THE RISE OF SMALLER EMERGING NATIONS AS TRADING POWERS

Recent research by UBS economist Jon Anderson illustrates how trade is being reshaped in the developing world.  It will probably not surprise you to learn that between 1998 and 2008 six developing nations recorded an increase in exports (as measured by manufacturing & GDP) of more than 25 percent.  What will surprise you are the names of these countries.

The emerging market countries that grew their exports by the largest percentage were not the big countries one might expect, such as China, Brazil or India.  Instead, they were smaller countries, with less celebrated economies.  They were Cambodia, Thailand and Vietnam in South East Asia and the Czech Republic, the Slovak Republic and Hungary in Eastern Europe.

Why did these countries record the highest increase in exports?

Consult a world map and the answer becomes clear.  To quote Dr. Anderson "… all of these countries sit in exactly two small locations in the world directly east of traditional developed Europe [the Czech Republic, the Slovak Republic and Hungary], or just around the shipping lanes from the original Asian Tigers [Hong Kong, Korea, Singapore and Taiwan]." As we can see, "…the largest beneficiaries of the great secular expansion in global trade were those situated next to it, either in terms of outright proximity to markets or proximity to the sea- based production chain."

TRADE ROUTES ARE CHANGING

In our opinion, it is significant that emerging nations are becoming less and less dependent upon the developed world for import and export trade.  According to estimates produced by the world trade organization, trade between emerging markets increased by 18 percent per annum from 2000- 2008.  This was a much larger increase than the trade between developed and emerging nations or the trade between developed nations.

Why?

1.)  For many years developing nations have been forming new trade relationships with each other.

It is clearly no accident that President Lula of Brazil has visited over 60 developing nations during his tenure and is working hard to develop trade with many nations.  This policy of extending Brazil’s economic influence throughout the developing world is similar, albeit on a smaller scale, to China’s huge efforts in this area.  India is also working to develop and enhance its trade contacts among developing nations, as are smaller countries all over South America, Southeast Asia, and Eastern Europe.

2.)  Many developing countries have begun acquiring assets in other less developed nations to fill their need for raw materials.

Companies from China, India, Brazil and others are acquiring properties: mines, oil fields, production facilities, farms and other assets in a large number of countries.  These companies may be acting for their own benefit or as part of a national policy to secure raw materials and other elements of production.  Not only does it make the purchasing country more secure by guaranteeing that certain materials available for key growth industries, it also provides them with a potential economic advantage over competitors because they can source their materials at lower price or in greater quantities.

CHINA’S RARE EARTH INDUSTRY

Recently a wave of fear has been caused by China’s announcement that they would implement export controls on some of their rare earths.

This announcement has caused the world to awaken to an issue that we have been commenting on for years.

Rare earths are necessary to make many high tech instruments and products that we rely on in our modern technological society for consumer, industrial and military goods. A lack of availability of some rare earths will create economic and militarily difficulty for many nations until alternative sources of these rare earths are developed elsewhere.  It is likely that the alternative sources of these materials will be found and/or produced, however, a long time lag before sufficient production of these raw materials could damage the competitive position of those who do not have access to the required supplies.

THE AGE OF U.S. DOMINANCE DRAWS TO A CLOSE

It is not an accident that English has been the language of commerce, diplomacy, and military activity for the past several decades. The U.S. dollar is the world’s reserve currency and has also been used as the national currency by many nations around the globe.

The U.S. dollar’s position as the world’s reserve currency has been based on the U.S.’s leadership status on the world stage, not just on economic issues, but on political, martial and social issues as well.

In short the U.S. sends foreign aid and other programs to allies and potential allies, and even fights wars to strengthen the political and economic positions the U.S. and our allies.  Very few would argue that U.S. companies and industries are not among the beneficiaries of these efforts.

Today, as emerging economies rise in global economic prominence and an increased proportion of global trade is being conducted between developing nations, the U.S. is losing its central role in world trade.

THIS TREND WILL EVENTUALLY IMPACT THE U.S. DOLLAR’S POSITION AS THE WORLD RESERVE CURRENCY.

As the U.S. loses economic power, American citizens and most especially American investors should be prepared to have the U.S. excluded or at least not included in many multilateral trade, economic and political talks.  This will decrease the clout and the economic benefit for many large U.S. companies and industries.

STOCK VALUATIONS

Asian stocks in fast growing nations have begun to sell at prices equal to or at a premium to U.S. and European stocks. Why is this happening?

