Stephen’s Posterous

Karl Rove, former Senior Advisor to President George W. Bush, writes that President Obama's decisions will eventually lead to higher inflation, higher interest rates, higher taxes, sluggish growth, and a jobless recovery.

The Labor Department is expected to report unemployment over 8 percent with 200,000 more jobs lost in May 2009. Congressional Budget Director Douglas W. Elmendorf predicts that unemployment will continue rising into the second half of next year and peak above 10%.

Mr. Rove says that President Obama describes job losses as job gains. The President does this by estimating how many jobs are saved because of his Stimulus Package. The Labor Department does not collect data on jobs saved. Mr. Rove calls this President Obama's, "Clairvoyant ability to estimate."

However, the former National Economic Council Director Keith Hennessey said on his blog that the stimulus will be ineffective because the additional economic growth it spurs will come six to nine months later than it could have. This is due to the fact that only $185 billion of the Stimulus Package will be spent this fiscal year.

Also, much of the Stimulus Package has been saved, not spent, since the national savings rate has risen from 0% to around 5%.

Mr. Rove says for the Stimulus Package to be more effective, it should have been front-loaded into this fiscal year. He thinks that President Obama's Team idea that each dollar spent for the Stimulus Package translates into a dollar-and-a-half in growth is fiction. The costs of stimulus reduces future growth.

Mr. Rove writes:

No country has ever spent itself to prosperity. The price of stimulus has to be paid sometime.

The real improvements in the economy are the result of the expanded money supply by the Fed and the U.S. Treasury helping the financial sector.

Mr. Rove believes that the Fed's actions are risky. Easy money and expansionary policies are not sustainable. Inflation may be just around the corner unless the government can collect the money back. He also belives that government will likely hamper private investment because the government will need a lot of capital to finance its debt.

Mr. Rove writes:

It is becoming clear that the economy is now the top issue. Mr. Obama's presidency may well rise or fall on it. The economy will be his responsibility long before next year's elections. Americans may give him a chance to turn things around, but voters can turn unforgiving very quickly if promised jobs don't materialize.

Mr. Rove says that Obama's honeymoon allowed him to push for the largest expansion of the government in U.S. History.

Source.

Hedge fund Universa Investments L.P. is planning to launch the Black Swan Protection Protocol-Inflation fund according to the Wall Street Journal. The fund is based on a premise of hyperflation as a result of the massive stimulus efforts of governments around the world.

Universa Investments is known for its connection to Nassim Nicholas Taleb, author of the 2007 bestseller The Black Swan.

The Wall Street Journal said that Universa Investments is trying to capitalize on a wave of investor demand for its products. The fund will invest in options tied to commodities such as corn, crude oil and copper, as well as options on stocks such as oil drillers and gold miners. The fund will also bet against Treasury bonds.

FINalternatives said that the fund is the brainchild of Mark Spitznagel, a longtime collaborator of Taleb who owns and manages Universa. Mr. Taleb himself has no ownership stake in the Santa Monica, Calif.-based firm, but is a major investor and adviser.

There are risks involved when investing in this fund. Some believe that deflation may be much more or a risk than inflation. Others believe that inflation may not take hold for awhile. As written in the Wall Street Journal:

David Rosenberg, chief economist at Gluskin Sheff, a Toronto wealth-management firm, believes inflation won't take hold until consumer spending rebounds, which he thinks could take years. Says Mr. Rosenberg: "Not until the household sector expands its balance sheets are we likely to see the re-emergence of inflation on a sustained basis."

The minimum investment in the firm's other funds has been $25 million, but the company rarely accepts investments less than $100 million

Austrian-born Peter Brabeck led Nestlé, the world's biggest food group, as chief executive for 11 years before becoming chairman last year.

The 64-year-old combines that position with roles as vice-chairman of Credit Suisse and cosmetics group L'Oréal, where Nestlé has a big stake. A Nestlé veteran, he joined the company in 1968 and worked in a variety of roles including in Latin America, and in culinary products and marketing, before becoming chief executive in 1997.

Nestlé has been one of the few consumer groups to be relatively untroubled in financial performance by the economic crisis. In a sign of the strength of Nestlé's senior talent, two of its most senior executives, Paul Polman and Lars Olofsson, have left to head Unilever and Carrefour, with Paul Bulcke staying to become Nestlé's chief executive.

In an interview with FT.com, Mr Brabeck talked about the return of inflation, why the food crisis is getting worse and why water could run out sooner than oil. Edited highlights appear below.

How deep will the current recession be?

Very deep, and it will be relatively long.

Could it be a depression?

This is terminology. I'm more worried that what we are doing today in some countries might be the basis for a new crisis.

