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Where Inflation is Higher than Interest Rates, Liquidity will Flow

By Monty Guild      Printer Friendly Version Bookmark and Share
Oct 28 2010 2:52PM

www.guildinvestment.com

Where inflation is higher than interest rates, liquidity will flow

In the world of stock, commodities, and real estate investing, it is common knowledge that capital flows to where inflation exceeds the cost of borrowing. Clearly, if you can borrow at 4% and inflation is 6% it pays to borrow money and speculate in the appreciating stocks, commodities, and real estate. This is the situation in many developing nations today, especially in China, India, and some other countries in Southeast Asia and Latin America; borrowing costs are less than the commonly accepted “true? rate of inflation. Additionally, companies and industries are growing, and this makes stocks in those countries doubly attractive.

In much of the world, investors have learned that government inflation statistics are inaccurate, almost always erring on the side of understating inflation. Thus, it is no surprise that China, India, Malaysia, Singapore, Thailand, Indonesia, and the Latin American countries that we favor may be recipients of substantial capital inflows in coming months. Their growth is creating inflation and their central banks, for the most part, are being too cautious about raising interest rates to reign in this inflation. This is a green light for investors who are pouring money into the stock and currency markets for these countries. In many cases, the countries have no choice but watch their currency rise and watch their stock market rise as large inflows augment the local capital. The capital ends up in commodity or growth-related stocks as investors try to preserve or grow the buying power of their money.

It is not hard to see the course of action that these markets will take if you just put yourself in the shoes of the local investor with money. In many cases, they cannot get money out of the country easily. They can buy gold, real estate or stocks, and some bonds may be available from their bank.

For example, if you are a Chinese citizen, and local inflation is 5% but your bank account is only earning 3%, you will buy some stocks so that your money can keep up with the cost of living. You have already been buying real estate to do the same thing, but that is getting harder, especially after you get beyond your 2nd home. Therefore, you are looking elsewhere and are considering buying gold bullion and Chinese stocks.

World commodity prices reach highs in U.S. dollar terms

Corn, wheat, soybeans, sugar, cotton, gold, silver, and copper are all doing well, as are some other commodity prices, especially meats. The prospect of money printing (QE) by the U.S. and other nations along with tight supplies, are both responsible for the price moves.  However, can we not say that tight physical supplies exist because many investors have purchased and stockpiled commodities to hedge against the inflation they believe is approaching, thus precipitating such an eventuality? The shortages are occurring as industrial and commercial users increase their stockpiles. This is one reason that we have long argued that commodity prices, especially food and precious metals would move higher. They have been moving, and we believe we are in the middle stages of their moves. In the press you will undoubtedly hear shouts of ‘bubbles’ from those who have missed the price moves or who have been short.

(Continuous Commodity Index Five Years)

(Commodities included in the Continuous Commodity Index are: Energies 17.64%, Grains 17.64%, Livestock 11.76%, Softs 29.40%, Metals 23.52%.)

The long process of China’s ascent to an economic power continues as more bonds denominated in the renminbi are being floated.

China has dropped some of its exchange controls with Hong Kong, thus the flotation of Chinese renminbi denominated bonds is moving ahead in Hong Kong.  This is creating more of a Chinese bond market.  It also allows other non-Chinese organizations to float bonds in the Chinese currency and tap the Chinese market for investors.  The Asian Development Bank and McDonalds Corporation are two recent issuers of these bonds, and more will be coming.  As Chinese capital controls are being loosened, bond floatations that would previously have occurred in U.S. dollars, euros, or Japanese yen will be more frequently issued in renminbi.

Key players at the U.S. Federal Reserve begin to promote higher inflation target

Ben Bernanke and Charles Evans are both prominent figures at the U.S. Federal Reserve, and they along with other Fed members have been arguing in recent weeks that while printing money will be helpful, what will be much more helpful is inflation targeting. Specifically, they want to target inflation at a rate in excess of the current inflation rate. This is a change of policy that bears close watching. For decades, the Fed has worked to keep inflation down and to keep inflationary psychology under control. Now that deflation is a potential problem in the U.S., a serious problem in Japan, and possibly other parts of the developed world, the Fed want to do the opposite. They are actually going to try to convince people to believe there is some inflation, so that they will invest as if they needed growth, spend rather than save, and pay down debt.

Although the nation is over-levered and needs to cut spending, the Fed’s hope is that companies and families begin to invest more to create economic growth and more jobs. They have created a new jargon for the plan to increase inflation. They call it the mandate consistent inflation rate and they will set it initially at 2%. If inflation exceeds 2% they will tolerate this as long as it is providing a pick-up in economic activity. Selling to the public the concept that inflation will be rising is the technique that they are using in an attempt to avoid the stagnation and deflation that Japan has suffered over the last 20 years.

