STAGE 2: EUROPEAN SOVEREIGN DEBT UNDER ATTACK

Taken together, the Icelandic and Greek financial crises can be seen as the second stage of the larger global banking crisis.  The first stage of the global banking crisis, which began in late 2007, was centered in the European and U.S. mortgage and mortgage derivative market.  The second stage began with Iceland’s monetary and fiscal crisis in 2009 and continues with the current Greek crisis, and is centered in European sovereign debt.

The global crisis banking crisis is a multi-phase global economic crisis caused by years of over-borrowing followed by the current deleveraging.  This deleveraging was, of course, set in place by all those who gambled with their own and other people’s money.  As time passes, more and more of these gamblers will be unmasked and there will be more countries, companies, industries, and individuals who will lose face and capital in coming months and years.  We anticipate that these problems will continue as various sectors delever over the next six to eight years.

Many believe that the other European nations will act to bail out Greece, and then perhaps Spain or other over-levered nations in Europe who experience debt problems.  We disagree.  In our opinion, the International Monetary Fund (IMF) is the lender who will bail out the damaged European nations.  In our opinion, it is too hard for European nations to go to their taxpayers and tell them that they are directly or indirectly guaranteeing the debt of a foreign country. 

As is their custom, the IMF will extract a high price in terms of the deep cuts in expenditures and increases in taxes demanded of the borrower.  In our opinion, the period of easy borrowing is over for the Greeks, and probably for several other European nations whose debt will come under attack in coming months and years.

The current chaos is creating substantial demand for gold and other precious metals.  Holders of Euros are seeking to acquire more gold, and holders of other currencies such as the Japanese Yen and U.S. dollar are undoubtedly thinking of following suit.  Buying gold to hedge against the probability that the Yen and U.S. Dollar will be under attack in the not too distant future is not unwise.

THE FUTURE OF THE DELEVERAGING CRISIS

The coming phases of the deleveraging crisis will simply be different flavors of one major phenomenon with one major cause.  We are saying this because we do not believe that most investors realize how long and pervasive this deleveraging crisis will be.  If this were a baseball game, we would only be in the 2^nd inning (for non baseball fans among you, that means we are only 20-25 percent through the crisis).

Furthermore, crises are still brewing with respect to the solvency of U.S. states, and the legal subdivisions within the countries in the European Union.  These crises have yet to become globally recognized.  In order to bail out the states and other governmental entities below the national level, a huge quantitative easing (money printing) process will eventually be instituted in many countries.  The effect will be to keep the developed nations economies (and their currencies) under pressure for years.

Governments are not alone.  Many industries, such as banking, financial services, and insurance remain under pressure to decrease their leverage and raise capital.

GLOBAL ECONOMICS

OIL DEMAND UP STRONGLY

The global demand for oil is created by demand for energy in China, India, and other Asian nations.  The world’s supply is not sufficient to handle all of the demand.  Although some pessimists talk about gluts, any price declines in oil will be short-lived.  We are buyers of oil on dips and we continue to expect oil prices to top $90/barrel by the end of 2010.

GOLD IS IN DEMAND BY EUROPEANS

Europeans have been buying gold (which is at a new high in Euro terms).  The obvious reason for their purchases is to hedge the negative effect of a declining Euro.  Many Europeans remember that two world wars were fought on their territory, and that owning some gold has saved many lives and many  fortunes.  During times of crisis they gravitate strongly to gold, and the current crisis is no exception.  European central banks and the IMF may sell gold, but the average European is more likely a buyer than a seller.

U.S. STOCKS

U.S. stocks have been gradually rallying, and we believe that this rally could continue for a few months.  It will cease when short term interest rates in the U.S. rise one or two more times.  We continue to see a broad range of U.S. companies that are overpriced, but there are also values to be found for those who are bargain hunters.

INTEREST RATES

Interest rates in the U.S. and other parts of the world are starting to rise.  The U.S. raised the Discount Rate last week and many pundits argued that the increase was of no importance.  We disagree.  For many decades, we have seen interest rate increases as a warning signal to get out of markets.  In every country, stocks compete with short term interest rates for investors.

If short term rates start to rise, stocks always correct.  U.S. interest rates have seen their lows.  Historically, after the second or third rise in rates, U.S. stocks undergo a larger correction.  When will the second and third rate increases take place?  We imagine that they will happen before the end of 2010.

CHINA

China’s economy continues to expand in spite of concerns among uninformed observers that a slowdown is looming on the horizon.

It is worth noting the many internal changes taking place in China during its continued growth phase.

Change #1

For the past twenty years, migrant workers have streamed into the Eastern seaboard from the nation’s interior agricultural centers in search of manufacturing work, but today, that trend is changing.  Farming families are now making money in agriculture or finding work closer to home.  Migrants are no longer pouring into the East coast and the resulting shortage of migrant workers is sending up the price of labor.  In many manufacturing areas wages are up 20 percent or more.

Change #2

Economic growth is now taking place in many regions of China, and the once ubiquitous assembly line manufacturing for export is now a smaller percentage of economic activity.  Most new jobs are to be found in retail, consumer products, infrastructure, and heavy industry.  These jobs are located throughout the country.

Change #3

A consumer economy is gradually developing.  The savings rate, which we believe to be about 30 percent in China, will gradually fall as the government installs the beginnings of a social safety net.  Currently, the (extended) family is the only social safety net and saving is key to family survival.

Change # 4

China has been building out their infrastructure for many years.  The infrastructure development is by no means complete, but the build-out is very impressive not only in big cities but in second tier cities as well.  This infrastructure will give China a competitive advantage in developing faster economic growth.

Change#5

China is targeting new industries to lead the world in the 21^st century.  Clean energy in all forms is one of their major undertakings.

Also worth noting:

Food price inflation in China and India is another worry.  We expect inflation to be 5 percent in China in 2010.

China’s stock market has been consolidating and moving sideways due to a concerted raising of reserve requirements to stop speculation on real estate.  We believe that about six months before rates peak China’s market will rise strongly.  In the interim, we are selecting low P/E, fast growing companies.

INDIA

India’s economy is booming and, in our opinion, the Indian stock market is currently overpriced.  Inflation is rising and we expect interest rates to follow.  Although we applaud the job that Prime Minister Singh has done on the economic front, we will wait for a correction before moving into Indian shares.  The growth areas include many sectors of the economy such as construction, pharmaceuticals, technology, consumer banking, real estate, and consumer goods.  The nation’s infrastructure is slowly improving but will take decades to become first-world.

As many have heard, the IMF is selling a large amount of gold that was contributed to them by member countries in order to raise cash to help countries with problems.  The countries who deposited the gold with the IMF have agreed to the sale, yet even with this large sale hanging over the market, gold prices remain strong.  It is widely rumored that India will be the purchaser of the IMF’s gold.

Indian officials have stated from time to time in the world press that they are buyers of gold at market prices.

ATTRACTVE INVESTMENT AREAS

Bargains continue to be available, but one must be thorough and careful in picking them.

