Investment Picks

Fourth Quarter Gold Rally

2006-10-07T13:35:00.000-07:00

Well, I'm hoping for a fourth quarter gold rally. Checking the five year gold price chart, it looks like this has been a perennial phenomenon. And there are, I believe, at least 2 good reasons why: 1. Christmas; and 2. The Chinese Lunar New Year Celebration, which will arrive a little late next year, on February 18. We are now passed the Chinese National Day celebration, which takes place in the first week of October. So the Chinese should be back in the market next week and they should be buying in preparation for their New Year celebration, when gold is traditionally given as a present. I've never put much stock in pattern recognition as a reason to buy stocks. But in this case there are reasons behind the pattern. I would think that investors with more liquidity (oh, shucks, let's just say money) would smooth out the seasonality by buying off season and selling on season, but for some reason this does not seem to have been happening. And with gold prices down quite a bit since May, I think that this is the ideal time to see a blow out gold rally as we near December. Well, we will see. But don't say I'm wrong if prices plunge tomorrow. If they have not gone up by December 10, then you can say it.

Rising Interest Rates Press Government

2006-10-01T14:59:00.000-07:00

In the NY Times today there is an article about how rising interest rates are causing the interest payments of the U.S. Government to rise. RIGHT! Just one more reason why the Fed is going to think twice about raising interest rates again, any time soon. Plus, the slowing economy will cause a diminution of government receipts. That latest interest rate increase was a real disaster for the U.S. government, and the vaunted independence of the Fed is far from complete. Mr. Bernanke likely will not wish to go down in history as a one term governor. My prognosis, either the dollar falls significantly over the next two months, causing an increase in manufacturing for import substition and exports, or the Fed is going to lower interest rates sometime in early 2007. Some other part of the economy needs to step into the breach left by the housing melt down.

Dollar Falling

2006-09-21T14:20:00.000-07:00

Well, the dollar has fallen back a bit, and I must say that it is about time. With housing falling through the floor, something else must pick up the slack in the economy, unless we (the U.S.) want to have a recession that we cannot afford. Surely, also, it is about time we started to reduce our massive trade deficit. So...the dollar should fall, to boost manufacturing so that we do not slide into recession, and so that we at least have a chance of beginning the process of closing the trade gap. It is my hope that the annual trade defecit will never reach a trillion dollar. But that will require a real decline in the value of the dollar. It will be interesting to see the further housing statistics, when they come out.

These are the Times that Try the Gold Bugs Soul

2006-09-16T11:43:00.000-07:00

The army of gold is camped in Valley Forge, enduring a mighty cold winter. When will it end??!!! What about the Chinese Lunar New Year on February 17, 2007. Don't the Chinese give gold to each other. Shouldn't that light a fire under demand.

Timbo's first rule is: The Market is a Chaotic Manifestation of a Chaotic World.

Believe it, baby.

Prices spike up and down way too far. There are people who believe in stop losses, and other nonsense of that sort. So when the price of something goes down, it can just cascade, mercilessly.

But the fundamentals of the huge U.S. trade deficit and rising demand in China, India, Vietnam and Thailand are still there. I guess that this is just an object lesson to keep some money in cash for the occasional melt down, so it can be used as a buying opportunity.

Four Possibilities

2006-09-08T16:13:00.000-07:00

Right now there are four possibilities for the economy, all with different implications for fed policy and through fed policy, for the market:

1. Inflation high, economy growing: Fed must raise interest rates. Stockmarket down.

2. Inflation high, economy tanking: Fed will want to raise interest rates, but may not, in order to spare the economy. Stockmarket even, maybe up a bit.

3. Inflation low, economy growing: Fed need not raise interest rates. Stockmarket up.

4. Inlation low, economy tanking: Fed might even lower interest rates. Stockmarket up.

I think we have #2. As Robert E Lee said after Pickett's Charge: "Too bad, too bad, ohhhh, too bad."

One problem for the stock market, is that observors are looking at employment, and employment is a trailing indicator, so they may confuse #2, our actual situation, for #1. But house prices and house sales have been the driver of our post '02 consumer boom and without them, and with no other growth engine added to the soup, boom will turn to bust. It might take a little while for it to show up in the statistics, which always trail, but it will eventually. Let's hope the Fed reads things aright and does not slap the economy with another interest increase. I rather trust they won't, because things will become clearer as we move forward.

The Thing That is Wrong

2006-09-08T04:51:00.000-07:00

In my other blog, where I outline my philosophy of investing, I state that if one follows the most widely accepted methods of evaluating stocks, then one's chance of outperforming the market is very, very low. But the market is wrong all the time, misled by recent experience into a position that is simply illogical. This is what the dotcom boom was all about, and in fact what every bubble has been all about.

So, what is it now that is illogical and yet accepted. What is it that people will look back upon and say, "Wow! How could the market have been so very wrong?" I believe it is the U.S. trade deficit.

Now, some might say housing values. They might say, "We have had an unreasonable run-up in the value of housing and it is just in desperate need of a correction." I disagree with this view, althouh there are certainly some markets in the U.S. that are due for a correction, chief among them Las Vegas and south Florida. I also think that in the short term (next six months) the entire housing market looks like a disaster.

One thing to bear in mind with housing is that the statistics are so very old, even when they are first published. We just had a report about the second quarter housing market, even though we are more than 2/3 of the way through the third quarter. The press was treating it as if this had to do with current conditions. It is very important, when viewing housing, to remember that there are no good statistics for what is happening at the moment. The best you can do is to get an idea of how things were a few months ago.