Asia has:

1.)  3 billion new consumers

2.)  Robust trade between Asian economies and other developing markets.

3.)  Strong banking systems, not the highly leveraged banking systems that we find in much of Europe and in the U.S.

4.)  Reasonable expectations of growth for companies and economies as a whole.

5.)  Populations with strong entrepreneurial spirit and the desire to rise up the economic ladder.

We have often discussed the problems facing the developed nations, so I will not go into detail again here.  Suffice it to say, that while Asia enjoys much of #s 1-5 the developed world is busy dealing with:

1.)  A badly damaged banking system.

2.)  Overwhelming debt (This debit is so high that if inflation develops, and we believe that inflation is inevitable, interest costs can overcome growth every rapidly.).

3.)  Low economic growth.

The emerging economies of Asia have 5 positives on their side and the developed world has 3 negatives.  If you are a global investment analyst, it’s not hard to choose where to invest.

If the Obama administration wants to gain favor with investors, may we suggest that they consider extending tax cuts and implement other programs to spur capital formation and new job creation in the U.S.   If the administration were to undertake such a program the U.S. economy and U.S. stock market would immediately benefit.

MEXICO AND U.S. IMMIGRATION

Many Americans are aware of a serious problem, which has been growing in Mexico for some time.  Mexico’s police, economic and political systems are collapsing.  Most serious is the fact that a large percentage of all of the police forces in Mexico may have been compromised or moved into the employ of drug traffickers.  The causes of this problem have been a long time in the making.  For generations police and political corruption has been an open secret in Mexico.  The effect of chronic corruption combined with the lack of growth of a middle class, the high profits in the drug business and a volatile social environment Mexico has been brought to a tipping point.

To those who live in the Southwest of the U.S. and share a state border with Mexico this has become more obvious in just the past 6 months.  In our opinion, many more Mexicans will vote with their feet and leave Mexico for the U.S. if they can figure out how to get here.

We expect the U.S. to end up spending a large amount of money fighting narco terrorism in Mexico and, eventually, on U.S. soil.

SUMMARY

During the past few weeks; gold, silver, wheat, corn and some other metals have been accumulated by investors.  We believe that the current news background will continue to support higher prices for precious metals, grains, oil, and fast growing stocks in countries with high growth rates.

We believe that political instability in Mexico, Pakistan, Afghanistan and elsewhere will keep investors focused or risk rather that reward.

In such an environment it is our experience that one is wise to hold gold, oil, high yielding stocks and food commodities and to keep a large percentage of cash available to spend should opportunities arise.

If the Obama administration were to continue the tax rates currently in effect rather than raise them, and if they were to implement programs to stimulate capital formation and new business development and thus job creation in the U.S., the U.S. economy the stock market and the election prospects of Democrats would all be benefited.  It would be a change in their approach of tax and spend but perhaps they have been listening to the electorate.

We continue to warn all readers against long-term bonds of any issuer.

We see inflation developing in India, China, and elsewhere and believe that within a few quarters this inflation could be imported into the developed world.  In such an environment holding long duration bonds could lead to huge losses.

For those of you who hold Municipal Bonds, we will be happy to analyze the stability of the issuers of your bonds free of charge.  Contact our office at (310) 826-8600 if you would like to accept this free offer.

Thank you for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

BRAZILIAN ELECTIONS IN OCTOBER

We believe that it is important that the new Brazilian administration continue the many successful programs that flowed from the Lula government.  Currently, Dilma Rousseff, Lula’s hand picked successor is enjoying a 20 point lead over her opponent Jose Serra according to one Sao Paulo newspaper.  Should Rousseff win, will she be able to continue along the path blazed by Lula?

Brazil has prospered this past decade for a variety of reasons.  After Lula’s election in 2002, a fortunate confluence of good national economic management, strong industrial production, strong exports, and relatively moderate inflation [by Brazilian standards] created increases in the standard of living for many Brazilians.

Lula’s policies have been more centrist than leftist.  Brazil has enjoyed a surge in demand for products and raw materials from Asia.  They have experienced a calming of inflation as a result of moderate monetary and fiscal policies, and have also enjoyed some luck as the world experienced a dis-inflationary trend at the same time.  These combined events have led to strong economic growth, large increases in auto and home ownership, improvement in infrastructure build out, and an expansion of the already strong auto, aircraft and computer industries.

Brazil’s successes have had significant positive influence on the world and especially on Latin America.  Brazil’s future trends will be heavily influenced by the October 3rd election and the psychology of Brazilian and global investors that result from the election.

