by Monty Guild and Tony Danaher

European Crisis In The Headlines; Irish Example Proves That The European Sovereign Debt Situation Will Be Solved By Money Printing

Ireland gets a bailout and at least part of it will be provided by money printing, aka quantitative easing (QE).  This bailout is not enough to solve the entire problem that Europe faces as a whole, which has been delayed as predicted.  It is not surprising that Europe’s short embrace of austerity has been unsuccessful.  It seems that politicians rarely choose austerity until all other alternatives have been exhausted.  History is replete with examples of this pattern.

It is obvious now and has long been obvious that Europe will go for QE combined with a small smattering of austerity.  Their claims of “implementing real austerity” are largely just political talk, and we believe they will opt for very moderate and insufficient levels of austerity.  Every experienced observer has learned to watch what they do, rather than believe what they say.  The European nations are bailing out Ireland, and Portugal is next, to be followed by Spain, Belgium, Italy and even France in the future.  The solution that politicians will embrace will be QE because a program of strong economic austerity means the end of their political careers.  They will put their careers above their national interest and the interest of the Euro community.

 

The U.S. Dollar Is A Poor Alternative To The Euro

The last two weeks has seen short-term speculators buying the dollar to hedge their shorts on the dollar and selling inflation-benefitted assets such as gold, silver, oil, food and base metals.  When cooler heads prevail and investors deeply analyze the situation, they will see that the U.S. dollar is a poor alternative to the Euro.  The U.S. dollar is poorly managed, Congress has already saddled the U.S. with enough debt to keep the dollar under pressure for years, and the Federal Reserve has made it clear that it is their intention to devalue the dollar.  The U.S. sponsored a 2nd round of QE, which was implemented to improve exports, to stop a deflationary psychology from forming and to create enough inflation in the U.S. economy to inspire the populace to begin investing to stay ahead of inflation.  When investors begin to focus upon these obvious points, the inflation benefitted investments will rocket ahead

 

Ignore What They Say, Watch What They Do—The Excuses That European Politicians Will Use

The politicians in the responsible countries will use excuses in talking to their constituents.  We believe it is likely that they will say something along the lines of the following:  The taxpayers must not be penalized for actions that were taken by our irresponsible sister countries in the EU.  Our concern is only with our own banks, which have made many loans to Greece, Ireland, Spain, Portugal, Belgium, Italy and therefore we must help out our domestic banks.  This QE will be good for our economy and especially for our banking system.  Our taxpayers are only being penalized in the short-term to help themselves, because a strong banking system is in the national interest and in the personal interest of each citizen.

Of course, this argument is partially true, a strong banking system is fundamental to a strong economy.  However, the rest of the argument is baloney any way you phrase it.  We believe that the banks from the responsible European countries such as Germany, Sweden and Holland undoubtedly made many of the stupid loans to Greece, Ireland, Portugal, Spain, etc., often because they were pressured by their own politicians to support their sister nations in the EU.

 

Ben Bernanke Calls A Spade A Spade

In response to criticism from all quarters, Ben Bernanke has told the nations exporting to the U.S. and Europe that they have enjoyed the benefits of these exports while the U.S. and Europe have borrowed money to pay for the imports.  China and others then unwisely accused the U.S. and Europe of over-consumption.

He explained that the U.S. is taking action to reduce the problem by depreciating the dollar.  In essence, he stated are going to do QE, lower the dollar and export more.  This will gradually improve the U.S. import-export problem, yet it will take some time to work.

I am glad to hear Bernanke standing up and speaking and I appreciate the fact that he is honest enough to admit the U.S. plan.  This plan is not a new approach and has been used by Britain and the U.S., when they were world reserve currencies, several times over the last century with varying results.

 

Inflation Ahead

As our readers know, many nations hold inventories of food stuffs to help farmers balance supply and demand and provide a stock for times of emergency.  Seeing inflation ahead, more nations are concerned about an adequate and reasonably priced supply of food for their citizens.  On November 16, 2010 the United Arab Emirate state Abu Dhabi announced that they would establish a government-owned trading house aimed at securing food supplies for the import-dependent nation and making profits by trading the same commodities they purchase.  It is not hard to see why nations are getting increasingly involved in these markets; food prices have been rising and will continue to rise as many in the world gain buying power and move to upgrade their diets.  Prices of many food commodities have moved upward and price volatility has increased in the last half dozen years. We expect more nations to follow Abu Dhabi’s lead.


Regulation Of Commodity And Stock Markets To Stop Damaging Activities In Shadow Banking Sector

At the time of the derivatives and financial crisis that occurred in 2008, we had warned of such events repeatedly for over 3 years prior to that time, we continue to see risk and the risk comes from the shadow banking system and its associated derivatives.  It is with some satisfaction that we note that global regulators will turn their attention to the lightly supervised shadow banking market according to Lord Turner as reported in the Financial Times.  Shadow banking instruments include money market funds and non-bank investment vehicles such as levered ETF’s.

