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IT’S ALL HAPPENING – STOCKS AND GOLD ARE MOVING UP TOGETHER

IT’S ALL HAPPENING – STOCKS AND GOLD ARE MOVING UP TOGETHER

WORLD INVESTMENTS AND THE MAJOR STOCK MARKETS

The U.S. and other major stock markets are strengthening as investors notice that real estate is losing its grip as the premier investment area. As a result, money is shifting from real estate to stock markets globally. If we look on a macro scale, we see that real estate bubbles worldwide have been driven by excess liquidity. This excess liquidity is in the world’s pension funds, investment portfolios and large corporations, and is a result of central banks all over the world increasing liquidity by excessive amounts over the past decade.

This excess liquidity creates a giant wave of money, which moves around the globe following higher rates of return that become apparent. For example, if an asset class like private equity does well for two years, all of a sudden there is too much capital available for private equity investment and returns eventually fall. If commodities appear to have excess returns because the demand from India, Russia, China, Brazil and other growing economies, then investors flood into commodities, and commodity producers. It is the same for real estate and global stock markets. Then, when these assets classes no longer produce higher returns, investors look elsewhere. The wave of money moves on.

It should be obvious to even the most casual observer that real estate, after its massive appreciation of the last few years is no longer cheap. Where will the next opportunity occur for excess returns?

We believe that it will continue to be in some commodities, and in stock markets of countries that can demonstrate stable economic growth at a rate above 3%, and that also provide liquidity for global investors. Which countries qualify? In alphabetical order they are Brazil, Canada, China, some European countries, India, Russia and the U.S. We will look for growth companies at low valuations in these countries.

There are going to be some smaller countries that can grow at these rates, but their markets are relatively small to absorb large amounts of capital. Other markets, which can absorb large amounts of capital, are commodities and currencies. All of these markets will alternate in attracting funds as the perception of excess returns waxes and wanes.

Some will fault me for ignoring the Middle Eastern and emerging markets. These markets may grow very rapidly, but with how much stability and how much liquidity?

GOLD IS DOING WELL AS PEOPLE LOSE INTEREST IN CURRENCIES

Gold is strong versus almost every currency.
1. People don’t necessarily want U.S. dollars, but they don’t want Euros, Yen and Pounds more. They are buying gold instead of holding currencies.
2. Both Chinese and Indian people have a tradition of buying gold. Both countries are increasingly prosperous, as are their inhabitants. More wealth means more gold purchases.
3. Gold is being demanded more by the Chinese. It appears they may be investing some of their surplus in gold rather than in depreciating currencies.
4. Inflation is definitely rearing its ugly head.

CURRENCIES

The dollar has been a strong currency as U.S. interest rates have risen faster than interest rates in almost any other country. However, it is not hard to find currencies that have done better than the U.S. over the last few months. Three come to mind, the Canadian dollar, the Hong Kong dollar and the Chinese Renmimbi.

The Canadian dollar is less than 1% below its high versus the U.S. dollar, and the Hong Kong and Chinese currencies are at new highs. Consequently, this year the U.S. dollar has been strong, but not invincible.

Apart from the above currencies the dollar has been strong, and may remain strong, as long as interest rates continue to rise in the U.S. faster than they rise elsewhere. Many economic observers expect U.S. interest rates to peak in February or March. Although it is early to say for certain, we may see the dollar peak at the same time.

Many professional investors that I speak with dislike the dollar. They believe that it is overpriced, and that the U.S. government continues to mismanage the economy. They site the huge deficits and resurgence of inflation to make their point. Rather than hold dollars they are holding Canadian, Hong Kong and Chinese currencies and gold. We have long been in this camp and agree with them.

THE JAPANESE MARKET CONTINUES TO IMPRESS US

Japanese stocks continue to impress us. The favorites rotate from financials to machinery to export companies, and the market continues to be able to absorb the rotation and make progress. On an historical basis, Japanese stocks remain inexpensive and we believe that they may continue to be attractive for several years. We continue to hold what we own, and are watching the developments.

PROPERTY STOCKS IN HONG KONG ARE ATTRACTIVELY PRICED IN OUR OPINION

Hong Kong is a clean and fairly transparent way to play China. Because of the British tradition of governance, Hong Kong listed companies generally have major accounting firms auditing their books according to British accounting principles. A British style legal system has remained in Hong Kong, as well.

Thus, sophisticated investors who are afraid of the lack of transparency of China are open to investing in Hong Kong. One way to make money in China is through Hong Kong property companies who are gradually accumulating properties in China. We favor those companies, which are selling at about book value and have dividend yields exceeding 2 or 3%. Most of their holdings are in Hong Kong where the occupancy rates are very high. These companies generally hold high quality office and industrial properties and the occasional shopping mall complex or apartment building. If we can buy these assets at book value we are buying them at a tiny fraction of their market value. Often these companies will build new buildings and increase their dividends as their rents rise. Periodically, people realize how undervalued these companies are, and mark them up by 30 to 50%.

ENERGY STOCKS

IN OUR LAST EMAIL, WE MENTIONED THAT WE CONTINUED TO LIKE ENERGY AND ENERGY SERVICE STOCKS, BUT WE WILL PROBABLY SELL THEM IN MID WINTER WHEN DEMAND FOR ENERGY IS AT ITS HIGHEST.

Energy and even more energy service stocks continue to be attractive and may rise until mid winter.

In 2006 we would not be surprised to see market manipulation in the energy markets by governments selling from their strategic stockpiles.

For example, 2006 is an election year in the U.S. The price of gasoline and heating oil is important to the electorate, and the politicians know that very well. We will not be surprised to see pressure from congressmen and senators to sell from the U.S. strategic petroleum stockpile into the market in the U.S. to diminish the effects of high-energy prices.

In the 1970’s major governments tried to diminish the psychotically effects of a high gold price by selling some of their gold stockpiles. In the short run, it forced the price of gold down but in the long run it was an utter failure, gold went from $35 dollars to $870 per ounce.

We continue to believe that energy will be an interesting theme as long as China, India, and others continue to grow. However, 2006 may be a year where these stocks rest and consolidate, or even decline, before resuming their up trend.

SUMMARY

As we have been saying for a while, our continuing themes are energy, precious metals, growth stocks with visible prospects and low valuations, and Japan. Hong Kong property companies also provide opportunity. We believe that mid 2006 may bring a rally in the U.S. stock market and a possible decline in energy prices. This rally will be most likely to occur if investors (who control the huge wave of liquidity that seeks out higher returns) are confident that the U.S. Federal Reserve believes that inflation is under enough control to stop raising interest rates.