Lula’s centrist path, caused interest rates to decline.  The decline allowed the purchase of autos, homes, and other goods by Brazilians, which of course stimulated economic growth and raised more families to middle class status.

U.S. VOTERS, HAVE YOU EVER HEARD OF SCOTT RASMUSSEN?

Mr. Rasmussen is a political pollster.  Why have Mr. Rasmussen’s polls been so accurate while other U.S. political pollsters have been quite inaccurate?  Why does he see big changes ahead for the U.S. political environment?

Mr. Rasmussen, who has traditionally been seen as a Republican pollster is teaming up with Scott Schoen, a pollster for Bill Clinton to write a book about the new U.S. electorate, and why traditional polling organizations have recently been quite wrong about voters’ intentions.  In their book, they discuss how polls have come to dominate political behavior as never before.  Politicians watch them and react to them constantly.

They also discuss how both Democratic and Republican pollsters are giving their readers misleading results because “The trade-offs pollsters offer voters often don’t make sense to them.  How you frame the question often obscures the result you get.” In other words, the premise behind the question asked often is not shared by those who are questioned.

His surveys poll large numbers of people electronically every night, instead of using less frequent personal interviews of a much smaller number sample like most other pollsters.  His track record in calling recent elections has been far superior to other polling organizations.  Here are a few points he has discovered about the electorate.

“THE MAJORITY OF DEMOCRATS, REPUBLICANS AND INDEPENDENTS ALL DISAGREE WITH POLITICIANS ON AT LEAST TWO OF THE FOLLOWING THREE QUESTIONS:”

1) “Whose judgment do you trust more; political leaders or the public’s?

2. Has the Federal government become its own special interest group?

3. Do Government and big business often work together in ways that hurt consumers and investors?”

It seems obvious that all types of voters believe that the government does not have the public’s best interest in mind, and as a result they will turn many incumbents out of office in November 2010.

In an interview in the Wall Street Journal on August 21, Mr. Rasmussen said “This will be the third straight election in which the people vote against the party in power.”  “The GOP will benefit this year, but 75 percent of Republicans say their representatives in Congress are out of touch with the party base.  Should they win big this November, they should move quickly to prove they have learned lessons from the Bush years.”

AUSTRALIAN STALEMATE

The recent Australian election ended in a hung parliament with both the Labor party on the left and the Liberal-National coalition on the right unable to attain a majority.  Both sides are now negotiating with independents and other blocs to form a coalition of 76 seats to form a government.  We believe it will be much better for Australia and its business environment if the more conservative government is formed.  We will watch and comment after a government is finalized.

LONG-TERM BONDS ARE NOT A WISE INVESTMENT IN OUR OPINION

It is disturbing to us when a huge percentage of investors agree that one type of investment is the superior vehicle.  We recall the era of 1998 to 2000, when tech stocks could do no wrong and many unsophisticated investors and speculators believed that tech stocks were a one way street to riches.  Today, we have a similar mania where 98 percent of investors believe that buying U.S. treasury bonds including long-term bonds is a wise idea.  We dispute this idea and strongly warn our readers to watch out.

Long-term bonds in this country are discounting a continuation of a low inflation environment; and we all know that inflation in the U.S. is currently not a problem.  How do we know that inflation will not return in the future?  Many investors seem to be discounting a non-inflationary or even a deflationary environment for years to come.   If inflation were to return, purchasing a 30 year bond at current low interest rates could produce immense losses for the unwary.

We further believe that people are ignoring certain signs. For example, there is high and rising inflation in India and rising inflation in China, Brazil and many other parts of the world.  Just as the United States engendered inflation in the 1970’s and exported it to Europe and much of the world, the inflation currently taking place in Asia and elsewhere could easily be exported to the U.S. and Europe in coming years.

We do not agree with buying long duration bonds unless you intend to be a very active short term trader.  In our opinion, longer term investors should avoid long duration bonds!

GOLD AND STOCKS

Clearly, the stock markets of the developed world have spoken.  They are interested in high yielding stocks with assured and growing income and they are not interested in most other stocks.  Gold related shares are the only sector that does not pay high dividends which appears to be doing well in this environment.

Gold itself is acting brilliantly, as continued efforts to hold the price down by those who do not like to see the price of gold rise, are being neutralized by those governments, institutions, and individuals who continue to use every price decline as a buying opportunity.  Wise gold investors will use dips to buy.

