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CONTINUING TO BELIEVE IN COMMODITIES (GOLD, FOOD, OIL) AND FOREIGN MARKETS

CONTINUING TO BELIEVE IN COMMODITIES (GOLD, FOOD, OIL) AND FOREIGN MARKETS

Please notice the chart reflecting the trends in the holdings of U.S. treasury debt by Japan, China, and the U.S. This chart tells the story of what is happening to the U.S. dollar and the U.S. economy.


You will notice that Japan is increasing their holdings of U.S. debt. This means they are buying U.S. debt, selling yen to keep the value of the yen from rising too much. It seems clear to us that the Japanese exporters are suffering greatly as the yen has risen to high after high and they are pressuring the Japanese government to do something to get the yen down. Despite their efforts, the yen has continued to strengthen. How long will this continue if it’s ineffectual?


The Chinese, on the other hand, have been decreasing their ownership of U.S. government securities for over a year. They decreased their holdings from $983 billion in Sept 2009 to $846 billion in July 2010 (which is the latest data in the chart). It is no secret that the Chinese have been diversifying their large reserves away from being so concentrated in U.S. dollars


Meanwhile, the U.S. Federal Reserve is now increasing their purchases of U.S. treasuries, and are planning to do a lot more of it in the near future. This is quantitative easing—pumping money into the U.S. system—and it is a primary reason, the dollar is, and will continue to be, weak.

As you know, if the supply of an asset or commodity rises and the demand stays the same, the price will fall. In this case, the asset or commodity is U.S. dollar denominated treasury bonds. Large budget deficits are increasing the supply of these U.S. dollar denominated bonds each month. For now, Japan is increasing their holding, but it looks like the appetite for these bonds from other countries is waning. This is a key reason the price of the U.S. dollar is falling.

India to allow foreign retail investors to buy Indian stocks

India’s Fabian socialism is slowly giving way, and foreign retail investors may soon be welcomed into the Indian equity market. Guild Investment Management is a registered Foreign Institutional Investor (FII) in India. We went through the registration process twice, and remember the inefficiency, expense, and hassle of going through the permitting process to get registered. The process was filled with delays, occasional surprise government taxes or fees, and bureaucratic hoop-jumping. When we did it in 2007, the process was slow, but when we did it in the mid 1990’s, the process was laughable. This makes us hopeful that they are moving in the direction of opening more to foreigners, and making it fairly easy for international investors to invest. If they do this it would be a major improvement for Indian stocks; sending them much higher.

U.S. financial authorities are frightened that U.S. may fall, like Japan, into a prolonged deflation

Clearly, U.S. Federal Reserve officials are frightened that the U.S. may be falling into a Japan-like deflationary environment, and that it may last for many years. The Japanese stagnation and deflation cycle has lasted for 21 years, and is not near ending. Those visiting Japan today know what I am talking about. The entire nation is suffering from a depression about the future prospects of the nation and its people.

As we mentioned two letters ago, we believe that Federal Reserve officials will try to create inflation in order to reverse the deflationary trend toward which the U.S. is moving. Currently, core inflation is at a 29-year-low. All of the following data points argue for more inflationary activity and targeting: a deleveraging banking system; consumers who save and cut spending; a foreclosure crisis on home loans (which means lower home prices); and an increased popular movement towards greater public sector austerity.

The Fed’s actions are intended to get the consumer into an inflationary psychology, in which investing, spending, and expanding business are paramount, rather than the retrenching, deleveraging, saving, and cost-cutting psychology.

If they are successful in doing so, we can avoid going through what Japan is. If not, we could see a long and devastating deflation in the U.S. As we have been stating for years, politicians will never consciously opt for deflation, since deflation ruins political careers and destroys the hope and verve of a nation.

We expect more quantitative easing (QE), and inflation targeting at 2% or more (up from the current 1% target). We believe the Fed wants to allow inflation to rise to 3%, before they need to reign in any inflationary tendencies.

Tuesday’s panic about the fact that China raised interest rates by .25% is absurd.

To say that the market’s reaction was overblown is an understatement, and it was evident Wednesday, when many markets turned higher again. China will not stop growing because of this or even if rates were raised by an equal amount once a week for a month.

