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Updated @ 8:00 a.m. EDT, Tuesday, August 14, 2007.


WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.

By far the biggest mistake most investors will make in 2007 will be to buy their favorite funds and shares too early. --Steven Jon Kaplan

IN ANY GLOBAL ECONOMIC SLOWDOWN, IT'S ALWAYS GREENBACK FIRST, GOLD SECOND (August 14, 2007): Since the beginning of last week, while the U.S. dollar index has rebounded strongly from a 15-year low in the early morning of Monday, August 6, 2007, there seems to be a record number of bearish articles on the greenback. They all follow a similar line that, with the U.S. housing market declining and U.S. growth slowing, it's just a matter of time before the U.S. dollar follows suit and plunges into oblivion.

As my wonderful economics professor Dr. Carl F. Christ used to say, these theories are fabulous--with the minor caveat that they do not in any way correspond to the facts! If you look back at all of the global economic slowdowns that have occurred since the U.S. dollar was delinked from gold in 1971, they all have one thing that stands out clearly: in the early months of each contraction, the U.S. dollar always rose in price, and by a substantial amount. There is not a single exception to this rule.

One reason that this is the case is that when the worldwide economy is expanding, people are willing to invest in many areas, and to lend to practically everyone. However, when times turn tough, people always revert to a known quantity of certainty, like a safe home base. Whatever the structural and other problems with the U.S. economy, it is sure that the U.S. government will repay its debt obligations. As money has therefore been flowing to the perceived safety of U.S. dollar-denominated time deposits and U.S. Treasuries, this flow of funds into the United States has helped to push up the U.S. dollar.

On a macroeconomic basis, most analysts have cut their projection for U.S. growth to roughly 2%-3% over the next several months, with some already talking about a recession. Therefore, even if we have a recession accompanied by growth of negative 2%, this would be only 4%-5% below current consensus expectations. However, in countries like India, China, Malaysia, Indonesia, and elsewhere, most analysts have been predicting anywhere from 10% to 13% growth. Therefore, if there is a global economic slowdown, which is looking increasingly likely, and these countries experience actual growth rates of, say, 3%, this would represent a shortfall of 7%-10% below the consensus. Since the shortcoming outside the U.S. will exceed the disappointment within the U.S., this would logically lead to a higher U.S. dollar relative to most other world currencies.

Many investors believe that gold is a safe haven in times of economic uncertainty. The fact is that the U.S. dollar, rather than gold, is always the safe haven of first choice. After the U.S. dollar has risen during each economic slowdown, generally for a period of several months, investors usually then switch to gold as a way of diversifying their portfolio, and gold then often responds with a strong rally. This is especially true if central banks around the world are cutting interest rates, which makes gold--which pays no interest--more competitive as an investment alternative.

You are certain to hear over the next several weeks that "gold is not responding" to the global economic slowdown. Remember that this is pure nonsense--it never "responds" initially, only later on. After everyone else has finally given up on gold for this supposed "lack of response", that will be the time to buy it in earnest--but not before.

  • Overview of Gold Mining Shares (updated August 14, 2007)
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    IS THE GLOBAL EQUITY CORRECTION OVER? YOU'VE GOT TO BE KIDDING (August 5, 2007): It is amazing how many in the media have been insisting for the past two years that the U.S. residential real-estate decline is "nearly over" or "will bottom next year". The problem is that it will continue to be "next year" for several more years. It is often forgotten that in Japan, residential real-estate prices fell every single year from 1990 through 2004, inclusive (that's fifteen consecutive years), and experienced a total average nationwide decline of 64% during that time span.

    As housing prices continue to decline, people will perceive themselves to be poorer, and will therefore spend less and borrow less. This will continue to exert a powerful contractionary and deflationary impact on the U.S. economy, just as was the case in Japan. However, because the stock market is a far more volatile asset sector than housing, equity prices will fluctuate sharply in both directions over the next several years.

    The current direction will continue to be lower. While fear is beginning to return to the U.S. equity market and to other equity bourses worldwide, the magnitude of fear is not nearly at the level which has marked the end of all major corrections in the past decade. In 1997, 1998, 2001, and 2002, the important fear gauge VXO went above 50 each time, and even exceeded 60 in 1998. Currently, VXO stands at 26.42--and while that represents a doubling over the past few months, it will have to double again over the next several weeks in order for U.S. equity indices to complete their correction which began on July 17, 2007 (July 19 for many technology indices such as the Nasdaq).

    The media headlines are still saying "what stocks you should buy now". Because of the correction, one is reading a lot more about "looking for value", "looking for relative strength", and "looking for undervalued bargains". If you follow these analysts, you will end up mostly looking for trouble.

    When you are on a ship which hits a huge iceberg and is about to sink, the objective is not to find the safest place on the ship. The objective is to get the **** off the ship as quickly as possible!