This is positive for gold

There may be no wiser person about global economic and financial events than Jim Sinclair who runs the JSMineset.com web site and is a well known gold mining CEO and entrepreneur. Jim and I spoke about this issue and he points out that the Fed and its principle officials will have to make a lot of speeches about this plan and try to sell the concept of inflation to the U.S. population, and to the world. The more they sell it, the more the public will see the need for targeting inflation at a rate higher than the current rate and the more the public will shift into a program of protecting their assets from inflation by purchasing gold, commodities, stocks, and income earning real estate. This is also positive for stocks, commodities and other investments, but is bad for bonds.

While cost-cutting is needed, it is deflationary; Business and employment growth should also be incentivized

In the U.S., many voters are notifying their representatives to push an agenda of cost cutting. In Europe cost are being cut and retirement ages increased. People have been slashing costs and trying to balance their personal budgets and they want their government to do the same. We agree that cost-cutting and waste reduction are important and needed on a national scale in many developed countries. Yet it is important to also realize that these actions are deflationary.

If costs are cut, some benfits are realized. For best results, changes to spending patterns must also be made by businesses. Businesses must be incentivized to grow and to create jobs; without such emphasis on increasing employment by incentivizing growth, the economy will head into a prolonged depression/deflation in the developed world. In order to avoid such an outcome, it is necessary to encourage the spread of the psychology that more inflation, let’s say 2% or 3% will be tolerated (and in fact encouraged) in developed countries. It is also important to reinstitute some kind of incentive, tax incentive, reduction of bureaucratic obstacles or otherwise for new industries to be created and encouraged to grow; much like the changes in regulation and taxation for investment promulgated by the Reagan administration in the early 1980’s in the U.S. These eventually gave rise to many technological, medical, and associated industries… which eventually provided the government with huge tax receipts.

Summary and Recommendations

We still like the same themes and investments we have been discussing. Our current recommendations are:

Investors should continue to hold gold for long-term investment. It will move to $1500 and then higher. Traders sell spikes and buy dips. Gold-related news:  South Korea decided this week to increase the percentage of gold in their investment portfolio.

Investors should continue to hold oil. Oil-related news: positive, U.S. onshore inventories are neutral and offshore inventories held in tankers have declined substantially. A negative news event is that there will be an increasing supply from Iraq.

Currencies:  For long-term investment, we do not like the U.S. dollar, Japanese yen, British pound or the euro. We do like Canadian, Australian, and Singapore dollars, the Thai baht, Malaysian ringgit, and Indonesian rupiah. We would use the current pull-back in these currencies as an opportunity to establish long-term positions.

Investors should continue to hold shares in India, China, Singapore, Malaysia, Thailand, Indonesia, Colombia, Chile, and Peru. We would use any pull-backs as an opportunity to add or initiate positions for long-term investors.

Investors should continue to hold food-related shares such as grains, wheat, corn, soybeans, and farm suppliers.

Continue to hold U.S. stocks for a further rally.  Long-term U.S. liquidity formation through QE will create demand for many assets, including U.S. stocks. Short-term U.S. stock market indices are near resistance areas, traders can consider taking profits.

Thanks for listening.

General Disclosures about this Newsletter

The publisher of this newsletter is Guild Investment Management, Inc. (GIM or Guild), an investment advisor registered with the Securities and Exchange Commission. GIM manages the accounts of high net worth individuals, investment partnerships, trusts and estates, pension and profit sharing plans, and corporations, among other clients.

Your receipt of this newsletter does not create a personal advisory relationship with GIM although some recipients may also be advisory clients of GIM. GIM has written advisory agreements with all its personal advisory clients, which sets forth the nature of that relationship.

The newsletter makes general observations about markets and business and financial trends and may provide advice about specific companies and specific investments. It does not give personal advice tailored to the needs, objectives, and circumstances of individual readers. Whether investment ideas and recommendations are suitable for individual readers depends substantially on the personal and financial situation of that reader, which GIM, as the publisher of the newsletter, makes no effort to investigate.

GIM attempts to provide accurate content in its newsletters to the extent such content is factual rather than analysis and opinion, but GIM relies primarily on information compiled or reported by third parties and does not generally attempt to independently verify or investigate such information. GIM does not guarantee the accuracy of such information. Moreover, some content and some of the assumptions, formulas, algorithms and other data that affect the content may be inaccurate, outdated, or otherwise flawed.

Please note that investing in stocks, other securities, and commodities is inherently risky, and you should rely on your personal financial advisors and conduct your own due diligence in connection with any investment decision.

A Special Comment for Guild’s Clients

If you are an investment advisory client of GIM who is receiving this newsletter, please note that the fact that a general recommendation is made of a particular security, commodity, or investment area  to its newsletter subscribers does not mean that investment is suitable for you or should be purchased by you. For example, GIM may already have purchased such securities on your behalf or purchased securities in the same industry (and an increase in the position for you may represent too much concentration in one security or industry), or GIM may believe the investment is not suitable for you based on your risk tolerance or other factors.  If you have questions about the recommendations in this newsletter in relation to your account at GIM, please contact Monty Guild or Tony Danaher.

