In our last missive, we set out our plan for 2008. Should you like to review it can be reviewed on our website www.guildinvestment.com.
Before we start, our thanks go out to all of our investors, many of whom are very successful business and professional people who always bring important information to our attention. We appreciate very much the wisdom shared by our clients and friends. Finally, let me give credit where it is due; to Jim Sinclair. In my opinion, Jim has been fearless and strong in his position that gold would work for the past several years, and it has worked exactly as he predicted. He remains the world’s greatest gold analyst.
OUR VIEW ABOUT MORE INFLATION IS NOT WIDELY ACCEPTED. WHY ARE WE CONFIDENT THAT WE WILL BE CORRECT?
Several analyst and money manager friends who we respect have expressed a difference of opinion about our prediction that inflation will be a defining economic event of the next year.
The common arguments against our inflation theme are that inflation is not a long-term problem because:
- It is all about food and energy. Food and energy inflation have historically been short-lived and once production is increased, prices moderate.
- Once the “pig” of higher oil prices transits through the “python’s stomach”, the comparable inflation is minimal. For example, once the one year anniversary of the big oil price increase passes, energy prices do not go up as much percentage wise in the next 12 months, and the inflation numbers are muted.
- The current deflation of the global credit crisis is a counterbalancing effect which will keep developed world inflation balanced by banking system deflation.
Our arguments for a pronounced increase in inflation and inflationary psychology are:
1. Food and energy are not one-time occurrences. Their prices will continue to rise for years to come. This is due to increased demand for energy to fuel world growth and increasing demand for more expensive food and more meat in the diets of people becoming more affluent overseas. The supply of food is not growing fast enough to make up for: the increased consumption of meat (it takes about 8 pounds of feed grain to produce one pound of beef for example), and for the increased production of ethanol. The food price increases we are experiencing are not one-time events, but will continue. We have been predicting them for 2 years; they have existed for 2 years and will continue.
As for energy; energy demand is rising and the supply is fixed. Therefore we expect higher energy prices to continue to filter through the value chain for products and services globally.
We have been predicting higher energy prices for five years. We continue to see energy prices rise in 2008, although at about a 15% rate, more slowly than the rate of increase for the last few years. Still, energy price increases for the last few years are still making their way into the prices of everything we consume. Some items are contracted for long-term delivery and it takes longer for them to be able to raise their prices. While this often slows the onset of inflation, it also slows the ability to rein in inflation. For example, it takes years for the cost of a transport ship to rise to include the higher energy costs in the materials and labor within it. Such vessels are built on long term contracts. Eventually however, the price of ships must rise substantially to include the higher costs.
2. Wages have risen in the developing world due to higher food and energy prices, and the rising value of the local currencies versus the U.S. dollar. Yes friends, the Indian Rupee, Chinese Yuan and many other currencies of third world nations are rising versus the once "almighty dollar’. This will have the effect of causing Chinese, Indian and other suppliers of cheap goods to the “developed countries” to ask for higher prices in coming contract negotiations. Clearly, costs are rising in China and elsewhere. Logically, their profit margins will be squeezed regardless of the amount they sell to the "developed nations". In short, their currency is rising and their labor and raw materials costs are rising, but many of their selling prices are fixed on annual contracts. The effect is lower profit margins.
Since their selling prices are still way below "developed country" prices, they can raise their prices by 20%, 30%, or even 50 % without fear of price competition from "developed country" competitors. Their only price competitors are other developing nations, who also have to fight rising costs.
So, if the developing countries raise their prices, those prices are going to be passed through to the "developed country" consumers. In addition to that, the cost of transportation, storage, and capital to hold inventory are also rising. The retailers in the U.S. or Europe must include those cost increases as well to make a profit…hence, prices will rise.
3. The very concept that the current banking crisis is eventually leading to deflation is unreasonable. Thus far, what has the response been to the crisis as we have outlined in many of our memos?
The response has sown the seeds of a very big, very potent inflation which will be fueled by rapid money supply growth, public bailouts of bad banks, central bank loans made on poor collateral, and the many other mechanisms used to insert liquidity into the world financial system. If successful, these methods will eventually lead to more money in the system and thus more money available for borrowing and speculation. This will act as the fuel for more inflation.
Those vilified members of the Federal Reserve who have the temerity to stand up and say that inflation is a problem are correct. They are intellectually correct, and are being honest. The problem is that they are politically inconvenient and will not be listened to.
4. The U.S. dollar is losing its status as the world’s reserve currency just as the United States is losing its position as the world’s most powerful nation. As the dollar falls the cost of all imported goods rises, increasing inflationary pressure. Let us face the facts, Americans have been living beyond their means, as have the Europeans and the bills are coming due.
5. U.S. prices have been held down by changes made to the U.S. consumer and producer price indices for the last several years. For example,www.shadowstats.com tells us that removing the owned housing index and substituting the rental index in the indices has helped reduce the CPI considerably. While real estate prices rocketed and the cost of housing soared for homeowners in the last decade, the announced inflation numbers were artificially low in our opinion. Thus, the current decline in the price of owned properties versus rentals properties will not help the price indices…unless they change the index again.
In summary, we still think that prices will rise, and that people will take notice. We don’t know how long the governments can keep restructuring the statistics to show a rosy picture but we can be sure that the job will get harder to do. Soon they will be unable to avoid stating the truth that we all know…inflation is (and has been) a lot higher than admitted. Even if they refuse to admit the obvious, we need only look at our own costs and the price of goods that we purchase to know the truth. Investors can only be fooled so long…they now understand the facts. We expect investors will show a preference for the themes that benefit from global growth and inflation, and that is how we are invested.
We plan to focus on FOOD, GOLD, ENERGY, BASE METALS and related industries, NON-U.S. CURRENCIES, and on buying the stocks of good, fast growing economies on dips. On dips we plan to buy CHINA, INDIA, BRAZIL and RUSSIA.
Thank you for listening, and we look forward to hearing from you in 2008.