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On The Heels of Maturity & EuphoriaDer Invest
Informant
2006 Outlook Sir Peter Ustinov, the British-Russian actor / comedian once quipped, "It takes two divorces and going broke once to make a real man". I have that lurking feeling the West may soon at least witness quite a few more real men in and about town. Ok, let's get serious. Why would we in the West be going broke, if not already there? (Personal bankruptcies in US and UK at all time highs) I personally think the biggest overriding factor facing the world can be summed up as "maturity". The Western world is moving towards a rather momentous maturity of sorts - maturity of consumer debt, maturity in housing, maturity in rates, maturity in credit, maturity in pension defaults, maturity in population demographics - which not many people fully comprehend, in combination with new births elsewhere (China, India, Brazil). It is slow and creeping and may take many years. This covers financial, economical and social aspects. In fact one leading analyst was to have said, "I have no idea how the markets will do this year, nobody does, but the biggest fears I have for the markets are more related to geopolitical and environmental risks." So although the pundits are touting 'buy buy' now, we should nevertheless be aware that opportunity is born of crisis - that is why vigilance and constant re-tuning of our portfolio is a must. Turbulent times cannot afford complacency. So while the World Economic Summit plans to convene soon in Davos, Switzerland and hob knob around with the invited "giants of industry and politics", we have listed here a number of risk factors (no order of importance implied) currently at play in the financial and geopolitical realms which we see as being the real threats:
The bottom line in most of the above issues is either energy or some sort of financial re-positioning on the part of US Dollar creditors. The common denominator in 90% of above is instability, fear and positive for gold. The other side of the coin appears to be a euphoria of sorts. Despite the rather scary list of inherent risks above, no matter where one looks these days there is a seemingly unbridled optimism in many markets and sectors - warranted or not - which investors seem to be discounting or simply ignoring. Be it real-estate, base metals, technology, pharmaceutical, and many more, people believe the good times may last forever. The DAX up 27% and at highest level since 2001, FTSE up +30%, gold up +20%, housing up, US Dollar up, etc. et.al. The point is simply that the global risks are growing and that many sectors are directly or indirectly in the line of danger. Some projections are now for oil to go to $80/bbl. This is certainly within distance right now. The main point investors should be addressing is a) where is there an oversupply of something, b) where is there an undersupply of something, and c) what are the tangential risks associated with each. We could certainly make the case that the US Dollar is in oversupply in foreign reserve holdings, i.e the game of we export our goods and we import your US Dollars. We could also make the case that if the Fed (as just recently indicated) sees interest rates levelling off then certainly they must think the economy is slowing and possibly help both consumers and housing owners who have accumulated too much debt. Corporate America sees the inverted yield curve ahead which points to sluggishness and low growth. Likewise, foreign creditors may then sniff the economic winds and slow their foreign investment in equities and slow their Treasury purchases. This would necessarily hurt the USD. Equally, what good is an US equity which rises but only to be converted back to the purchasers local currency at a loss? Should the ECB then continue to close the rate spread with the Fed (which certainly is a possibility) then the foreign purchasers have another alternative than just the US Dollar. John Hathaway of the Tocqueville Gold Fund stated that the Euro was a "piece of garbage" as it was a currency overseen by a committee of bureaucrats. Similar to most currencies I suppose. Yet, as we know, one mans "garbage" is another mans "treasure". It's all relative when the world collects financial garbage as a means of doing business. One need only to find the "best" garbage. So what is our current investment outlook based on the above maturity and euphoria? We are looking for undersupply and risk-averse resources that the world needs. We are looking at future resources which may continue upward based on those list of risks above. We are looking at regions coming out of their cyclical slumber and which may hold more upside potential. We are looking at historical safehavens. We are looking at investor and creditor psychology should the world's reserve currency start to weaken. I have already stated many times that the strategy of the Fed was to raise in order to have something to cut if they require it. Now with the Fed possibly raising one more time to 4.5% that might seem a level at which to hold. Our current investment views for 2006 :
