The Prudent Investor's Outlook 2010

Wednesday, January 20, 2010

EXECUTIVE SUMMARY: I do not buy into any recovery hopes.
Now please read the rest:
As 2010 may become the year where we finally kiss goodbye John Maynard Keynes' deficit spending ideology out of pure necessity, I want to remind readers of JMK's only quote I fully agree with; "The market can stay irrational longer than you can stay solvent."
Given the new paradigms created in 2009 - Peace Nobelist Obama and Time's man of the year Bernanke - the risks lie definitely on the political side. E.g. note that Bernanke has not been confirmed only 11 days before the end of his first term as the Fed head that will enter history as the so far biggest money printer.
While all central bank chiefs have done a terrible job in forecasting since the onset of the credit crisis in August 2007, uncertainty now rises one more level as official data has become questionnable in several nations, beginning with China's creative GDP accounting and ending with outright data fraud in several EU member nations. I place the US somewhere in between. Calls from the OECD last year to change accounting in order to paint a rosier picture are not exactly supporting my trust into official numbers.
Having read screens of 2010 projections without end I notice that analysis focuses on political risks to an extent not seen in the last 25 years.
My perspective is not limited to 2010 but rather the 2010/2011 period as I fear a double dip depression and I have a 20-year history of forecasting price or other changes way too early.

Easy Economic Outlook: Nothing Gets Better
The economic outlook is fairly easy: Consumers worldwide are scrambling to pay off their revolving credit i.e. credit cards while burdened with mortgage payments. At the same time demand contraction adds to unemployment while hopelessly overindebted Western nations get squeezed between eroding tax revenues and higher social transfers.
So far fiscally irresponsible politicians had an easy life with the key central banks holding interest rates at artificially low levels. But in my opinion this manipulation of rates may come to an end soon. It is simply not rational that the riskiest economic period since the 1930s converges with the lowest interest rates on record.
This game may go on a little more but it should be self-understood that not all so called "developed" nations can rely on the rest of the world to blow up debt-to-GDP ratios to Japan's current 200%. We cannot be all in debt at the same time.
It also stifles any hopes of recovery as central banks will have to raise interest rates with hyperinflation on the horizon. The West's creditors are getting an idea that all the debt they hold could get inflated away, leaving them with what was always left at the end of a bubble: a lot of promises not worth their paper.

The Euro is Not a Currency But an Experiment
The Eurozone started out under a now forgotten set of convergence criteria that limited the debt-to-GDP ratio at 60% while also prescribing a 3% limit on budget deficit growth. These Maastricht criteria have silently been thrown out the door as the list of European countries-in-crisis gets longer with every month.
While I have been bearish on Federal Reserve Notes (FRN) since the beginning of this blog, rapidly unfolding events in the Eurozone have created an equilibrium in the structural weakness of both unbacked fiat currencies.
Greece's troubles unmask the Euro not so much as a currency but an experiment - that will end as ALL European currency unions in the last 3 centuries: as a disaster, throwing the old continent into a possible chaos of sovereign defaults.
This may not happen in 2010 as the EU will do everything to stimulate growth. The ECB has already signalled it is ready for another year of the cheapest money in history. The Fed takes the same complacent view.
Add in that everything that is pesented as a recovery is the result of fiscal stimuli while burned-out consumers will face a string of rising public service costs. Germany, the industrial locomotive of the Eurozone expects every 4th car dealership to close its doors forever in 2010 after a cash for clunkers system benefitted mainly Asian micro compact car producers in 2009.
Greece folds under its public expenditures and I need to drink the same kool aid to believe the country's and the ECB's view that it will manage to cut deficit growth from currently 12% to 3% within 3 years.
25% unemployment in Spain, Austria's banking problems in the strongly contracting Central Eastern European countries, a declining UK economy suffering double from a crashing pound (no more sterling for those,) and bankrupt communities all over America and Europe do not spell "growth" to me - except a desperate continuation to paper it all over with more central bank money that has held up markets despite the terrible fundamental outlook.

The End of Keynesianism
Realizing that globalization has led to the worldwide phenomenon of indebtedness the last decade's euphoria for Keynes deficit spending may go out of fashion very soon for a simple reason: One more time in history it is payday as investors will discover that too much leverage always leads to the same inevitable end and the unwinding process has still a long way to go. According to the latest BIS figures from June 2009 (pdf), the notional amount of OTC derivatives has again surpassed the $600 Trillion mark while gross market value has declined from $32 Trillion to $25 Trillion. 60% of these are interest rate bets. Maybe this explains why the ECB and the Fed have already announced to remain on auto-pilot for at least another year. Yeah, yeah, they will always say they are vigilant. But this kind of vigilance led to the biggest credit crunch in history.
Politicians worldwide will run into a wall of higher interest rates in 2010 when investors begin to request an adeqaute risk premium again. 10-year rates around 5% while the economies are in a free fall and true consumer inflation running easily above that level should make it clear that we will see an inevitable wave of rapid repricing of public debt.

Why Do Soybeans Cost 60% More in China Than On "World Markets?"
I do not have to dive deeper into contorted commodity markets. Eric de Carbonnel does an excellent job keeping us updated on worrisome events like the fact that soybeans trade at a 60% premium to so called world market prices, using Chinese price data. With such divergences turmoil can be seen ahead and latest reports that tea skyrocketed in the UK are an early warning indicator of more food inflation to come.
Marketskeptics.com warned already last November that US agricultural production is on the decline.

Ongoing Fiscal Insanity
Helpless governments will probably do their best in aggravating the crisis. Hooked to debt-spending, declining tax revenues come hand in hand with higher social expenditures due to an aging population amidst steadily rising unemployment. If we see 2009 as the year that was survived thanks to fiscal stimuli, 2010 could become an annus horribilis.
Looking at the example of the Bank of England, which printed hundreds of billions of pounds, and now faces an anyway sinking UK economy, continental Europe and the US will continue on this outdated path of money printing excesses until all dams break and investors stampede into "real" assets, meaning anything you can store in a vault, the deep freezer or the backyard. Copper hoarding Chinese pig farmers may give you an idea of what's to come when we see declining trust into the purchasing power stability of unbacked paper money.

Market Expectations
Expecting a general meltdown within the next 24 months I have squared all non-producing equity positions, save a few bets on non-US silver juniors and rare metal companies. Being long precious metals in bullion and the ZKB ETFs appear the best way to weather the coming financial hurricane. I prefer to be out a year ahead than a day too late.

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