We continue to see growing countries that are well situated to supply the Chinese economic machine with raw materials or partially manufactured products as attractive investment opportunities.

We are concerned about some emerging markets due to high valuations.  This has kept us out of India and Taiwan.  We are currently focused on U.S. and European technology and energy companies, fast growing companies in the developed world, gold bullion and Canadian gold mining companies, companies with new oil discoveries (wherever they may be located),  Indonesia, Thailand and some specific Chinese companies.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

DEBT LEVELS IN G-7 COUNTRIES

We continue to be positive on Asia.  One of the major reasons we currently favor Asia is the fact that public debt in the G-7 nations (U.S., Britain, France, Canada, Germany, Japan, and Italy) is expected to be over 119% of their combined GDP in 2014; a stunning figure.

Imagine owning a business with gross revenues of $1 million, outstanding debts of $1.19 million, and cash flow from your business to service the debt of about 5% of gross revenues.  This means the company has only $50,000 per year to service the outstanding debt.  If the average interest rate on the company’s debt is 5%, the debt load on your company would be increasing your debt each year.  Your repayment of $50,000 would be less than your interest expense about $59,500.

Imagine further that you forgo using the cash from the business for debt payment, and choose to borrow more to keep your debt payments current.  Bankruptcy would seem to be only a matter of time for the company.  At some point, finding suckers (lenders) will be difficult.

DEBT LEVELS IN EMERGING ASIA
By 2014, emerging Asia is expected to see their debt burden decline from 35% of GDP to 32% of GDP.

THE CRISIS OF THE EUROPEAN SOCIALIST MODEL

Greece’s problems have been widely reported.  It is rumored and expected that Ireland, Spain, Portugal, and Italy may soon join them in asking for handouts from their neighboring European countries.

The problems stem from the countries’ highly-paid government employees and the long-term promises made to government employees.  Relative to the private sector, public sector employment does little to generate GDP growth.  The European welfare states handed out politically-expedient gifts to large public employee unions, and now the countries are facing bankruptcy as a result.

In a recent London Telegraph article by Ambrose Evens-Pritchard, the author captures German sentiment by quoting an article in a German newspaper, the Frankfurter Allgemeine.  The German paper asked why taxpayers should bail out the debts of a country that thinks it an outrage to raise the retirement age to 63.  “Should Germans have to work in the future until 69 instead of 67 so that Greeks can enjoy early retirement?”

Evans-Pritchard goes on to say, “Europe’s leaders still refuse to face the awful truth: that monetary union is unworkable as constructed.  That different labour markets, different sensitivities to interest rates, different economic structures, have caused the gap between north and south to grow ever wider; that a chunk of Europe…is on the cusp of a debt deflation spiral.”

This spells big belt-tightening in the aforementioned five heavily indebted European countries.  It also puts the entire Euro community in danger of losing its common currency over time; it is possible that several countries will have to leave the Euro and reestablish their own currencies at devalued levels.

Below is a link to an important New York Times article about how global investment banks helped Greece and other countries hide the truth about their finances for many years.

To Read Article Click Here.

OUR MARKET VIEWS

GOLD AND CURRENCIES

We believe the current and ongoing European crisis gives gold an impetus to move higher.  We have been adding to our gold positions at current levels and will continue to buy if prices fall.

Yesterday’s transparent attempt by the IMF to scare the gold market down by announcing a sale of gold by European IMF contributors has been a failure.  This reminds us very much of the situation in the 1970’s when the IMF gold sale was met with strong demand.  When the markets recognized that there was strong demand in spite of the IMF sales, gold moved much higher within a few months.

Today, it is clear that there is large demand for gold from central banks.  China, India, Sri Lanka, and Russia have been buyers at these price levels, and we are sure there are others.  Many nations have openly discussed their intention to expand the gold component of their reserves.  Technically, gold look remarkably strong in the face of attempted downward manipulation.

The Australian and Canadian dollars appear to be building technical bases and will resume their rise.  On the other hand, we remain bearish on the Euro and prefer the U.S. dollar to that currency.

GLOBAL STOCKS

On dips, we are gradually accumulating Chinese, Thai, Malaysian, Indonesian, and other undervalued foreign stocks.

Within the developed world, we are focusing on Canadian and Australian energy and precious metals companies, and a few U.S. technology companies which are fast-growing and selling at low valuations.

OIL

We are buying oil related companies which we believe will make substantial new discoveries in coming months.

SUMMARY

In general, we prefer to be conservative; making purchases on market weakness to capitalize on the current volatile, and often irrational, markets.  After China finishes raising interest rates to reign in run-away real estate prices, and rising food prices, we expect the faster growing countries’ stock markets will resume their rising pattern.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

World markets are frightened that the fastest growing economy in the world will slow too rapidly. Thus, when China tried to slow real estate speculation with a series of actions over the last three weeks, many global investors panicked and sent stocks down in most of the world.

We find this interesting for the following reasons:

China is now recognized as the engine of world economic growth, with over $2.4 trillion U.S. dollars in surplus capital and a fast growth rate.  People are looking more and more to China.  The new saying is, “If China sneezes, the world catches a cold.”  More and more countries are exporting to China, India, and non-Japanese Asia; and less to the U.S. and Europe.

Investors who do not know much about China’s economics are panicked that China’s economy will somehow implode because the government is trying to reign in speculation in real estate.  This is patently wrong.  China will grow rapidly in 2010.

There is a difference between the real estate speculation that is currently taking place in China with the speculation that occurred in the U.S. and Europe that eventually imploded.

In China, real estate speculation has been the result of large capital surpluses in the hands of Chinese investors.  These investors have few options for investing their capital.  Their options are:

A) They can buy stocks, although most of them already have stock portfolios.
B) They can purchase physical commodities like gold, but not futures on commodities.
C) They can buy residential real estate (apartments) to rent or to hold for appreciation.
D) They can hold bank deposits which pay a low interest rate.

Contrary to the developed markets of the North America, Europe, and Japan, China has virtually no bond market.  In addition, sending money overseas for investment is close to impossible for Chinese investors.  Within the developed world, bonds and foreign investments soak up a lot of capital, but this is not so in China.  For these reasons, China has a large amount of surplus capital looking for a place to invest.

CHINA’S GDP WILL GROW BY AT LEAST 9% IN 2010, EVEN IF THE REAL ESTATE BUBBLE DEFLATES

Today, wealthy Chinese who invest in real estate put 50% down and pay higher interest rates than an owner occupied apartment purchaser would pay.

Compare this to the low down payment, or no down payment, real estate speculation that we saw 2-3 years ago in the developed world.  In China, there is no speculation based on the feeling that they can quickly sell for a big mark-up; thereby it is OK to take on a lot of leverage.

The Chinese economy is booming because consumer and infrastructure spending are growing at double-digit rates.  Accordingly, a decline in real estate activity as the government brings the real estate bubble under control will not cause the economy to grow by less than 9% in 2010. 