State intervention, especially in the financial sector, should be strong and short. My feeling is that we are going into state intervention which is long, shallow and will continue for many years. And if you look at state deficits being created just now, there is no short way out of this crisis.

Do you think governments have done enough to stabilise the situation?

I am more worried about too much than too little.

Would you be worried about protectionism?

Absolutely. Although every politician says . . . that we should avoid protectionism, every single politician when he comes home does exactly what he was saying we should not be doing. So I think this is a big danger for the future of the economy.

A big topic for consumer businesses is inflation or deflation. Which are you most concerned about?

At the moment, I'm more worried about inflation, because basically all macroeconomic decisions which are being taken will lead us to inflation.

And in a big way?

That I cannot judge. But what I know is that we already see indications that inflation is picking up, and we are just starting. The stimulus projects that are being put into place mean that the printing machine will start to work and this is clearly the start of inflation.

How much has Switzerland's image been hurt by UBS [with big subprime losses and an investigation by US authorities] and the potential end of bank secrecy?

I would say Switzerland has always had the image of being a very special case. Now, over the past 40 years, it was all seen very positively. And perhaps over the past 10 years we started to see Switzerland as a special case, but with some negative aspects also. And there is no doubt that the UBS case has put another shade on this special case.

What kind of changes do you think private banks might have to make on bank secrecy?

First of all, I don't believe Switzerland is a tax paradise, frankly speaking. But if you look at the future of the banking industry, my feeling is that the Swiss banks will continue to do very well, based on the quality and on the service they can provide, not so much on the bank secrecy.

You are worried about the scarcity of water. What would your worst-case scenario be?

That we continue to treat water as we do today, [as] a commodity without any price. Under those circumstances the world will run out of water long before we [run out] of oil.

What should be done to help solve this?

The water issue comes back to three simple things. The first is infrastructure. If you look worldwide it's about 60 per cent of fresh water that we are losing due to insufficient infrastructure. The second is political decisions. It is absolutely unacceptable that we are using food for biofuels. We need 9,100 litres of water to produce one litre of pure diesel. This is not sustainable.

The other aspect is that 93 per cent of all water consumption is in agriculture, and as water has no price there is no economic incentive to improve the productivity.

Is the food crisis in poorer countries getting worse?

[It] is getting worse. Don't forget that food prices are today about 60 per cent higher than only 18 months ago. And this means those people who spend 60 per cent, 70 per cent of their disposable income on food have been hurt very, very strongly.

Are we [therefore] likely to see more social unrest?

I personally believe that food prices will continue to increase because the demand, even during this crisis, will be in 2009 about 3 per cent to 4 per cent higher than last year.

China recently decided to stop Coca-Cola acquiring a Chinese company. Is that a worrying sign?

First, it's a sign that, also in China, the regulatory authorities are becoming tougher. The decision per se is discussable, but I would also say that if the same case had happened in Europe, I'm not so sure Europe would have allowed this acquisition.

Why is Nestlé doing so well when many of your competitors aren't?

It might have to do with our historically long-term view of things. And by identifying critical issues early on. When we talked about the increase of raw material prices, one-and-a-half years before they happened, nobody believed us.

Source.

If inflation comes roaring back, the first place many people feel the pinch may be in food prices. The cost of corn, soya and wheat has fallen sharply from the levels they reached last summer at the height of the commodity boom. But lower prices mean lower returns per acre, so farmers are cutting plantings of marginally productive land to maximise profits.

European farmers cut plantings of winter wheat 2 per cent this year. In the US, which supplies half the world’s corn and a fifth of its wheat, officials expect plantings of those crops to decline 1.2 per cent and 7 per cent respectively. The US Department of Agriculture says aggregate 2009 plantings of the eight biggest grains could fall the largest amount in 20 years.

This is precisely the set-up investors who worry about a rapid return of inflation fear: low prices lead to underinvestment and cuts in productive capacity. When the economy picks up, prices soar because suppliers, in this case, farms cannot keep up with renewed demand.

Food prices might rise even in the absence of an economic recovery. Export stockpiles are tight. That has not been a big problem in recent years thanks to an unusually long spate of good weather. At some point, that lucky streak will end.

Such concerns help explain why food prices have not fallen as far as those of other commodities. Prices for corn, wheat, soya and rice have dropped nearly half from their 2008 peaks, but they are still trading at about double their average prices of the past 10 years.

Corn, at $4 a bushel, costs the same as it did in 2007. Aluminium, by contrast, is trading at levels not seen since 2003. Natural gas prices have not been so low since 2002. Food prices are unlikely to fall into line with those of other commodities. Indeed, they may not have anywhere to go but up.

Source.