In our opinion, the regulators try to do their job but they react slowly and are subject to lobbying by many groups who are undertaking activities which are damaging to confidence in the financial markets.  According to the Financial Times, “regulators (are) to focus attention on (the) shadow banking sector”.  These instruments and others act as non-regulated financial institutions and we believe that they have the potential to be dangerous. They along with fast trading led to one major flash crash in May of 2010 and much-increased volatility in recent months.  New regulation of these instruments would be a long overdue first step.

 

China Increases Bank Reserve Requirements

Why are banks raising reserve requirements when inflation is rising?  Because raising reserve requirements removes liquidity from of the economy.  Raising reserve requirements is the opposite of what is being done in U.S., Europe and in many South and East Asian countries who are trying to keep their currencies from rising too much versus the U.S. dollar.   In China, the blunt instrument of government policy has been unable to stop inflation and we seen no reason for the Chinese government to be able to do more than manage inflation downward with their new policies.  The impetus of more liquidity flowing into China and other fast growing countries will put upward pressure on inflation and on the value of the local currencies.

In coming months the world press will be full of news of how many countries including China plan to control capital inflows and prices by edict.  These types of controls have never been effective.  In summary, liquidity will continue to flow into countries where growth is taking place and these country’s stock markets will benefit.

 

Gold

Many countries are experiencing more inflation and in order to cope they are adding to their store of gold bullion.  India, Russia and China have recently added to their gold reserves.  For example, last month Russia added 600,000 ounces to their national inventory.  Russia now holds about 25 million ounces.

Even though gold prices are up 20% this year, Indian consumers have bought more gold than they did in 2009.  Many observers had felt that as prices rose Indian demand would fall, this has not proven to be the case.

 

Chinese Food Inflation Has Risen And Now China Is Taking Action With Positive Results

Within China, food and herbal medicine prices rose substantially in last 12 months.  There are several reasons behind the price rise:

1. Hoarding:      As real estate investment is being curtailed, people are moving to gold and traditional Chinese medicine to hoard as a store of value.  Wholesalers and merchants are hording foodstuffs to profit as prices rise according the Global Times of Beijing.

2. Exports of food and medicines are up.

3. Bad weather is partly to blame as some crops were in modestly short supply.

The Chinese government has taken action against profiteers and price gougers.  Since the government began to take action two weeks ago, prices have fallen about 4%. Our six-month-view is that food prices may rise at a 10%-per-year rate.  The days of very rapid food price rises in China are over.

 

Summary And Recommendations

Investors should continue to hold gold for long-term investment.  We have been bullish on gold since June 25, 2002 when it was selling at about $325 per ounce.  In our opinion, it will move to $1,500 and then higher.  Traders should sell spikes and buy dips.  Even after its recent pullback, gold is still up 327% since June 25, 2002.

Investors should continue to hold oil-related investments.  We have been bullish on oil since February 11, 2009, at which time oil was trading at $35.94 per barrel.  After the recent pullback, oil is trading at $83.70 per barrel, which is up about 133%.

Currencies:  For long-term investment, we do not like the U.S. dollar, Japanese yen, British pound, or the euro.  As we mentioned in our September 14th letter, we like the Singapore, Thai, Canadian, Swiss, Brazilian, Chinese, and Australian currencies.  We would use the current pull-backs in these currencies as an opportunity to establish long-term positions.  Since September 14, 2010, these currencies have appreciated or depreciated versus the U.S. dollar by the following percentage: Singapore dollar +1.2%, Thai baht +7.2%, Canadian dollar +0.1%, Swiss franc +0.4%, Brazilian Real -0.3%, Chinese Yuan +1.1%, and Australian dollar +2.4%.

Investors should continue to hold shares of growing companies in India, China, Singapore, Malaysia, Thailand, Indonesia, Colombia, Chile, and Peru.  We have been recommending these markets in these commentaries since September 14, 2010, and we would use any pullbacks as an opportunity to add or initiate positions for long-term investors.  Stocks in these countries have appreciated in U.S. dollar terms by the following percentages since September 14, 2010:

 

Country

Stock Index Appreciation/Depreciation in USD

Singapore

2.9%

Malaysia

-0.1%

India

3.0%

China

6.5%

Indonesia

8.4%

Thailand

9.2%

Colombia

3.3%

Chile

4.4%

Peru

24.3%

 

We believe long-term investors should continue to hold food-related shares such as grains, wheat, corn, soybeans, and farm suppliers.  Since we said the grains had bottomed on December 31, 2008, these have all appreciated substantially.  We see more price rises ahead.  Since December 31, 2008 the price of corn is up about 30.2%, wheat is up about 6.6%, and soybeans are up about 26.8%.

We believe U.S. stocks can rally further.  Our reason for becoming more bullish on U.S. stocks on September 9, 2010 is that over the longer-term, liquidity formation through QE will create demand for many assets, including U.S. stocks.  Since September 9th, the S&P 500 is up about 6.9%

Thanks for listening.

 

 

 

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