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SOMETIMES WE GET LUCKY

SOMETIMES WE GET LUCKY

Privately we have been increasingly bearish on the prospects for long-term bonds for many months. We waited until August 27, 2010 to put out our first strong recommendation that readers sell their long-term bonds in the U.S. Clearly we were lucky with our timing. Almost immediately long-term U.S. government bonds began to fall in price and rise in yield, and since that time investors have lost 2.5 percent of the value in their 30 year U.S. government bonds. When you consider that at the price peak of long-term U.S. government bonds only paid 3.6 percent per annum, 2.5 percent equals 8 months of interest income.
In the three letters since that time, we have reiterated our sell opinion on long-term bonds. As of today, we are recommending that investors sell long and intermediate-term bonds with maturities of 10 to 15 years or greater.
It is our strong recommendation that investors sell long and intermediate term U.S. bonds including U.S. treasuries, U.S. government agencies, municipal bonds, or corporate bonds. In our opinion, it is a very unwise bet to gamble that interest rates will stay down.

DO NOT FIGHT THE LAST WAR… INFLATION IS THE RISK, NOT DEFLATION

Remember the Maginot Line? Fighting the last war is almost always a mistake in the investment world.
Between WWI and WWII, during the period 1930-1935, the Maginot line defense system was constructed by the French at the huge cost of about seven billion francs. The line extended between Luxembourg and Switzerland along the French/German border, and was widely thought to be impregnable by tanks. The French knew the Germans had expansionary plans and they figured they would use the tank weapon, so they used the logic of the last major war to determine where the invasion might take place.
When Hitler ordered an offensive in early 1940, the German army invaded France through Luxembourg and Belgium through the somewhat mountainous Ardennes; around the northern flank of the Maginot line. The French military had reasoned that because the Ardennes region was heavily wooded and somewhat mountainous, the Germans would not send tanks from that direction. When seven tank divisions reached Dinant, Belguim on May 12, 1940 the French Government abandoned Paris.
Why do we mention this historical event? The last successful stock or bond market investment strategy is much the same as the Maginot line. In our opinion, believing that disinflation or deflation will continue, and inflation will not return is fighting the last war. Inflation in the emerging world is a demand pull and it is a force to be reckoned with. Please see the following article: New York Times "Inflation in China Is Rising at a Fast Pace" 09/11/2010
Inflation will soon arrive in the developed world in the form of cost push inflation. Key sources of this inflation will be the rising costs of imported goods and services, and the rising cost of raw materials. Cheap labor and land found in the developing economies have been a source of disinflation for manufactured goods for nearly a generation. The tide is changing and these developing economies will begin to export higher costs instead. The inflation figures coming out of the developing world are key numbers that investors should watch. For example, China’s recently released data can be found here: Yahoo Finance "China’s inflation edges up, driven by food costs" 09/11/2010
MEXICO

Many months after we warned the investment world that a war is going on in Mexico, the Secretary of State mentions the problem. To quote an article by Paul Richter and Ken Dilanian in the Los Angeles Times about Secretary Clinton’s talk on the subject of Mexico last Wednesday: “ Clinton’s comments reflected a striking shift in the public tome of the Obama administration on the bloodshed that has cost 28,000 lives in Mexico since December 2006.” In less than four years, the Mexican drug war has seen more than six times as many deaths as U.S. Military casualties in Iraq since March 2003.
The U.S. has a huge problem and most Americans are not yet aware of the magnitude of the issue. As war for the control of Mexico is taking place on the U.S.’s southern border, the U.S. must take action to defend its territory and to stop the war and bloodshed from moving into the U.S. Currently, the drug cartels’ strategy is to buy police forces and politicians that will not prosecute the murder, kidnapping, intimidation, brutality, corruption, and drug trafficking. The problem looks to be accelerating and is going to spill over into U.S. border territories.
We believe that the major narcotics-smuggling cartels are opening a new strategy. It appears that their new strategy will be to continue their old style of functioning while expanding their influence by pretending to be revolutionaries and working to undermine the political framework of the Mexican government. We have no doubt that their ultimate goal is to gain control of the entire governmental apparatus of Mexico and to extend their power from control over numerous corrupt police forces and local politicians to control of the very highest levers of power in Mexico. Stay tuned. This will be a battle of substantial size and duration.
JAPAN HAS TO DO SOMETHING ABOUT THE STRONG YEN

Japan must do something to stop the continued devastating rise of their currency. It is damaging their export machine and is currently contributing to the Japanese economic stagnation which has lasted for much of the last 20 years. What they will do we do not know, but we expect that the pain threshold has been realized and Japan will do something to devalue the Yen.
GOLD

Gold has broken out above the highs of June 2010. We remain very bullish on gold and gold shares. Some hedge funds have been long gold bullion and short gold shares. We believe this to be a big mistake.
SUMMARY OF OUR INVESTMENT VIEWS

• Bullish on gold and silver bullion and shares.
• Bearish on long and intermediate term U.S. bonds.
• Bullish on U.S. stocks for a trading rally, which will continue for at least a few more weeks.
• Bullish on stocks in Indonesia, Singapore, India, Thailand, Malaysia, Peru, Colombia, Chile, and China.
• Bullish on Singapore, Thai, Canadian, Swiss, Brazilian, Chinese and Australian currencies versus the U.S. dollar
• Bearish on the Japanese Yen versus the U.S. dollar.
We still remain bearish on long-term bonds, and especially many municipal bonds in the U.S. We will be happy to look at your municipal bond portfolio and offer our suggestions for free. Please do not hesitate to contact Aubrey Ford or Anthony Danaher at 310-826-8600.
We look forward to hearing your thoughts or comments. Thanks for listening.


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