On The Heels of Maturity & Euphoria
the following is an excerpt from our 08 January Latest Letter
Randolph Buss, © copyright 2006
2006 Outlook
Sir Peter Ustinov, the British-Russian actor / comedian once quipped, "It takes two divorces and going broke once to make a real man". I have that lurking feeling the West may soon at least witness quite a few more real men in and about town. Ok, let's get serious. Why would we in the West be going broke, if not already there? (Personal bankruptcies in US and UK at all time highs) I personally think the biggest overriding factor facing the world can be summed up as "maturity". The Western world is moving towards a rather momentous maturity of sorts - maturity of consumer debt, maturity in housing, maturity in rates, maturity in credit, maturity in pension defaults, maturity in population demographics - which not many people fully comprehend, in combination with new births elsewhere (China, India, Brazil). It is slow and creeping and may take many years. This covers financial, economical and social aspects.
In fact one leading analyst was to have said, "I have no idea how the markets will do this year, nobody does, but the biggest fears I have for the markets are more related to geopolitical and environmental risks." So although the pundits are touting 'buy buy' now, we should nevertheless be aware that opportunity is born of crisis - that is why vigilance and constant re-tuning of our portfolio is a must. Turbulent times cannot afford complacency.
So while the World Economic Summit plans to convene soon in Davos, Switzerland and hob knob around with the invited "giants of industry and politics", we have listed here a number of risk factors (no order of importance implied) currently at play in the financial and geopolitical realms which we see as being the real threats :
- US / Israeli Attack against nuclear-prone Iran
- Bird Flu is now creeping more westwards throughout Turkey
- The ongoing messy war in Iraq / Presidential ratings low / fallout from Abramoff scandal
- Oil has now reached $64/bbl again
- Oil Instability in Russia and Middle East
- Oil Instability in Nigeria due to pipeline attacks
- Oil & Gas Disputes between Japan and China in Japan Sea
- No Improvement in USA refining capacity
- No rapid improvement in alternative energy sources
- The US economy / consumer debt may be slowing considerably
- The US economy's current account / trade deficit remains stubborn
- The US interest rate outlook and its effects / inverted yield curve points in direction of slow down or recession / a new untested Fed Governor
- The ECB is seemingly itchy to scratch their interest rates higher
- The sclerosis surrounding EU political union / constitution
- The increasing risk of US Dollar creditors diverging away from US instruments (Asia - trade; M.East - Petrodollars)
- India, China and Eastern Europe will likely continue strong growth as global competition forces cost-cutting measures in the West
- Asia-Pacific countries with strong US reserves may decouple and/or reduce dependence on the US Dollar / trade, especially if US consumer slows
- Global Wealth is shifting to "gold friendly" nations of Asia Pacific region
The bottom line in most of the above issues is either energy or some sort of financial re-positioning on the part of US Dollar creditors. The common denominator in 90% of above is instability, fear and positive for gold.
The other side of the coin appears to be a euphoria of sorts. Despite the rather scary list of inherent risks above, no matter where one looks these days there is a seemingly unbridled optimism in many markets and sectors - warranted or not - which investors seem to be discounting or simply ignoring.
Be it real-estate, base metals, technology, pharmaceutical, and many more, people believe the good times may last forever. The DAX up 27% and at highest level since 2001, FTSE up +30%, gold up +20%, housing up, US Dollar up, etc. et.al. The point is simply that the global risks are growing and that many sectors are directly or indirectly in the line of danger. Some projections are now for oil to go to $80/bbl. This is certainly within distance right now. The main point investors should be addressing is a) where is there an oversupply of something, b) where is there an undersupply of something, and c) what are the tangential risks associated with each.
We could certainly make the case that the US Dollar is in oversupply in foreign reserve holdings, i.e. the game of we export our goods and we import your US Dollars. We could also make the case that if the Fed (as just recently indicated) sees interest rates leveling off then certainly they must think the economy is slowing and possibly help both consumers and housing owners who have accumulated too much debt. Corporate America sees the inverted yield curve ahead which points to sluggishness and low growth. Likewise, foreign creditors may then sniff the economic winds and slow their foreign investment in equities and slow their Treasury purchases. This would necessarily hurt the USD. Equally, what good is an US equity which rises but only to be converted back to the purchasers local currency at a loss? Should the ECB then continue to close the rate spread with the Fed (which certainly is a possibility) then the foreign purchasers have another alternative than just the US Dollar.
John Hathaway of the Tocqueville Gold Fund stated that the Euro was a "piece of garbage" as it was a currency overseen by a committee of bureaucrats. Similar to most currencies I suppose. Yet, as we know, one mans "garbage" is another mans "treasure". It's all relative when the world collects financial garbage as a means of doing business. One need only to find the "best" garbage.
So what is our current investment outlook based on the above maturity and euphoria? We are looking for undersupply and risk-averse resources that the world needs. We are looking at future resources which may continue upward based on those list of risks above. We are looking at regions coming out of their cyclical slumber and which may hold more upside potential. We are looking at historical safehavens. We are looking at investor and creditor psychology should the world's reserve currency start to weaken. I have already stated many times that the strategy of the Fed was to raise in order to have something to cut if they require it. Now with the Fed possibly raising one more time to 4.5% that might seem a level at which to hold.
Our current investment views for 2006 :
- Precious metals shall remain in a long-term upward bias
- Energy complex due to continued increased usage and risk
- Alternative energy resources such as uranium since oil/gas remain under threat (China, India and many EU states are now planning reactors)
- Short to mid-term positive on JPY and EUR
- The Chinese Yuan will probably not yet rise substantially against the USD
- The markets will "challenge" Bernanke at some point this year; Ben, do you talk the talk or walk the walk on rates?
- Exposure to more emerging markets
- Eurozone / Japan underweighted as both may commence with more rate tightening
- US underweighted as this may be a repeat of UK markets, i.e. property slowed and so did the consumer à BoE now looking to lower rates
- As we stated in one of our Latest Letters 2005, the US housing market will not crash, but just die a slow death - right now inventory is rising, prices are coming down and flattening
- The US GDP and 'economic health' will not be robust, nor will it tailspin, more a grinding lower of sorts
Portfolio
So, following our 2005 strategy, our 2006 strategy looks quite similar. Trends are not changed over night. So even as 2005 was a tough year for picking DOW or NASDAQ winners, we were quite successful following our long term strategy and belief in the resource and precious metals sectors as our portfolio was up over 30%. Now more than ever do we believe that some of the above key elements are in place for gold / silver and metals to further profit from instability and the associated psychological forces at work on investor sentiment. Safe havens are always sought after in times of fear or crisis. It is also important to realize that until now the public has not really yet sought out the precious metals, i.e. we are not quite yet in phase 2 of the metals sector where the public starts to climb aboard. The funds have sniffed out metals as of mid 2005 and that is why in such a small capitalized market the volatility is proportionately greater. Since Nov. 2005 gold is up 16%. In the final month we decided to liquidate a number of positions at 50% for fear of an overdue correction. This turned out to be correct even though we did not quite hit the peak of the rally. C'est la vie. The re-correction upwards started again and is currently in place though looking a bit frothy. We sense a lot of people out there see the same systemic risks to the "global financial system" as we do. Gold has today hit a 25 year high at $543 in Asian trading.
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US Household real-estate assets as a share of GDP has risen from 103% to 150% since 1997.
For more on this article and more charts for the 2006 strategy outlook please visit the homepage www.dinl.net in the Latest Letter box.
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timestamp : 13:05 CET / Berlin, Germany
Randolph Buss
editor@dinl.net
www.dinl.net
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