    Eventually, central banks around the world will begin to aggressively cut interest rates, and this will cause a powerful worldwide equity rebound. However, it will likely be October before the bottoming process has been completed--so don't even think about buying just yet, unless you are simply placing good-until-cancelled orders enormously below their current levels. Most major equity indices are likely to decline 20%-25% more from today's prices, with volatile indices such as the Nasdaq probably experiencing an additional pullback of 30% or more. Emerging-market equities remain subject to the possibility of a further 50% or greater plunge even after their recent sharp losses.

    The greatest mistake that most investors will make in 2007 will be to purchase their favorite shares too early. Wait until everyone you know is losing their head, before you stick your own neck out.

    WILL INVESTORS BE FOOLED AGAIN WITH GOLD MINING SHARES? (July 23, 2007): Unfortunately, the answer to this question is yes. Since September 2006, a popular index of gold mining shares called HUI has made a peak five times near 370, including right now. On each of these five occasions, almost all gold analysts loudly proclaimed "upside breakout!!!" and insisted that you had to buy gold mining shares right away, if not sooner. They said that if you didn't buy gold mining shares immediately, you'd be left at the train station, missing the boat just before it makes a rocket shot to the moon, Alice!

    Wouldn't you think that if something happened exactly the same way four times, you'd expect the fifth time to also be the same? In the real world, even an average five-year-old child would be able to figure out pretty accurately what is going to occur the fifth time after seeing anything happen four times previously. The problem with most investors these days is that they have forgotten the lessons they learned when they were in kindergarten.

    The promoters of most precious metals investments don't think the public is smart enough to want to accumulate them when they are a true bargain. They think the public will only buy gold or gold funds when they are setting new highs, and so they crank up their sales machine full blast whenever a new peak is achieved. When they really are a great buy at depressed levels, these promoters purchase them only for their own benefit, and keep quiet about them until the next high is reached.

    In my old-fashioned opinion, in order to buy low and sell high, first you have to buy low. However, given the success of real-estate promoters to push overvalued real estate near its recent peak, other financial advertisers have followed their lead in emphasizing hype over substance.

    There are a few simple rules of thumb for buying gold mining shares which have proven reliable for the past seven years. Instead of rules or discipline, however, most investors seem to be more interested in buzz and excitement. People are not concerned with valuations; they only want the latest "hot" product. The problem with buying a trendy product, instead of one with intrinsic value, is that it only takes a change in psychology for anything red hot to become ice cold.

    The chilliest investment right now is the U.S. dollar, which currently has the most bullish traders' commitments in its entire history. This means that the U.S. dollar is set for a huge rally, to begin immediately, that will persist and intensify over the next several months. This will significantly depress the prices of precious metals and their shares. The global equity market, at a historic peak of complacency, is set for a typical cyclical correction, which will put additional downward pressure on all equity sector groups including gold mining shares.

    People are always looking for the "secret to financial success". Here is the truth: there are no such secrets. As with everything in life, the only sure road to any goal is to first establish a disciplined plan and then to follow it through to its conclusion.

    CURRENT ASSET ALLOCATION (August 14, 2007): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 1.5%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 35%; Treasuries between 2 and 10 years in duration, such as IEI and IEF, 12.5%; TOC, 0.5% (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 30.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 52%; short CFC, 3%; short GLD, 17.5%; short GDX, 2%.

    REMINISCENCE OF THE WEEK (August 5, 2007): Way back in 1966, our family stayed one week at a mountain camping retreat in the Poconos called "Barrow Lodge". Each morning, all of the residents got together to sing the official camp song, which began like this: "We welcome you to Barrow, we're mighty glad you're here . . . ." After all of us sang the song in unison, the parents split up from the kids, not to get together again until after supper. We had a wonderful time, so a few years ago I was telling a co-worker about the place. He insisted that it never existed, so I told him, "I'll bet I can even find the camp song on the internet". I was wrong--it was nowhere to be found. The only reference to "Barrow Lodge" was a small radio station. So, in frustration, I sent an e-mail to the owner of the radio station, telling him that there used to be a real place called Barrow Lodge, and sending him the lyrics to the camp song. I didn't expect any response, but I quickly got back a corrected version of the lyrics, along with a question as to how I knew about the camp. The radio station owner was the son of the couple who had started the place in the 1940s. Unfortunately, the camp lasted only one year after our stay; the Federal government forced his parents to sell using eminent domain, with the intention of building a dam--which was never built. The land remains abandoned to this day. The radio station owner had saved some promotional postcards about the original Barrow Lodge, and graciously sent me one--which stands proudly on my piano. An identical postcard four decades earlier had encouraged my parents to take us there in the first place. There are currently two different Barrow Lodge postcards for sale on Ebay (is anything not available on some online auction site these days?), but I have no intention of selling mine.

  • Best of Previous Reminiscences
  • (c) 1996-2007 Steven Jon Kaplan Your comments are always welcome.

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