Some investors have come to believe that lending to industrial and consumer companies will stop as China reigns in real estate lending.  We disagree with this theory. There is no shortage of financing available for other types of businesses.  Businesses can get financing to buy inventories and production machinery.  Capital is available for Chinese companies to buy smaller competitors in China and abroad (the news media is full of stories of Chinese companies buying foreign suppliers).

In short, China is not going to implode if the Chinese government is successful at deflating the real estate bubble.  The government believes that the currently too-rapid growth will moderate to a more acceptable 9-10% rate if the real estate bubble deflates.

SUMMARY

The current market declines in global markets will lead to a buying opportunity in Asian and selected Latin and Eastern European markets within 2 to 3 months.  When the decline has run its course, we will also look closely at opportunities in Canada, Australia, Europe and the U.S.

In 2010, we expect to see China will grow by 10%, India by 8%, Brazil and non Japan Asia by 5%.  Some other well-run countries will grow in excess of 5%.  This means corporate profits in these nations will grow substantially, leading to higher prices for stocks.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

THE OBAMA ADMINISTRATION APPEARS TO BE GETTING PANICKY

This week the Democrats lost a key senatorial seat in Massachusetts, a state that has long been a liberal stronghold.  The loss of this supposedly safe seat stunned Washington and put the Democrats on edge.  In response, they’re doing what any left wing populist administration that’s frightened of losing seats in the current election year would do blame big business.

They will continue attacking big business, especially Wall Street, and other industries, because they believe that the attacks may garner votes in the fall elections.  Perhaps the target of these attacks will be the natural gas or coal industries or perhaps other industries that lay off employees or move operations abroad.

This is standard populist fare, and the same type of behavior that has taken place for decades in periods when the public is disenchanted with the party in office.  If those in office are right-wing populists they attack government and blame big government for the problems.  If they are left-wing populists they blame big business for the problems.  Since the government is currently controlled by the left-wing, they are implementing the standard left-wing approach.

The latest attack is on Ben Bernanke the Chairman of the Federal Reserve.  There is talk that he may not be re-appointed to the position and a more left-wing economist will be appointed.  This has un-nerved the stock market, and with good reason.  Attacks on business and on the Federal Reserve are not the stuff of which market rallies are made.  We see this as very negative for U.S. stocks.  We expect this kind of attack to continue until the elections in early November 2010.

If the Democrats lose many seats in November in spite of their attacks on business, at that time one can expect the market to rally. Until that time, the U.S. stock market could be volitale, we much prefer to invest in foreign markets.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

The Resolution Trust Corporation (RTC) was the organization created to clean up and liquidate insolvent savings and loans during the last major U.S. real estate crisis in the late 1980’s and early 1990’s.  We predicted the coming of a new RTC-like organization over a year ago.  That prediction has materialized, as the Federal Deposit Insurance Corporation (FDIC) is now undertaking the same role played by the RTC twenty years ago.

Let us examine the parallels to today.  In the late 1970’s and 1980’s, the real estate finance industry was a big donor to politicians in the U.S. Congress and to the executive branches at both state and federal levels.  After a decade or two of influencing legislation in their favor, too much power was in the in the hands of the savings and loan industry.  This led to abuses in banking and real estate finance that created the savings and loan crisis, and the failure of over 700 institutions.  The government’s plan to resolve the crisis called for the formation of the RTC to manage the liquidation of bad saving and loans portfolios, and the taxpayer picked up the bill for the losses.

Today, the banking industry, especially the Wall Street branch of the banking industry, is the big donor to the legislative and executive branches in state and federal governments.   Will history repeat itself with a few variations?

Already the taxpayer has been asked to contribute hundreds of billions of dollars.  The derivatives crisis still continues.  The underlying culprit behind the banking crisis, unregulated derivative transactions, continues unchecked.  It remains to be seen if the power that the banking industry currently holds will result in further problems for the economy, financial markets, and the taxpayer.  Many experienced observers believe that there is a strong possibility that another and much bigger crisis will develop.

FDIC HAS TAKEN THE JOB

Sure enough, the FDIC, a federal agency, has taken on the role of bailing out and selling bad banks.  About 140 banks were shut down in 2009 by the FDIC, and about the same amount were shut down in 2008.  The banks that have been taken over represent about 4% of total deposits.  This is an immense sum, and there remain many banks on the watch list.  In the last two years, we have pointed out twice that the Federal Reserve believes that there are about 3,000 banks on their solvency watch list.  Approximately 300 have thus far been liquidated, there is a long way to go until the remaining problem banks have either raised enough capital to create stronger balance sheets, or are liquidated by the FDIC.

If we assume that 50% of the troubled banks identified by the Federal Reserve (or about another 1,300) must be liquidated, we have several more years of liquidation before the banking system will be healthy in the U.S.

THE EXTEND AND PRETEND SYNDROME

According to contacts of ours in the banking industry, federal bank inspectors and legislators pressured the Financial Accounting Standards Board (FASB) to suspend fair value accounting requirements.  This allows the banking industry to overvalue and consider ‘current’ a large number of questionable commercial real estate loans on bank balance sheets.  This positively overstates the financial condition of many weak banks. Professionals in the banking and real estate industries refer to this game by the name of “Extend and Pretend”.

Loans which are not making principal and sometimes even interest payments are considered good enough to continue to be held on the lending bank’s books at cost.  This game of extend and pretend is intended to work until the value of real estate assets begins to stabilize.  The hope is that the price of commercial real estate will stabilize and slowly begin to rise so that banks will actually be repaid these loans.

An excellent article appeared in the January 11, 2010 issue of Business Week entitled “Not So Radical Reform”.  It is about financial regulation and how it is being watered down in the U.S. Congress.  Needless to say, this is a very negative prospect and one which, in our opinion, will probably lead to future declines in the standard of living of most Americans.

Below is a link to the article:

Businessweek

OUR OUTLOOK FOR ECONOMIC GROWTH AROUND THE WORLD

In our opinion, stock market appreciation is a function of corporate profit growth.  Corporate profit growth depends upon the industry or industries in which the company operates and the growth rate of the countries in which the company operates.  A summary of the markets which we believe are attractive for investment in 2010 and their estimated growth rates.

Asia Pacific (faster growing countries)

Australia	3%
China	10%
Hong Kong	4%
India	7%
Indonesia	6%
Korea	5%
Singapore	6%
Taiwan	5%

Another category is slowly growing countries where investments in exporters may be successful.

Japan

1%

Japanese currency declines are good for exports. Even though the Japanese economy is slow growing.

The following countries produce commodities. Corporate profits in export and commodity related industries may exceed national economic growth.

