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Updated @ 9:15 p.m. EST, Monday, January 1, 2007.


WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint roughly once per week. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence from my journal.

If one never acquires the reading habit sufficiently to pick up another book, at least, habitually, read the writing on the wall--especially between the lines. --Ray Newton

DEFLATIONARY WAVES AND COUNTERWAVES (January 1, 2007): The mainstream financial media keep talking about "rising inflation", while Fed officials continue to make comments about "persistently high inflation". However, if one looks at a chart of gold mining shares, or a chart of U.S. Treasury yields, one quickly discovers the truth: on May 11, 2006, the worldwide financial markets began an important deflationary wave which will likely continue for the next several months or longer.

The first assets to be pressured lower by this deflationary wave were the prices of precious metals and their shares. Treasury yields then followed in the second week of July; copper, in the middle of October; U.S. equity indices, in late November and in December; other base metals such as nickel and zinc and tin, probably later this month. Over the next several months, equity indices worldwide will move noticeably lower, as will the prices of artwork, racehorses, and a vast array of overvalued assets. Real estate, the most uniformly overvalued asset of all, began the deflationary cycle in late 2005.

All waves have their corresponding counterwaves. Once the U.S. Federal Reserve and other central banks worldwide realize that this deflationary wave is having serious consequences such as rising unemployment and more rapidly declining real-estate prices than had been anticipated, these folks will begin to aggressively cut interest rates. This will engender a temporary pause to the deflationary impulse, and will create an environment of rebounding assets, especially for precious metals and their shares, as well as for other assets that had generally gone out of favor in the past several years, such as largecap growth shares. This rebound will likely begin around the summer of 2007, and will last perhaps for 1-1/2 years.

However, central bankers can only do so much. They cannot prevent an even more powerful deflationary wave from regaining control in 2009. This deflationary wave will be far more devastating than the current one. It will likely cause a huge worldwide pullback in equities, similar to what was experienced in 2000-2002. Real estate, both precious and base metals, artwork, and virtually all major asset classes will see a significant decline in their respective valuations. Unemployment will surge into double digits in many countries, even possibly in the U.S. The U.S. might experience year-over-year deflation for the first time since 1931.

Once this worldwide asset collapse ends, perhaps in 2011, it will be followed by one of the greatest reflationary periods in world history, as governments worldwide do whatever they can to stimulate the economy, without regard to inflation or rising interest rates. Interest rates will likely double in most countries within a few years, including the U.S. Precious metals and their shares will surge, with gold soaring well above the $1,000 per ounce level.

Baby boomers and other retirement investors are likely to get wiped out twice. As the deflationary waves cause equity indices to collapse, 401K participants will--far too late--move whatever money is left from their collapsed equities into the "safety" of bonds. Just as the maximum number of participants are in bonds, interest rates will then more than double, thus wiping out much of these bond holdings with a few years. After achieving a very deep nadir, equity indices will see their greatest percentage gains in many years, but few people will remain in these investments to benefit from them.

While all of this up-and-down excitement is going on, real-estate prices worldwide are likely to move in only one direction--lower--eventually surrendering all of their gains in nominal terms since 1999. Thus, these deflationary waves and counterwaves will cause a great decrease in global prosperity.

These are my cheerful thoughts for the New Year. Be sure to get out of the stock market in time, so that you will enjoy a prosperous 2007.

  • Learn more about Steven Jon Kaplan and watch a live interview on MarketWatch.
  • I am currently offering a daily e-mail subscription service for $110.50 (U.S. dollars) for one year, or $37 for three months. Under this service, I will send you an e-mail every business day, and a special weekly review on Sunday, giving specific timely buy/sell recommendations, as well as long-term guidelines for money management. I will also respond to any e-mail questions that you may have regarding my daily updates. Payment can be made through PayPal, credit card, or check, whichever you prefer. Your e-mail address will not be given to any other person or organization under any circumstances.

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    BASE METALS LEAD THE WAY FOR THE WORLDWIDE EQUITY MARKETS (December 21, 2006): The most important development in the financial markets in the past two months has been the progressive deterioration of base metals prices. Beginning in mid-October, copper began to decline; it has since fallen to its lowest level in several months, with almost zero media coverage of this event.

    After hitting new daily highs so frequently that it became almost boring, nickel and zinc--which had each experienced incredible percentage gains in 2006--have begun to stage a moderate pullback. Other base metals have grudgingly begun to follow them lower. Nickel and zinc still have an incredibly long way to decline before they reach anything resembling support levels.

    When base metals are falling progressively in price, this means that the actual rate of worldwide economic growth is going to be significantly lower than most observers have been anticipating. Thus, the recent decline in copper, nickel, and zinc will soon translate into a corresponding pullback for worldwide equity indices.

    Very quietly, even with the headlines about new Dow highs being broadcast practically every day, major exchange-traded funds such as QQQQ have recently touched their lowest levels in several weeks. The number of new daily highs on all major exchanges has been systematically contracting. Meanwhile, according to Bloomberg, the dollar ratio of top executives' selling to buying recently touched 63.18, the highest such ratio recorded since at least 1987. The question is not whether equity indices will decline sharply worldwide, but exactly how much and when.

