great reflection of just how interested people are in gold. Our numbers are the lowest in 18 months. People don’t value gold right now.

I went to PDAC a few weeks ago. I dread going to any of the gold shows. There are simply too many stories to keep track of. I know less when I leave than when I arrived but it does give me a chance to get a feel for what ordinary investors are doing. For the first time in 9 years, I saw ordinary new investors and I got a sense that the gold market is changing.

For one thing, I’ll predict a lot of consolidation in the next year. There is a lot of money floating around looking for a safe haven and what could be safer than gold? I think the big news will be takeovers; lots of them and that will put a floor under the price of metals shares.

But the public is interested and I think will be buying in a big way. While I think there is a great risk of another deflationary default on an international basis, I don’t see there being a lot of risk in gold and silver shares. They have already been walloped.

I saw a few companies that really interested me. I bought shares in the ones I liked and some are or will be advertisers so I’ll make the traditional disclaimer. Your profits are not shared with me and neither should your losses. Take some responsibility for your own investment decisions. I’m human and my opinions are as biased any anyone else.

One of the real stories was that of Arco Resources (ARR-V) located in Oaxaca Mexico near the San Jose mine of Fortuna Silver. The management of Arco was associated with the San Jose mine and they know the area well.

I think of Arco as a concept stock. The stock has a clean history; it only came public three years ago but failed to get traction. The company management is very experienced in the Oaxaca area and have picked up what they believe are the best projects around the area, many have had prior production.

I wish they hadn’t had to do a financing at $.05 recently as the existing shareholders got whacked but I was a buyer on the open market at $.05 when I heard the story and I was a participant in the PP. Arco has enough money in the kitty to give drilling a serious go. If they hit what they and I hope they hit, the stock will run. But in the $.05-$.06 area it’s a cheap lottery ticket with a lot of potential.

If you are a believer in owing a US based project, Premium Exploration (PEM-V) should be on your target list. They have a minable resource in Idaho with 531,000 ounces of gold in the inferred category already at Friday-Petsite and another 100,000 ounces at Buffalo Gulch (great name). The project is on a major regional structure some 28 km long with a lot of blue sky potential.

I met with management of PEM in Toronto and I like the project and the management a lot. The company is well cashed up, they are drilling in elephant country and if you perceive the US as being a safe climate to invest in, you won’t find many companies with this kind of blue sky and such a small market cap. It’s a medium priced lottery ticket.

If you are a long time reader of 321gold and can remember back to when I wrote about Pebble many years ago, when I went to Toronto, I came across the next Pebble. The company is called Kiska Metals (KSK-V). Kiska did a deal with Rio Tinto on a giant block of land 90 mines NW of Anchorage. They have 527 square km of Alaska State mining claims and a 50-person camp.

The deposit is a gold-rich, copper porphyry. Within the main Whistler zone, they have 5.75 million ounce AU equivalent resource in inferred and indicated combined. It’s a district and they have new gold discoveries 23 km south and 17 km east south east of Whistler. With a $48 million dollar market cap, you are buying gold in the ground for less than $10 an ounce and their discovery costs are less than $4 an ounce.

Kiska has a one time back-in deal with Rio that should be triggered in the 1st half of 2010. Rio can back in by repaying double Kiska’s expenditures and agrees to fund the project through pre-feasibility to earn 51% and can earn another 9% by funding and advancing to a production decision.

In either case, Kiska wins big. I was the first guy to write up Northern Dynasty and this is another giant porphyry target. I was impressed with the management of Kiska, the company is funded for a major drill program and a lot of uncertainty will be removed once Rio announces their decision. The stock is very very cheap right now and is a perpetual call on both gold and copper.

The last stock of this report is by far the most interesting because it is so unusual. First Bauxite (FBX-V) was founded by Ioannis (Yannis) Tsitos, veteran of 18 years with BHP Billiton. While at BHP, Yannis looked at hundred of different projects and completed more than 50 JV agreements with various companies on behalf of BHP.

Mr. Tsitos saw an opportunity in a high-grade refractory bauxite only found in a few places on earth. China controls the market and allows only a small amount of this special bauxite to be exported every year. Russia, India and Brazil produce the high-grade bauxite but only produce enough for their own demand. First Bauxite has their projects located in Guyana.

If you are familiar with minerals, you may recognize the name bauxite. It is the mineral used to produce aluminum. However, the refractory bauxite deposit located by First Bauxite is used as a flux in the production of steel, cement, glass and furnaces. It’s far more valuable than ordinary aluminum ore.

Where ordinary bauxite is valued at about $35-$50 a ton, what is termed Refractory Calcined Bauxite (RASC bauxite) is worth $400-$500 a ton. That’s the same as having a half ounce gold grade or 30 ounce silver.

FBX plans for early stage production of 100,000 tons per year bauxite. They expect to complete the feasibility study in the 1st quarter and begin production as early as Q2/2011 with a production cost of less than $200 per metric ton. FBX anticipates revenue of over $26 million in 2011.

First Bauxite is a great example of someone understanding the economics of mineral production. The company has picked a highly profitable niche market with little competition. Management really impressed me. The company is selling at a potential 1.5 times next year earning. Naturally there will be dilution to finance production but this is one of the most attractive juniors I saw at PDAC.

Obviously I have not gone into great detail on any of these companies. I don’t want to bore readers silly and the companies have done a pretty good job of telling their stories on their websites. I encourage any potential investors to look into the company closely before investing but I liked them a lot.

Arco Resources
ARR-V $.06 (Mar 29, 2010)
ARRXF-PK 96 million shares fully diluted
Arco Resources website

Premium Exploration
PEM-V $.335 (Mar 29, 2010)
61.8 million shares
Premium Exploration website

Kiska Metals
KSK-V $.85 (Mar 29, 2010)
KSKTF-PK 56.6 million shares
Kiska Metals website

First Bauxite Corporation
FBX-V $1.25 (Mar 29, 2010)
FIBCF-PK 45.3 million shares
First Bauxite website

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Bob Moriarty
President: 321gold