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November 29, 2004

November 29, 2004

We like the same investment themes that we have liked for 2 years.

ENERGY STOCKS

As we predicted in our November 8, 2004 letter, oil did not have a big correction and now it is rising again. We expect energy companies to do very well in coming weeks and we continue to own British and Canadian oil producers and U.S. natural gas and coal producers. Demand from developing countries like China, Russia and India and political problems worldwide argue for relatively high energy prices for some time to come. This is especially true when we consider the political problems in Iraq, Venezuela, Nigeria and possibly Iran. Finally, with world producers operating at full capacity, where will new supply come from if a major producer has political or delivery problems?

U.S. LOW P/E GROWTH STOCKS — GROWTH AT A REASONABLE PRICE

We continue to find good quality companies selling at very low prices compared to their growth rates. These companies are in several industry groups. Many are small and medium sized companies that have been ignored by the market for various reasons. Although we see opportunity in these as well as in energy stocks, we are not sanguine about the outlook for most U.S. stocks in 2005. We expect a mediocre U.S. market in 2005, with some sectors doing very well and some sectors performing poorly.

ASIAN STOCKS

We have been optimistic about the growth prospects of Asia for years and we now see China, Taiwan, Korea and Singapore and India as continuing beneficiaries of a weak dollar. The weak dollar is already causing global investors to allocate resources away from the U.S., and toward faster growing economies with stronger currencies.

GOLD SHARES

Gold shares are a proxy for currencies and act as money in times when the public loses confidence in the management of a currency or currencies. It is remarkable how often the public, in one country or another, sees the need for gold as a substitute for the local currency. We expect gold shares to be a core component of our portfolios for several years to come. At any time they may experience corrections, and we will try to add to positions on these corrections.

FOREIGN CURRENCIES

What we have been saying for years is now on the nightly news. It’s too bad that the public is years late realizing the problem. Now the U.S. wants to get the dollar down rapidly and they want to do it to be able to say to the buyers of our bonds something like “Well the dollar has fallen by 15% recently and 30+% in two years, so now it is cheap so start buying our bonds again.” We expect the dollar to decline off and on for a few more years. There can be strong rallies in the dollar and we will use these rallies to add to our holdings of foreign currencies.

CHANGING OUR ATTITUDE TOWARD STEEL STOCKS

Several weeks ago we wrote that it was time to take profits in base metals and steel stocks. We were expecting increases in production from China, which would act to satiate worldwide demand. Although we have not changed our mind about base metals shares, recent news of steel shortages in Japan has changed our short-term opinion on the attractiveness of steel shares. Even after China has increased their steel production substantially, there is still a shortage in East Asia that will keep steel prices high globally. We believe that steel shares are attractive.

JIM SINCLAIRS WARNING

On Friday November 26, I received an important missive from my long time friend, the brilliant Jim Sinclair. He pointed out that the Chinese and Russians have recently both alluded to the fact that they may stop buying U.S. dollar denominated debt. If they follow through on these statements, it is the end of the dollar as the world’s reserve currency.

I agree with Jim that these are important symbolic gestures and they are a way of putting pressure on the U.S. government to put its fiscal house in order in a hurry. However, there may be some time before the US dollar completely loses its position as a world reserve currency. The world currency must be the currency of a nation which can politically, as well as economically, exert some of its will on its sister nations. Thus, some strong political and military power is part of the package of economic leadership and reserve currency status.

Jim is very correct that the psychologically charged status of the U.S. dollar will put continued downward pressure on the dollar and put upward pressure on gold and foreign currencies.

ECONOMICS AND POWER IN CHINA AND RUSSIA

In any case, it is obvious that both the Chinese and Russians are putting pressure on the U.S. In our opinion, they are doing so for different reasons.

The Chinese are angry about the pressure on them to revalue the Yuan and they are returning the pressure to the U.S. They do not want to revalue their currency, as that would hurt their exports and their plan for global economic and military domination. Make no mistake, China wants to dominate the world economically, and I see little reason to expect that they will not do so before my life is over.

They are very methodically building and strengthening their military and their economic game plan. Their plans are proceeding well, however, they still do not have the economic competence to manage their economy in an efficient manner. Today, it is a mixed economy with many large, corrupt and inefficient government enterprises whose purpose is social engineering and economic nationalism. These enterprises must be brought under central government control and the corruption inherent in the government banking sector must be rooted out. When this takes place, China, with its large cash surplus and strong economic growth rate, will be in a position to become a reserve currency country.

Russia is angry for a different reason. They are tired of what they see as U.S. interference with their former satellites. Specifically, the Ukraine situation has them irritated, in our opinion. They do not want freedom of choice for the people of their former satellites and particularly not for the Ukraine. Mr. Putin wants to put his boys in positions of power so that he has allies for the numerous political and economic skirmishes to come. He also wants to strengthen ties with China so that when China becomes dominant, Russia will be well situated to manage their political affairs on the world stage.

U.S. ECONOMIC POWER AND U.S. DOLLAR RESERVE CURRENCY STATUS

Clearly, the U.S. is nearing the end of its reign as the world’s most powerful economy. The U.S. dollar is gradually losing its status as the world’s reserve currency. In our opinion, coming decades will see China as the world’s most powerful economy and their currency will be the world’s reserve currency.

China is growing very quickly. India is growing very quickly. The U.S. will be growing much more slowly in coming years. Within a few decades,
China will dominate world economic activity. The U.S. will be number two, and Europe a distant third.

China is purchasing assets on a global basis. They are in the process of bidding for natural resources and resource transportation facilities in South America and in Canada. In the U.S. they are quietly buying companies in prosaic and traditional industries like auto parts. Their goal is to spend their huge current account surplus of cash on raw materials to supply raw to their manufacturing-based economy. They understand that their domestic demand will increase the need for raw materials globally, so they are using some of their cash to purchase assets. In Canada, they are bidding for Husky Oil and Noranda Mines. In South America, they are buying natural gas, oil pipelines and other resources.

Commodities are important for China’s continued growth and are a weapon that can be used to minimize the growth rates of those to whom China is opposed. They need only to withhold access to certain commodities to slow the growth rates of some competitors.

Any casual student of history knows that political, economic and military power are deeply interrelated. As we all know, China and Russia have been students and practitioners of power politics for many centuries.

Well, enough of the memo. Please contact us with criticisms, opinions and ideas.