A true contrarian look at investing and at life in general.
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.
COMMODITIES ARE SET FOR A SHARP PULLBACK THROUGHOUT THE FIRST HALF OF 2008 (December 28, 2007): Commodities have become extremely popular as an asset class for investment, to the extent that many investors who wouldn't have touched them a few years ago are now jumping aboard the bandwagon. On any financial cable TV show, you will see one bullish commodity analyst after another telling you why demand from China will drive this or that commodity higher, or how the falling U.S. dollar will continue to increase the demand for commodities, or whatever they think the public will find easiest to understand. One almost never sees a bearish commodity analyst.
What all of these analysts have forgotten is that the financial markets are cyclical, not linear. Once any trade becomes too popular, it will cease to be profitable.
The U.S. dollar index began a major rally on November 22, 2007. So far, this historically important rebound has received so little media coverage that analysts continue to speak about "the falling dollar". Whenever any trend is so completely "dissed" by the media, it will always intensify until it can no longer be ignored. The U.S. dollar will continue to move higher throughout 2008. Partly this is because anticipation of a new U.S. President will strongly support the currency; partly this is because an eventual withdrawal from Iraq will be positive for the budget deficit; partly this is because amateurs around the world have been selling short the U.S. dollar. After being burned by selling short the Japanese yen which later surged, Japanese housewives switched to selling short the U.S. dollar, "which can't go up" [just like real estate "can't go down"]. Do you think they're going to suddenly be right this time?
Mostly, the U.S. dollar will rise because the "decoupling" myth will be smashed. This myth, which is extremely popular with the media, states that the U.S. housing market and the U.S. economy will slow, while the economies of emerging markets will accelerate. To believe this nonsense is to go against all of economic history, which has proven that whenever the dominant economic power of the day has gone into decline, the rest of the world has gone into an even greater contraction. Yes, U.S. housing prices have fallen, and are now down 6.1% year-over-year, according to the Case/Shiller index. But housing prices in the rest of the world will fall by an even greater percentage, since they are even more overvalued in most countries. Sure, the U.S. economy will probably slow, and quite possibly even go into recession in the first half of 2008. But if the anticipated U.S. economic growth rate, currently set around 1.5% by most observers, ends up being negative 1.5%, then that is a shortfall of only 3%. Double-digit growth rates anticipated for China and other emerging markets in 2008, which currently average around 13%, are much more likely to be around 6%. This would represent a disappointment of 7%, which is obviously much greater than the U.S. shortfall. Therefore, the U.S. dollar will rise in value, since currency fluctuations are primarily a function of actual growth rates versus their anticipated values.
What this all means is that the prices of commodities, especially gold, silver, and crude oil, are set to fall sharply over the next several months.
If you look closely, the financial markets have already been anticipating this development. When gold mining shares were peaking in early November, there was substantial insider selling by top executives of gold producers. Over the past three months, there has been persistent and intense insider selling by top executives of nearly all energy companies. Just as the public has been eagerly buying, the big boys (and a few big girls) have been selling. Ask yourself this: who will be right, those folks who are living in real mansions, or those who bought McMansions with zero money down in recent years?
In addition to the insider behavior, if you look at a chart of the indices of gold mining shares or energy shares, their downtrends are evident. Gold mining shares as a group, for example, have fallen by double-digit percentages from their peaks of November 7, 2007. During this time, the price of gold has remained little changed. Historically, the shares have always led the metal, both higher and lower. It is more likely that the Hillary Clinton will become a Republican than to see a failure in this reliable financial pattern.
It is also true that gold commercials, who are the wealthiest and most knowledgeable participants in the gold market, have never been more heavily and consistently net short than they have been in recent weeks (this data goes back to 1986). Additional information about the traders' commitments can be found at http://www.cftc.gov/ or http://www.softwarenorth.com/ .
