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Updated @ 11:45 p.m. EDT, Monday, March 31, 2008.


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.

Whenever anything looks absolutely unstoppable, it always stops. --Steven Jon Kaplan

COMMODITIES JOIN EQUITIES IN A MAJOR GLOBAL DOWNTREND (March 31, 2008): The "outlandish" predictions in my previous update, stating that the U.S. dollar would begin a major rally while commodities undergo a historic collapse, is already well underway. The greenback's rally will likely continue through the first quarter of 2009, and will see a total gain of at least 20% and perhaps even more than 30% against most currencies. Meanwhile, commodities had become the last refuge of amateur speculators around the world, and are now in the early stages of punishing these folks for assuming foolishly that a global economic contraction would magically allow commodities to avoid the same inevitable fate as equities. In a worldwide downturn, everything that falls must converge. [My sincere apologies to Flannery O'Connor.]

Congratulations to Barron's for essentially repeating the message of my previous update in their cover story of this week's issue. While they were two weeks late, they were otherwise absolutely on the money in all aspects.

REAL ESTATE WILL LEAD TO REAL SUFFERING (March 31, 2008): It is becoming understood that the real-estate bubble will cause severe consequences for the global financial markets. However, there are two critical points which most investors have missed regarding this bubble.

The first point is that the real-estate debacle is not a subprime issue. While lending to noncreditworthy borrowers has certainly exacerbated the problem, the real dilemma is that no one--not even a person with an excellent credit history and a solid, dependable income--wants to pay off any loan which exceeds the value of the asset on which the loan is based.

If someone has bought a property for $700,000 on zero money down, then even if that person is unemployed and has a terrible credit rating, and has an adjustable-rate mortgage which is about to reset at a much higher interest rate, the primary difficulty is not the loan itself. If the house is now worth $2,000,000, that person will likely be able to get favorable credit terms one way or another. In the worst case, he or she can simply sell and pocket the $1.3 million profit, and find another place to live.

However, if someone has bought a house for $700,000 on zero money down and that house is now worth only $500,000, then the risk of default is enormous even with a fixed-rate, prime mortgage. Who would want to pay off a loan on a depreciating asset? That's like flushing money down the toilet. And if this person sells the property, will the bank forgive the $200,000 difference? The more that real-estate prices decline, the more that supposedly "good" mortgages will find themselves in foreclosure.

The second point is that it is not a U.S. problem, but a global issue. While there were probably more subprime loans in the U.S. than elsewhere, the average price of a U.S. home after recent pullbacks is roughly 70% above its fair value. While this is dangerous, there are many countries such as Ireland and the U.K. where housing prices--even after recent pullbacks--are still at roughly triple fair value. Since all assets eventually regress to fair value sooner or later, the ensuing decline will be much worse in many countries outside the U.S. in percentage terms.

Most importantly, as real-estate prices plunge worldwide, this will create less prosperity. The "negative wealth" effect from people feeling poorer as a result of the reduced equity in their homes will cause the current global slowdown to eventually become a major worldwide recession. This may not happen immediately, but it will surely happen within a year or two at most.

  • Special Overview of Gold Mining Shares, updated on March 31, 2008.
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    GLOBAL EQUITY MARKETS ARE SET FOR THE NEXT PHASE IN THEIR CORRECTION (March 3, 2008): U.S. equity indices have declined for four consecutive months from November 2007 through February 2008, as global equities have eventually joined them without exception. As the availability of credit becomes an increasingly serious issue and the lack of new borrowed money makes its contractionary impact on the global economy, evidence of a worldwide slowdown is becoming increasingly apparent. However, fear of an additional decline, as is most accurately measured by the index VXO, has shown that most investors throughout the world believe that the stock-market correction ended in January. This lack of concern will soon translate into substantially lower lows for equity indices in all countries, with the greatest declines about to occur in emerging markets where growth expectations are by far the most unrealistic. Eventually, major equity index and fund support levels from 2006 and even 2005 will be experienced as the euphoria of 2007 leads to the panic of 2008. You can't have one extreme without the other.

    COMMODITIES WILL SOON JOIN EQUITIES IN THE GLOBAL DOWNTREND (March 3, 2008): In the early weeks of the U.S. stock market's decline, there was a popular theory that certain Nasdaq stocks like Apple Computer (AAPL) and Google (GOOG), along with some emerging markets like India, would somehow be magically exempt from the global downtrend. This illusion persisted for weeks, and even took on the popular title of "decoupling", until the above securities plunged dramatically in order to catch up to the reality of reduced desire for equity risk.

