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As a hedge fund manager one lives between the realms of market volatility/mass paranoia and an unending stream of data collection. The main objective of the exercise is to know that no matter how right you may be on your analysis of value and expected future returns you are operating in an arena (investment markets) that can become irrational at any moment.
The future is an unknown. But something that can be known is value. Therefore with value correctly analyzed (especially in the mining sector) one has some assurances of the future worth of an investment even after market drops.
It is also important to have an understanding of basic economic truths which do exist! There are reliable cause and effect relationships that over some period of time eventually determine stock and bond market behavior.
Let’s start with some basic facts that are obvious, easily perceived and known and a few logical assumptions. These facts and assumptions help us form predictions that will hopefully help us with investments.
Facts:
- U.S. Budget Deficits will exceed $1 trillion per year for many years. (even if this is off by 20-30% it is still a major factor and disruptive force).
- The U.S. money supply has increased by almost $1 trillion in just the last three years, the greatest three year increase of money in the history of the world.
- The European money supply increases were $3.7 trillion (2.75 trillion Euros) over the last 10 years. That’s more money created in 10 years than the last 2000 years of Europe’s existence.
- The European budget problems and debt levels will continue to be a force for a loose monetary policy – at least for 2-3 years. A default will not be allowed under any circumstances (this is actually an assumption but one that is so strong it becomes almost as good as a “factâ€.)
- The fight between corporate-state capitalists and social democrats in the U.S. and Europe will continue with both sides adding to economic inefficiencies. These two groups have a lock on economic policies. The end result is less productivity, waste and the stifling of economic progress. Economic progress is the result of free markets and free people, not socialist or corporate-state capitalism. The local baker is still able to bake some bread despite the authorities strangling him with paperwork, inspections, trade restrictions and tax increases used to save (pay off) the big banks, car companies and other favorite corporate and social groups of the government.
- India and China are now more important than the United States to certain industries, therefore some industries will boom because of China.
- India and China have increased their money supplies so dramatically in the last 5 years that the inflationary repercussions will be profound. India’s money supply has increased 160% in 5 years, China’s 180%.
- Silver and gold buying has been exceptionally strong in these countries in the last 5 years and as inflation rates in these countries increase over the near and medium term precious metal buying should accelerate.
- The largest economy in the world is the U.S. economy. The key problems that face the U.S. are as follows: 1) high unemployment; 2) huge built-in debt increases on state and federal levels; 3) looming pension shortfalls in most state, national accounts, and corporate shortfalls; 4) weak housing and auto markets
From the above we now can move into logical conclusions and hopefully guidance on the future trends of various investments.
Conclusions:
- U.S. monetary policy will remain loose until the economy improves further as the authorities are still under pressure to boost the economy.
- Interest rates and inflation rates will increase in almost all countries from an overexpansion of money and credit the last two years. These increases will not be severe in 2011 but will accelerate in the following years.
- Fears of debt defaults will continue in most of the G-20 countries and will drive a loose monetary policy for the foreseeable future.
- Central banks raising interest rates is not a sign of tight money or a change of policy. It is very easy for the Fed or the ECB to raise rates by 1-2% and still create $500 billion of fiat money overnight.
- China and India will experience higher inflation rates than the U.S. and Europe, therefore precious metal buying from these countries will increase.
- The U.S. stock market and economy will muddle along due to the enormous liquidity increases in recent years and low interest rates. As inflation returns to the U.S., interest rates will rise to keep up.
- European economies will also muddle along from the liquidity created from the recent country bailouts and prior money supply increases.
- China and India will also be a dominant force effecting precious metal prices due to more of their populations entering middle class status.
- Demand for oil will continue to outstrip supply even if most world economies move sideways. If Brazil, Asia and India continue to industrialize it will create more demand for oil. Since 80% of all the worlds oil fields are in unstoppable annual production declines of 5-8%, oil supply will not be able to keep up with demand. The world consumes 3.5 barrels of oil for every one it discovers. A huge shortfall is looming in the next 5-10 years which will have a dramatic impact on geo-politics.
