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Waking Up to Inflation — Part 2

Waking Up to Inflation — Part 2

(Our commentary below is a continuation of last week’s discussion on the current climate of mounting inflation)

Rising prices at the pump.  Higher food prices.  These in-your-face realities are waking up a somnambulant public to the new dawn of inflation.

Such realities are not lost on investors who, unlike the general public, are hip to other signals of economic distress.  For instance, the International Monetary Fund last week scolded the U.S. about its out-of-control debt situation.  And just a few days ago, bond rating agency Standard & Poor’s did likewise.  Both admonished the U.S. for not having a plan to deal with its deficits.

Do such developments help investors gain a deeper understanding of how the world turns?  It appears so.  It appears to be dawning on smart people around the globe that the U.S. is going through a watershed period of great challenge.  Will the long-reigning Superpower remain the Superpower or just another power?  The great challenge here and now is for the country to own up and begin seriously addressing its growing deficit, its habit of living and spending beyond its means, and implementing a long-term plan of deficit reduction.  And we mean serious, not just the usual reeking discharge of political blather, spin, blame, and obfuscation that flows out of Washington.

It is because of the rising deficit that gold and silver have continued to soar while other markets have paused.  Worldwide, investors are seeing a future that includes inflation and a devaluation of the buying power of the world’s reserve currency.  So they are gobbling up gold, silver, and other stores of value to compensate and protect themselves.  And it’s not just investors, but governments as well.  China, India, and seventeen other countries have been major buyers of gold for their national treasuries during the last twelve months.

Here is what Standard & Poor’s (S&P) said this week: “We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium and long term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer AAA credits.”  In other words, they are saying that the U.S. needs to shape up or lose its AAA credit rating.  Wow!

Can S&P’s bombshell, and the IMF chiding the week before, sober up the U.S. Congress and provide a cover to start to act responsibly?  We know that some senators are starting to work in a bipartisan way to solve the deficit.  However, there is little doubt that Congress overall lacks an understanding of economics.  Most senators are lawyers and many congressional members have been professional politicians for most of their working lives.  They are well-versed in doing favors for lobbyists, making promises, and catering to the fears and greed of their constituents, but they are on unfamiliar ground when it comes to getting things right and doing the best possible job for the country.  As perennial watchers of Washington hanky-panky it is quite clear that they do not understand (or do not care about) many of the long-term implications of their actions.

“Never lose hope” is an old saying.  So we will reserve some hope that our elected officials come to their senses.  We are glad that some members of Congress are finally starting to think about finances and the deficit.  Some have been taking tutorials from Fed Chairman Ben Bernanke about what the deficits are and what they really mean.  It’s a start.  Hopefully, the interest will spread.


Not Just Inflation —

Other Reasons for the Gold, Silver, Oil, and Grain Boom

 To be sure, investors globally are concerned about inflation, which is already high in many parts of the world.  Thus, they are buying gold, silver, and other commodities priced in dollars as hedge against a continuance of inflation.  But inflation is not the only cause for the current boom in value.


Gold and Silver

 In China, real estate loans have been cut off to wealthy buyers who were acquiring multiple homes as investments.  Many Chinese investors already own stocks.  Bonds in China are hard to find.  Gold, however, is an alternative and attractive investment becoming more readily available to Chinese investors and they are making it a bigger percentage of their portfolios.  The same is happening in India.  Gold and silver are being snapped up by wealthy and even middle-class Indians.

Many countries are adding gold to their national portfolios as a hedge against the possibility that the U.S. dollar will continue to weaken.


Oil

 Oil is benefitting from increased demand by investors and hoarding by consuming countries and companies.  Moreover, last weekend Saudi Arabia said it was cutting its output by 800,000 barrels per day, stating that the global market was “oversupplied.”  This is while Brent Crude sells at over $120 per barrel.  We recently discussed how Saudi’s increased social spending was raising domestic costs.  Infusing cash into the population there and in other oil-producing nations is one way to help keep the potentially-restive natives content in a part of the world witnessing unparalleled social turmoil and protests.

Another reason for closing the tap may be Saudi anger related to the treatment of its allies in Egypt and Bahrain during the current turmoil by the western powers.  Not only have they not supported the standing governments in those countries but have even actively encouraged their ouster.  The West is being seen as undependable friends in the eyes of Saudi Arabia, Kuwait and other traditionally friendly oil-producing states.  Slogans and cries for democracy give little comfort to the Middle East oil producers.  Increasing their oil output for the benefit of keeping energy prices down in the west is a diminishing priority.


Food

 Food prices are rising.  Increased hoarding and demand for a more protein-rich diet are fueling higher prices.  The food supply can be increased but only very slowly.  Meanwhile, demand is rising faster, and the growing demand is controlling grain prices.  After a pullback in February and March, corn is back on the move, and we are adding it to our recommended list again.


Debt Blight: Who will Purchase Treasury Bonds?