SUMMARY

Investors should avoid long-term bonds, and continue to focus on using dips to buy gold and high yielding income stocks [especially in the oil sector].  We believe that the recent decline in oil prices has ended, and expect oil prices to rise over the next few weeks and months.  Demand for energy from the developing world continues to grow and Saudi Arabia is starting to think more about conserving some of their oil resources for future generations.

China, India, and other growing nations will be well situated for investment, but we prefer to wait to add money to global stock markets until we see how the seasonally volatile September-October time frame unfolds.

Historically, many stock markets, especially in the U.S. and Europe have been very weak in September and into October as investors return from summer holidays.  Accordingly, we hold large cash positions and very few equity positions other than high yielding energy stocks or gold stocks in the portfolios.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

HOW “CONSERVATIVE” IS YOUR MUNICIPAL BOND PORTFOLIO?

The municipal bond market has performed well in recent years.  A long period of declining U.S. interest rates and growing fears of rising tax rates have helped them outperform other investments.  In our opinion, there are many under-disclosed risks and problems in municipal bonds of which investors who own them should be made aware.  Muni bonds are a nearly $3 trillion market, and are often sold as conservative assets.  The following opinion piece from today’s Wall Street Journal by Steve Malanga discusses how some states have been less than forthcoming about their fiscal health.

Due to years of fiscal manipulations, many states, counties, municipalities, school districts, and public utilities are going to have trouble refinancing their debt in the coming years.  It is not just the Wall Street banks and large public companies who have used financial trickery with their balance sheets.

Some municipal bond investors, underwriters, and issuers are hoping that the Federal Government money printing machine will come to the rescue of insolvent states, counties, and municipalities.  We do not believe that hope is an investment strategy.  If you have a municipal bond portfolio, please feel free to call us and we can help you understand what investment actions you might consider.

How States Hide Their Budget Deficits
By Steve Malanga
23 August 2010
The Wall Street Journal

In April, the New York State Comptroller, Thomas DiNapoli, issued a damning report on the Empire State’s financial practices. Albany’s budgets, he observed, increasingly employ "fiscal manipulations" to present a "distorted view of the State’s finances." Money shuffled among accounts to hide deficits, loans made by the state to itself, and other maneuvers Mr. DiNapoli called a "fiscal shell game" are meant to "mask the true magnitude of the State’s structural budget deficit."

The comptroller’s report produced yawns. Last week, however, the Securities and Exchange Commission (SEC) filed fraud charges against New Jersey for misrepresenting its financial obligations, particularly its pension obligations, and misleading investors in its bonds. New York — and many other states — had better sit up and take notice.

The Citizens Budget Commission of New York recently measured states’ obligations against their economic resources. New Jersey was rated in the worst fiscal shape, but it judged other states that employ questionable budget practices, including New York, California, Illinois and Rhode Island, to be only marginally better. Closer SEC scrutiny of these states’ muni offerings should be welcomed by investors, and also by taxpayers from whom legislators often try to hide the true depth of fiscal problems until they grow unmanageable.

New Jersey is an object case in how such manipulations eventually backfire. The problems go back nearly 15 years, to when the then-relatively healthy state decided to borrow $2.8 billion and stick it in its pension funds in lieu of making contributions from tax revenues. To make the gambit seem reasonable, Trenton projected unrealistic annual investment returns — between 8% and 12% per year — on the borrowed money. The maneuver temporarily made the funds seem well-off.

In 2001, when legislators wanted to further enhance rich pension benefits, they valued the state’s plan at its richest point: 1999, when the system was flush with borrowing and the tech bubble hadn’t yet burst. The scheme proved disastrous, of course, because the stock market has since gone sideways, and New Jersey has achieved nowhere near the returns it needed on that borrowed money.

Meanwhile, New Jersey compounded its woes with other ploys. In 2004, the state broke the cardinal rule of municipal budgeting when it borrowed nearly $2 billion to close a budget deficit, which is like borrowing on your credit card to pay off your mortgage. (The state supreme court ruled this move unconstitutional but allowed it to go forward anyway because it didn’t want to "disrupt" government operations.) Over time, New Jersey’s combination of overspending in its budget and underfunding of its pensions resulted in a tidal wave of tax increases and spending cuts.

Now, even if Gov. Chris Christie can solve the state’s long-term, structural budget problems, New Jersey will have to find some $3 billion a year in new revenues to begin contributing again to its pensions.

Municipal bondholders seem complacent in the face of such problems. They like to assert that they have first dibs on any tax revenues. But New Jersey has written so many "guarantees" into its constitution — whether regarding pensions or citizens’ right to a "quality" education — that sorting out the competing interests in a fiscal crisis could keep the courts busy for years.