Conflicts of Interest

As of the date of this newsletter, GIM’s investment advisory clients or GIM’s principals owned positions in equities and etfs in areas that are the subject of the commentary, analysis, opinions, advice, or recommendations contained in this newsletter.  These positions are equities and etfs of the following countries: U.S., Canada, India, China, Singapore, Thailand, Malaysia, Indonesia, Brazil, Chile, Colombia, and Peru, as well as other countries not mentioned in this newsletter.  In addition, GIM’s investment advisory clients or GIM’s principals owned equities and etfs related to the following commodity markets: gold, silver, oil, copper, and agriculture.

GIM and its principals have certain conflicts of interest in its relations with its investment advisory clients and its newsletter subscribers resulting from GIM or its principals holding positions for its clients or themselves which are also recommended to its clients. GIM may change the positions of its clients or GIM’s principals may change their positions (increasing, decreasing, and eliminating them) based on GIM’s best judgment at any given time, including the time of publication of the newsletter. Factors that lead GIM to change or eliminate its positions may include general market developments, factors specific to the issuer, or the needs of GIM or its advisory clients. From time to time GIM’s investing goals on behalf of its investment advisory clients or the personal investing goals of GIM’s principals and their risk tolerance may be different from those discussed in the newsletter, and the investment decisions made by GIM for its advisory clients or the investment decisions of its principals may vary from (and may even be contrary to) the advice and recommendations in the newsletter.

In addition, GIM or its principals may reduce or eliminate their positions in an investment that is recommended in the newsletter prior to notifying the newsletter subscribers of such a reduction or elimination. The publication by GIM of a "target price" or "stop loss" for a particular security or other asset does not necessarily represent the price at which  GIM intends to sell or will sell any such assets for its advisory clients or the price at which GIM’s principals intend to sell any such assets.

As a consequence of the conflict of interest, GIMs clients or principals may benefit if newsletter subscribers purchase assets recommended by GIM since it could increase the value of the assets already held by GIM’s investment advisory clients or GIM’s principals. On the other hand, GIM’s principals and clients may suffer a detriment if they seek to acquire additional shares in securities that have been recommended and the price of the securities has increased as a result of purchases by newsletter subscribers.

To help mitigate these conflicts, GIM seeks to avoid recommending the securities of individual companies where GIM or its principals have an ownership position and where the issuer is small or its securities are thinly traded-that way sales by GIM in advance of possible sales by newsletter subscribers would not be likely to cause any significant decrease in the sale price to newsletter subscribers. GIM has a fiduciary relationship with its investment advisory clients and cannot agree on behalf of such clients to refrain from purchases or sales of a security mentioned in the newsletter for a period of time before or after recommendations for purchases or sales are made to its newsletter subscribers.

GIM encourages you to do independent research on the securities or other assets discussed or recommended in the newsletter prior to making any investment decisions and to be especially cautious of investments in small, thinly-traded companies, which are usually the most risky investments that you can make.

Disclaimer of Liability

GIM disclaims any liability for investment decisions based upon information or opinions in its newsletters. GIM is not soliciting you to execute any trade. Nothing contained in GIM’s newsletters is intended to be, nor shall it be construed as an offer to buy or sell securities or to give individual investment advice. The information in the newsletter is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation, or which would subject GIM to any registration requirement within such jurisdiction or country.

NOTICE TO RECIPIENT: Guild's current and past market commentaries are protected by copyright. Apart from any use permitted under the Copyright Act, you must not copy, frame, modify, transmit or distribute the market commentaries, without seeking the prior consent of Guild. This E-Mail is meant for only the intended recipient of the transmission, and may be a communication privileged by law. If you received this e-mail in error, any review, use, dissemination, distribution, or copying of this e-mail is strictly prohibited. Please notify us immediately of the error by return e-mail and please delete this message from your system. although this email and any attachments are believed to be free of any virus or other defect that might affect any computer system into which it is received and opened it is the responsibility of the recipient to ensure that it is virus free and no responsibility is accepted by Guild Investment Management for any loss or damage arising in any way from its use.

Thank You.

Monty Guild
and Tony Danaher
October 27th, 2010

 

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Disclaimer of Liability: GIM disclaims any liability for investment decisions based upon information or opinions in its newsletters. GIM is not soliciting you to execute any trade. Nothing contained in GIM’s newsletters is intended to be, nor shall it be construed as an offer to buy or sell securities or to give individual investment advice. The information in the newsletter is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation, or which would subject GIM to any registration requirement within such jurisdiction or country.

NOTICE TO RECIPIENT: Guild's current and past market commentaries are protected by copyright.  Apart from any use permitted under the Copyright Act, you must not copy, frame, modify, transmit or distribute the market commentaries, without seeking the prior consent of Guild. This E-Mail is meant for only the intended recipient of the transmission, and may be a communication privileged by law. If you received this e-mail in error, any review, use, dissemination, distribution, or copying of this e-mail is strictly prohibited. Please notify us immediately of the error by return e-mail and please delete this message from your system. although this email and any attachments are believed to be free of any virus or other defect that might affect any computer system into which it is received and opened it is the responsibility of the recipient to ensure that it is virus free and no responsibility is accepted by Guild Investment Management for any loss or damage arising in any way from its use. Thank You.