In the long run (two years from now), the housing market will start to come back, just because a long term decline in the housing market would have too disastrous an effect on the economy. One way or another policy makers will be sensitive to the enormous damage that can be done to the average person and will act to mitigate. The Fed may have its vaunted independence, but the Fed Chief must testify before congress, peridodically, and if he is hurting constituents, well, he might get a rather frosty reception.

The thing that is really illogical is the trade deficit. It only feels normal because that is the way things are now. It is not normal, nor is it sustainable for a country to have a deficit as large as that of the United States. There have been some reports that some European countries have deficits that are just as large. But this is not a fair comparison, because when a set of countries have a common currency, there is no way to keep track of tourist spending. The countries with the supposed large deficits are big tourist destinations, like Spain and Portugal. So those statistics were not comparable with the U.S. trade statistics, which include services and therefore tourist spending.

The U.S. trade deficit is equal to over $2,500 per person per year. So in 40 years, not counting compounding and starting at zero, our indebtedness would equal $100,000 per American. This is unsustainable and will, one way or another, in a way no one can predict, be slowly corrected over time.

Steel, the Real Deal

2006-09-05T03:00:00.000-07:00

"Steel??? Oh, I think the rise in steel stock prices is over." It seems that nobody, but nobody agrees with me on the bright propsects for the American steel industry. And why should they: the steel industry had very poor returns for a good 40 years, from 1962 to 2002. It entered that era rich and booming and it came out of that era as just a tiny, beleagured portion of the economy. It was one of the worst investments to have made. Forty years of bitter experience is a lot to go against.

But consider the reasons that steel in America should continue to rise:

1. Resource scarcity: as oil and gas become more scarce it will take a greater effort to get the same amount out of the ground. We will have to drill down deeper for smaller deposits. That takes more steel.

2. Need for more power generation: For years the U.S. coasted on nuclear power plants producing more. So the level of investment in power plant building could be small. Now we must make up for lost time and building power plants requires steel.

3. Huge trade deficit: We must somehow reduce the U.S. trade deficit. The dollar has a lead weight attached to it, in the form of the trade deficit. Hence, we must make more stuff to ship overseas to pay for what we import. Some will be made of steel. The falling dollar will also make foreign steel brought into this country more expensive, helping the U.S. producers.

4. Booming demand from oil states: Burj Dubai, soon to be the world's tallest building, will take steel to build. The whole Persian Gulf is crazy with construction.

Even one of these factors would be enough. But 4 (and counting). Also, steel company stocks are remarkably cheap. The market cap of U.S. Steel is about the same as that of American Eagle Outfitter's, a teen clothing retailer. It is unfortunate that U.S. Steel just makes sheet, tube and a little bit of rolled plate, because I think plate and blooms (girders) is where the market is really at. Also, Arkansas Steel is a great buy. I own them, so in a sense this advice is self interested, but I own them because I think that they are fabulous, fabulours investments.

The End of the Consumption Boom

2006-09-04T15:17:00.000-07:00

In the chronolgy in the previous post, I have listed a U.S. consumption boom. This boom is just now ending.

During the dot com boom, a tremendous amount of investment was flowing into internet startup companies. This created rising employment, which kept people happy. But then, the dot com bust came. A great number of people lost their jobs, causing a recession. To correct this, and the added kick downstairs created by the 9/11 attacks, the Federal Reserve Board quickly lowered interest rates all the way down to their lowest levels in many, many years. This, along with more liberal mortgage lending policies (e.g. interest only loans) caused home prices to increase and started a consumption boom, in which many people borrowed against their more valuable homes and spent the money. This had the intended effect of bringing the nation out of the recession.

Normally, the consumption boom would have led to a production boom, to meet the enormous demand. And it did...in China. If the production boom had occurred in the U.S., prices would have risen, but we had quiescent inflation because tens of millions of people who had previously been peasants or peasant children in China were now entering the world economy as factory workers, actually bringing prices down a bit. Now we have a truly huge trade deficit, and the transformation of China into an industrial economy is largely complete. They are ready to move on to service economy status. Partially due to U.S. pressure, but also as a means of combatting their own inflation, the Chinese have allowed their currency to appreciate with respect to the U.S. dollar. We have started to have inflation and the Fed has slammed on the brakes, by raising the Fed Funds rate to 5.25%. Whew..... So???

The consumption boom is ending. Now we need for production to start to catch up. One of two things will happen. Either 1) the U.S. dollar will fall on its own, giving our manufacturing sector a boost to help to make up for the destruction of employment in the housing sector or 2) The Fed will have to cut interest rates. I think 1) will happen, but if I'm wrong and 2) happens, then I hope the Fed is fast about it, because the housing part of the economy is deteriorating very quickly. In any event, we will see a reversal of the trend of the past 20 years, with manufacturers soaring on great demand and consumption related business: retail, gaming, second homes starting to decline. Continued investment will cause an overshoot, causing real pain and suffering in these industries. One manufacturing group that I think will, very sadly, be left out is U.S. automotive. I think Ford and GM are pretty much goners at this point. Its very, very sad, but true. But I think that we will see rising employment at U.S. Toyota, Honda and Hyundai plants and their suppliers. I don't know how the U.S. will pull out of this incredible trade deficit, but somehow we will and the effects are going to be dramatic and widespread.

Where we are, How we got here

2006-09-04T11:52:00.000-07:00

The last ten years have been a remarkable epic in the economic history of the United States and the world. The big turning points have been:

1998: Asian Financial Crisis

2000: Beginning of Dot Com bust

2001: 9/11; U.S. dollar apogie

October 2002: Brief Stock Market Meltdown

2003-2006: Consumer Boom; Economic recovery

First Half of 2006: Fed keeps raising interest rates and kills houing market. End of Consumer Boom.

Current Sector Picks: Steel, Oil, Precious Metals

Sectors to Avoid: Retail, Gaming