Here we go!

So as the forecast on December 8th, 2009 predicted ("Short-Term Dollar Strength on Worldwide Crappiness") the Euro is now within spitting distance of $1.40 to the dollar. So far so good. But the ferociousness with which it smashed though its 200 day moving average makes me inclined to wait for further weakness rather then booking profits now. I believe that the Dollar will certainly hit $1.35. Depending on the management of the Grecian crisis, the Euro easily could fall further but $1.35 is a recurring motif I feel comfortable with.
(It was the exchange rate when I first started paying attention to the markets in 2005, it was the rate just before the panic began in late July 2007, and there has been a lot of congestion around $1.35 over the past year.)












In other news, readers of this blog will note that I have been pretty bearish throughout the past year. Not to the point of outright shorting the S&P 500, but certainly not holding any long U.S. equity positions either. The theme since December 6th, 2008 has been to pursue a simple "reflationary" strategy, with a diversified portfolio split between base metals (LD, +141%), rare metals (1211.HK, +524%), junk-bonds (PHDAX , 46%), Brazilian and Indian Equities (EWZ, +156%, INP, +129%), and Inflation-Protected Government Bonds (TIP, +11%). This strategy was intended to be long only, with a "buy on dips" mentality.

I believe it is time to close out this portfolio and move to cash. Investor bullishness is the highest its been since 2006. China is removing liquidity. The VIX is near its 3-year lows and Junk-Bonds have returned to yields not seen since the moments before the panic in July 2007.

We may be moving into a new phase of the crisis. The big story of the Panic of 2008 was the run on the "cyber" banks, the money-market accounts where investors park their cash. The sudden withdrawal of cash from these accounts after the Primary Reserve fund "broke the buck" ushered in a wave of forced selling as money-market accounts sold their investment holdings to meet redemptions. We are unlikely to see a liquidity panic of this sort again. It is likely that the troubles in Europe will spread in unexpected ways. The specter of a Greek sovereign default will seriously undermine faith in the European Monetary Union, and until there is a clear protocol for dealing with the Greek crisis, we may very well see a solvency panic of the sort which accompanied the failure of Lehman Brothers.

I am not suggesting that this crisis is imminent, simply that the December 6th, 2008 portfolio reallocation has made stunning, one-in-a-lifetime returns, and there is enough uncertainty to the outlook to take a breather and reflect.

I am a firm believer that equity investors must be burned three times before a true bull market can begin. I've never read this anywhere, it simply seems like a prerequisite to the necessary capitulation which allows assets values to reach appropriate valuations for the onset of a bull market. I mark the bursting of the tech bubble as burn #1 and the panic of '08 as burn #2.

As a corollary to this thought however, I would reiterate my comments of last spring. The questions regarding L, W, or V shaped recoveries are misplaced. With the increasing globalization of the world financial markets and the shifting demographic patterns between developing and developed markets, I believe we will see a W-shaped recovery in the 1st world and a V-shaped recovery in Brazil and India.

We may very well be approaching half-time in this (so far) three year long bear market. Don't let anyone try to fool you into thinking otherwise.

Forecast

Real Estate. We are in the midst of an inflationary depression. On one side we have the ravages of debt. On the other, an uneasy coalition between the printing press and the psychology of a people.

The government will continue printing dollars to support the economy. Debt which pushed up asset values will now cause them to deflate as people pay down their debts instead of buying. The over-leveraged will continue to experience pain and their defaults will further damp asset values. The government prints dollars under different names but its key effort is to replace the personal spending that is now devoted to saving.

The rise of gold is unremarkable. Against copper, gold has risen about 40% since the beginning of 2007. Against oil, gold has risen 60%. Against stocks, of course gold is up 120%.

I'm not sure exactly how much gold has risen against "real estate," but with housing prices roughly down about 30% nationally, and gold up around 100%, we can all guess the relevant math.


Of course we are looking at values versus their peak, but that is exactly the point. The point in the past which we pick for measurement is arbitrary; we can only make decisions in the present. We are looking for the point at which we collectively hit our debt maxima, and we are guessing the point at which the government will target for suitable valuation.

Of course, this assumes that the government has any agency in the matter, which it does, but only indirectly.

My biggest mistake in the past 2 years has been trusting in the efficacy of printing dollar bills. It turns out this is an extremely blunt instrument. The government can no more guarantee asset values.

Our collective debt will hold down "real estate." But "real estate" values hold a reflexive power over broad swathes of the economy. The government will thus target a price level based on real estate values.

In this process, the government will anchor the values of all other goods. Tangible, fungible goods will attain a steady state value. Tangible but subjective/discernible goods, another. Subjective paper goods will suffer against common paper but against gold most of all. Gold, the most subjective of goods.

Regardless, under the best of scenarios, we will see "real estate" values depreciate by the scale of each buyer's dreams... assuming these dreams are rooted and leveraged in paper.