The most talked-about investing strategy these days isn't stuffing money in a mattress, it's the reflation trade he bet that the world economy will rebound, driving up interest rates and commodities prices. Even though the economy continues to struggle, investors are looking ahead to time when the massive rescue efforts by central banks and governments gain traction.

They are focused on raw materials and commodity-related stocks that would benefit from the surge in infrastructure spending. They are looking to exploit potential bottlenecks in production that could lift prices and corporate earnings. Some are layering on insurance against a spike in inflation should central banks lose control of their stimulus efforts.

"Between the bailouts and the stimulus, it's pretty clear that we're going to have some inflation when we get out of this mess," says Roger Ibbotson, founder of Ibbotson Associates and chairman of hedge-fund manager Zebra Capital Management. It may not show up for another two years, he says, "but after that I think it's quite likely and I think you should be positioning a portfolio against that."

Evidence of the trade shows up in higher yields on bonds that adjust for inflation and a surge in prices for commodities including copper, up 19% in March, zinc and oil. Shawn Rubin, an adviser at Smith Barney in New York, has moved some clients partly into natural-resources stocks while using strategies to protect against a spike in inflation.

One way is to use options, where an investor is able to use relatively small amounts of money and take positions that would profit from a massive drop in Treasury prices or a near doubling in gold prices. While in the short run such trades may not work, "it's a long-term move," Mr. Rubin says. "You want to buy insurance when it's cheap."

For now, the U.S. remains in a deflationary mode. The economy is believed to have contracted roughly 5% in the first quarter. Consumer prices are expected to post a year-to-year drop of 1.3% through June, according to the latest Wall Street Journal survey of economists.

Despite the recent rally that lifted stocks 20% from their lows as of Thursday, the common definition of the return to a bull market, though they promptly fell again Friday, most investors expect a challenging environment well into next year. But the Federal Reserve has taken dramatic steps to revive the economy and stabilize the financial system. It has lowered interest rates essentially to zero and is on track to pump more than $2 trillion into the credit markets.

On top of that, there is the $787 billion federal stimulus program coupled with a growing budget deficit. Around the globe central banks and governments are making similar moves.

Paul Kasriel, director of economic research at Northern Trust, says the Fed will likely err on the side of ensuring the recovery is sustained "and usually that means they will be late" in turning against inflation. The "political sentiment will be toward inflation and in preventing deflation," he adds.

Until a few weeks ago, investors weren't even thinking about preparing for a recovery, hoarding cash and U.S. Treasury bonds and defensive stocks that would perform better than most in a recession. And the longer the economy takes to rebound, the longer it will take for the so-called reflation trade to pay off. In the meantime, investors with those bets run the risk of big losses.

"Until real demand recovers, the trade has a chance of getting ahead of itself," says Mark Liinamaa, natural-resources analyst at Morgan Stanley.

Mr. Liinamaa suggests investors keep a "survivor bias." That means "looking for names that have low cost structures and balance-sheet capacity to still be standing" even if demand doesn't recover soon. He cites steel producer Nucor as one example.

Already there are signs that the market is less worried about deflation. That's clearest in the market for Treasury Inflation-Protected Securities. Back in February, five-year TIPS were priced for a 0.5% drop in consumer prices, now that's swung around to a 1.35% increase.

The magnitude of the expected inflation rise predicted by TIPS may be small, but the direction tells the tale, says John Hollyer, a co-manager of Vanguard Inflation-Protected Securities Fund.

"The fiscal and monetary stimulus are causing investors to say there's a decent chance the Fed will be successful and there will be an increase in inflation," he says. Other markets are yet to reflect a shift toward inflation fears. In the Treasury market, where inflation erodes the value of the interest payments over time, the 10-year bond is yielding just 2.761%.

But it isn't just the ripples from the money flooding into the financial system that has some looking at a "reflation" trade. Even if there isn't a strong recovery, the economic collapse has taken substantial amounts of raw-material production offline.

Reduced inventories could in turn result in price-rise bottlenecks even with just a moderate rebound in demand from commodity users.

"You could see a reflation in commodity prices even without broad inflation in the overall economy," says Jason Trennert, chief investment strategist at Strategas Research Partners LLC. He is recommending energy and materials stocks, as well as an exchange-traded gold fund, to play the reflation trade over the next one to three years.

The possibility of rising commodity prices without inflation was highlighted last week in a report from Cambridge Energy Research Associates estimating that half the new oil and gas production that was in the works is now at risk of being deferred or canceled. While crude-oil prices are still down 64% from their high hit last summer, they are up 54% from their low hit on Feb. 12 and are up 17% this year.

It isn't just Washington's stimulus that has investors preparing for inflation. For many, the source of potential capacity constraints could well be China.

