U.S. BOND MARKET FALL—EFFECTS WILL BE FELT WORLD WIDE
Last week, the U.S. bond market fell substantially and yields rose as investors finally began to see the obvious: Quantitative Easing (the purchase of U.S. Treasury bonds by the Federal Reserve) and its potential inflationary pressures are weakening the U.S. dollar.
As most economists will tell you, the U.S. economy is in a depression. Statistically speaking, most depressions are deflationary and therefore accompanied by a fall in interest rates. However, the bond market’s recent behavior provides evidence that the current depression is not deflationary. On the contrary, inflationary pressures are building and interest rates are rising. Bond investors, looking ahead and seeing a light, are realizing that it is the headlight of an oncoming train…and this oncoming train is the trillions of dollars of U.S. bonds which must be floated by the Federal Reserve in the next few years. The consequences of this flotation will include a weakening of the dollar and an increase in interest rates. Investors are finally awakening to this trend which we believe will continue for some time.
Certainly, the last two weeks have rewarded our long held global investment strategies. In our view, this is not the end, but rather the beginning of the decline in the U.S. dollar…and the rise in many other investment areas. Accordingly, we continue to believe that the wise investor will not hold U.S. dollars, but rather invest their portfolio in oil shares, gold shares, better-managed non U.S. currencies, and stocks in countries where corporate profits will grow rapidly, such as China, India, and Brazil and selected other countries.
For several years, our commentary has brought attention to the looming deficits and the questionable methods of financing them that have become so prevalent. The current situation of the U.S. economy thus comes as no surprise to our readers. [Please see our archived commentaries at www.guildinvestment.com for more details]. What may be a surprise to our readers is how long the U.S. dollar will decline, and how high many alternative areas of investment, including the areas mentioned above, will rise.
We do not mean to imply that there will be no price corrections. In fact, investors should be aware that a correction in one or more of the areas we mentioned could take place at any time. However, they must remember that these are just corrections in a long term uptrend.
We strongly recommend that you use these corrections as buying opportunities. Do not let go of your strong positions just because profit takers or market manipulators temporarily slow down or reverse the trend.
THIS MAJOR TREND WILL LAST FOR A PROLONGED PERIOD
Use declines to add to your foreign currency and strong stock positions. We expect something close to what was seen in the late 1970’s, when investors globally tried to diversify out of a depreciating U.S. dollar. At that time, the U.S. dollar fell, while the prices of gold, commodities, and many stocks in growing companies rose. Today, China, India, Japan, and other buyers of U.S. treasury bonds reiterated that they would continue to buy U.S. treasuries. Those are kind words, but looking at the available cash of some of these countries, we see that they do have much cash to use on U.S. bonds. So their words just may be meant to keep their existing positions from falling to rapidly.
GLOBAL STOCK MARKETS LOOK FORWARD—FOCUS ON CHINA AND INDIA
As we have expected, global markets are rising even though global economic growth continues to shrink. Markets always look forward; the only question is how far forward do they look?
For example, every professional money manager knows that you buy cyclical stocks, like steel, oil, coal, and heavy manufacturing shares when earnings are low or nonexistent, and when orders and backlogs are collapsing. They also know you must sell the same industries when business is booming, when profits are high and everyone thinks they will go on rising because “this time it’s different”.
Gold (COMEX)-One Year Chart
Crude Oil (NYMEX)-One Year Chart
As we pointed out several weeks ago, the North American, Chinese, and European stock markets are currently selling for about the same P/E ratio versus last 12 months earnings. The difference is the forward earnings of the four regions. We expect China’s corporate profits to grow at a rate in excess of 17% per annum for the next five years, and Indian corporate profits to grow at a rate in excess of 13% per annum. We expect Brazil to grow corporate profits at about 10% per annum, while in Europe, Japan and the U.S. corporate profits may grow at a rate of about 5% per annum for the same time period.
Since stock market valuations are highly correlated with corporate profit growth, we expect Chinese, Indian, and Brazilian stock markets to greatly outperform the North American, European and Japanese stock markets over the next five years…especially when measuring the returns in U.S. dollars.
U.S. NATIONAL DEBT
The U.S. national debt is currently about $11 trillion, which is about $100,000 for every household and about $36,000 for every American resident. We are paying about 4% interest on this debt, but rates will be rising and we will be paying much more as Quantitative Easing and an ugly U.S. balance sheet cause our creditors to demand much more interest on the money that they lend to us. When interest rates get to 8%, as they soon will, the cost of servicing this debt will escalate even more rapidly. Disconcertingly, none of this realism is found in the Congressional Budget Office’s estimates, where they expect the U.S. to enjoy continued low interest rates.
The Congressional Budget Office, which always estimates much too low (we assume due to political pressure), states that the budget deficit for this fiscal year is $1.8 trillion. Looking ahead they estimate next year’s deficit to be about $1 trillion, and state that it will stay in the high ranges (above $0.5 trillion) for at least the next few years. In our view, these numbers underestimate the severe deficits we will be facing.
UNFORTUNATELY, THE U.S. HAS NO CHOICE. IT MUST CONTINUE TO PRINT MONEY AND DEBASE THE DOLLAR
China is positioning itself using a panoply of agreements that include allowing Chinese Yuan bond financing by Hong Kong banks, arranging trade related currency swap agreements with Brazil and six other countries, and working with countries and companies all over to world to lock up assets that it will need to run its production machine. China’s purchases include oil, coal, iron ore, nickel, and zinc to name a few. In short, China is buying assets worldwide –including an ever increasing share of the world’s gold supply — to stoke its economic machine in coming years.
China’s lust for gold is significant and deserves note. The fact is that China has been buying much more gold than it is producing. China is buying gold in the open market, willing to take gold off of the hands of the poorly managed IMF and central banks like Britain, who sold most of their gold at about $250 per ounce. Britain, the IMF, and others who have been, or will be, gold sellers appear to us to be operating with an excess of pompous verbiage and a shortage of common sense.
Gold will be an instrumental part of any new monetary system that is created in the world to succeed the current Breton Woods system. When the U.S. turns over power as the world’s reserve currency to China, it will be China’s large holdings of gold and large cash hoard which will make them a new monetary superpower. When that transition takes place, the old cliché about the golden rule, “Whoever holds the gold makes the rules” will be remembered for its wisdom.
It has been some time since we discussed Hugo Chavez and the devastation his economic policies would cause. President Chavez has not been satisfied with badly damaging the Venezuelan economy and causing Venezuela’s oil production to decline. His latest activity is arresting top Venezuelan military officials as he seeks a tighter grip on the military. As we have stated, he plans to become president for life, and his continued economic mismanagement and politics of class hatred will end up costing Venezuelans dearly for decades to come.
Next week we will discuss the U.S. financing of General Motors and the probability that the outcome will be much like the previous adventures in Britain, France and Italy when those governments attempted to take over and manage failed automobile manufacturers.
Thanks for listening.
Monty Guild and Tony Danaher