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WHEN DECIDING WHERE TO INVEST, FIRST LOOK FOR THE GROWTH

WHEN DECIDING WHERE TO INVEST, FIRST LOOK FOR THE GROWTH

If you are looking for growth, look at China, India, and the demand for oil from the aforementioned nations…and from many others.  However, the investment area with the fastest growth in the world is…the available supply of U.S. debt.  This is followed closely by the growth of debt in many European countries.

1. Growth of U.S. and European Debt
According to official statements by the U.S. Congressional Budget Office, the investment area with the fastest growth over the next two to five years will be the supply of U.S. debt.  While investors typically look for growth to identify areas for potential investment, this growth of supply of debt may not be met with an increase in demand.

In order to stimulate demand for any product, sellers offer incentives, especially when supply grows rapidly in a short period of time.  What kind of incentives have debt sellers offered historically?  A higher yield on the debt is the first and most common offering to sway potential buyers.  That would mean higher interest rates.

Today, U.S. and European nations find themselves in the unenviable position of having to sell increasing amounts of debt to increasingly wary buyers.  Many buyers have asked why these governments don’t cut the price of the bonds by lowering the value of the currency so that the buyer is not stuck with a high priced bond that might decline in value in coming months and years.  We believe the U.S. Treasury, the issuer of U.S. Government bonds, may wish to implement this strategy.  A lower dollar may help solve the problem of selling more debt, but it may anger previous buyers who hold a large amount of U.S. debt already…think Saudi Arabia, Japan and China.
A declining dollar also helps solve the problem of declining U.S. exports.  With a lower dollar, the U.S. will export more and the economy can recover more rapidly.

2. Growth of China
Respected economists are predicting 8.2% GDP growth in 2009 and 9.6% GDP growth in 2010.  In our opinion, this makes China a good area for long term investment.

3. Growth of India.
Early indications are for 6% growth in 2009, and we are expecting 6.5% or better growth in 2010.

4. Growth in demand for oil and energy. 
Oil demand is strong from those countries where economic growth is strong, primarily China and India.  Elsewhere, demand is growing more slowly, and we project that demand will continue as we move toward slightly stronger global growth.  In our opinion, $60 per barrel oil is a good buy.

RUSSIA — STILL A DANGEROUS PLACE TO INVEST

Those of you who have read our memos over the years are aware that we have been pessimistic about the investment environment in Russia for some time.  While Russia may represent R in the acronym BRIC (Brazil, Russia, India, China) that is so often used to describe the new fast growing emerging economies of the 21st century, Russia is not and attractive area for investment, in our opinion.  Russia’s court system is corrupt in the extreme…and even Prime Minister Putin and President Medvedev agree.
We have not been investing in Russia recently for this reason, and we wanted to bring the readers up to date on some recent business events in Russia which offer little hope of any return to an attractive investment environment in the near future.  An excellent article on this subject appeared in this week’s The Economist titled "Courting Disaster" with the subtitle "Russia’s Dismal Investment Climate."  The following is the last three paragraphs of the article for your perusal.

“…The clearest indictment of Russia’s investment climate came a few days ago from IKEA, a Swedish retail chain, whose local operation has grown quickly since it opened its first store near Moscow in 2000. On June 23rd IKEA said it was suspending its investment in Russia because of the “unpredictable character of administrative procedures”, a euphemism for graft. A symbol of Russia’s economic rebound from the 1998 financial crisis has become an emblem of its dire investment climate.

Among 181 countries surveyed by the World Bank for ease of doing business, Russia occupies 120th place, below Nigeria. Transparency International gives Russia barely two points out of ten—its worst performance in ten years, which puts it on a par with Kenya. Until recently the Kremlin had no need to worry about things like property rights and the rule of law. Its oil wealth ensured an economic boom, no matter how it treated investors. Most of the money that flowed into the country came in the form of loans rather than foreign direct investment.

Now the loans have dried up. The Russian economy is forecast to contract by 8.5% this year, an especially dire performance by the standards of the so-called BRIC countries (the others are Brazil, China and India). Russia still blames the global economic crisis for its misfortunes. A closer look at IKEA and Telenor, as well as many of Russia’s own companies, suggests the truth is more complicated.”