How much will commodities decline? The price of gold will eventually go below $700 per ounce, probably in the spring of 2008. The price of crude oil will decline even further, eventually going below $60 per barrel, no later than the summer of 2008. Gold mining shares will most likely make some kind of double bottom with their lows of August 16, 2007, which would imply a decline of roughly 30% from their current levels. Whenever top executives start buying these shares again, and you hardly ever hear commodities discussed any more on your favorite financial cable TV show, that will be your signal to jump in to ride the next wave higher.
While precious metals shares have been in a strong long-term bull market for just over seven years, there have been five pullbacks averaging more than 1/3 for gold mining shares in less than six years. More details about this and similar information about precious metals investing can be found in the link immediately below.
THE U.S. DOLLAR REALLY CAN RALLY AFTER ALL (December 17, 2007): Readers of my November 27, 2007 column, seen in its entirety near the bottom of this update, were mostly skeptical of my conclusion that the U.S. dollar had begun a strong rally. How can it move higher when everyone is saying that it will move lower?
The whole point is that not only was everyone saying that the U.S. dollar would move lower, they were betting on it. Fund flows into mutual funds that would benefit from a falling U.S. dollar surged to record levels. Japanese housewives and other currency-trading amateurs around the world who had been selling short the Japanese yen, and got badly burned when that currency surged in October and November, switched to being short the U.S. dollar instead. Obviously idiotic investors don't learn from their mistakes.
Major banks and brokers were telling their clients how to buy complicated products that would benefit from a falling U.S. dollar. Portfolio managers and financial analysts were investing in a way that would "benefit from a continued fall in the U.S. dollar". Those who were promoting dot-com web sites a decade ago were promoting their investment wares on the internet, telling folks "HOW TO HEDGE AGAINST A FALLING U.S. DOLLAR BEFORE IT'S TOO LATE!!!" With such a crowded trade, there was no way that it was going to be successful.
Have you heard anyone besides myself explain how to hedge against a rising U.S. dollar? The U.S. dollar index has recently accelerated its upward surge which had begun from a historic all-time low on November 22. While there will be pullbacks from time to time, the uptrend in the greenback will likely continue until around the time of the U.S. Presidential election on November 4, 2008.
Of course the U.S. economy will contract and almost certainly go into an actual mild recession, but other worldwide economies will experience a more severe and more unexpected slowdown. This will provide strong support to the U.S. dollar in relation to the valuations of other currencies.
BE PATIENT WHILE EVERYONE ELSE IS IN A HURRY (December 17, 2007): The biggest mistake that most people will make over the next several months will be to purchase their favorite equities and/or commodities too early. Since we have not had a serious global equity correction since 2002, most people have forgotten how to trade during a correction, or even how to recognize its existence. As the U.S. dollar continues to move higher, most equity sector groups and commodities will decline. This will reflect a global economic contraction, exacerbated by falling housing prices around the world.
The secret to financial success over the next year will be to remember that to buy low and sell high, first you have to buy low. Buying low doesn't mean purchasing something as soon as it has fallen by 10% from a multi-decade peak. It means waiting for your favorite assets to form a major bottoming pattern at a deeply depressed level that closely matches a past historic nadir. If a double bottom is completed with a major low from 2006, then that would likely qualify as a potential buying opportunity.
Therefore, be patient. While everyone else will be overly eager to buy on dips, they will repeatedly make the mistake of getting in too early. Remember that those who missed out on the last bull market in anything will always get in far too soon, and will therefore fully participate in the next bear market in that asset. Wait until your friends give up in despair or when they start telling you that it's hopeless or dead money, wait a little longer just to be sure, and then finally jump in.
2007 was full of fake upside breakouts, which have provided wonderful short-selling opportunities to those who recognized them. 2008 will similarly enjoy an abundance of false downside breakouts that will be the best buying opportunities in three years. Have plenty of cash on hand to make heavy purchases whenever you see such a phony collapse. The greater the unanimity of people that are telling you it's a mistake, the more you will know that you are doing the right thing.