"China's stimulus package may be even more important for the inflation trade than what happens in the U.S." says Mr. Trennert. China pledged to devote nearly 75% of its $586 billion stimulus package to infrastructure development and reconstruction of an earthquake-stricken area. The U.S. is allocating just $48 billion to direct infrastructure spending.

China's efforts have rippled through to the markets for at least a few metals. Prices for copper, commonly used in power generation and construction, are up 44% from the low hit in December. Zinc, needed for producing galvanized steel used by utilities and the auto industry, is up 24% from its low.

Rising prices stand to benefit the commodity-producing economies. That has encouraged John Baur, a co-manager of Eaton Vance Global Macro Fund, to avoid long-term U.S. Treasurys in favor of Brazilian debt. That country's stock market is up 12% this year.

China's refined-copper imports soared 99% in February from a year ago, perhaps indicating that "they want to have the material available" when infrastructure projects start, says Catherine Virga, a researcher at commodities research firm CPM Group.

Source.

With the US and other countries monetizing budget deficits, the chance of rapid inflation has surged. The annual production of gold, the traditional hedge, is far below the world’s rate of monetary growth. An inflationary panic could thus bring an explosive gold price rise.

Gold has little intrinsic value; if it had never been coined its price would probably rest around the $250 per ounce of the late 1990s. However because of its history it is regarded as an inflation hedge and store of value, and that psychological association becomes tighter as inflation worsens and the gold price rises. Hence arguments about the irrationality of gold investment are wrong: in an inflation-prone environment belief in gold becomes self-reinforcing.

Alternative safe-haven stores of value, such as foreign currencies and US Treasuries, are falling away as the Swiss and Japanese authorities seek to weaken their exchange rates and the US runs ever-greater deficits.

In the stagflationary conditions of 1980, the gold price peaked at $875, the equivalent of $2,300 today. However the rise to 1980’s inflation levels was gradual; monetary policy in the 1970s was only moderately over-expansive and the US fiscal deficit was modest by current standards.

Including the Fed’s March 18 announcement of further monetary stimulus, monetary and fiscal policies in the US and globally are far more inflationary than in the 1970s. Consequently, there’s a real threat that if inflation returns, it will do so violently.

Smart investors are hedging against this possibility through gold. Hedge fund tycoon John Paulson paid $1.28bn for 11.3% of AngloGold Ashanti. That company is unprofitable at present gold price levels, but would hugely benefit from a price rise.

Should other hedge funds turn to gold, its price could soar. At current prices, annual gold output is worth only $104bn and the global gold stock only $5.12 trillion. Central bank gold reserves total $895bn, a fifth of currency in circulation. Even a quintupling in the gold price, to $5,000 per ounce, would raise the value of annual gold production only to $500bn and the global gold stock to $25tn, just 20% above the world’s M1 money supply.

Recent bubbles in stocks, housing and commodities have been driven by easy credit. The ongoing US Treasury bond bubble is driven by desire for a safe haven. When it collapses, a gold bubble driven by inflationary concerns may be inevitable.

Source.

The US Federal Reserve is increasing its balance sheet by another $1 trillion, including $300bn of Treasury bonds, the Federal Open Market Committee said on Wednesday, March 18, 2009. Yet the pace of US economic decline seems to be slowing, while deflation is nowhere visible. Fed policy is now high-risk, and resurgent inflation may strike sooner than expected.

The FOMC said it expects inflation to remain subdued with some risk it could "persist for a time below rates that best foster economic growth”. Notably, the Fed is not now forecasting actual deflation. That’s not surprising, since February’s top-line consumer price index rose 0.4%, equivalent to 4.8% annually, while core consumer prices also rose, by 0.2%.

The Cleveland Fed’s median CPI was 2.8% above the previous year. February’s producer price inflation was marginally lower, with the headline index rising at 1.2% annually and the core measure at 2.4%.

Meanwhile, last week’s unexpectedly strong February retail sales and Institute for Supply Management index readings suggest that economic decline is slowing.

The experience of the 1970s in both the United States and Britain demonstrates that the Fed’s theory that inflation won't co-exist with economic slack is wrong. Thus an over-inflationary monetary or fiscal policy could quickly produce accelerating inflation even while recession persists.

The Fed’s proposed purchase of $300bn of long-term Treasury bonds, when combined with the Obama administration’s record budget deficits, is particularly risky. Running large budget deficits and monetising them through central bank purchases of debt is a highly inflationary policy that has got plenty of emerging markets into trouble.