- Oil is too valuable to burn as fuel. It is an essential ingredient in the manufacturing of over 400,000 products from clothing to cell phones. Â
- Long term bonds will be dangerous investments as higher inflation rates force interest rates higher. The easiest investment rule is always sell long term bonds when rates are low (as rates can’t go anywhere but up) and buy bonds when rates are very high (because rates eventually go back down, creating a strong capital increase in bond values).
- Gold will remain in a bull market trend. Unfortunately after a major move up from the last two years a consolidation and trading range is most likely. A range between $1150 and $1650 is possible but most likely a $1250-1450 Â trading range looks reasonable for 2011.
- Mining companies will have plenty of cash flow if these price ranges prevail.
- Gold will eventually go much higher over the next 5 years.
- Gold buying by institutions has increased due to fear of monetary defaults. Gold will go into another major leg up when inflation returns at high or even alarming levels. Keep in mind almost no establishment financial institution (even those bullish on gold) is expecting inflation rates of 10-12% in the U.S. and Europe. If this scenario comes to pass then gold buying will go into a bubble mode. This could take many years to unfold.
- Gold investors that were momentum players are now exiting the trade and will dampen demand but it appears that most of the money going into gold is from people and institutions that want asset insurance. It is my belief that these people will not sell gold and will in fact be buyers on pullbacks. Therefore corrections in gold should have plenty of underlying support.
- Silver will be more volatile than gold
- Because silver is the poor man’s gold. It will outperform gold in 2011 and for years to come since 90% of the world’s populations are poor.
- Senior and mid-tier gold and silver mining stocks are currently selling at reasonable (for precious metal mining stocks) 9-12 times next years (2012) cash flow estimates and therefore no where near a speculative high or bubble valuation. This means purchases on pull backs makes sense.
- Mining stocks will experience high volatility as the underlying precious metal pricing dynamics are: 1) near all time highs; 2) absorbing a huge run up in just the last six months and susceptible to trading sell offs; and 3) gloom and doom buying could be curtailed as the banking systems have not collapsed as advertised or feared.
- Therefore trading positions as well as long term positions are advised. Value and production growth should be the key criteria for all mining investments. Grass roots exploration stocks should be avoided, or at best be only a small portion of your portfolio, as these are among the highest risk investments in the world.
- Money management in 2011 will be best served by a conservative attitude and higher than normal cash positions to take advantage of any pricing sell offs in the precious metal sector and selected industrial stocks
- Real estate is probably becoming a better long term bet at this time. But local knowledge should be your guide. With inflation surely on the horizon, real estate will again be a place for some assets. This will not be a get rich quick sector again for decades  but with “blood in the streets†some long term values are surely showing up.
- With inflation one has to worry about the stock market, since higher inflation equals higher interest rates and higher interest rates are not friendly to industrial stocks. I would be very selective in this area.
- Trading ranges may be the order of day for the stock market and precious metals until more horrific economic problems show up. Be aware that plenty of bad news has been discounted already.
One of the great problems in the world is that solid economic truths, concepts and, therefore, advice has been hard to come by as the field is littered with so many “experts†that have bought into illogical and indefensible theories and lies. Many of these “experts†have attained high places at universities, news outlets or banking institutions. From these lofty and exposed pulpits they have influenced the power structure and establishment institutions in most countries with their unproven and false theories.
Nobel Laureate Milton Friedman has said that the greatest economist that ever lived was F.A. Hayek. George Orwell was inspired to write his classic book, 1984, after reading Hayek’s great work The Road to Serfdom.
Hayek was without doubt one of the great thinkers of our age. Many years ago I took a film crew to Germany and interviewed him. The interview has been turned into a documentary and is being entered into various film festivals around the world. This is the only interview in his career where he answered very controversial and politically sensitive questions.
His answers to these questions and his discussions of two dozen subjects pertaining to economics and politics very much relate to the investment climate today. This documentary, I believe, will be hailed as one of the greatest dissertations on economics ever recorded. Without using any big words and with brilliant clarity, the best of F.A. Hayek in a never before seen 60 minute interview is now available.
The film is called The Hayek Prophecies and can be viewed at www.thehayekprophecies.com
In my opinion this is the most important one hour you will ever spend to learn from the greatest political-economic thinker of the modern era.
Happy New Year and good luck in the markets.
Best,
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