GLOBAL ASSETS ARE PRICING IN A MOST DANGEROUS ASSUMPTION (November 26, 2007): The prices of everything from crude oil to gold mining shares to emerging-market equities to Chinese art to Dublin real estate are all making the same basic assumption: that the U.S. dollar will continue to decline in value. While this appears to be the safest bet imaginable, it also seemed to be a "sure thing" in December 2004, just before the U.S. dollar staged a strong rebound which lasted for nearly a year and which had a profound effect on the global financial markets.
This time, there are even more people who are "certain" of a continued decline in the U.S. dollar, and literally trillions of dollars worldwide that has been invested directly or indirectly upon that expectation. In fact, the anticipation of a weaker greenback is so ingrained in the minds of many global investors that practically everyone has acted to protect their portfolios against a falling U.S. dollar, even though a rising U.S. dollar is likely a far greater threat. Multi-decade peaks for most commodities and for many equity sector groups would soon lead to sharp pullbacks if the U.S. dollar were to suddenly rally over the next several months.
Whenever a nearly unanimous consensus of investors is lined up on the same side of any given trade, it is virtually always the point at which it is most likely that the market will move sharply in the opposite direction. Just a few months ago, many amateur currency traders such as Japanese housewives were betting on a weaker Japanese yen and a stronger Australian/New Zealand dollar. The sudden resurgence in the yen and a decline for the Australian and New Zealand dollars forced this "yen carry trade" to be busted, but instead of closing their positions entirely, these speculators after being badly burned (financially speaking, of course) merely switched to being short the U.S. dollar and long various emerging-market currencies such as the Brazilian real and the South African rand. You can easily guess whether they will be burned yet again.
The financial markets always load up with the maximum possible number of participants before they then frustrate the collective expectations of those participants. This is not going to be the first exception to the rule. With so much money betting directly or indirectly on a weaker U.S. dollar, the financial markets are poised to move dramatically in precisely the opposite direction. Exactly when this will happen is uncertain, but since so few are prepared for it to occur, it is likely to be sooner rather than later.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, which appeared on newsstands worldwide.
CURRENT ASSET ALLOCATION (December 28, 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%), 4%; municipal bonds, including MYJ, 2.5%; KRE, 1%; TOC, 1.5% (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 and in the PayPal money-market fund, 7%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 50.5%; short EWM, 1%; short ILF, 1%; short GLD, 17.5%; short GDX, 2.5%; short USO, 3.5%; short BIK, 1.5%.
REMINISCENCE OF THE WEEK (December 12, 2007): When I was in high school, the father of one of my best friends became my buddy. His name was Jack Martin, and we shared a love of music. Especially during my college years and for a few years thereafter, we went to see some truly great jazz and folk performers together: Count Basie; Pete Seeger with Arlo Guthrie; Oscar Peterson; Ahmad Jamal; Anita O'Day with Harry "Sweets" Edison; the Modern Jazz Quartet. I especially remember a concert in a small, crowded club in downtown Baltimore featuring the great jazz violinist Stephane Grappelli; during a break between sets, the violinist's forty-something backup band took a much-needed break, while Mr. Grappelli himself, at that time in his mid-70s, played jazz piano throughout the intermission.
My favorite time with Jack was a fine early summer day in 1984. We drove early in the morning to a waterfall in western Maryland where we sat and talked about life for several hours. In the afternoon, we went to visit a friend of his who had four musical children. They each performed a classical piece in turn on their various instruments, starting with the youngest, as I accompanied them on the piano. The oldest one, about sixteen years of age, played Bach's Violin Concerto #2; this well-known work has a piano reduction that would have been impossible for me to sightread competently if I had not practically memorized it several years earlier to win a statewide competition with a violinist friend in high school. All of us shared a delicious and leisurely dinner together before we returned home. Either before or since, I cannot recall a more memorable day.