Europe

Norway

2%

Latin America

Brazil	5%
Chile	4%

North America

Canada	3%
Mexico	3%
U.S.	3%

SUMMARY

Opportunity to enjoy stock market appreciation can be found in many sectors of the investment world in 2010.  Stocks in fast growing counties such as those mentioned above.  Stocks located anywhere in the world which are strong exporters.  Companies which are producers of food, copper, gold, and oil.  Manufacturers of machinery which are used to produce commodities (mining, farming, and oil drilling equipment and services), or machines that are used to build manufacturing facilities (machine tools) should also do well.  Transportation equipment will benefit as global trade begins to gradually resurge in 2010.

In the last half of 2010 we expect to see rising inflation in many parts of the world.  This will increase demand for commodities, especially precious metals.

The outlook for currencies depends on many variables, including relative economic growth rates, financial decision making, and interest rate trends.  Unless the U.S. changes their current financial strategy, the U.S. dollar will continue to decline over the long term. This decline will be punctuated by periodic dollar rallies, such as the one currently taking place.

Please accept our best wishes for a happy, healthy and successful New Year.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

The debt crisis in Dubai is just the first of many that will occur in the Middle East and Eastern Europe in the coming years.  It was a wake up call, but not particularly serious by itself.  Many Eastern European countries, the Baltic nations, Hungary, Ukraine, Bulgaria, Slovenia, Kazakhstan, Romania, the UAE in the Middle East, Vietnam in Asia, are in poor economic shape.  Their economies are over-levered, and have low income levels. The property markets in the Middle East and Eastern Europe have a long way to fall, and many banks (primarily in Europe) will have to be bailed out as a result of their unwise loans to these regions.

We used the panic as a buying opportunity, adding to our oil and gold shares.

CHINA

Investors do not get your hopes up… China will not revalue the Yuan soon.

Chinese Yuan per U.S. Dollar

In our opinion, China will not revalue the Yuan further until inflation resurges in China to the five percent level.  We do not expect this to occur until the middle of 2010 at the earliest.

China’s politburo met last Friday and announced that it plans to “maintain the continuity and stability of economic policies, and continue to implement the proactive fiscal policy and loose monetary policy.”  In other words, grow and create jobs, keeping the Yuan low so they can export.  In effect, they are also saying ‘we are loaning the west a lot of money…who are you to tell us to revalue our currency?’

INTERVENTION TO STRENGTHEN THE DOLLAR WILL BE ATTEMPTED IN EARLY 2010

Many nations are getting tired of losing exports due to a very weak dollar…and Yuan.  For the last year the Yuan has not appreciated versus the dollar.  Government officials in these nations will want show their domestic exporters that they are working to reverse the situation.

Thus, we expect a weak dollar and strong commodities until year end 2009.  In early 2010 however, we expect a number of nations to engage in coordinated intervention to send the dollar higher and their currencies lower.

THE CURRENCY INTERVENTION WILL INITIALLY FIND SUCCESS…THEN AFTER A SHORT PERIOD OF SUCCESS, WE EXPECT IT TO FAIL

The nations who intervene may be able to create a rally in the U.S. Dollar, but it should not last more than a few months.  This is based on historical precedents of government intervention.

FOOD COMMODITIES AND FERTILIZERS

Grain commodity prices will be stronger in the next few months as the demand for food world wide will grow.  After dipping during the past year, global food and grain demand has stabilized.  The global stores of grain are still at historically low levels.  This creates a scenario where global food production will have to grow at very rapid rates for a decade or more to reverse the impact of the low food grain carry forwards.  Additionally, the use of grains for ethanol [energy] production exacerbates the situation.   

We have been buying fertilizer shares and will be adding to these positions on price weakness.

INDIA

India’s GDP grew by 7.9 percent in the third quarter of 2009.  As we have expected, India continues to move ahead with strong economic and industrial production growth.

FACTS EVAPORATE MYTHS

There are some common myths we would like to dispel.  A few of them we have mentioned in the past, but their wide circulation argues for another reminder.

Myth 1.  China is dependent upon exports to the U.S.

Of total Chinese exports, 38 percent go to emerging markets, 21 percent to the European Union, 18 percent to the U.S. and 8 percent to Japan.  Additionally, exports have fallen to about 14 percent of China’s GDP if you include only the value added in China.  Total exports including those partially manufactured goods brought into China from other countries (and which have value added in China before export), make up about 30 percent of China’s GDP.  

The fact is that exports to U.S. make up somewhere between 2.5 percent and 5 percent of China’s total GDP.

Infrastructure and consumer sectors have replaced exports as the main drivers of China’s GDP growth.

Myth 2.  Very little is manufactured in the U.S. anymore.

Merrill Lynch provides us with the following facts “…the U.S. is still the largest manufacturer by a long shot, making up 20 percent of the world’s total manufacturing output.  Furthermore, when focusing on the value added (as defined by the World Bank), the U.S. contributes more than double the production of the next largest producer, China.”

Myth 3: The U.S. does not export much except software and weapons.

Fact: The U.S. is the world’s third largest exporter (Germany is number one, and China is number two).  The U.S. exports value added industrial chemicals and supplies, capital goods like production machinery, computer and telecommunications equipment, motor vehicles and parts, and aircraft and aircraft parts.  The U.S. also is the world’s leading exporter of food, feed, and beverages.  Additionally, many billions of dollars in consumer goods, medicines, and media and entertainment products are exported by the U.S. each year.

SUMMARY

Until year end we expect commodities, including food and gold to rise, and the U.S. dollar to remain under pressure.  Oil prices should rise as cold weather asserts itself in the Northern hemisphere.  China’s currency policies are not likely to change in the near term. Developed economies will continue to slowly improve.  Faster growing economies, especially in Asia and Latin America will continue to attract investors.

We hope everyone has a wonderful holiday season.  Please call us if we can be of service.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

President Obama was met by strong language from China’s chief banking regulator hours before he arrived in China.  Chief regulator Liu Mingkang said a weak dollar, low interest rates, and other actions have “led to massive speculation".  He was saying, in effect, that the U.S. carry trade (a process in which the U.S. Dollar is borrowed and then sold to purchase assets such as commodities, stocks, and real estate) is creating asset bubbles around the world.

He pointed out that many countries are experiencing a rise in real estate prices due partly to the low interest rates in the U.S. and elsewhere which encourages speculation.

It is true that speculative economic activity has continued in some countries unabated while the U.S., Europe, and Japan have experienced big recessions.  In the faster growing countries, there is no denying that prices are rising for investment assets.

MANY ARE ASKING “WHEN WILL THE CHINESE RENMINBI SEE A RAPID RISE IN PRICE?”

China, which up until last summer had let its currency rise versus the U.S. Dollar by a few percent per year, will have to allow their currency rise more rapidly to keep inflation at bay.  Over the years, we have observed that the Chinese are gradualists and will only let their currency rise when inflation starts to bite.  We see them letting the Renminbi’s value rise more rapidly when Chinese inflation reaches 5%.  This will probably occur in late 2010.

U.S. ECONOMY-A BAD CALL

We have been too pessimistic on the outlook for the U.S. economy.