Broad money growth, whether by the M2 metric or by the St. Louis Fed’s MZM figure, has been running at over 15% annually since last September. The $1tr further expansion of the Fed’s balance sheet is very likely to accelerate this. The effect may not be obvious in the short term. But at some point, it is almost inevitable inflation will return, probably with force.

The Fed will then need to reverse policy with the speed and verve of a racing driver. Unfortunately, the odds are against it doing so before inflation has taken hold.

Source.

Suki Cooper is on the Commodities Research team at Barclays Capital, which focuses on the precious metals markets covering gold, silver, platinum and palladium.

Gold broke briefly back over the $1,000 per troy ounce last month driven by an explosion of interest from embattled investors. As the credit crunch continues to evolve from a global financial crisis into a worldwide economic recession, will this momentum increase, or might gold become vulnerable to profit taking?

Suzi Cooper answers the above questions and many more.

With the dollar so strong can we really see gold holding more than $1000 an ounce?

Suki Cooper: Gold’s legacy as a monetary asset and with key consumption being outside of the US means there is a positive relationship between the dollar and gold prices. A weakening dollar would certainly appear to be broadly supportive of an uptrend in gold prices, but the converse does not necessarily hold true. In the past, a strong dollar has not necessarily prevented gold prices appreciating.

Although the gold/dollar relationship is strong it is not one that will unquestionably cause an equal and opposite reaction. History shows this relationship tends to weaken during periods of dollar strength, and the relationship becomes stronger during periods of dollar weakness. Back in March 2008, when gold prices breached the $1000 level for the first time, the dollar had hit record lows against most major currencies as well as inflationary concerns being ripe.

This time, gold prices have rallied despite the traditional drivers not being supportive. Instead this rally is being driven by safe haven buying in light of concerns over the broader economy. Investor demand has been tremendously strong. In our view, prices are more likely to make a sustained move above $1000 in the second half of the year in line with our expectations for the dollar to weaken against the euro.

At what point will gold become less attractive than other asset classes?

Suki Cooper: Given its dual role as a commodity and a monetary asset, gold prices tend to flourish in an environment that is supported by its fundamentals and the external environment. Thus if its underlying physical market balance is in excess surplus and there is not sufficient investment demand to soak up that excess, prices would come under pressure.

Investors buy gold for many different reasons, as a dollar hedge, equity hedge, hedge against market uncertainty, inflation hedge, and as a safe haven asset to name but a few.

To what extent do you believe the current gold price is reflecting investor sentiment or do you believe that fundamental demand is the primary driving force?

Suki Cooper: So far this year, we have seen signs of mine supply stabilising, but jewellery demand weakening. In contrast we have seen a surge in investment demand, whether we are looking at paper exposure, ie futures or physical exposure ie bars, coins and physically backed ETPs, exchange traded products.

To date the growth in investment demand has been more than sufficient to offset the decline in jewellery demand. In our view, this rally lies firmly in the hands of investors. Sentiment remains positive towards the metal. Speculative futures positions continue to hover around 5 month highs and inflows into the physically backed ETPs in the first two months of this year exceeded inflows for the entire year, last year. Inflows in February doubled the previous record which was only set in January.

If one accepts the notion that world economies and currencies are in a slow but long-term decline, should we expect silver to continue to rise as a safe haven or will its reduced demand in industrial applications pull the rug out from under it?

Suki Cooper: Much of silver’s uptrend has been fuelled by gold’s positive performance rather than its own fundamentals. The gold-silver ratio shot up from the mid-50s at the start of 2008 to over 80 towards the end of the year. Compared to a long-run average of around 60, current levels would imply silver is undervalued whereas gold is overvalued.

However, the fundamental outlook for silver has deteriorated. Photography and jewellery demand for silver has been on a downtrend in recent years, but taking into consideration downward revisions to global GDP growth, the outlook for industrial demand is also set to remain weak over the forthcoming months. In turn, the underlying supply and demand outlook for silver looks set to remain unfavourable in 2009.

The real driver of silver prices despite its poor fundamentals has been the tremendous growth in investment demand as investors have built exposure to silver as a cheap proxy for gold.

How much refined silver is there above ground versus above ground refined gold in the world and with the Gold:Silver Ratio at nearly 70:1 ($910/$12.77) do you think that silver is a better option than gold?

Suki Cooper: In terms of above ground stocks the gold:silver ratio would be around 4:1. In our view, the fundamental outlook for gold looks more favourable in comparison to the fundamental outlook for silver.

Although gold jewellery demand has suffered in light of higher prices, investment demand has been able to offset this. Despite higher prices, the gold supply response has been rather muted. We expect total supply from mine output, official sector sales and gold recycling to fall year-on-year.