In China, interest rates are still below the inflation rate that most Chinese believe really exists. As in the U.S., official Chinese inflation statistics are inadequate. Chinese GDP growth will be strong in 2010 and for the next few years. Any decline in the Asian markets over the next few days or weeks created by reaction to this raise of interest rates will create buying opportunities.


China’s New 5 Year Plan

Growth is still the priority and it will focus on westward development in its interior regions with emphasis on technology and on critical industries. We believe this means an increased focus on mining resources and building their military. About $600 billion has been set aside for these areas thus far.

China’s plan will boost the social welfare of migrants from inland to the big cities and shift more migrants into urban residential status. This will also mean higher monetary compensation for farmers if their land is expropriated by urban development, and the opening of non-crucial sectors for more private investment. Social well-being is also highlighted, including housing for the poor, infrastructure build out, more roads, dams, bridges, ports, airports, railroads, etc.

Rumors about bad debts in China are clarified

For months there have been rumors of large bad debts had been created by city and provincial governments connected with borrowing to finance real estate projects such as government buildings and high-rise office buildings. China has done an audit and found up to $500 billion of potentially bad debts. This is a much smaller amount than some of the rumors have proposed.

China has the reserves and the economic growth rate to manage some bad debt issues. China’s total holdings of foreign bonds and currencies have risen to $2.6 trillion dollars.

This new high level of reserves reflects a small number of loans to the U.S. government and to its agencies. The Chinese have been diversifying their holdings to include more euro bonds and more bonds of the numerous countries with whom they trade. This is why the smaller countries in Southeast Asia and Australian currencies have been rising so rapidly: both the Chinese buying and the knowledge of this buying, which causes investors like us to buy the non-U.S. currencies.


Our Recommendations:

Investors should continue to hold gold for long-term investment. It will move to $1500 and then higher. Traders sell spikes and buy dips. Gold-related news: South Korea decided this week to increase the percentage of gold in their investment portfolio these purchases could be substantial. China continues to buy gold.

Investors should continue to hold oil. Oil-related news: Positive U.S. onshore inventories are neutral and offshore inventories held in tankers have declined substantially. A negative news event is that there will be an increasing supply from Iraq.

Currencies: For long-term investment, we do not like the U.S. dollar, the Japanese yen, British pound or the Euro. We do like Canadian, Australian, and Singapore dollars, the Thai baht, Malaysian ringgit, and Indonesian rupiah. We would use the current pull-back in the favored currencies as an opportunity to establish long-term positions.
Investors should continue to hold shares in India, China, Singapore, Malaysia, Thailand, Indonesia, Colombia, Chile, and Peru. We would use any pull-backs as an opportunity to add or initiate positions for long-term investors.

Investors should continue to hold food-related shares such as grains, wheat, corn, soybeans, and farm suppliers.
Continue to hold U.S. stocks for a further rally. U.S. liquidity formation through QE will create demand for many assets, including U.S. stocks.

All of these recommendations have unrealized profits. All of these positions are long-term recommendations; traders may want to sell rallies and buy dips.

A new recommendation is for investors to cover the short on Japanese yen. The Japanese just do not have the resources nor the political willpower to fight against further price rises in the yen. We have been wrong lately on our recommendation to sell short the yen after it has risen about 4% over the past 5 weeks since we said we were bearish on it. We continue to see the yen as overvalued, but it can stay overvalued longer than we had anticipated.

Another new recommendation is that we are less bearish on U.S. long-term bonds. We are removing our bearish view on long-term U.S. government bonds. 30-year U.S. treasuries have been volatile, but they not appreciated or depreciated from the point where we recommended that they be sold in August.

Why the change in recommendation? We still believe that too many bonds are being issued, and that the U.S. Federal Reserve has begun to target a higher inflation rate than we have currently experienced in the U.S. Both of these views are bearish on bonds longer term, however, we are also seeing positives that balance out some of the negatives. The first is the view that more QE is likely to occur, and the second is the fact that many pessimists believe that the U.S. economy will sink into depression, both of which are creating a strong demand for bonds. Thus, our current opinion is that we believe that it is too early to sell them short. The day will come for that, but it is not yet here.

Thanks for listening.