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WE CONTINUE TO SEE INFLATION GLOBALLY

WE CONTINUE TO SEE INFLATION GLOBALLY

Before we get started, we would like to extend our best wishes for health, happiness and success to all of you.  There is much anxiety and hyperbole in the news, and we wanted to take a moment and say that we wish everyone all of the best in life.

FASB’S NEW ACCOUNTING RULES SHOULD CAUSE BANKS TO STOP THE BEHAVIORS THAT LED TO MANY OF THE CURRENT MORTGAGE PROBLEMS.

FASB stands for Financial Accounting Standards Board.  This board creates accounting policies for CPA’s, corporate accountants and auditors.

The CPA profession is making big changes in their allowed accounting procedures for off balance sheet companies.  These changes will continue, and it will accelerate the de-leveraging process that is underway in the world of finance.  Many financial companies have been using off balance sheet companies to hold speculative investments…on big margin.  There are several reasons these speculative positions (one could call them gambles) were put off balance sheet.

1.  To circumvent banking regulations which are meant to limit leverage
2.  To help minimize taxes
3.  To allow the institution to take bigger risks that would not sit well with shareholders, regulators and other stakeholders, but which have the potential to make (or lose) a lot of money.  If they make money, the operators get big bonuses and profit sharing, if they lose…well the shareholders would have to bail it out…in the long run.  In short run, the incentive to speculate in these off balance sheet entities was huge.
In essence, these new accounting standards which the CPAs are promulgating under pressure from the U.S. Securities and Exchange Commission will insert some sanity by disallowing these off balance sheet, highly speculative investment vehicles called SIV’s, or special investment vehicles.

The institutions will be required to reflect new vehicles on their balance sheets.  We believe that since some companies may not survive if they have to insert the old vehicles into their balance sheets today, the old vehicles will be allowed to be wound down without being inserted into the balance sheet.  Of course the ultimate effect is the continued de-leveraging of the world financial institutions, which has been going on for several months.

To read more on FASB’s proposed changes, click the following link to an article in the Friday, May 2nd edition of the Wall Street Journal. 
http://online.wsj.com/article/SB120969084241961495.html.

WE OFTEN ASK OURSELVES “WHY IS INFLATION RISING SO RAPIDLY IN THE COUNTRIES LIKE INDIA AND CHINA, AND SLOWLY IN U.S., EUROPE AND BRAZIL?”

In our opinion, there is an obvious answer to this.   Brazil, Europe and the U.S. have more sophisticated management of their economic data’s construction and how it is distributed to the public.  The article by the famous political commentator Kevin Phillips to which we supplied a link to in our last letter [see archives] continues to be the key.  Mr. Phillips points out that U.S. economic statistics have been actively manipulated by presidential appointed economists and statisticians since John F. Kennedy’s administration in the early 1960’s.

Europe and Brazil are much the same.  They are very good at denying the facts and manipulating the statistics to do so.  Argentina is a champion of such behavior…today Argentina’s admitted inflation is 9%, but The Economist magazine estimates that the true figure is 25%.  India and China admit to inflation today of about 8.5%.  This is probably fairly accurate.   Today, the U.S., most of Europe and Brazil are claiming about 4% inflation.  In our opinion, 4% is understated.  Inflation in these countries today is probably approaching 8%.  Globally, inflation is rising.  Thus, we are continuing to invest with high inflation expectations as we have been saying for 2 years.

BRAZILIAN GOVERNMENT BONDS GET UPGRADED BY S&P…AND BRAZIL’S STOCK MARKET CONTINUES STRONG

We have liked the economy of Brazil, and things within Brazil continue to improve. Banks, consumer and base metals companies should do very well for some time.  We are buying Brazilian banks and consumer stocks, and we continue to favor Brazilian base metals companies.  Brazil is not suffering from the western problem of bad mortgage investments.  Their real estate market is strong, their consumers are spending, and their industrial machine is growing.  Many do not realize it, but Brazil is an industrial powerhouse which manufactures many large machines, computers, and aircraft; and of course Brazil exports many farm and mineral products to the rest of the world.

CHINA IS DOING VERY WELL…QUIETLY…AND ITS STOCK MARKET IS AGAIN ROLLING ALONG

As we have mentioned, we have re-entered China during the recent decline in their market.  Since October, the Chinese stock market fell 50% while corporate profits moved along at about a 25% annual rate.  In the last twelve months, their GDP growth was over 10.8%, and inflation (which is more accurately reported than in the west) was 8.5%.  This GDP growth and inflation have allowed the average company to continue to grow at about 20% a year.  How do you beat that in the U.S., or Europe where the average company is growing at about 4%?

Also, because Brazil and China were booming along, they did not drink the poison of subprime real estate loans and leveraged bets on mortgages as their economies had plenty of profit potential and smart ideas unfolding before them.

CHINA AND SAVINGS…CHINA IS THE KING OF SAVINGS AND WILL INFLUENCE THE WORLD A GREAT DEAL IN THE COMING TEN YEARS

According to a recent report by Merrill Lynch, China is now the world’s leading saver and will be the biggest investor offshore.  Today, China’s resources are very conservatively managed, primarily in low yielding government bonds.  However, now that they have surpassed Japan as the world’s largest offshore saver, Merrill believes that they will move toward more aggressive management of their assets.  We believe that they will hold lesser amounts of conservative U.S. government debt, and more global stocks and bonds.

We believe that if China follows the traditional pattern, about 25% will go into foreign stocks and 75% into foreign bonds.  Chinese banks will probably expand their offshore lending as has been the case with banks in other countries in the past.  China, both alone and with Chinese entrepreneurs, will make more direct investments in offshore companies.

GLOBALLY IN THE MEDIA…A DRUM BEAT CONTINUES…PROMOTING BUYING THE US DOLLAR

This is an obvious effort to rig the dollar up by changing investor psychology.  It may work for a few months, and the dollar may rally for a while as it did for about a year from late 2004 until late 2005 before resuming its recent major decline.  In our opinion, the dollar may rise versus some European currencies but will likely fall versus the Chinese Yuan and some other Asian currencies, especially those of developing countries.

GOLD AND THE U.S. DOLLAR

In our opinion, if the U.S. dollar rallies against the European currencies, and falls against the Asian currencies, we expect that it will not be bearish for gold.  Many of the biggest buyers of gold are in China and the Middle East (two areas where we expect the currencies to continue to rise versus the U.S. dollar).  Investors should be alert to this change, and look at the rise in currencies of countries which are big gold buyers, China, Middle Eastern countries, and India among others.

OUR THEMES…WE CONTINUE TO EXPECT INFLATION GLOBALLY

In general, our themes remain the same.  Several of them have been six year themes, and others have been two to four year themes.  We remain focused on dealing with the current and oncoming inflation that the world is experiencing and will continue to experience.
• Energy-Energy resources are needed to meet the huge and growing demand from China and other developing nations.
• Food-Companies which serve the food production industry are attractive as global increases in wealth lead to upgrades in diet.
• Precious Metals-Precious Metals are being bought in the Middle East and China, but being sold in Europe.
• Chinese and Brazilian stocks-We have favored the stocks of the faster growing countries for years.  Recently, we stopped viewing Russian stocks as attractive.  India is good long-term, but we believe it is overpriced short term.
• Asian currencies-The currencies of the faster growing developing nations in Asia, especially the Chinese Yuan, are attractive, but the Yuan’s rise will likely continue to be managed by the Chinese officials.
• Base Metals-To meet the huge infrastructure building driven demand from India, China and other developing nations, base metals in massive quantities will be needed.

Thanks for listening


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