In contrast, we expect modest growth in overall silver supply, this combined with the deterioration in demand for key end uses of silver, means excess surplus is set to grow y/y. In turn, should we start to see net redemptions in the build of investor interest, silver could be exposed to further downside risk, in light of its weaker fundamentals for prices to fall back on.

Can investment demand for gold keep growing over the medium/long term at a rate high enough to outweigh the falling jewellery demand?

Suki Cooper: At least for now, the growth in investment demand has been more than sufficient to offset the decline in jewellery demand and the slowdown in producer hedge-book buybacks. But traditionally jewellery demand (which normally makes up around 70 per cent of demand) has tended to provide the floor to prices, physical buyers return to the market as prices ease and provide a cushion.

Low and stable prices are the most favourable for key jewellery consumers but even in an environment of higher prices, demand tends to return to the market as price volatility eases. However, as this end use has dried up in light of higher prices, that floor is yet to be tested. The rally is dependent on investment demand, in our view, the drivers to support investment demand are set to remain positive throughout this year. Longer term, should the investment demand turn less positive, prices will once again be dependent on jewellery demand to provide a floor.

Will gold resume its traditional inverse relationship to the dollar or will gold fall in conjunction with the dollar as it has recently benefited from the flight to safety as well. 

Suki Cooper: As mentioned previously the gold/dollar relationship tends to weaken during periods of dollar strength, and the relationship becomes stronger during periods of dollar weakness. In our view, those investors who choose to hold gold as a currency hedge are likely to return to the market as the dollar weakens. In turn prices are likely to receive a boost as a specific purpose hedge as well as continuing to attract safe haven buying.

Some very smart people are saying that the gold ETF’s are really paper gold holders and that there is little or no physical gold in their own warehouses. What does this mean?

Suki Cooper: Not all gold ETFs are physically backed, the underlying for some of the products is allocated gold, unallocated gold or even futures. Those that are physically backed, do say on their websites that they hold allocated gold.

I understand that gold acts as a safe haven, even though it has few industrial uses, because it is relatively scarce. I gather platinum has more industrial uses and is even scarcer, yet it is not seen as such a safe store of value as gold. Why is that?

Suki Cooper: There are a number of reasons, although platinum is also a precious metal, it does not have a legacy as a monetary asset. Industrial demand makes approximately 80 per cent of total platinum demand yet only accounts for around 10 per cent of total gold demand.

Gold plays a dual role as a commodity asset and a monetary asset, and safe haven buying has supported gold prices, but the two metals have very different dynamics at play. Platinum has on occasions benefited from positive sentiment across the precious metals, but platinum prices move more in tandem with its supply and demand dynamics.

We’ve seen gold rise during this financial crisis reinforcing its safe haven status despite a sharp drop in demand in markets such as in India. However, do you think that the price will continue to be at elevated levels as the recession deepens and investors shun every asset class except cash?

Suki Cooper: There is potential for a correction in the near term, as the investment horizon of new investor demand is tested. Thereafter we would expect renewed investment demand to buoy prices as investors return to the market turning to gold as a dollar hedge or an inflation hedge; in line with our expectations for the dollar to weaken against the euro on a 12-month basis, and deflationary concerns to give way to inflationary concerns as well as broader safe haven buying.

The factors which boosted prices to $1000 the first time round and the factors that boosted prices to $1000 this year are likely to combine to create a gold favourable environment.

Some economists say that we are heading for a period of high inflation, a point of view I agree with. If that is the case, Gold is clearly a good investment. However, there are many ways to invest in Gold, such as coins, ETFs, mining stocks etc. Which one is the best?

Suki Cooper: Gold is sometimes bought as a hedge against inflation, but it is far from a perfect or dynamic hedge and may need to be held for longer periods to be effective. Many studies show that gold can be a leading indicator of inflation but this strategy should be implemented with caution as gold provides a leveraged return.

In terms of gaining exposure, this depends on whether one is seeking exposure to the physical asset, in which case storage costs, insurance and security are some of the factors that need to be taken into consideration. Whereas investing in stocks does not give you access to just the underlying gold prices, but also other factors that will impact the share price.

Depending on which ETF is chosen, this can be a way of gaining exposure to gold without having to store and insure the metal.

Could you please compare the gold with other precious metals such the platinum and palladium in terms of investment attractiveness in 2009? What would be the best investment strategy in precious metals in 2009?

Suki Cooper: Although the precious metals complex can move together, the fundamental outlook for the metals is set to vary significantly. The outlook for platinum and palladium looks weak in the near term as the bulk of demand, over 50 per cent, is centred around the auto industry.

We expect the platinum market to be in a modest surplus this year, as falling demand has been matched with curtailed supply. The surplus is likely to be concentrated in the first half of the year with vehicle sales falling in key platinum markets.