Russia RTS Index (last 5 years)

SHORT SELLING

Short selling without an uptick
There remains a secret of which most of the public is unaware.  The secret is how much money trading operations at major brokerages have made shorting stocks during the recent bear market.  There is no doubt that the removal of the uptick rule (after much lobbying by the financial services industry) exacerbated the decline in U.S. stocks.  In our opinion, it hurt the American people, their retirement savings, and has caused the U.S. market to fall farther than it would have otherwise.  There is also evidence that it may have caused many small companies (the engines of growth in the U.S. economy) to suffer, keeping them from accessing the markets for capital.

The SEC is now considering whether to bring back the uptick rule.  In our opinion, it should be brought back as soon as possible.  Several financial thinkers like Jim Sinclair, Jim Cramer, and many others agree are on record agreeing that the uptick rule should be reinstated.  Arrayed against a reinstatement are the traders who find it easier to make large sums of money by driving stocks down with their relentless sell orders without having to wait for an uptick to get executed.  A letter-writing campaign to the SEC in support for reinstatement of the uptick rule has begun, and for those who wish to register their opinion, we suggest that you do so soon.
Naked Short Selling
Naked short selling (selling short shares without first borrowing the shares from someone who holds them) has been a popular tactic to force small, undercapitalized companies to refinance, often under very unfavorable terms.  This tactic can profit the naked short seller handsomely.  Naked short selling circumvents many securities laws, but they are rarely enforced.  It is almost like counterfeiting shares of a company.  In our opinion, naked short selling is at least as dangerous as the short pools of the 1930’s that the then head of the SEC, Joe Kennedy, worked to stop (this was of course after he had profited greatly as a principal of short pools of his own).  President Roosevelt appointed Kennedy because as one of the short pool operators he knew exactly how they worked.

Today, much of the naked short selling takes place outside of the U.S. by foreign brokers who are not supervised by the SEC, but some of it takes place in the U.S., and it has been responsible, in our opinion, for much of the battering that stocks took in the recent bear market.
CHINA, INDIA, FRANCE AND BRAZIL JOIN RUSSIA IN COMPLAINING ABOUT THE U.S. DOLLAR’S ROLE AS THE WORLD RESERVE CURRENCY
In recent pronouncements by high government officials, all of these countries have suggested that a new arrangement be concluded to handle world reserve currency duties.  Some suggest a group of currencies should share the duty; some suggest the gradual removal of the U.S. dollar.  All agree that more trade should be done in bilateral currency agreements directly between nations without transiting through U.S. dollars in the process.

Currently, many bilateral and multilateral trade agreements are being undertaken, omitting the dollar as a pricing or clearing currency.  In addition, many trade loans in other currencies by-passing the dollar’s traditional role are taking place.  These recent developments indicate the beginning of a multi-year process through which the U.S. dollar will decrease in influence and eventually be replaced by a new world reserve currency or currency basket. The change will not happen this year, but it will happen.

The communiqué from the upcoming G-8 meeting will likely reaffirm the dollar as the world reserve currency.  Japan, Saudi Arabia, the Philippines, and many others for whom the U.S. provides a defense umbrella, will not take kindly to the idea of losing the U.S. dollar as world reserve currency.  They feel a debt to the U.S. for military and/or humanitarian support, so they will do what they can to delay the removal of the U.S. dollar as world reserve currency.  The tug of war will proceed for some time.

A TRIP TO CHINA

Monty Guild, Tony Danaher, and our analysts frequently visit companies and analysts in countries where we have invested or may be interested in investing.  Over the years, we have prioritized travel to Europe, India, China, Hong Kong, Southeast Asia, and Latin America.  In recent years, trips to China and other parts of Asia have been made about twice a year by Monty, Tony, and our other analyst associates.

In the coming week, Monty will be traveling with analyst associate to two cities in China and to Hong Kong, and will be reporting to the office daily on the companies and industry analysts that they are meeting.

SUMMARY

We continue to believe that buying India, China, oil and gold on dips will provide excellent long term returns.  One curiosity is that while China has been in a bull market, the U.S. based ETF’s that focus on China have underperformed the local market, and have not tracked the appreciation of their underlying index components.  Currently, we have noticed that there exists the largest discrepancy in the ETFs’ history between the value of U.S. based Chinese ETF’s and their index component values in China.

Either the U.S. and European speculators are not aware of the underlying values of the components of the Chinese indexes and the ETF shares are selling at a growing discount, or investors in the U.S. are anticipating that the Chinese market will follow the U.S. and European markets lower…which has not happened.  We will keep monitoring this situation as an opportunity may be in the making.

Thanks for listening.


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