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THE MARKETS CANNOT MAKE UP THEIR MINDS

THE MARKETS CANNOT MAKE UP THEIR MINDS

The second quarter was very eventful. European sovereign debt came under suspicion, and many waves of fear flowed through global bond, currency, commodity, and stock markets.

The source of this anxiety and fear was the projection of future economic activity. Global bond, stock and commodity markets are a discounting mechanism of future events. They rise and fall prior to economic events which shape business activity in future years.

We and others spend long hours striving to determine what tomorrow’s economic environment will look like. Since the markets represent an amalgam of the decisions, actions, and trades of the many investors and traders trying to anticipate the future, it is important to be aware of how most people are investing and trading, while also being aware of the logic and feelings that are motivating these trades. Traders have a much more short term focus (concerned only with results for a few days or even a few minutes) and investors strive to see months and years ahead. Thus, the views of traders should not be confused with the views of investors.

Today, it seems clear that almost all markets are struggling to decide whether or not they should have confidence in the future growth prospects of the world economy. One day, bonds, commodities, and stocks behave as if there is an expectation of a rise in inflation that may become unmanageable. The next day, they behave as if the world expects a deep depression and a great shrinkage in world economic activity is what lies ahead.

MOST POLITICIANS AROUND THE WORLD HAVE DETERMINED THAT INFLATION IS BETTER FOR THEM THAN DEFLATION

We see all major governments moving rapidly and decisively to pump money into their financial systems. This is done, of course, in hopes of avoiding a politician’s worst fear: a deflation/economic depression that could send him and his party unceremoniously, and possibly permanently, into political oblivion. The only exception to this has been the attitudes of many German politicians.


NOW WE MUST WATCH AND WAIT FOR THE ECONOMIC DATA TO DETERMINE IF WE WILL EXPERIENCE INFLATION OR DEFLATION

During this period of watching and waiting, we believe a conservative approach is warranted. To us, a conservative approach means: hold a large percentage of assets in cash and in currencies that are rising (currently, the U.S. dollar seems to be most popular) and hold gold, adding to gold positions on price declines.

Gold has outperformed stocks, other commodities, and bonds over both the historical time frame of centuries as well as over the last few years. We believe that the inflation we foresee will benefit the price of gold, since gold has risen faster than inflationary indices during periods of inflation. Should deflation develop, we believe that it will leave gold prices generally flat while increasing gold’s buying power. We believe that gold’s buying power will increase, as it is common for the price of goods and services fall during a deflationary period.

We and others spend long hours striving to determine what tomorrow’s economic environment will look like. Since the markets represent an amalgam of the decisions, actions, and trades of the many investors and traders trying to anticipate the future, it is important to be aware of how most people are investing and trading, while also being aware of the logic and feelings that are motivating these trades. Traders have a much more short term focus (concerned only with results for a few days or even a few minutes) and investors strive to see months and years ahead. Thus, the views of traders should not be confused with the views of investors.

Today, it seems clear that almost all markets are struggling to decide whether or not they should have confidence in the future growth prospects of the world economy. One day, bonds, commodities, and stocks behave as if there is an expectation of a rise in inflation that may become unmanageable. The next day, they behave as if the world expects a deep depression and a great shrinkage in world economic activity is what lies ahead.

MOST POLITICIANS AROUND THE WORLD HAVE DETERMINED THAT INFLATION IS BETTER FOR THEM THAN DEFLATION

We see all major governments moving rapidly and decisively to pump money into their financial systems. This is done, of course, in hopes of avoiding a politician’s worst fear: a deflation/economic depression that could send him and his party unceremoniously, and possibly permanently, into political oblivion. The only exception to this has been the attitudes of many German politicians.

NOW WE MUST WATCH AND WAIT FOR THE ECONOMIC DATA TO DETERMINE IF WE WILL EXPERIENCE INFLATION OR DEFLATION

During this period of watching and waiting, we believe a conservative approach is warranted. To us, a conservative approach means: hold a large percentage of assets in cash and in currencies that are rising (currently, the U.S. dollar seems to be most popular) and hold gold, adding to gold positions on price declines.

Gold has outperformed stocks, other commodities, and bonds over both the historical time frame of centuries as well as over the last few years. We believe that the inflation we foresee will benefit the price of gold, since gold has risen faster than inflationary indices during periods of inflation. Should deflation develop, we believe that it will leave gold prices generally flat while increasing gold’s buying power. We believe that gold’s buying power will increase, as it is common for the price of goods and services fall during a deflationary period.

GOVERNMENTS WILL FIGHT TO KEEP DEFLATION AT BAY

It is yet to be seen whether deflation and depression will come, or whether governments will be able to arrest the world’s deflationary tendencies. Perhaps the inflationary tactics that they are attempting such as quantitative easing (printing money) will allow them to avoid this. Other investment prescriptions for such an environment are short sales of the various currencies as they alternatively strive to lower their value, and short-selling companies which cannot do well in a slow growth stagnating environment.

MANY HAVE ASKED US WHICH TENDENCY WE EXPECT TO EMERGE

We are not yet certain what the ultimate outcome may be but we can see some coming road signs, which are as follows:
1. The world will experience a beggar-thy-neighbor battle to lower currencies, as countries compete to lower the value of their currencies in order to gain an advantage by growing exports and attracting tourism. Interestingly, this view is shared by our very wise and experienced friend Jim Sinclair, who sees a major inflation resulting from a crisis.
2. There will be a continuation of slow, mildly depressed economic activity in Japan, Europe and the US. We do not expect a clear depression but rather slowing and stagnating economic activity.
3. Thirdly, inflation will eventually develop. This will be caused by the currency declines that many countries will engage in with the objective of lowering the value of their currencies. Whether this inflation accompanies a depression, as has happened many times in the historical past, or an economic expansion is still hard for us to foresee at this time. As economic data is presented we will update you on our opinion.

SUMMARY

Buy gold on dips and avoid most foreign currencies until the US dollar finishes its current bout of strength. Short sales of weak currencies and of companies which cannot manage well in a period of stagnating economic growth in Japan, Europe and the U.S. should be considered. We are monitoring the rapidly growing Asian countries and making a list of quality companies for future investment.

FAST TRADING AND THE FLASH CRASH OF MAY 6, 2010

Many of our readers have been concerned about fast trading and believe that in the recent past it has tended to destabilize markets. We draw your attention to the link below to an article which was written in the June 30, 2010 edition of the Wall Street Journal. We foresee that circuit breakers will be implemented to stop the negative effects of fast trading.
http://online.wsj.com/article/SB10001424052748703374104575337270344199734.html?KEYWORDS=fast+traders+face+off+with+big+investors+over+gaming
New technological developments often have unintended consequences, and eventually those consequences are removed by adjustments to the market system.
Although fast trading has been a nuisance and has served to destabilize markets on a couple of occasions in the past, the markets are currently in the process of introducing circuit breakers to diminish or remove the risk of market volatility. While we do not agree with the thesis that the fast trading provides the markets with liquidity, we do not view fast trading as a long term impediment to fair and liquid markets.
Thanks for listening.


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