Monthly Strategy – May 2011
Mostly unchanged from April…
Economic Growth
The world economy is growing, but the rates of growth are not impressive. Extremely loose monetary and fiscal policy have clearly put the U.S. in the leading position among the developed countries.
Developed Europe has its share of problems, with most acute being debt burden peripheral Europe. European counties have taken more prudent route and have chosen to moderate their expansive fiscal and monetary policies and this will take it’s toll with lower (than U.S.) economic growth.
Earthquake and tsunami stricken Japan deployed massive monetary stimulus. Rebuilding efforts will need massive financing which will mean more debt issuance. In the short term this will spur growth and revive the economy, but the consequences for the long term (Japan debt burden is already beyond anything labeled normal) could be dire…
Emerging markets are clearly two tiered. We have China as a global manufacturing power house and a massive commodity importer and on the other side rest of the Brasil and Russia which are big beneficiaries of China commodity expansion. So it all comes down to China.
China has started to tighten monetary policy both with rising bank reserve ratios and increasing key interest rate. Economic growth has clearly slowed. Rising interest rate do not bode well with real-estate bubbles, with fixed asset investment based economies, or with any kind of speculation… So, I would be very careful on China.
I think they there is a threat that monetary tightening will bring the economic growth bellow the threshold needed to keep the ponzi scheme fixed investment based economy running. The alternative is to return to monetary expansion and suffer high inflation.
To sum up: All kind of headwinds ahead of the global economy. If we have rising commodity prices coupled with expansive monetary policy spurring inflation and anemic economic growth the result is my new base scenario – stagflation.
Equities
Looks like market is bound to erase all “big recession” loses in the next year.
I still believe that the market is overvalued, but it makes no sense to try to pick a top in this kind of circumstances, I’ll wait until the uptrend is broken. By the looks of it the waiting could last for a while…
Bonds
I think that Mr. Bernanke game plan is to have interest rates low longer than anyone expects (I don’t expect a rise in 2011). I expect principal reinvesting will continue. I expect “extended period” formulation will be kept for a while.
Despite all the big names calling bonds will have its day of reckoning with the end of FED asset buying program I think the the effect will be moderate as I believe the key is in the short end of the curve and until this moves nothing major will happen.
Further down the road, inflation is a big threat…. Longer term bonds and inflation do not go hand by hand.
Commodities
Potential inflation is a big generator in commodity investment flows with precious metals being the prime beneficiary.
Energy Commodities
Crude Oil – with Libya being out of the markets the excess capacity is almost nonexistent and when we couple this with loose monetary policy and declining dollar – the only way is up.
U.S. natural gas – the supply/demand balance is bad. The only hope is that redirection of LNG cargoes to Japan will bring the supply down. Storage smaller than expected in last couple of weeks. Could become interesting this fall…
Industrial Commodities
This is the weakest link in the commodity universe. I’m continuously puzzled by aluminium strength.
Copper – one of rare commodities with deficit in production. On the other hand price is pressured by large (Chinese) stockpiles.
Agricultural Commodities
Apparently China has started to boost its inventory of agricultural commodities. This means long all the way.
Precious Metals
I am not buying the conspiracy theories surrounding the precious metals complex (especially silver), but I think that no one can refute scarce physical supply. Long all the way.
Currencies
I think the U.S. dollar is undervalued, but ECB key interest rise is a strong factor in prolonging the time to the trend reversal.
I believe Yen is set to weaken on massive Japanese QE and subsequent resumption of the world’s favorite carry trade.
Agricultural Commodities, Aluminium, Ben Bernanke, China, Copper, Crude Oil, EU, Euro, FED, FOMC, Gold, Japan, Japanese Yen, Natural Gas, Steel, U.S. Dollar