Currency Update  I have left the chart above from the last Letter because I think it is an important guideline to keep in mind. Although the USD is getting some negative press right now I think it is important to realize that the USD may continue a slow grind higher in 2006 based on the interest rate differentials and the simple lag times it takes for turning points to feed through. Of course a crisis of some sorts (no doubt there are plenty that could happen) could weaken the USD but currently I see a rolling over of Fed FFR rates to 4.5% and an incumbent strength or holding of the USD. Of course the outlook for the ECB to raise rates is gathering strength despite the political pressure mounting for them not to, but the ECB wants to show who is boss, and their mandate is not to stimulate the economy but rather to keep inflation reigned in. Right now these seem to be diametrically opposed goals in anaemic Eurozone with rising energy costs. Short term we see below the Euro pushing upwards out of the channel and shooting for 122,45 its 200 dma. The 2005 showed a full 100% correction and maybe we need to give it some room to breathe a bit. Nevertheless, I would not be totally surprised to see the USD show some strength. I am probably in the minority.  My other two currency choices at this point are the Jap. Yen and Canadian Dollar. Although the CAD has been on an extended run, it should continue to profit from the strength in energy and metals. This has been a big winner for us these last years and we will continue to play this card. There is certainly enough in the above outlook segment to warrant a pro-CAD outlook for us. The Yen, although expressedly weak throughout 2005 is starting to show possible life both in cyclicality and the Bank of Japan possibly raising rates on strength in its economy. If this is the backdrop then this puts a small crimp in the carry trade between JPY and USD. Should this be the case then JPY may start to gain considerable ground on the USD throughout 2006, especially if the Fed to hold and BoJ to raise - this lessens the spread and hinders the carry-trade game. I like this risk to profit outlook. It's not a given, but it's certainly on our close radar watch.   Inverted Yield Outlook In the chart below we see a proxy for the inverted yield curve which happened in the 2001 blow-out as shown in the red box. There has been a lot of banter and chatter about the inverted yield curve in the press and media. Although not necessarily a "gimme", the recession looks set to at least get a psychological foothold in the US markets and investor's minds. This would go along way in my opinion to supporting our portfolio outlook above but not necessarily right away. Again, grinding lower may take time, even 12 months or so. Housing toppy to negative biased, consumer debt extended and further strangled on rising rates both leading to US weakness, as housing and consumer make up a very large portion of GDP be sure, the Fed and many people are keeping an eye on this. This will slow the aggregate demand and help others abroad to play "catch up" with US previous growth. It's now becoming as Hathaway said, what "garbage" do I want to invest in and where?   We are looking for resolve in the 10yr. yield but as yet the price continues to hold support at the 108 level above, with downward bias having been already tested three times in the past 18 months.  Portfolio So, following our 2005 strategy, our 2006 strategy looks quite similar. Trends are not changed over night. So even as 2005 was a tough year for picking DOW or NASDAQ winners, we were quite successful following our long term strategy and belief in the resource and precious metals sectors as our portfolio was up over 30%. Now more than ever do we believe that some of the above key elements are in place for gold / silver and metals to further profit from instability and the associated psychological forces at work on investor sentiment. Safe havens are always sought after in times of fear or crisis. It is also important to realize that until now the public has not really yet sought out the precious metals, i.e. we are not quite yet in phase 2 of the metals sector where the public starts to climb aboard. The funds have sniffed out metals as of mid 2005 and that is why in such a small capitalized market the volatility is proportionately greater. Since Nov. 2005 gold is up 16%. In the final month we decided to liquidate a number of positions at 50% for fear of an overdue correction. This turned out to be correct even though we did not quite hit the peak of the rally. C'est la vie. The re-correction upwards started again and is currently in place though looking a bit frothy. We sense a lot of people out there see the same systemic risks to the "global financial system" as we do. Gold has today hit a 25 year high at $543 in Asian trading. - - - - - - - - - - US Household real-estate assets as a share of GDP has risen from 103% to 150% since 1997. For more on this article and more charts for the 2006 strategy outlook please visit the homepage www.dinl.net in the Latest Letter box. More on this in upcoming issues - if you would like to know more, please sign up for a free subscription to Der Invest Informant here. As well, please visit the site daily and read the latest information and inputs. Randolph Buss / Berlin, Germany email: editor@dinl.net More on this in upcoming issues
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