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PERIODIC MARKET CORRECTIONS AND ROTATION OF LEADERSHIP WILL OCCUR….. THEY ARE NORMAL AND THEY CREATE OPPORTUNITY

PERIODIC MARKET CORRECTIONS AND ROTATION OF LEADERSHIP WILL OCCUR….. THEY ARE NORMAL AND THEY CREATE OPPORTUNITY

Although temporarily painful, market corrections are a healthy development.  Rising markets, that periodically correct, and climb the proverbial wall of worry, last longer and rise higher.

The current market correction in metals, energy and stocks is a normal one; and we have expected it.  Accordingly, we have built a large cash position which we will use to buy good stocks as they fall to attractive levels.  We like panic days like yesterday.  They provide low prices at which to buy stocks.

Long experience has taught us to buy when others are throwing things away irrationally.   Yesterday looked like the start of one of those periods to us.  We are actually excited at the prospect of finding some good bargains.

The extreme pessimism that dominated the market psychology on July 26, 2007, was much like we have seen near the bottom of past market corrections.

The gold, metals and stock markets may not have seen the end of this correction, but a lot of the damage has already been done.  Many stocks are within a few percent of their eventual bottoms, and when the markets rally, the rise will be quick and volatile…and it will leave many would-be buyers on the sidelines.

YEN CARRY TRADE

Part of the panic is caused by fears that the borrowing of cheap yen at 0.5% per year or less to invest in foreign currencies, metals, bonds and stocks will end.  A further fear is that there will be a panic to unload all of the aforementioned groups of investments.  This is a panicky and patently unreasonable fear at this stage.

Let’s look at the facts.  When you borrow at 0.5% and reinvest at 5.25% in British pounds or 6.0% in Australian dollars you make a huge spread for your efforts.  The Japanese currency must rally a lot to remove your profits.  The Japanese saver who is the main user of the carry trade is weakening the yen every time he or she sells yen to invest abroad in a foreign currency to earn more interest.  Thus, downward pressure on the yen will continue until Japanese interest rates rise more than a little bit from these levels.  They must rise high enough to convince the Japanese saver that investing abroad is no longer profitable.  In our opinion, the carry trade panic is just another excuse for a market correction.  The correction has been brought on by a desire of traders to take profits.

CHINA

China’s trade surplus of June was a record. China’s economic growth looks like a record too; an astounding 11.7 % in the second quarter.  It gets a little boring reporting month after month that China, India, Singapore Thailand, Brazil, Indonesia, Hong Kong, Korea and many other countries are enjoying record growth.  It may be boring, but it’s profitable.

PEOPLE ARE SLOW TO REALIZE THAT WORLD ECONOMIC LEADERSHIP IS SLIPPING FROM U.S. HANDS

In the 1960’s the U.S. was by far the dominant economy in the world. Europeans were very slow to realize it.  Even twenty years after the end of World War II, Europe clung to the illusion that it was still the economic center of the world.  At least they hoped so.

Much the same is happening in the U.S. today. Today, the U.S. is transitioning from the most powerful nation economically to a much less powerful status.  China will within a few decades be much more powerful than the U.S.  Possibly India will surpass the U.S. as well.

We expect the U.S. will hang onto its illusion for a long time, maybe decades like the Europeans did.  It must be human nature to remember past glories. U.S. illusions will decline as the dollar declines.

THERE ARE SOME POTENTIAL CLOUDS ON THE HORIZON…LONGER TERM:

1. After the Beijing Olympics in summer 2008, will it be like year 2000 in technology (lots of preparation and building which outstrips demand)? Will China be temporarily overbuilt?
2. The U.S. presidential election and the raising of taxes in the U.S. after April 2008.
3. There is a surplus of liquidity in the system, thus the problems in the U.S. subprime, credit markets, etc. are not yet devastating.  When the surplus liquidity is finished being pumped into the system, watch out below.  The estimated date of this occurrence?  Hard to say now.  We are watching.
BONDS…..WE ONLY HOLD VERY SHORT TERM MATURITIES OF THE BEST QUALITY ISSUERS DENOMINATED IN NON U.S. CURRENCIES

We have serious concerns about bonds.  After a 27 year interest rate decline, why not a ten year rises in interest rates?  Such is the nature of cycles, and the interest rate cycle is no exception.

Several weeks ago we sold all the income related stocks and bonds for our clients with the exception of short term government bonds (less than 2 years duration).  These are all denominated in currencies other than the U.S. dollar.  Our favorites for the past few years have been British government bonds denominated in pounds, Canadian government bonds denominated in Canadian dollars and Australian government bonds denominated in Australian dollars.  We used to own Euro denominated German bonds, but the yields were too low.  We also owned New Zealand bonds but sold them because of New Zealand’s large current account deficit.

WE HAVE BEEN HARPING ON OUR THEMES FOR YEARS, AND THEY ARE STILL THE BEST THEMES IN OUR OPINION
1. Growth in demand for Energy
2. Growth of China, India, developing Asia and Brazil
3. Continued growth in demand for Base Metals and Precious Metals
4. Continued decline in the value of the U.S. Dollar
5. Growth in demand for Transportation Equipment to transport the raw materials for the world’s growth
6. Growth in demand for Financial Services to deliver the capital for the world’s growth
As everyone knows these themes have been correct and the investment vehicles connected to these themes have been rising for years.

Yet, as we examine the economics, the politics and the social issues surrounding these and other themes, our best analysis leads us to the conclusion that THESE REMAIN THE BEST THEMES FOR THE NEXT FEW MONTHS.


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