Although we anticipated and correctly called the direction of the U.S. economy, we were too pessimistic about the duration and depth of the correction.  We now believe that the U.S. economic correction has probably seen its lows.  Over the next year, we expect to see slow growth from the U.S., Europe, and Japan.  The economic growth will be slow compared to what we expect from China, India, Brazil, Indonesia, Taiwan, Singapore and Hong Kong.

REWARDING THOSE THAT CONTRIBUTED TO THE CRISIS! 

THE NEW YORK TMES
Home Builders (You Heard That Right) Get a Gift
November 14, 2009
By Gretchen Morgenson

ON Nov. 6, President Obama signed the Worker, Homeownership and Business Assistance Act of 2009 into law, extending unemployment benefits by 20 weeks and renewing the first-time homebuyer tax credit until next April.

But tucked inside the law was another prize: a tax break that lets big companies offset losses incurred in 2008 and 2009 against profits booked as far back as 2004. The tax cuts will generate corporate refunds or relief worth about $33 billion, according to an administration estimate.

Before the bill became law, the so-called look-back on losses was limited to small businesses and could be used to counterbalance just two years of profits. Now the profit offset goes back five years, and the law allows big companies to take advantage of it, too. The only companies that can’t participate are Fannie Mae and Freddie Mac and any institution that took money under the Troubled Asset Relief Program.

Among the biggest beneficiaries are home builders, analysts say. Once again, at the front of the government assistance line, stand some of the very companies that contributed mightily to the credit crisis by building and financing too many homes.

This is getting to be a habit: companies that participated on the upside and are now reaping rewards from the taxpayers on the downside. The banks that underwrote so many dubious loans, for example, received government aid to get them lending again. Unfortunately, that hasn’t been the result.

One can make an argument that throwing money at the banking system is necessary if we are to jump-start the economy. And banks need a bigger capital cushion to protect against future losses.

But dropping helicopter money on the home builders — the folks who massively overbuilt in community after community — seems decidedly less urgent (unless you are one of these companies, of course). Given that the supply of housing far outstrips demand, it is unlikely that these companies will use these tax breaks to hire workers (unless they go into a completely new line of business).

“I AM surprised that home builders are getting hundreds of millions of dollars given that many have very strong balance sheets,” said Ivy Zelman, chief executive at Zelman & Associates, a research firm. “We question the public policy decision to gift home builders with capital that many will not use to create jobs, since they admit that job growth will be dependent not on capital, but on improving demand.”

When Mr. Obama signed the law, his administration said the tax break would help “struggling businesses.” But as Ms. Zelman pointed out, many large home builders are sitting atop mountains of cash. Pulte Homes, which will receive refunds exceeding $450 million under the new law, has $1.5 billion in cash and cash equivalents on its balance sheet, according to its most recent financial statement.

Hovnanian Enterprises is another big beneficiary of the tax break. It anticipates a refund of $250 million to $275 million next year. It had $550 million in cash in its most recent quarter.

Smaller recipients include Standard Pacific, which is poised to reap cash refunds of $80 million under the new tax break. According to its most recent financial filing, Standard Pacific held $523 million in cash and cash equivalents.

Finally, Beazer Homes told investors that it expects to receive a refund of $50 million. The company reported cash and equivalents of $557 million at the end of September.

Some of the home builders poised to receive tax refunds have even more cash today than they did last year.  D.R. Horton, for example, has $1.966 billion in cash, up 45 percent from September 2008 levels. And some are healthy enough to have retired significant amounts of debt from their balance sheets this year. Pulte has bought back $1.93 billion in debt in 2009.

So what do these companies plan to do with their refunds?

Ken Campbell, the chief executive of Standard Pacific, said the money would allow his company to continue buying land. “Will we build more houses or will there be more people employed in the first quarter? Probably not,” he said. “Will employment accelerate when the market starts to grow? It will.”

Caryn Klebba, a spokeswoman for Pulte Homes, said in a statement that the company planned to use the funds it receives “to support its current operations and, when market conditions improve, fund future growth and expansion.”

In other words, job creation does not seem imminent, notwithstanding the claims of the administration or those in Congress who supported the giveaway.

Representative Lloyd Doggett, a Texas Democrat, has conducted a lonely fight against the tax break all year.

“Some have said this is like a bridge loan to these companies,” Mr. Doggett said in an interview. “Well if it’s a loan, it is like a no-doc loan, because the recipients provide no indication that they will create jobs or do anything other than keep the money. I just feel it is a total windfall.”

Unfortunately, this seems to be another example of an age-old phenomenon: Good Things Come to Those With Lobbying Power.

Securing this tax break was a top priority for home builders, lobbying records show. The Center for Responsive Politics reports that through Oct. 26 of this year, home builders paid $6 million to their lobbyists. Last year, the industry spent $8.2 million lobbying.

Much of this year’s lobbying expenditures were focused on arguing for the tax loss carry-forward, documents show.

Among individual companies, Lennar spent $240,000 lobbying while companies affiliated with Hovnanian Enterprises spent $222,000. Pulte Homes spent $210,000 this year.

That’s some return on investment. After spending its $210,000, Pulte will receive $450 million in refunds. And Hovnanian, after spending its $222,000, will get as much as $275 million.

Meanwhile, the bag that we taxpayers are left holding gets bigger and bigger.

THE problem here is that this public policy decision was made with little to no input from the public. Sure, tax rebates like these give a lifeline to companies that were about to sink beneath the waves, but would it be so terrible if some builders that lost their heads during the housing mania ceased to exist? It is not as if a housing shortage will result or that more jobs will be lost if these companies don’t receive these tax breaks.

Pretending to promote job creation, the government is dispensing cash to companies that either do not need it or need it precisely because they didn’t run their businesses prudently. Isn’t there something wrong with that picture?

IRAN HAS PROBLEMS, BUT THE AYATOLLAHS WILL NOT GIVE UP.  THEY MUST STAND AND FIGHT, BECAUSE THEY HAVE NO PLACE TO GO.

After all, who will take them?  Will Saudi Arabia to the South? Will Russia and Turkey to the North? Will Iraq to the West? Will Pakistan to the East?

The truth is very few places on earth would welcome them.  A new generation of Ayatollahs is rising.  They have yet to gain enough influence, power, and money to be satisfied, so they will continue to do what they must to stay in charge as long as they can.  The following article points out what they are doing to stay in power.

THE WALL STREET JOURNAL

Revolutionary Guard Tightens Security Grip

Intelligence Agency Replaced by New Organization Reporting to Khamenei; Fallout From Massive Street Protests Over Election
By: Marc Champion

BRUSSELS — Iran’s elite Revolutionary Guard has sidelined the country’s intelligence ministry, forming a new organization that reports directly to the Supreme leader, Ayatollah Ali Khamenei.

Interviews with Iranian analysts and opposition figures, along with recent government announcements, depict a shift under way since Iran’s clerical regime was shaken by the massive street protests that followed disputed presidential elections in June.

