This is a time of great risk and great opportunity.
On one hand, there are many problems (we will enumerate a few of them later in this letter), but on the other hand, there are many opportunities. To take advantage of the opportunities:
I) One must be willing to invest for a few years without the need for quick, panicky withdrawals of capital.
II) One must be willing to tolerate volatility…as the financial system has weakened. Volatility has reverted to the type that was seen in the 1970’s. That period, like today, was a period of big problems and big opportunities. During that period, the markets returned only about 4% per year for the decade (with many wild fluctuations), yet some sectors especially oil, gold, and food related returned much higher returns.
We began managing money in 1971 and between that period and the end of the decade we soundly outperformed the markets with a combination of energy related, gold, and small cap growth stocks. (For more information on how we did then, and how we are doing now, call our office and speak to Aubrey Ford in our marketing department at 310-826-8600.)
Gold went from $35 to nearly $800 an ounce during the decade. The price of oil rose ten fold, and many foods soared in price. The volatility was enormous. There was intervention from all sides. The government sold commodities into the market to dampen prices. The politicians engaged in a campaign of blaming other forces like speculators for the problems, when it was their monetary and fiscal policy which created the problems in the first place.
SIMILARITIES TO THE 1970’S ARE MANY
The similarities are numerous. Both periods experienced inflation, economic stagnation, bank failures, government intervention, and so on.
In the 1970’s if you had a combination of long-term investment money and perspicacity you could make a lot of money…but you had to wait out some hard times, be patient, and stick to your beliefs while you were being bombarded by numerous so-called authorities telling you that what was happening was not actually happening. Similar to today, the government wanted us to believe that: 1. Inflation was not actually as bad as you knew that it was. 2. The U.S. dollar was going to remain strong, even as it was falling. 3. They told you that commodities were rising because of speculators, not because of unwise long-term U.S. and foreign government fiscal and monetary policy. 4. They said that things would soon return to normal, and it was unwise to avoid bonds and other losing investments because inflation would soon disappear.
Meanwhile, contrary to the publicity put out by a combination of establishment banks and the governmental officials, inflation ramped ahead, stocks were volatile, bonds fell, commodities rose, and the U.S. dollar plummeted.
FAST FORWARD TO 2008
We can go into detail about today’s problems, and have done so in many of our commentaries over the past few years, but let’s summarize them. The current chain of events is something like this:
Inflation is strong and getting stronger and it is not being caused solely by food and energy price rises.
Inflation is being caused by many complex and interrelated variables. A few of the main ones are:
• Growth of the world’s population.
• Decisions by many governmental leaders in the newly industrializing world to create a much larger middle class. They want to encourage the growth of industry, while shrinking the percentage of the population engaged in agriculture, so that new, more efficient agricultural methods can be introduced in their countries. This has caused an unprecedented migration to the cities from the countryside in many fast growing, newly industrialized nations, especially China and India. Demand has soared for infrastructure building goods and services.
• Money supply growth of over 14% globally, and interest rates which are below the inflation rate in many countries.
Combining these variables with several other malignancies tied to poor monetary and fiscal decisions by central banks around the globe, and you get the current environment: high inflation and stagnating economic growth in the industrialized world, and high inflation and strong growth in the countries which have current account surpluses or other growth drivers.
What we know:
1) Inflation is here to stay for a while. Two of the major reasons and many minor reasons were outlined in our last three letters.
2) The U.S. dollar is headed lower.
3) Commodities are headed higher due to inflation and demand is rising and supply is slow to respond.
4) The U.S. and world banking crisis will last for years and is more likely to be a big driver of inflation.
5) Commodities will fluctuate, but most will continue to rise for a number of years due to rising demand, inflation, and a weak dollar.
1. Hold currencies of countries with current account surpluses such as Norway, Australia, Canada, Gulf oil producers, and China
2. Hold commodities, especially gold, food and fertilizers…and secondarily coal and other energy related companies.
3. Look for countries which can grow through it all…and buy them when they fall in price. China may be getting cheap, and we are watching it carefully. Foreigners have taken a lot of money out of China. The boom days are forgotten, but the average company is growing at 20% and P/E’s have fallen by 70% from their highs. It is setting up for a big rally…the question is when.
4. Be wary of the press reports and the PR spin found on financial TV and in other media…read global economic statistics to get a better picture.
5. Buy when people are pessimistic, and when they are saying this time inflation is over and this time soybeans, gold, coal, etc. have peaked and must fall in price long term. Remember, until something is done to address the weak U.S. dollar and inflation by the central banks and commercial banking institutions who are responsible for the problems, there will be no long term decline in commodity prices.
6. Have an intermediate to long term view, and ignore day to day fluctuations…In our opinion, watching the tape minute to minute will drive one mad.
INFLATION: A GLOBAL PROBLEM
TOO FEW COUNTRIES ARE FIGHTING INFLATION, AND THOSE THAT ARE, ARE DOING TOO LITTLE TOO LATE.
Government action has been too little too late. Current account surplus countries are creating inflation with their currency sterilization, and current account deficit countries are creating inflation with their banking system bail out.
As we have said over and over for years, there will be no big interest rate rises in the U.S. Anyone who thinks so will be disappointed that inflation will be tolerated, because the Federal Reserve has no other choice. Do they want to put the banking system down for the count? No! Their job is to help it. They will help it by keeping interest rates too low and this will cause inflation to be too high. Inflation is too high already and the bailout is just getting started for the world banking system. It will continue for a long time…and the effects are inflationary.
Action by current account surplus countries is too little too late.
The U.S. dollar is headed lower due to triple deficits, low interest rates, rising inflation and a general flight from the dollar by account surplus countries reducing their huge dollar reserves and/or relaxing their currencies’ peg to the dollar.
INFLATION IS HERE AND HAS GRIPPED NATIONAL AND INTERNATIONAL PSYCHOLOGY.
Within a few years the prices of many commodities will rise much higher.
IF YOU NEED PROOF LOOK AT THE PRICE CHARTS OF GOLD, COAL, OIL, FERTILIZERS, CORN, SOYBEANS, SUGAR, AND WHEAT.
Senator McCain is running AWAY from President Bush, and Senator Obama is running AGAINST Bush. The U.S. is in for a difficult few years. Whoever is elected president will be very unpopular in a few years. The triple deficits will determine the new president’s financial options and it will begin to dawn on the American people that their standard of living is falling for at least a few years. In our opinion, they will not respond happily to that discovery.
Taxes will rise, growth will slow, and general standard of living will fall….not a situation that presidents like to visit upon their constituency.
President Bush will likely be remembered in years to come as a failed president, and the coming president will inherit the product of his failures. This means public dissatisfaction with nationally elected officials in the executive and legislative branches will grow in coming years. Current polls suggest that Senator Obama will be elected president. He should be careful not to get people thinking that he will protect them from economic upheaval. He won’t be successful, and he and his party will suffer when living standards continue to decline.
Thanks for listening.
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