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2011 — An Investor’s Road Map

2011 — An Investor’s Road Map

2011 — An Investor’s Road Map

What lies ahead on the 2011 road map for investors?  Here’s our analysis of the current and coming terrain.

Right Now

Fear and trepidation dominate the world stock markets and have taken them down.  There’s fear over slower growth in China, the failure of several financially-floundering European nations, a double dip recession in the U.S. and Europe, and the imminent end of QE2.

The realization that QE2 did scant little to stimulate economic activity, create jobs, and /or boost U.S. real estate prices is also bothering the markets. To many observers it appears that all QE2 did was run up asset prices of gold, oil, stocks, and some other commodities.

Why didn’t it work?  Simply said, monetary policy as a mono-therapy cannot cure the ills of the U.S. economy. The sick economy needs other medicine, such as better fiscal policy and less burdensome regulation. Present regulations in place hurt all businesses, and especially small businesses. It is common knowledge that the small business sector is the growth engine of the American economy. Over the last decade, almost all growth in employment has come from small businesses. The big business sector, meanwhile, has been attacked by the Obama administration and it is understandably concerned about adding too many employees. And in the public sector, budget realities have come home to roost and at all government levels (local, state, and federal) workers are being laid off left and right.

Down the Road: Political Panic

In the past few months, American politicians have expended a good deal of their limitless hot air talking up deficit cutting, which means reducing spending and raising taxes. However, as the summer progresses, we expect them to start changing their tune in the direction of tax cuts or hiring incentives. By about September, many U.S. politicians will realize that if they don’t create some significant economic stimulation and job creation plan by mid 2012, they will be booted out of office by a dissatisfied electorate in the November 2012 elections. This is not a concept that career-minded politicians relish.

QE3 is the inevitable answer.  Print more money in an attempt to jump start the economy.  This is hardly a Made-in-the-U.S. recipe. We expect like-minded policymakers, from Europe and perhaps even Asia, to join the QE bandwagon. Slowing growth generates political panic, which in turn leads to stimulus incentives.

What this Means to You


In our opinion, these developments spell opportunity.  Look for another major rally in gold, oil, commodities, and stocks (especially companies in economies that produce oil and other key commodities). The rally should develop in the latter part of the summer or in the fall.

When the authorities conjure their QE3 version of liquidity creating, they will spark a major stock market rally in gold, oil, the emerging markets, the U.S. stock market, and possibly European stocks.  The response may very much resemble the rally that took place from late summer 2010 through April 2011.

The appropriate investments are those we continue to recommend (see below). We will not sit idle this summer. Rather we will utilize the summer doldrums and the current period of fear to target and accumulate investments in the most promising areas.


The Changing Complexion of the U.S. Stock Market

The financial service sector is shrinking. Energy and technology are growing.

Here’s the background.  The periodic bubbles that influence the shape of the market have caused some interesting changes in the values of industry groups.  In 2007, banking and financials made up almost a quarter of the total capitalization of the S&P 500 Index. Market capitalization refers to shares of stock outstanding times the price per share.  According to recent data from the Bureau of Labor Statistics and Federal Reserve of St. Louis, the figure has now dropped to about 15 percent.  Bloomberg also reports that the number of American financial industry jobs has declined from 8.4 million in 2006 to 7.6 million today.

Clearly, the growth areas of the U.S. economy (and the areas where job opportunities lie) today are in energy, energy services, engineering, and technology hardware, software, and services. Employee gluts abound in financial and legal services. We believe this is the situation in Europe as well.


Global GDP and Stock Markets — Who Looks Good?

A recent article in The Economist online magazine envisions a $10 trillion global growth in gross domestic product (GDP) from 2010 to 2013. Obviously, not every economy will benefit equally. Where will the most growth take place?  Here are the gainers, according to the article, compared to current levels:


Russia  +47%

Indonesia +30%

China   +28%

India    +25%

Brazil    +22%

Australia +17%

Mexico +17%

Britain   +16%

Canada +13%

U.S.  + 10%


As we have discussed in many previous letters, we believe GDP growth leads to corporate profit growth and corporate profit growth leads to stock price appreciation.  If you believe this as we do where do you want to invest your money?  The emerging world and the commodity producing nations have real growth. The developed world will have very slow growth indeed over the several year period.


An Oil Price Benchmark That Isn’t

The small Oklahoma town of Cushing has been a significant refining and trading hub for crude oil in the U.S. and claims itself as the “Pipeline Crossroads of the World.”  For most of the last decade the price of its West Texas Intermediate (WTI) crude and Brent crude in the North Sea (Brent) have kept within a couple dollars per barrel. However, that has all changed in the last few months. As of the close of business on June 10th, the differential was $19.30. WTI closed at $99.29 per barrel and Brent at $118.29.  By the close of trading June 13th, the spread had grown to more than $21 per barrel.