As alarming is how Jersey-style fiscal practices have proliferated in other states.

The manipulations date back to the late 1970s, when taxpayer revolts produced spending caps and constitutional limits on tax increases in states. Rather than hew to these restrictions, politicians found increasingly inventive ways around them.

State officials have acknowledged such practices are growing common. During the 2002 recession, a report by the National Association of State Budget Officers admitted that states were employing "creative, innovative . . . adjustments" to budgets. They include financing current operations with debt, moving money from trust funds dedicated to specific tasks (like highway maintenance) into general funds, and pushing payments to vendors into future fiscal years.

"The long-running use of gimmicks is part of the reason most state budgets are in crisis today," noted Eileen Norcross of the Mercatus Center at George Mason University in a recent study.

The federal government has served as enabler. Although the special tax-free status it bestows on municipal bonds amounts to a subsidy, Washington does little to enforce responsible budgeting. In its fiscal stimulus packages of 2009 and 2010, for instance, the federal government funneled hundreds of billions of dollars to the states without regard for their fiscal practices, treating irresponsibility in New Jersey and New York the same as prudence in, say, Texas and Indiana.

California granted its workers big pension and benefit enhancements in 1999. As in New Jersey, those benefits were based on unrealistic projections of stock-market returns over the long term. Now the costs of those pension enhancements — which have added some $4 billion annually to the state budget and hundreds of millions more to municipal costs — have deepened Sacramento’s fiscal woes, which it is solving with more ploys, like pushing tax refunds and payments to vendors into future years.

These maneuvers often don’t make it into bond presentations. Like New Jersey, Illinois used extensive borrowing — including a whopping $10 billion offering in 2003 — to make its pensions appear well-funded. The state then skipped contributions into the system for several years, creating additional funding problems. A recent study by Joshua Rauh of Northwestern University projects that Illinois’s pension system is among a handful that, like New Jersey’s, could run out of money in the next decade.

Yet a presentation made by Illinois officials to potential investors in June mentioned the pension borrowings only briefly, then painted a rosy picture of the state’s fiscal practices. "Does the state have the Will To Govern needed to address its challenges?" the presentation asked. "YES" it answered in big, bold letters. The presentation then touted modest pension reforms that the state had enacted, even though legislators are doing little to ensure the system’s long-term viability.

The SEC should demand, at the very least, that states acknowledge the unease of their own in-house experts. There is nothing in the nearly 200 pages of New York’s current disclosure document for investors, for instance, that hints at the state comptroller’s concerns over the direction of the state budget. In refreshingly candid language, Mr. Napoli describes in his report a growing lack of transparency, which hides the state’s true fiscal condition, as a "deficit shuffle."

If that’s a new dance step, it’s one that investors and taxpayers everywhere need to work harder to ban. The SEC should help.

Please don’t hesitate to call us about this or any other issue. Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

INDIA IS BOOMING

India’s GDP is growing rapidly and is expected to rival China’s GDP growth for the next few years.  Prime Minister Manmohan Singh’s government has done an exceptional job.   His administration has been able to gradually decrease the bureaucratic overreach into parts of the economy and he has been able to deliver economic assistance to the people in rural areas in a more efficient manner.

Historically, government spending intended for the rural areas has in large part been misappropriated by corrupt politicians and by civil servants who accept pay but do not show up for work.  In recent months technology has increased the communication between the government and villagers in the countryside.  Rural populations can now report misbehavior by government employees in their regions.  The technological developments have led to increased attendance at work by government employees including teachers, nurses, etc.  Villagers are beginning to believe that their concerns are being heard.  Handheld phones and village computer terminals have given farmers an unprecedented opportunity to sell their crops directly and avoid middlemen.

Villagers’ incomes and consumption are on the rise, and the Indian economy is expanding more rapidly due to the fact that rural as well as urban citizens are enjoying the growth.  We expect Indian GDP growth in the 8 percent-10 percent range for the next two or three years, which is well above the historical pattern; a very impressive outlook.

CHINA TO OPEN GOLD MARKET

According to an article in the August 4th Financial Times by Leslie Hook, “China moved yesterday to further liberalize its gold market, increasing the number of banks allowed to trade bullion internationally and announcing measures that will encourage development of gold linked investment products. The move by Beijing’s central bank comes as the country’s investors pour record amounts of money into gold in a trend that is becoming a significant factor in global prices…”  Click the following link to read the entire article:  http://www.ft.com/cms/s/0/49c6bbac-9f2a-11df-8732-00144feabdc0.html

We have long been of the opinion that Indian and China will be large and growing consumers of gold, and this pattern continues to establish itself.  As wealth grows rapidly and inflationary fears rise in both countries, gold is an obvious alternative that will fill a larger part of Chinese and Indian portfolios.