The loyalty of the intelligence and security services became a major concern for hard-liners running the regime, analysts say. The changes could have the effect of formalizing the tough and sometimes brutal approach taken with dissidents and protesters in the months since the election.

Some of the intelligence takeover has been publicized. Ayatollah Khamenei announced recently that the Revolutionary Guard’s small existing intelligence unit would be elevated to become a much larger official organization. State media named Hassan Taeb, previously commander of the Basij volunteer paramilitary organization, as the head of the new intelligence operation.

To read full article please visit http://www.guildinvestment.com

SUMMARY

As expected, oil, gold and foreign stocks continue to move up, but we are not ready to sell.  We continue to hold and look for higher prices in coming weeks and months.  Our favorite investments remain oil and oil shares, gold and gold shares, stocks in faster growing countries, export stocks in developed countries, and currencies that can appreciate versus the U.S. dollar.

Thanks for listening.  Please contact us with your comments and suggestions.

Does the Obama Administration want the U.S. dollar to decline?  We believe it does.  On November 5th, the U.S. Federal Reserve announced that they intend to keep “interest rates exceptionally low” for an “extended period of time.”  Given that the U.S. Dollar is already under pressure due to low interest rates, the Fed’s announcement is the equivalent of saying: “go ahead and short the dollar”.  In our opinion, it is clear that this announcement ushers in a period of extreme volatility and a continued downward bias for the U.S. Dollar.

During the Clinton and GW Bush administrations, it was common for U.S. Treasury officials to make statements about the need for a strong dollar.  Historically, financial leaders have been circumspect about declaring that their currency is overvalued.  This is especially true for countries like the U.S. where the government is trying to sell trillions of dollars of debt to investors to finance the immense current and expected future budget deficits.  We therefore find it shocking that the world’s most important central bank has made statements that strongly encourage a decline in its currency.

However, an examination of the current administration’s economic approach provides a possible reason.  On November 2nd 2009, President Obama called for a new “post bubble growth model” with a greater focus on exports, and referenced the fact that Germany, which he called “a wealthy, highly unionized industrial nation,” has been a very successful exporter.  It does not take a rocket scientist to understand that his goals include more unionization and more exports.  And because U.S. union workers are in general much more generously compensated than non-union workers, we believe that the only way that the U.S. can achieve higher exports is to devalue the dollar.  We therefore believe that it is a goal of the Obama administration to see the dollar decline.

These events add credence to our view that one should avoid the U.S. dollar for major cash balances and instead hold the Australian, Canadian, Norwegian and Brazilian currencies.  We also continue to believe that investors should continue to hold oil, gold, and foreign stocks for the long term.  In our opinion, the profits in these areas may be just beginning to occur.

ANNIVERSARIES

November 5, 1999 was the 10 year anniversary of the removal of Glass Steagall.  We believe as do many others that the removal of Glass Steagall directly led to the financial melt down of the last two years.  Please see below for the New York Times article about the subject. 

CONGRESS PASSES WIDE-RANGING BILL EASING BANK LAWS
By Stephen Labaton
Published: Friday, November 5, 1999

Congress approved landmark legislation today that opens the door for a new era on Wall Street in which commercial banks, securities houses and insurers will find it easier and cheaper to enter one another’s businesses.

The measure, considered by many the most important banking legislation in 66 years, was approved in the Senate by a vote of 90 to 8 and in the House tonight by 362 to 57. The bill will now be sent to the president, who is expected to sign it, aides said. It would become one of the most significant achievements this year by the White House and the Republicans leading the 106th Congress.

”Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century,” Treasury Secretary Lawrence H. Summers said. ”This historic legislation will better enable American companies to compete in the new economy.”

The decision to repeal the Glass-Steagall Act of 1933 provoked dire warnings from a handful of dissenters that the deregulation of Wall Street would someday wreak havoc on the nation’s financial system. The original idea behind Glass-Steagall was that separation between bankers and brokers would reduce the potential conflicts of interest that were thought to have contributed to the speculative stock frenzy before the Depression.

To read the full article, please visit our website: http://www.guildinvestment.com

This week we are celebrating the 20 year anniversary of the fall of the Berlin Wall.  As an international power Russia seemed quiescent 20 years ago.  Today, there is no doubt that the relative harmony of the Gorbachev years has given way to the militarism and bullying of the Putin years.

“THE SILENCING OF PAUL VOLCKER”

Maria Bartiromo of CNBC interviewed Paul Volcker on November 3, 2009. She entitled her interview with Mr. Volcker  “The Silencing of Paul Volcker.”

Ms. Bartiromo evidently believes that Mr. Volcker is unable to speak his mind about the need for separation of the banking activities of major banks from their trading activities.  As we stated in last week’s letter, Mr. Volcker has voiced the opinion that banks and their lending functions should be regulated by the Federal Reserve and that trading institutions should be separate from the bank lending system.

In GIM’s opinion, these trading activities, which employ immense leverage, are dangerous.  We believe that trading excesses could cause immense losses and instability to the entire banking system at any time.  And it is not hard to imagine that such a crisis would require further taxpayer bailouts for institutions that are “too big to fail.”

THE G-20 MET LAST WEEKEND AND MADE IT VERY CLEAR NO MONETARY TIGHTENING WOULD OCCUR AT THIS TIME

In effect, the G-20 said all systems are go for economic expansion globally.  The G-20 said in their news release, “Economic and financial conditions have improved following our coordinated response to the crisis.  However, the recovery is uneven and remains dependent on policy support. We agree to maintain support for the recovery until it is assured”

May we translate?  All systems are go for global economic expansion.  When this news became public the U.S. dollar fell and gold rose substantially.

U.S. MONEY SUPPLY CONTINUES TO BOOM

U.S. money supply is rising rapidly and this is another indicator of coming inflation and higher commodity prices in years ahead.  When combined with a lower dollar, this type of indicator has quite frequently led to inflation.  It is for this reason among others that we call for a resurgence of inflation in 2011.

INDIA AND SRI LANKA BUY GOLD

Many had feared that the IMF’s pre announced sales of 400 tons of gold would hit the market and cause the gold price to plummet.  We have long held that this decade, as in past decades, IMF gold sales are always taken by central banks that want to diversify out of currencies and into gold for part of their reserves.

Currently, the central banks of many emerging countries hold only about 3.5 percent of their assets in gold while developed countries have about 35 percent of their reserves in gold.  It is no secret that many emerging countries want to buy the IMF gold in order to raise their status in the community of nations and diversify their holdings out of the declining dollar.

India bought half the gold one month after it went on the market (a record quick sale) and Sri Lanka bought gold for their reserves in the open market.  Both purchases were at prices above $1,000 per ounce.  The purchase raises India’s gold holdings to 6 percent of their reserves from 4 percent. China’s gold percentage to total reserves is lower than India’s.  It seems obvious to us that many other nations will buy up any gold offered by the IMF or other central banks at market prices.  If they do, we expect the price of gold to rise much higher to accommodate a rise to 10 percent in India and China’s gold reserves.  China mines a great deal of gold internally.  If they decide to hold their domestic production to add to their reserves as Chinese financial figures have suggested they do, we could see gold move to much higher prices.

