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July 9, 2003

July 9, 2003

ECONOMICS

US economic signals remain mixed, but positive indications are becoming more prevalent. We still think the odds of inflation and deflation are about equal. However, the stock markets in the US, Europe and Asia are reacting positively to the expansion of the money supply, and the expectation that the velocity of money will start to rise. An increase in the velocity of money usually lags behind an increase in economic activity. The increasing liquidity in the global economy is building optimism.

WORLD MARKETS

Problems still remain in the global economy, but investors have not made money in the markets for 3 years on average, and a lot of money has been lost. Professional traders are currently saying, “Recent economic news is slightly more positive, so let’s look at the sunny side; it’s OK to pay high prices for small tech stocks now, because in the long run they can earn a lot of money”. Further, traders are plunging into the markets where stocks have been declining for years, like Europe, Japan, Asia, US and some Latin American countries. The current trader’s logic is if these economies pick up, they will be able to profit in advance because as we all remember, the stock market is a discounting mechanism. If things deteriorate, traders believe that they will be able to run for the exits and get out before others. This is how the standard trader views today’s market.

The standard mutual fund manager’s view is different. They are paid to own stocks, so they might say, “Let’s own them; because if they go up without us, we’re going to lose our jobs. If stocks go down and people lose money, our business shrinks, but at least we don’t lose our jobs”. The mutual fund manager is playing it safe and buying stocks. It’s better for their own job security. They might rationalize by saying, “Anyone still in our funds after three tough years must be long-term investors”.

The Guild Investment Management view is this: the economy is in a transition stage; after this stage we will move either to recovery or to deflation. Recent economic news indicates deflation may not occur. In case of recovery we have to own stocks that will benefit. Buying the best growth stocks at low P/E ratios is our style of investing, so we search for those. (We discuss this in more detail later). We haven’t been heavily in stocks during the bear market, and have protected capital.

For a few months, we have been selectively buying companies with decent fundamentals in order to capitalize on the market’s continued rally.

Should we experience deflation, we have gold shares that we will be adding to, and which should make up more of our portfolio by the time gold bottoms in August. Traditionally, the seasonal bottom for gold is July/August, according to the market technicians. In case of deflation we also have researched a long list of overpriced companies. We are prepared to short these (for those clients who sell short) once the market begins its downtrend.

As is our policy, if the market reverses we plan to sell our long positions and invest in short-maturity debt instruments. If the market continues to rise or moves sideways, we will continue to seek out fast-growing companies in good industries that are selling at ratios below those of the industry and market leaders. This style of investing is called “growth at a reasonable price” or GARP, and at GIM we have been employing GARP for 4 decades.

ATTRACTIVE INDUSTRIES AND COUNTRIES

Today some of our favorite industries are

Asian Technology
Asian and Russian Telephone
Japanese low PE manufacturing
Chinese low PE manufacturing
European telecom
U.S. Special Situations

Chinese tech companies are benefiting from rapid Internet acceptance among the young people of China. In this area, we own Sina Corp, Sohu.com and NetEase.com. When we first bought them they were selling at less than 10x expected earnings and growing at over 100% per annum. We bought them and then sold them (in order to lock in profits and avoid market downdrafts), and have bought them again. We expect continued rapid growth in different types of Chinese Internet usage including instant messaging, video and written messaging and multiple-player games. Only 60 million of China’s 1.3 billion people currently use the Internet. We expect that number will grow to 300 million Chinese people within a few years. For many years, I have not seen an industry with more upside potential than this one. Yes, it is true there are potential negatives; For example, new competition, government tax increases, and higher tariffs from phone company partners. These companies cannot grow at 100% forever, but in the long run we expect big price increases in these stocks.

Another area we like is telecom in the developing world, where phones are scarce. UT Starcom is the leader at offering low-cost telecom facilities to developing countries. This California company has already garnered big contracts in China, Malaysia and Latin America and is working on several new fronts. This is not a small company as it enjoyed revenues of over $1.1 billion in the last 12 months. We expect future earnings growth well in excess of 20%. We are also invested in two cellular telephone operators who are expanding rapidly in Russia.

In Japan, after a 12-year bear market, Japanese stocks are cheap. The government is undertaking an effort to flush cash from savings accounts into the stock market. We own Japanese index shares that move up as money flows from Japanese savings into stocks. We do not know if this Japanese market rally will last for years, but we feel confident that Japan will continue its efforts to encourage stock market investing and penalize the holding of savings accounts, for at least one more year. Another way to invest in Japan is to own the big Japanese brokerage houses and high tech companies which will be the beneficiaries of growing Japanese equity investments by the public.

In the Energy Sector we have 2 themes:

1) Chinese oil and refinery stocks. The immense growth of China will create big and continuing demand for energy and refined products. In this area we have owned PetroChina and China Petroleum & Chemical, and plan to buy more on dips.

2) Canadian natural gas stocks. A cooler than normal summer may send natural gas prices lower this summer. Longer-term, however, we expect very high natural gas prices for the next year or two, due to numerous supply and demand variables that are moving us closer to a shortage scenario.

In the US we own special situations such as Tyco, Washington Mutual, and others that are showing improving fundamentals, and sell at reasonable prices.

CURRENCIES

From its lows in early 2002, the Euro rose 35% and is currently undergoing a correction, which began in June. We believe this is normal and expect the correction to last at least until August 2003, perhaps two or three months longer. After a long rally, a long correction and sideways action would not be at all unexpected. The Euro may continue to rise after this correction, however this is not certain. Developing economic, social and political events in Europe, Asia and North America will certainly have a major impact on the Euro’s long-term trends. Currently, we expect sideways, to slightly lower price action and we will continue to closely monitor events.

The Yen is currently in a sideways pattern and we expect the Yen to be neutral versus the US dollar for a prolonged period.

In summary, the US dollar had a substantial decline versus the Euro, the Canadian dollar, and Australian dollar, Norwegian Crown, British Pound and Swiss Franc. That decline has ended and we expect a short-term rally in the US dollar, followed by sideways action. The weak dollar currency play attracted considerable attention when the stock markets were declining. Now, currency speculators have their attention elsewhere. The world’s attention is on the hopes for economic expansion and stock market recoveries.

GOLD

Gold is in its’ seasonally weak summer period. Gold itself often bottoms in August or even as late as early September. We expect a bottom within the next few months and are buyers on weakness. Gold shares have far outperformed bullion recently, after under-performing early in 2003.

SUMMARY

After a brutally difficult three years, US, European and Asian markets have begun to attract buyers in recent months. We are participating in the global stock markets in the expectation that world economies will begin to recover in the second half of 2003. In the case of no economic recovery, we have a strategy in place to take advantage of opportunities caused by stagnation or deflation. In either scenario, we have identified opportunities that are attractive. And we will closely monitor the developments to determine which direction is most prudent.