My Two Cents - "The Four Horsemen"

11/23/2007

It’s a tough market. It’s tough being short because you fear the bounce. It is tough being long because you fear the fundamentals. So where do you go? You can’t go into cash because you know it is losing value. It is downright foolish to hold bonds because the only thing worse than holding something that is losing value now is holding something that is likely to lose even more of its value later. Luckily, there is some stability out there, at least from a common sense perspective.

The Fundamentals

Despite a reported GDP growth of 3.9% annualized for the third quarter, it is becoming more and more obvious that we are already in a recession or at least on the verge of one. Housing has continued to be a boat anchor, the banking sector is being hit with massive writedowns for mortgages gone bad, and fuel prices across the board have remained stubbornly high, forcing consumers to make the choice between cutting back on other areas or taking on even more debt. Couple all of this with the tab on our national credit card (now well over $9 TRILLION), and it is hard to imagine a scenario in which we pay of this massive accumulated debt honestly through overproduction and underconsumption. In my view, the fundamentals have been and will continue to be a drag on our economic performance, our economic standing in the world, and the American standard of living. It is also my view that the fundamentals, even though they are not talked about all that often, play a large role in determining the direction and strength of movements in the other areas discussed in this article.

The Dollar

The Dollar’s recent fall has been so dramatic that nobody even wants to talk about it. During a recent OPEC meeting, the oil ministers couldn’t decide whether or not they even wanted to mention the falling dollar. Certainly, much of the hype surrounding this meeting was political in nature, but the message is pretty clear: If we don’t talk about it, maybe nobody will notice. The dollar has gone nearly straight down; especially since the real turmoil in the credit markets began back in August. The US Dollar Index was poised around 82 as recently as August 15th. Early this morning, the Index traded just under 75. That adds up to an 8.5% decline in just over 3 months. While in the short-term there is always the possibility for a rally, the long-term fundamentals are awful. Given the fact that the US is the epicenter for the recent credit blowout (which is only beginning), has persistent trade deficits, a skyrocketing national debt negligible savings, and no apparent willingness to change any of it, I predict further declines for the Dollar going forward. While the short-term positives of the Dollar’s fall are trumpeted as ‘good’ for our economy, the long-term negatives are virtually ignored. A weaker Dollar will cause US consumers to pay more and more for imported goods (including oil and related products). Since there are no American-made equivalents for many of these products, consumers will be faced with the choice of either paying the higher prices or doing without. I know which side of the trade I’m betting on in this case.

Gold

Gold has been in a breakout since the credit crisis and subsequent collapse in the US Dollar began in August. Recently, the yellow metal has been consolidating a bit right around the $780 to $800 area, but even on the worst days of selling, gold has held up extremely well. I dare say that perhaps at least some people are beginning to realize that gold is REAL money and that, like the 1970’s, the time again has come to get out of paper and get back to a true store of wealth. The sad thing is that most will wait to buy gold until it has once again ‘proven’ itself, and will miss out on a tremendous opportunity. The same may be said for silver. Once you understand the fundamentals, the problems surrounding the dollar, and the rising price of nearly everything, the decision to possess real money becomes a much easier one.

Oil

The $100 watch is on for oil. Prices have been sitting firmly above $92 for the past few weeks, and any profit taking has been met with strong buying. Oil and gas inventories in the United States have continued to diminish and OPEC has been unwilling (or unable) to meaningfully increase production. There are two major themes going on in petroleum investing right now. The first is the argument that supplies are constrained while demand is rising hence the higher prices. The frightening component to this argument is that there seems to be no way to significantly increase supplies in the near term. While oil equivalents like tar sands, oil shale and ethanol are coming online slowly, the world demand is devouring these additions with appetite to spare.

The flip side of the coin is the argument that a worldwide economic slowdown, spurred by problems in the US residential mortgage market, will serve to destroy enough demand to cause stabilization in prices. I think this argument is flawed for at least two reasons. First, the argument is dependent on the fact that the US consumer is still the driver of the world economy. Therefore, any hiccup in the US economy will ripple around the world. Secondly, the argument doesn’t take into account the growth in demand of the nations that produce much of the world’s oil to begin with. There is simply less to export. Many of the Gulf nations subsidize oil and gas prices for their citizens and demand is on the rise.

Also, consumerism is growing in Asia; China in particular. Sales of consumer goods in China are rising rapidly. Wal-Mart, TV, and DVD player sales are through the roof. Car sales are up drastically. There are 1.5 billion people in China alone; approximately 5X the population of the United States. It is patently absurd to assume that as these people become more and more prosperous (as their currency appreciates against ours) that they will not consume more and more of what they produce, lessening their dependence on tapped-out consumers here. They will simply cease to need us as a market for their manufactured goods.

The good news is that these four horsemen can, have, and will continue to move together. Once we understand the fundamentals and the trends, we can use them to our advantage, despite whatever daily ‘noise’ the markets try to throw our way.

Best Wishes to all for a Happy Thanksgiving!!

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.