    GO GREENBACK GO (December 8, 2006): There are currently many differences of opinion in the financial markets. Some, like myself, believe that equities have completed a major peak in advance of a significant correction; others have given optimistic forecasts for a much higher stock market in 2007. There are many diverse opinions on interest rates and commodities. However, one thing on which everyone seems to agree is that the U.S. dollar will decline. The Economist is so certain of this that they made it a feature story last week.

    As far as I know, although the U.S. dollar is the world's foremost reserve currency, it has no web site. There are no greenback chat sites. There is no U.S. dollar fan club, and there is not even one U.S. dollar guru to quote on those days when the dollar is higher, to tell you why it will continue to rise in value. The U.S. government may spend billions on defense and has literally an army of employees on its payroll worldwide, but it hasn't spent a penny to promote its own currency.

    Nonetheless, even without a PR man (or woman) to pump (or should I say pimp?) the U.S. dollar, it will gain substantially in value over the next half year or more. The U.S. has the highest rates on time deposits in the developed world. With a Democratically-controlled House of Representatives and a Republican President, there will be much less spending and higher taxes, which means a lower budget deficit and therefore a stronger greenback. The U.S. dollar also has a history of gaining in value in advance of a recession, as was seen in 1980, 1990, and 2000.

    Most importantly, however, is the sentiment itself. When there is a virtually unanimous consensus on anything in the financial markets, the opposite inevitably occurs. It's not different this time. As everyone is waiting for the U.S. dollar to collapse, it will stage a strong rally that will likely bring the U.S. dollar index close to 90.

    As the dollar rises, most equities and commodities will decline. If you want to know when to buy gold and silver, just turn on your TV. No, don't waste your time watching CNN or CNBC. Look at the travel shows instead. When they tell you that because of the strong dollar it's a great bargain to visit Europe, that will be your signal to purchase precious metals and their shares.

    GOLD MINING SHARES ARE HEADING AT LEAST 25% LOWER (November 12, 2006): Gold mining share indices and funds attempted to break and hold above their 200-day moving averages in the past week. This false "breakout" will soon be reversed sharply to the downside. As the financial markets slowly but surely realize that U.S. political gridlock means substantially less spending and higher taxes, and therefore a significantly lower budget deficit, the U.S. dollar will progressively strengthen, which will depress the prices of precious metals and their shares. Simultaneously, the Congress will tilt toward stricter environmental regulations, which will erode the profit margins of all hard-asset producers. Most importantly, equities worldwide will be experiencing a sharp decline in price-earnings ratios as we experience a global economic slowdown, which means lower prices for all equity sector groups, including gold mining shares. I am still expecting HUI, the Amex Index of Unhedged Gold Mining Shares, to reach 248, probably by the spring of 2007.

    HOW LOW WILL HUI GO? (September 10, 2006): HUI is the Amex Index of Unhedged Gold Mining Shares. How low will HUI eventually go, exactly, over the next several months? One very useful guide is to observe that on December 2, 2003, HUI reached a peak of 258.60 which was not exceeded for about two years. (November 28, 2006) As a rule, during its bull market which began on November 25-26, 2000, HUI has gone modestly below each such high-water mark during each subsequent extended correction. Another guide is found by measuring the entire gain in HUI from its May 16, 2005 bottom of 165.71 to its May 11, 2006 peak of 401.69. If HUI surrenders exactly 61.8% of this increase--known as the key Fibonacci retracement--it would put HUI at 255.85. It's no coincidence that these two numbers are so close. If history is any guide--which it almost always is--then HUI should move a few percent below each of these numbers, and bottom near 248.

    CURRENT ASSET ALLOCATION (January 1, 2007, marked to market): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.25%), 10%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 31%; Treasuries between 2 and 10 years in duration, such as IEF, 10%; TOC, 2.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 29.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG) and related shorts, 47%; short CFC, 3%; short GLD, 17.5%; short GDX, 2%.

  • Overview of Gold Mining Shares (updated January 1, 2007)
  • REMINISCENCE OF THE WEEK (December 21, 2006): When I was a student at Johns Hopkins, I had an excellent economics professor named Dr. Carl F. Christ. By the way, his last name rhymes with "grist", not with that guy whose birthday is being celebrated next Monday. Each winter, the sophomores and juniors from my alma mater who are getting a minor in business visit New York City for one week, to learn about potential employment opportunities. I have been attending these gatherings for several years. Last year, I received an unexpected surprise when Dr. Christ showed up along with the students, and was deservedly given a special honor. I was even more surprised--and, frankly, a bit disappointed--when I discovered that Dr. Christ already knew all of the economists' jokes that I had learned from the internet. My favorite of these jokes is about a student who visits his favorite economics professor 25 years after graduation, and arrives on the day of the final exam. The student says to the professor, "I can't believe you're still asking exactly the same questions, word for word! I'll bet I could still get an A if I took this test today." "I'm sorry, but you'd fail," responds the professor. "The questions are exactly the same, but the correct answers are completely different."

  • Best of Previous Reminiscences
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