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THIS YEAR, ONCE AGAIN AUGUST WAS A VACATION MONTH….EXCEPT THIS YEAR IT WAS A VACATION FROM RATIONALITY AND CALM

THIS YEAR, ONCE AGAIN AUGUST WAS A VACATION MONTH….EXCEPT THIS YEAR IT WAS A VACATION FROM RATIONALITY AND CALM

Now, the markets are gradually recovering their balance but the long-term effects will be felt by investors…and one big effect is the heightened awareness of the fragility of the world’s financial system.  Central banks have fewer tools because much of the world’s banking system that has been created over the last two decades is a shadow banking system, centered around the derivatives markets, and out of the direct control of central bankers.  This limits the central banks’ options for dealing with a crisis such as this one.  They still have the option of flooding their local banking systems with money, which is what we see when we look at data from major countries.  Money supply growth is fast.

OIL
We hear today that OPEC will add 500,000 barrels a day to production, instead of impacting the price of oil negatively, the reaction was a big yawn, with oil prices rising $1.39 a barrel after the announcement.  The OPEC statement is pure politics.  OPEC is already producing way above their announced quotas.  Global oil demand is very strong, and global oil production is falling about 1 to 2 percent a year.

Russia today announces that their oil reserves did not grow this year as much as they had projected.  Like everyone else, Russia is having a hard time developing new reserves as fast as it would like.  In 2008, Russian exports will undoubtedly decline from 2006-2007 average as Russia will consume more of their energy at home.  This further tightens the world supply demand balance.  Higher oil prices will add to global inflationary pressures.

INFLATION IS COMING…..NO ONE SEEMS TO BE NOTICING IT IN THE DEVELOPED WORLD YET……BUT SOON THEY WILL SEE IT
Inflation is rising in the developing world.  65% of the average family budget is spent on food in the developing world versus 20% or less in the developed world.  Higher global food prices are being caused by increased demand for feed grains as people eat more meat (which is feed grain intensive), and as more ethanol is produced.  Both trends lead to food inflation.

Inflation is strong and rising in the developing world, it is only a matter of time before the inflation is exported to the developed world.  Remember, much of the low inflation in the developed world for the last few years is because the developing world has been selling goods cheaper than they could be produced in the developed world.  Over the last few years, when imported goods were substituted for locally produced goods, prices fell.  We expect the reverse will be true.  Imported goods, which have already captured market share will rise in unit price; fueling an inflation problem in the developed world.  The problem will be felt first in food, later in consumer goods and finally in industrial goods.

AS INVESTORS AWAKEN TO THE FACT THAT INFLATION IS A PROBLEM…. STRONG PRICE RISES WILL BE SEEN IN GOLD, OIL, COMMODITIES…..AND STOCK MARKETS IN COUNTRIES WHERE EARNINGS ARE GROWING FAST
In the coming years, as investors awaken to the trend, the prices of non real estate assets: gold, energy, base metals, all commodities and stocks in the fast growing parts of the world will be forced higher.  The U.S. dollar will continue to lose value versus all strong currencies and against gold.

Over the last decade, residential real estate assets got way too pricey in many parts of the world, and they need to decline for a few years to work out the imbalances.  Real estate finance needs to be re-structured after the collapse of many of the assumptions that fuelled the craze in low rates on real estate loans…..and the boom in real estate prices.  Here in Los Angeles, informed sources expect residential home prices to fall substantially.  Real estate loan prices will rise substantially and that will diminish the appeal of borrowing to own residential real estate.

THE WORLD CREDIT CRISIS – MOST OF THE PROBLEM IS IN DEVELOPED COUNTRIES

While the developed world continues to grapple with the effects of the current credit crisis, we believe the majority of the effect of the global financial crisis is over in the developing world.  In the developed world, the effects will be long-lasting simply because the developed world is where the debt/derivative crisis is primarily centered.

In countries like Hong Kong, China and India this is a manageable problem when compared to the growth rates that they are enjoying and the reserves and capital being imported into these countries from the developed world.  There will be areas that are problematic, but there will not be a big economic slowdown in these countries.  Their big problem would appear to be the high-priced stock markets, which have enjoyed good returns.  We will take some profits in these countries during the current rallies and wait for dips to re-enter.  As you know, these markets are volatile and one should learn to buy dips and to take some profits on rallies.

OUR THEMATIC INVESTMENTS HAVE NOT CHANGED AND ARE THE SAME AS LAST WEEK

Oil and energy related
Gold and precious metals
Non U.S. currencies
India
China
Emerging Asia
Transportation

We would like to extend our congratulations and thanks to Jim Sinclair for his consistent and brilliant calls on gold, and to Earl Gould, Gary Mintz, Steve Emerson, Jeff Cohen, Barry Sahgal, Ron Silverton and Geoff Johnson for their market wisdom.

Thanks again for listening.


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