 Few takers are stepping forward these days as the U.S. Treasury looks for bond buyers to cover the government’s climbing deficit now running unbridled at $130 billion per month, and projected out to $1.5 trillion for the current fiscal year.

Who will buy these bonds?

Japan?
Although they have been a big buyer in past decades, the Japanese need all the yen they can muster to rebuild their own disaster-ravaged country.

China?
Our biggest creditor is an unlikely candidate. The big trade surpluses of the past are evaporating.  Higher labor costs are beginning to hurt China’s export megabusiness.  Imports are rising with greater focus on increasing domestic consumption.  The inflation troubling China will be dealt with in part by raising the value of the yuan.  As this occurs, the cost of imports decreases, but exports become more pricey and will thus be affected. Exports have historically provided a major source of funds that China has used to buy U.S. Treasuries.  Lastly, China is trying to diversify its $3 trillion investment portfolio.

Europe?
No.  Europe has its own problems and member countries to bail out.

Our little reality check leaves the U.S. Federal Reserve pretty much as the last man standing, the remaining buyer of the country’s debt. Nothing really new here. For months, the Fed has been buying up new debt. So what’s different?  Now, it’s about spin and trying to play politics, and saying “we’re not doing it anymore.” It’s a pretty transparent game that doesn’t fool anyone. Unless U.S. interest rates rise substantially (which will stop the current and modest economic expansion), it will become difficult and even futile to entice others to buy U.S. paper.  If you can’t sell your bonds at the current interest rate, you must raise the rate the bonds pay.  It’s really very simple: You need fatter bait on the hook or else you don’t catch fish.

Putting better bait on the hook is a challenge, however.  The U.S. is not in a position to both grow its way out of the banking and economic crisis that started in 2008 and also raise interest rates simultaneously. Most economists say that rates must stay low to attract business. Thus, lowering the value of the dollar (to attract domestic and export business, and create economic growth and higher employment) is the most effective option.

Historically, the Fed’s dual mandate has been to maintain price stability (try to keep inflation down) while fostering full employment. In our opinion, accomplishing both will be next to impossible.  We believe that the Fed will continue to prioritize its mandate to increase employment and try to keep interest rates well below the inflation level.  As we pointed out last week, the actual inflation rate is staying far above the reported rate. (See our newsletter from last week where we discussed how inflation is already inching toward 10 percent, as measured by 1980s standards. You’ll find that report as well as our entire archive of newsletters for years past on our website at www.guildinvestment.com)


Summary of Current Recommendations

We continue to favor oil, grains, non-U.S. currencies and, most especially, gold and silver. We are adding corn to our recommended list today.  Gold and oil have been on the list for years.  We continue to favor the same currencies and countries for investment that we have recommended in the past.  Please see below.


Investment

Date

Date

Appreciation/Depreciation


Recommended

Closed

in U.S. Dollars

Commodity Market Recommendations





Corn

4/20/2011

Re-Open


Gold

6/25/2002

Open

361.2%

Oil

2/11/2009

Open

210.1%

Corn

12/31/2008

3/3/2011

+81.0%

Soybeans

12/31/2008

3/3/2011

+44.1%

Wheat

12/31/2008

3/3/2011

+35.0%


Currency

Recommendations





Short

Japanese Yen

4/6/2011


Open

-3.7%

Long

Singapore Dollar

9/13/2010

Open

+7.9%

Long

Thai Baht

9/13/2010

Open

+8.1%

Long

Canadian Dollar

9/13/2010

Open

+7.8%

Long

Swiss Franc

9/13/2010

Open

+13.5%

Long

Brazilian Real

9/13/2010

Open

+9.1%

Long

Chinese Yuan

9/13/2010

Open

+3.4%

Long

Australian Dollar

9/13/2010

Open

+14.2%

Short

Japanese Yen

09/14/2010

10/20/2010

-3.3%

 

Equity Market

Recommendations





India

4/6/2011

Open

-1.1%

Malaysia

4/6/2011

Open

-1.0%

Canada

3/24/2011

Open

+0.9%

Colombia


9/13/2010


Half Original Position sold

+3.1%


Australia

2/15/2011

Open

+5.9%

Japan

2/15/2011

Open

-10.6%

U.S.

9/9/2010

3/11/2011

+18.1%

Canada

12/16/2010

3/11/2011

+7.9%

South Korea

1/6/2011

3/3/2011

-2.9%

China

9/13/2010

1/27/2011

+5.0%

India

9/13/2010

1/6/2011

+7.9%

Singapore

9/13/2010

12/16/2010

+4.8%

Malaysia

9/13/2010

12/16/2010

+1.3%

Indonesia

9/13/2010

12/16/2010

+9.5%

Thailand

9/13/2010

12/16/2010

+11.9%

Chile

9/13/2010

12/16/2010

+8.9%

Peru

9/13/2010

12/16/2010

+32.2%

 

Bond Market

Recommendations


30 YR Long Term

U.S. Treasury Bond




08/27/2010

10/20/2010

0.00%