THE NEXT PRESIDENT OF CHINA

China’s next President will probably be the current Vice President, Xi Jinping.  He will inherit a number of problems that are developing in China such as public dissatisfaction with high home prices and public irritation with corruption and favoritism.  We anticipate he will favor the current policy of growing the economy with a well-planned series of goals to develop infrastructure, consumer spending and to provide new jobs in healthcare, consumer areas, education and construction to complement the existing factory job growth.

SUMMARY

This week’s pronouncements by President Obama and by the Federal Reserve add further conviction to our long held view that the U.S. Dollar will continue to slide in value. The GD-20 indifference to a declining dollar just raises the bearish thermometer. We remain bullish on oil, gold, non-U.S. currencies and foreign stock markets in fast growing parts of the world.

Thanks for listening!

Monty Guild and Tony Danaher
www.GuildInvestment.com

Last week, we had a short-lived rally in the U.S. dollar predicated on the unrealistic view that a weaker U.S. economy would send gold and oil down and the dollar up.  Only algorithm writers who are completely ignorant about stock and commodity markets could believe that a poor U.S. economy is actually good for the U.S. dollar.

After a few days, the dollar’s rally reversed and began to decline again while gold and oil are once again rising.  In our opinion, any declines in oil and gold prices over the next few months can be used as buying opportunities.

We expect oil to trade between $60 and $100 per barrel for the next two years.  After that, we expect oil prices to rise much higher.

We favor gold bullion and gold shares, oil stocks, U.S. technology companies that are poised to serve the world market through exports, and companies in emerging countries with growth potential.

INTEREST RATES

Last week, interest rates were forced up by the market, with the yield for U.S. ten year paper rising as the Treasury tried to sell $140 billion of new bonds.  Buyers are demanding higher rates, but the U.S. government is not going to raise short term rates until GDP growth increases substantially and remains good for a year or more.  Although the market may continue to force up longer term interest rates, we do not expect the Federal Reserve to raise short term rates.

Indeed, the U.S. Federal Reserve wants interest rates to stay low.  They realize that this is necessary to support asset values (even if they only move sideways).  A U.S. asset deflation occurred in 2008 and 2009, and the government is trying desperately to reverse the trend.  Although the stock market has succeeded in making a turnaround, real estate, cars, and many other asset prices remain deflated.

When it comes to keeping rates low and letting asset values rise, the U.S. Government clearly has a favorite method.  They prefer to depreciate the unit of measurement: the U.S. Dollar.

Most commodities are valued in dollars, so if one weakens the dollar, prices rise in U.S. terms, but many are falling in terms of strong foreign currencies, gold, oil and other stores of values.  While asset deflation continues in other currencies, asset prices have been rising in dollar terms.

CURRENCY CARRY TRADE

The currency carry trade occurs when investors borrow a given currency (let’s say the dollar) at very low interest rate and use the borrowed money to buy other currencies, stocks, and commodities.  It also occurs when and investors sell dollars short and later buy them back with depreciated dollars.  The carry trade is dependent on both interest rates and the value of the dollar.  And it has been one of the biggest factors responsible for the stock market rally in recent weeks.

The dollar’s recent rally has some believing the carry trade is winding down.  Perhaps fear of the big budget deficits and the low demand for U.S. Government bonds is causing investors to expect U.S. interest rates to rise sooner.  When the fear of rising interest rates pervades the markets, this causes speculators to unwind their carry trade by buying dollars back and selling their stocks and commodities.  In other words, the “carry trade” and the stock market rally are being endangered by potential higher interest rates caused by the big budget deficits.

We do not know if the market has reached its highs for 2009, but we do know that a small wave of fear is once again washing through investment markets.  The big decline of 2008 and early 2009 was cathartic.  The rally from this cathartic bottom has been normal, so any correction in global stocks and associated commodities will be short lived.  Perhaps short-term fears of a technical market correction causes speculators to cut borrowing (on which the carry trade depends), and to sell stock positions.

U.S. DEBT

The Economist magazine echoes many of our arguments regarding U.S. debt and deficits.  Last week’s Economist magazine had an important article entitled “Tomorrows Burden: Americas Debt Crisis will be Chronic Not Acute, and Long Lasting.”  The article elucidates many of the points that we have repeatedly made in our commentaries over the last several years.  It is well written, and I will take the liberty of paraphrasing the main points.

The author makes the point that there are three things that could lead to an acute crisis:

1.) A lender’s strike (no debt available)

2.) A crash in the dollar (possible not probable immediately)

3.) A rise in inflation (this seems remote to the Economist. It does not seem remote to us.)

The authors reason that the debt crisis will be long-lasting and chronic, but not acute.  That is unless one of these three issues develops.  We believe that we could experience all three of the above within a couple of years.  For those who would like to read the entire article, please see this link:

http://www.economist.com/displayStory.cfm?story_id=14699754

THE NEXT U.S. FINANCIAL CRISIS IS ALREADY ON THE WAY.

It will be an inflationary crisis, and it will commence about 2012.

The U.S. Government has guaranteed banks and the housing market.  It has borrowed hundreds of billions of dollars to strengthen the economy at the same time tax revenues are collapsing.  Social Security and health care financing will add to the burdens.  The banking crisis will probably turn into a long-term government debt crisis.

The United States has been living beyond its means, over-borrowing, and engaging in other irrational, unwise, and destructive behaviors.  These behaviors have been encouraged and abetted by the Congress, former Federal Reserve Chairman Greenspan, and both Republican and Democratic administrations.  A less powerful country, perhaps one which was not providing a military shield for much of the world, would have seen their currency and debt markets subjected to immense scrutiny and widespread suspicion and may have been forced to default long ago.

History has demonstrated two likely outcomes for the situation in which the U.S. currently finds itself.  The first is that bond and currency market speculators make default the inevitable outcome.  The second is that they devalue their currency substantially in order to pay back their debts in a diminished currency.  The day approaches when the U.S. dollar will meet the fate that so many other currencies have faced over the millennia…it will suffer a substantial decline and inflation will resurge.  This will probably occur no later than the end of 2012.

DEBT MARKETS

Contrary to the beliefs of some efficient market theorists, financial markets can remain highly irrational for extended periods of time.  Few things prove this better than the behavior of the U.S. debt market.

The reality is that investors should be scared of the U.S. debt market.  The U.S. continues to go to the markets with bond offerings, financing huge sums of borrowing to feed its ravenous appetite for spending that far exceeds the means of the taxpayers…or the logic of markets.

The markets continue to support the dollar beyond a reasonable level.  This support can be partially explained by the many relationships and financial activities the U.S. Government currently undertakes.  Over the years, the U.S. military’s largess and the dollar’s status as a world reserve currency have helped sustain the value of the dollar.  For example, the U.S. still incurs a large percentage of the military protection costs of Germany and Japan 64 years after the end of World War II.