Platinum is primarily used as a catalyst in diesel markets, and although diesel vehicles make up a growing share of the market in Europe, total sales have fallen. In terms of supply, we have seen cutbacks in response to lower prices, but platinum stocks remain close to historical lows, providing a deflated cushion should further production cuts start to emerge.

Even though the supply side remains supportive, a recovery in demand will determine whether prices start to recover slowly or encounter a sharper pick-up.

We expect palladium’s fundamentals to remain weak given the bleak outlook for demand. Palladium is primarily used in gasoline vehicles with the US being a key market, however, above-ground inventories remain high. Strong investment demand has been a key supportive factor for palladium prices, and in the near term remains key for prices.

The outlook for silver looks set to deteriorate further in 2009. Mine supply is set to grow, despite some lost production due to cut backs in base metals production; most of the new supplies stem from the start-up of primary silver mines. The market surplus is exacerbated by the industrial demand that is set to tumble due to the weakening macro-economic environment.

Gold on the other hand, has seen a surge in investment demand that has offset the weakness from the jewellery sector. If this investment demand continues to grow, the market could be in a physical deficit this year. Both gold and silver prices are dependent on continued growth in investor interest boosted on the back of safe haven buying while the platinum group metals are more dependent on a turn in industrial demand.

What do you believe will be the greatest pressures that will force commoditiy prices to rise, and what indicators should we observe to help us make this determination?

Suki Cooper: There are key factors on both the demand and supply side from where the greatest pressures that will force commodity prices to rise can come from in our view. One key factor has been the supply side which has been hit by a combination of declining prices and still sizeable input costs. There have been numerous projects across the metals, mining and energy sector which have been delayed or cancelled owing to tight financing conditions.

From the demand front, a more positive global economy will lead to increased commodity demand and pressure prices higher especially with the constraints faced on the supply side. China in particular has been key in commodity demand growth. However an uptick in economic growth will not mean the outlook for all commodities will be positive, as always it will be important to distinguish between individual commodities as it is specific underlying demand and supply dynamics that drive prices.

Source.

Must we look back to the Great Depression to really understand the current stock market?

A year or so ago, when a select few investment newsletter editors began arguing that we need to do so, the overwhelming majority of advisers believed that drawing such an analogy served little purpose other than fear mongering. It is testament to the severity of this bear market that the consensus opinion has shifted so much that it is now respectable to look to the 1930s for guidance about what is in store for equities.

I'm skeptical, however. That's not because I don't think that decade has much to teach us.

My skepticism instead traces to the small number of analysts and commentators who have really analyzed what an analogy to the 1930s truly entails. And if we are to genuinely learn the lessons of history, we have no choice but to start with an accurate assessment of what actually happened.

After examining several aspects of the stock market's behavior during the 1930s, it would appear as though a replay of that decade might very well be less scary than assumed by many of those who superficially draw the analogy.

Here are some myths about the Depression that should be dispelled.

Myth 1: It took 25 years for the stock market to recover its losses from the high reached just before the stock market crashed in October 1929.

It's easy to see why investors believe this myth to be true: It wasn't until Nov. 23, 1954, that the Dow Jones Industrial Average closed above the level at which it closed on Sept. 3, 1929, the date of its closing high before that year's crash. That's a recovery period of more than 25 years.

If the recovery from the bear market over the last year and a half were to take the same length of time, the Dow wouldn't again close above its all-time high from Oct. 9, 2007, of 14,164.53 until, you'd better sit down, Dec. 28, 2032.

The truth, however, is that it took stocks far less than 25 years to recover. According to Wharton finance professor Jeremy Siegel, the inflation-adjusted total return index of the U.S. stock market was just as high in late 1936 and early 1937 as it was at its precrash peak in 1929. That was less than eight years later.

That may not be great news to investors who are hoping to recover their bear market losses in just one or two years. But it's a whole lot better than taking 25 years to recover those losses.

Why the Big Difference?

One factor is dividends, which were substantial during the 1930s. At the depths of the Great Depression, in fact, the Dow's dividend yield was in the double digits. Ignoring dividends, which is what investors do when focusing on price alone, therefore, introduces a significant pessimistic bias into any historical analysis.

Another Factor is Deflation

The consumer price index actually dropped by 27% between its 1929 peak and its low in 1933. A stock that dropped by less than this amount in nominal terms over this four-year period, therefore, actually turned a profit in inflation-adjusted terms.

Yet another reason why it took the Dow so long to surmount its 1929 peak: The decision in 1939 to delete International Business Machines from the average. It wasn't added back until years later. According to Norman Fosback, editor of Fosback's Fund Forecaster, the Dow would today be more than twice its quoted level had IBM not been removed from the average in 1939.