DERIVATIVES REPORTED BY THE 14 MAJOR DEALERS

The 14 major derivatives dealers including Goldman Sachs, Morgan Stanley, and J.P. Morgan reported $449.2 trillion dollars in derivatives as of June 30, 2010.  The data was compiled by Tri Optima, an infrastructure provider for the over the counter derivatives markets. According to Tri Optima 74 percent of these derivatives are interest rate swaps.  These swaps allow bets on the direction of interest rates, and are used for hedging risk or to increase risk and potential reward.  By any measure the amounts of outstanding over the counter derivatives continue to be stunningly large and continue to hold the possibility of another banking collapse if the various sponsors and their counterparties are not carefully managed, and the transactions made transparent.

As we have discussed many times in these pages over the last few years, derivatives led to the over-leverage and eventual downfall of the U.S. and European investment banks and threatened to collapse the developed world’s banking system.  While the U.S. and European banking systems were melting down, the more conservatively managed banking systems of many Asian nations, Australia, Canada, and others avoided the problems.

The de-leveraging of the U.S. and European banking systems continues and will be a drag on economic growth in these regions for several years into the future.

SUMMARY

The world is awash in fear; fear of war in Middle East, fear of a double dip economic recession in U.S. and Europe, fear of inflation in China and India, and many other fears. In such an environment, gold and oil appear to be two of the wisest investment areas.  Among gold alternatives, we recommend gold bullion and gold shares with leverage to higher gold prices.  Among oil investments, we favor energy producers which combine growth in energy reserves and strong dividend payouts.

We also believe strongly in the long term economic viability for continued growth in India, Singapore, Malaysia, Thailand, China, and Brazil.  Although less certain, we will probably see continued growth in Canada, Australia, Taiwan, and Korea.

Europe, Japan and the U.S. appear to be set on low growth trajectories for the next few years.  When their currencies fall in value, the U.S., Japan, and Europe will be able to boost their export growth slightly, but all three areas will be dependent upon “quantitative easing” or money printing to keep their economies growing.  Longer term, money printing will lead to currency depreciation and inflation.  While these major money printing operations are happening, we expect that the respective stock markets may rise, but we believe that they will fall again when the injection of stimulus is completed.

Thanks for listening.  We hope you are enjoying the summer season, and we encourage you to contact us with questions, suggestions and criticisms or if we may be of service.

Monty Guild and Tony Danaher
www.GuildInvestment.com

China knows the evil of over the counter derivatives. They handle substantial financial fraud as a capital crime.

Going forward, listed derivatives with a clearinghouse function, margin requirements and standardized contract points can exist without endangering either China or the world. China has no significant backlog of the OTC type weapons of mass financial destruction. The Western World is overhung by $1.4 quadrillion dollars of notional value OTC derivatives before the BIS went to the cartoon value of "value to maturity," the ultimate Pollyanna computer fabrication. The size of the OTC weapons of mass financial destruction has grown during the crisis that they are in fact responsible for.

China, who considers major white collar crimes as capital crimes ( punishable by death), will not screw up themselves and the world in their version of the credit default LISTED derivatives.

Asia and Africa is where the future is. Now it is go East young man, go East.

China in Asia, and Tanzania in East Africa are the pots of gold at the end of the rainbow.

Regards,
Jim

Dear CIGAs,

WHY DOES HIGH PRICED REAL ESTATE SELL SO EASILY IN CHINA?

China appears to have a huge "grey" economy, meaning that it is fueled by grey or unreported income.  On July 19th, China’s most famous researcher on grey income, Dr. Wang Xiaolu, stipulated that actual urban household income may be 100 percent higher than the official data reported by the government.  He also concluded that China’s per capita disposable income in 2008 should have been 67 percent higher than the official data.

Dr. Wang goes on to say that China’s national housing affordability ratio (the ratio of  average home prices to average income) should have been about 2.8x in 2008, and is about 3.5x currently, which are lower than in many developed countries.  His research concludes that the income gap between the top 10 percent and bottom 10 percent of the population was 26x; considerably higher than the government’s estimate of 9x.