    Since then, as all equity markets around the globe have joined in the downtrend, investors have not abandoned their Peter Pan illusions of Neverland, but have simply shifted their fantasies from equities to commodities. Actual supply/demand data from all reliable sources demonstrate that the physical demand for all commodities has contracted sharply in recent weeks as the global economic contraction and sharply higher prices have combined to create significantly lower buying. Meanwhile, supply has progressively increased as miners and farmers have sharply accelerated production to take advantage of windfall profits.

    The only reason that this combination of lower demand and higher supply has not led to sharply lower commodity prices is that the introduction of new futures contracts and exchange-traded funds, at the same time that investors are fleeing the global equity market, has encouraged a huge speculative buying binge. This has caused commodities to soar to multi-decade peaks. There has never been such a sharp divergence between reduced physical demand and increased speculative demand. People who never cared about commodities are now the biggest buyers and cheerleaders, which always happens just before a plunge. Even the non-financial media have been promoting the myth of unlimited potential gains in commodities, which is one very reliable sign of a major peak.

    Speculative demand, however, cannot replace physical demand. The illusion of shortage created by fund buying will become a transparent farce once a critical mass of investors decides that additional gains are likely to be limited, and begin selling. The sudden influx of commodities into the open market, especially with no proven support levels for a long way down, will lead to a short-term collapse that will be dramatic in its intensity and a huge surprise to most investors.

    THE U.S. DOLLAR WILL SURGE HIGHER AT LEAST UNTIL THE END OF 2008 (March 3, 2008): The current growth forecasts by most economists are for the U.S. to enter a mild recession, while the rest of the world enjoys strong growth. While the U.S. projections are likely to be fairly accurate, the rest of the world will greatly suffer from decreased U.S. demand, while the credit crisis is already spreading around the globe. Current double-digit growth projections for many emerging markets are far too optimistic. Once the reality of a true global slowdown becomes evident, the U.S. dollar will benefit enormously as a safe haven. Its currently deeply depressed valuation will become an asset once it begins to rise, as it will be seen as one of the few truly underpriced global securities.

    In addition, the inevitable reduced U.S. military spending in Iraq, along with the increased likelihood of higher U.S. income taxes, will decrease the huge U.S. budget deficit and will provide additional support for the greenback. The anticipation of a new U.S. President will also create an aura of "moving in the right direction" that will contribute to a sharply higher U.S. currency.

    Once the U.S. dollar soon begins to rally, the huge army of speculative short positions will inevitably be forced to start covering their positions, which will accelerate the move and will lead to additional short covering. This will likely enable the greenback to rally for at least the rest of 2008, and possibly into early 2009.

    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, and then again on page M14 of their February 25, 2008 issue.

    CURRENT ASSET ALLOCATION (March 31, 2008): 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%), 2.5%; municipal bonds, including MYJ, 2.5%; KRE, 1%; XRT, 0.5%; 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, 4.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX, GOOG, in that order), 38.5%; short EWM, 1%; short ILF, 1%; short GLD, 20%; short GDX, 3%; short USO, 5.5%; short SLV, 2%; short DBA, 8%; short BIK, 1%; short EWZ, 1%.

    REMINISCENCE OF THE WEEK (March 31, 2008): When I was in college, I joined the chess club which used to meet each Saturday night starting around 9 p.m. and often going well past midnight. The only room large enough for us to meet at that time was in the same building and also the same floor as the university's Rathskeller, which used to blare loud disco music most Saturday nights. Eventually, we got used to playing chess with "Staying Alive" in the background and the reflections created by bright strobe lights.

    On one Saturday evening, the disco DJ stayed home and I was invited to perform at the Rathskeller on a grand piano for a special "Western Night". This was great fun, as people crowded around the piano to sing some old cowboy songs from the 1800s. Around midnight, so many people were leaning on one side of the piano that its weakest leg gave way and it suddenly collapsed onto the floor, dragging down a few dozen beers and creating an amazing mess--not to mention a loud dissonant crash. Luckily, there were no real injuries. I brushed myself off and walked over to the chess club to see if anyone was still around.

    There were still several intense chess matches in progress, so I sat down and watched. Not one person noticed that I was dressed as a cowboy with a ten-gallon hat. A few minutes later, a few of the women who had been gathered around the piano noticed me sitting in the club and walked over. One of them gave me a passionate kiss--which finally induced a few of the chess players to look up from their games.

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