The value of the dollar has also been preserved because the major debt holders; Japan, China, Saudi Arabia, and Britain are large exporters to the U.S. and/or those that are allied with the U.S. militarily.  Below is a chart from the U.S. Treasury Department:

LEVERAGE IN THE BANKING SYSTEM

Remember the terrible banking crisis of 2008-2009 that brought down Bear Sterns, Lehman, and Washington Mutual, and threatened others in the U.S. and Europe?  You haven’t forgotten, and we haven’t forgotten, but it seems that Congress has.  What’s more, they are squandering an opportunity to repair and revitalize the U.S banking system.  Today, the U.S. banking system continues to be dangerously speculative and interconnected.  Banks deny credit needed for small business, the major driver of employment, while engaging in unproductive speculation.  And although this is clearly a serious defect in the system, Congress has failed to address it.

Even more disconcerting is that the banking lobby has Congress’ ears.  Instead of listening to the proven, wise, and honest former Fed Chairman Paul Volcker, Congress is listening to the folks that brought us the last crisis.  So when Volcker makes the reasonable suggestion that banks and speculative trading activities should be separated, and that only banks with no involvement in trading for their own account should get government guarantees and bail outs, Congress isn’t listening.  Sadly, we fear that Congress’ unwillingness to face down the banking lobby guarantees that a new crisis is on the agenda for future years.

This is in sharp contrast to Holland, where the country’s largest bank is forced to sell its U.S. Internet banking operations and its insurance company in order to attain and maintain the use of government funds.  In Britain, the trend toward breaking up large banks is being pushed by the top economists at the Bank of England, and in other countries there are demands that banks stop speculation for their own account.  In our opinion, disallowing speculation by commercial banks is the only effective method to forestall the next system-wide financial crisis.

Thank you for listening and please do not hesitate to contact us with your suggestions.

Monty Guild and Tony Danaher
www.GuildInvestment.com

A new era in computing and delivery of information has begun.  If you aren’t yet familiar with cloud computing, you probably will be soon.  We expect there to be an onslaught of news articles, editorials, and advertisements about cloud computing accompanying Microsoft’s launch of their new computer operating system, Windows 7.

The term cloud refers to the Internet (most computer network diagrams use a cloud shape to depict the Internet).  Cloud computing allows companies and consumers access to virtually limitless processing power and storage.  In this new era, the personal computer (PC) will no longer be doing as much of the computing.  Rather, a vast network of data centers replete with huge storage systems and servers will operate complex programs, store information, and deliver web based services to computer and mobile device users worldwide.

Already, online games, web based email, and social networking sites operate from the cloud, and many new services will join them.  Smart phones, tablets, game platforms, net books, and other devices will get new operating systems and programs optimized to run from the cloud.  The cloud will change the way the technology business operates and how technology companies will compete with one another.

Longer term, this is not good for Microsoft’s old business model.  The PC has been their power base and there will be a very vibrant competition between Apple, Google, and Microsoft for dominance in the data center business and associated suites of services and applications.

Intel

MOBILE TELEPHONY AND INTERNET

Clearly, one of the great trends of 2009 and the coming few years is mobile Internet access.  With cloud computing so much in the news, and with the knowledge that the Internet is the basis of cloud computing as opposed to the desktop, we are looking at companies that access the Internet through mobile means via 3G (third generation) smart phones.  These include (as we have mentioned in previous memos) service providers, device makers, component makers, and software developers.  Our favorite ways to play the trend are through device makers and their suppliers.

This week, we had a number of conference calls from semiconductor companies who supply the necessary internal components for mobile devices and for cloud computing.  We also heard a stunningly bullish conference call from Apple Inc. which laid out how rapidly mobile 3G telephony is expanding in many countries.  Apple of course does many other things besides smart phones, and currently several of their consumer advice and retail businesses segments are also doing very well.

Apple

THE ECONOMIC GROWTH MODEL FOR JAPAN, EUROPE, AND THE U.S. IS POOR WHEN COMPARED WITH THE FAST GROWING COUNTRIES IN ASIA, AND WITH BRAZIL

CHINA, INDIA, AND BRAZIL

We can see China, India, and other countries growing, and the economic data is very supportive of this view.

We do not believe the same about the developed world.  Rather than inundate readers with every new data point about China’s growth, suffice it to say that their growth is fast and accelerating.  China just announced their third quarter GDP growth at 8.9 percent.  China’s foreign exchange reserves grew by $318 billion in the last six months.  Contrary to misinformed and naive reports, this came in spite of a big slowdown in Chinese exports.  The increase was due to the growth in foreign direct investment; foreign companies building plants, distribution facilities, retail outlets, and other enterprises in China.  The bears and naysayers on China’s economy are looking more incorrect with each passing day.

China’s economy has been moving from an export model five years ago to a hybrid model based on infrastructure, the consumer, and exports.  They have strengthened their relationships with markets within Asia and Europe, and are no longer as dependent upon the U.S. for exports as they once were.  The Chinese politburo is made of clearer thinking, and long-term goal driven engineers, and is very rational in its top down management and goal setting for the economy.  The banking system, although not perfect, is stronger than the U.S., European, and Japanese banking systems.  Capital is being allocated more wisely in China, and the country has huge trade balance of payments and current account surpluses.

India is also doing very well.  The national need for infrastructure is finally being addressed, and Indian entrepreneurs are running a strong economy.  India is still hampered by a socialistic bureaucracy that has always found a way to slow progress, as bureaucrats have used delay tactics and interference to make themselves more important and more wealthy.  Nonetheless, the country is showing strong growth and the middle class continues to expand rapidly.

Brazil is another success story.  Their banking system is operating very efficiently and the consumer is responding with increased demand for auto and home loans.  Much of this is due to the fact that Brazilian rates are now low enough for consumers to be able to borrow to buy a car or house.  Previously, periods of strong inflation and high interest rates had priced consumers out of the market for credit.  Today’s more reasonable rates and lower inflation have set the stage for a period of consumer demand and growth of the Brazilian middle class.

These three countries and many others in Asia are growing their middle classes rapidly.  The opposite is true in the U.S., Europe and Japan as many are falling from middle class security in these more mature economies.  All of this is the manifestation of today’s major world economic trend the decline of countries with overleveraged, weak banking systems and consumer focused countries of the developed world; and the rise of the emerging powers with stronger banking system, underleveraged economies, and industrial oriented leadership.

SUMMARY

Within the developed countries we are sticking to export oriented companies especially in high technology areas.  We remain bullish on most of the emerging nations of Asia.  Longer term, we like India and Brazil, but their markets have run ahead of their peers and may be vulnerable to a short term decline, we are monitoring them and looking for buying opportunities.  We continue to believe that oil, gold, and non U.S. currencies will appreciate.

Thanks for listening.  Please contact us if you have any questions or suggestions.

Monty Guild and Tony Danaher
www.GuildInvestment.com