In our opinion, this goes a long way to explain why the wealthy continue to buy real estate, and how they can afford the high prices.  It also explains why the government is so intent to spend national resources to build low income housing and to stop the speculation in high priced status properties so the wealth gap does not continue to escalate. China’s leaders consider, among other things, the Confucian ideal of moderation and a cohesive society in their planning.  Clearly, huge income and wealth disparities undermine these Confucian ideals.

CHINA TO IMPLEMENT CREDIT DEFAULT SWAPS IN THE SECOND HALF OF 2010; THIS WILL CHANGE THE WAY THEY MANAGE THEIR ECONOMY

China’s National Association of Financial Market Institutional Investors (NAFMII) recently announced their plan to launch a market for credit default swaps.  In China, these will be known as credit risk mitigation (CRM) contracts.  The NAFMII report said Chinese credit derivatives must follow the principles of simplicity and transparency and cater to the ‘real’ economy.

Economical management is paramount in China.  For years, the central government has allowed local governments to create economic growth through activities such as selling real estate to developers who in turn create housing and large commercial developments.  The ultimate effect of this has been more employment and more demand for raw materials.  Now, the Central Government is reigning in local government flexibility, and is going to manage the money supply by growing it and shrinking it in a manner similar to the U.S. Federal Reserve.  Furthermore, they will expand a bond market for Chinese government bonds and begin to use bond issuance as a method to control the money supply in China.

CHINA PLANS TO CHANGE THEIR ECONOMIC MODEL TO AVOID TOO MUCH SPENDING AND RISK-TAKING BY LOCAL GOVERNMENTS IN THE FUTURE

China has taken on a new policy approach translated by some as ‘loose fiscal policy and tight monetary policy’.  Loose fiscal policy refers to the bevy of tax incentive and other fiscal measures to stimulate spending by government and private developers on affordable public housing and other public works.

Tight monetary policy means government will continue to reign in loan growth, especially to Local Government Funding Vehicles.  Total loans in the economy are expected to decline over the remainder of 2010 and in future years.  The commencement of a government bond market in coming months will create another policy tool for government planners.

FACTS ABOUT CHINA’S LOCAL GOVERNMENT FUNDING VEHICLES [LGFV]

Many rumors are swirling around about these vehicles, most of which are inaccurate. They argue for the potential of a meltdown in Chinese economic activity.  We disagree with most of these confused analyses.

On July 20, 2010, China’s CBRC (China Banking Regulatory Commission) published information about outstanding bank loans including the loans to the local government funding vehicles.  Total loans outstanding to these vehicles were about 1 trillion U.S. dollars on June 30, 2010.  The report states that 27 percent were fully viable, 50 percent need to be serviced by secondary sources (legal guarantors or secondary cash flows), and 23 percent could pose a risk of default if cash flows do not improve or new guarantors are not found.  Let us focus upon the 23 percent with potential problems, which is about $230 billion U.S. dollars.

Of these loans, we assume that about 2/3 will benefit from rising land prices or cash flows from completed projects already under construction.  We estimate that about $75 billion U.S. dollars in bad loans will need to be written off or re-capitalized.  Assuming all of the questionable loans go bad (a very unlikely occurrence in our view) write offs would total $230 billion.

On a national level, China has about $1.4 trillion in cash reserves available.  In addition, the formation of a bond market, stock sales and cash held by provincial and local governments can also be used to restructure the bad debts.  Bad debts are likely to be anywhere from $75 billion to $230 billion in the worst case scenario. While this is serious, such figures are not unmanageable given the size of their reserves.

INDIA’S GDP GROWTH IS APPROACHING A VERY IMPRESSIVE 10 PERCENT

India will continue to grow rapidly.  We expect India’s high inflation (and rising interest rates) which have frightened many investors, will moderate after September when a successful monsoon season finishes with good rainfall, moderating food prices.

GOLD PRICES

We believe that all of the serious economic and political problems that have argued for a strong gold price continue to support rising demand for gold over the long-term.  India, Russia, China, and Persian Gulf countries are all accumulating gold.  A few weak, fiscally unsound institutions have been selling some of their gold to raise cash.  Demand has far outstripped supply over the last eight years and we have repeatedly seen that using periods of price decline to add to long term positions in gold is wise.

Gold recently approached $1,140 an ounce, which many technical analysts believe is a good buy point.   We suggest that gold taking partial profits in holdings on rallies and taking a larger percentage of your profits at $1650 per ounce.

We have been buyers during every prolonged period of gold weakness for years, and we continue to be buyers of gold during the current bout of weakness. A word to the wise is sufficient.