Here’s what’s going on and what this development means:

  1. There is a glut of WTI in Cushing. Major new drilling and well technologies have allowed North American drillers to unlock more and more crude from new fields and from older, formerly declining or played out oil fields.  Much of this new crude ends up in the Cushing system.
  2. There is also a lack of pipeline capacity to take crude from Cushing to the gulf coast for subsequent supplying to U.S. customers.  Oil delivery transaction prices are much higher in the gulf coast.
  3. A growing concern among futures hedgers and speculators is that the U.S. will raise margin requirements on crude oil futures contracts to unreasonably expensive levels just as has been done on silver and other commodities. This development has forced more hedging and speculation toward the Brent Crude contract in Europe.

What this means: the benchmark for global crude pricing is moving further away from the U.S. mid-continent pricing. The eventual effects will be less business for U.S. commodity exchanges and less liquidity/more volatility in U.S. oil prices.

Politicians, of course, desire lower oil prices and reduced speculation.  But will the shift of speculators out of U.S. markets to European exchanges fulfill their desire to lower the price of gasoline and heating oil in the U.S?  Hardly. The beneficiaries are limited by and large to people near Cushing. The price of oil at other locations in the U.S. is much higher than in Cushing, that is, closer to Brent than to WTI prices. Below are the price differentials between transacted crude prices and the WTI “benchmark,” according to Platt’s North America Crude Wire of June 10.


Type/Grade

Location of delivery

$ Premium over WTI
               
Basrah light     U.S. Gulf of Mexico   +$12.60
               
Eugene Island     St James, LA     +$15.00
               
Mars Blend     Clovelly, LA     +$12.00
               
Thunderhorse     Clovelly, LA     +$17.00
               
Alaska North Slope     Long Beach, CA     +$14.00


All of the above prices are at least $12 per barrel more than WTI.  Does this tell you anything about the worldwide demand for oil? Clearly, demand is high and rising abroad and elsewhere in the US, and we have a temporary glut in Oklahoma. Even with expanded  pipeline capacity that can take oil from Cushing to the Gulf of Mexico, we expect a future of higher oil prices in the US.

It is true that oil prices depend on the grade or quality of the crude, sulfur content and gravity are used to differentiate between sweet and sour crudes. Different crude grades require different refining methods. They can be more or less expensive to refine and transport than WTI. However, the price differences between a Brent barrel and WTI barrel are the widest ever, and those looking at WTI pricing are missing the big picture. In today’s oil scene, the Cushing price is unrealistically low. The Louisiana prices reflect reality.


Fed to Banks: Pony up more capital!

For the first time it looks as if banking regulators are showing some backbone. Here in the U.S. and in Europe, they are demanding less leverage. The same tone will likely spread as there is no question that many large global banks are in trouble. The problem is that they are not addressing leverage from derivatives.  It is too little and too late, especially after the moral harm created by the bank bailouts in the U.S. and Europe in past few years.   To read a Financial Times article on the subject, click link below:

FT.com Fed Signals Banks Will Face Equity Capital Surcharge.

To us, the big question remains this:  what about controlling and clearing derivatives through a central exchange so the world of derivative holders and writers can clearly know the risks involved?


Our Recommendations

Avoid bonds, especially those with long maturities. You are not being compensated for the risk you take as we head into an inflationary period. Long-term U.S. bonds have rallied because of investor fear over a double dip recession or deflation. We see both as  unlikely possibilities. Do not get sucked into the rally.  In our opinion, governments throughout the world will continue to create liquidity to bail out their over-levered  banking systems and absurdly overvalued bond markets. Sell long term bonds if you hold them.

Gold, oil, and emerging markets look good for the long term. Watch their performance throughout the remainder of 2011 as the U.S. and European economies slip further and panic develops.

Please see our recommendation table below.


Investment

Date

Date

Appreciation / Depreciation


Recommended

Closed

in U.S. Dollars

Commodity Market Recommendations


 



Corn

4/20/2011

Open

-2.0%

Gold

6/25/2002

Open

+369.6%

Oil

2/11/2009

Open

+163.8%

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

-5.5%

Long

Singapore Dollar

9/13/2010

Open

+7.9%

Long

Thai Baht

9/13/2010

Open

+5.9%

Long

Canadian Dollar

9/13/2010

Open

+5.0%

Long

Swiss Franc

9/13/2010

Open

+18.2%

Long

Brazilian Real

9/13/2010

Open

+7.0%

Long

Chinese Yuan

9/13/2010

Open

+4.1%

Long

Australian Dollar

9/13/2010

Open

+12.9%

Short

Japanese Yen

09/14/2010

10/20/2010

-3.3%

 

Equity Market

Recommendations





India

4/6/2011

Open

-8.9%

Malaysia

4/6/2011

Open

-0.2%

Canada

3/24/2011

Open

-7.9%

Colombia


9/13/2010


Half Original Position sold

+0.6%


Australia

2/15/2011

Open

-1.3%

Japan

2/15/2011

Open

-10.9%

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%