Myth 2: If we're playing out a 1930s script, now would be a bad time for long-term investors to get into the stock market.

Actually, if the stock market were to exactly adhere to a 1930s-like script, equities would provide a handsome return over the next five years.

Once again, this insight relies on data from Professor Siegel. To locate the date during the 1930s that is most analogous to today, he looked for the point at which the stock market after 1929 had, as is the case today, declined by around half on a dividend-adjusted and an inflation-adjusted basis. That point came at the end of 1930, just 16 months after the August 1929 stock-market top. Ironically, the current bear market is just 16 months old too.

According to Siegel, over the five-year period beginning in January 1931, the stock market produced an inflation-adjusted total return of 7%. That's right in line with stocks' long-term average performance, in fact.

To be sure, this myth does have a big grain of truth to it. Over the first five months of 1931, the first five months of this five-year period -- the stock market fell 60%. You read that right: That's a 60% drop on top of a 50% drop over the previous 16 months.

If the stock market today were to suffer a further decline of similar magnitude, the Dow Jones Industrial Average would be trading below the 3,000 level by the end of July.

So, to that extent, it is true to say that, on the assumption we're playing out a 1930s-like script, now would not be a good time to enter the stock market. But this truth pertains more to shorter-term investors than to longer-term investors. According to Siegel, in fact, an investor who entered into the stock market in early 1931 was made whole again by June 1933, despite digging a 60% whole in the first five months.

Myth 3: The stock market's recent extraordinary volatility provides a clue to the wild ride that lies ahead if we're playing out a 1930s-like script.

Actually, undeniably large as it has been, recent volatility doesn't even begin to compare to what it was like during the 1930s. In fact, there were eight calendar months during the decade of the 1930s in which the Dow rose or fell by more than 20%. The month with the biggest Dow move was April 1933, when the Dow rose by 40.2%. In August 1932, furthermore, the Dow rose by 34.8%.

The biggest monthly losses during that decade were almost as big. The largest came in September 1931, when the Dow lost 30.7%. These monthly changes dwarf what has been seen in the current bear market. The biggest calendar month loss so far came last October, when the Dow fell by 14.1%. The month-to-date loss for February is minus-17.2%.

To measure the magnitude of the stock market's volatility during the 1930s, I calculated the standard deviation of the Dow's monthly returns on a trailing 36-month (or three-year) basis. In mid-1933, this statistic rose to 15.4%, an extremely high number. During the current bear market, in contrast, this comparable statistic has never risen above 4.1%.

The bottom line? If we are indeed playing out a 1930s-like script, we have an incredibly wild ride ahead of us. But for those who have the intestinal fortitude to hang on, such a story would have a surprisingly happy ending.

Source.

With the Dow Jones Industrial Average below 7,000 at 6,763, the US stock market is well below its early 1995 level, adjusted for changes in nominal GDP. That suggests it’s cheap, if growth prospects are as good as they were back then. The risk, however, is that too much fiscal and budgetary stimulus will bring on growth-stultifying inflation.

On December 5, 1996, the Standard and Poor’s 500 Index closed at 744.38. That evening, Fed Chairman Alan Greenspan decried the market’s “irrational exuberance”. At its March 2, 2009, close of 700.82 S&P 500, the market is clearly exuberant no more.

It is not, however, exceptionally low. Greenspan announced a new easier monetary policy to Congress on February 23, 1995, the day the Dow Jones average, which had been generally rising since 1990, first reached 4,000. Adjusting for the 95% increase in nominal GDP since that time would give an equivalent Dow level today of around 7,800. That suggests that current levels are only somewhat below their long term trend, and that the 1996-2007 period represented a lengthy bubble.

Standard and Poor’s currently projects 2009 earnings on the S&P of $48.10. Over the 20-year period to 2008 the index traded at an average of 19.4 times earnings. That would give a current value of 933.14. That 20-year period however includes the 12-year bubble; taking a longer-term average of around 15 times earnings gives a valuation of 721.5, again, just slightly above the current level.

So, based on 1995 stock prices and long-term earnings considerations the market is just below a middling valuation. However, that assumes US growth and earnings prospects are as good today as they were in 1995, or over the long-term average. That’s where doubts creep in.

If the exceptional monetary stimulus since September produces inflation, which needs to be squeezed out, or the unprecedentedly large budget deficits in fiscal years 2009 and 2010 “crowd out” private investment, then growth and earnings prospects for the next few years would be below average.

In that event, the market as it stands today would be overvalued. Bailouts and stimulus can thus produce long-term uncertainty as well as short-term uplift.

Source.