U.S. MARKET VOLATILITY

Markets have been volatile and we believe that they will remain volatile until the U.S. Securities and Exchange Commission begins to rein in the activities of the high frequency trading community.  These fast traders create unstable markets, increase volatility, and are scaring individual investors away from the markets.  When their actions are moderated, market movements will be more driven by fundamentals, and the individual investor will return, making the U.S. stock and bond market much healthier.

SUMMARY

We believe that higher volatility warrants high cash balances as volatility leads to market dislocations and good buying opportunities.

In our opinion, gold is approaching attractive prices for additions to portfolios.  We also find some high-yielding oil related shares to be attractive on price declines.  Longer term, China, India, Malaysia, Thailand, Singapore, and Brazil continue to be attractive destinations for investment capital.

Thanks for listening.  We hope you are enjoying the summer season, and we encourage you to contact us if we can be of service.

Monty Guild and Tony Danaher
www.GuildInvestment.com

SO MANY ARE CONVINCED THAT DEFLATION IS AHEAD…WE ARE NOT CONVINCED

For years, a few have believed that inflation will be the long-term outcome.  We have been among them.  We mentioned months ago in our commentary that there would be short term deflationary influences within the U.S. and developed economies in the last half of 2010.  Even though the developed economies are struggling to grow, and we predicted that there would be concerns about deflation, we want to reconfirm with our readers that our long-term view that inflation is looming in front of us…and history bears out our thesis.

Recently, the wise Jim Sinclair wrote and sent to his many readers an excellent piece on the subject of inflation being a monetary event.  To read it, you can access it on http://JSMineset.com.

THERE IS HISTORICAL PRECEDENT FOR AN INFLATIONARY OUTCOME TO THE CURRENT WORLD FINANCIAL CRISIS

Parallels can be drawn from history with respect to the financial events that that the developed world is now experiencing.  Below, please find a link to a lecture and presentation that discusses the role indebtedness has played in financial crises and monetary events of the past, and what outcomes we can expect from this current environment.

We view this work—which was presented earlier this year at the Niarchos Lecture at Peterson Institute for International Economics by Harvard Professor of History Dr. Niall Ferguson—as a well stated and strong historical endorsement of our long held views of what is occurring now.  Dr. Ferguson has been getting a lot of press lately as he prognosticates the future based upon what has happened historically in world financial markets under similar circumstances.  Here is the link to the transcript of Professor Ferguson’s lecture and to the slide presentation:

http://www.iie.com/publications/papers/niarchos-ferguson-2010.pdf

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

The key here is Israel makes a serious miscalculation.

Dear CIGAs,

Although many have predicted over the past five years that Iran would be at war with the west or Israel, such an outcome has not developed.  We seldom comment on war preparation activities and have not done so recently, and although it is not our normal modus operandi, we would like to point out that currently many signs point to the potential for hostility with Iran to develop.  Please note the following points.

1.  Iran is becoming more isolated. 
2.  Russia has stated that they believe Iran may be close having a nuclear weapon.  Many believe that they may already have developed nuclear weapons.  It appears that Russia is starting to moderate their view on Iran to a view more similar to that of the western powers. 
3.  Iran’s friends in the Arab world, who have helped them in many ways, are starting to move a way from them. 
4.  Iran has sold much of the oil they had stored in tankers offshore.  It occurs to us that they maybe raising cash for an expected war. 
5.  We have noticed several countries buying gold, and a few are selling gold and/or borrowing against their gold holdings.  We do not know if Iran is engaged in this activity but if they are expecting war, they are undoubtedly trying to raise cash in order to support that effort. 
6.  We notice that Prime Minister Netanyahu and President Obama had a cordial conversation at the White House and Obama has recently expressed more support for Israel.

Could it be that we are approaching a war between Iran and Israel and/or the west, with the U.S. supporting Israel and Russia demanding concessions for not intervening?  Although we are not political analysts,  and we do not know that war is in any way an eventuality, we believe that it is a possibility.

Should a war develop in this oil producing region, fears that it could spread would likely send oil and gold prices much higher.  Should a war develop, the stocks of oil companies that produce oil in Canada and other politically safe locations would be in demand.

AS WE HAVE REPEATEDLY STATED, GROWTH WILL BE SLOW IN THE U.S., EUROPE AND JAPAN

The most recent meeting of the U.S. Federal Reserve Open Market Committee was somber.  Most members cut their outlook for growth and raised their outlook for unemployment.

The major take away was that the U.S. economy will take a long time to recover and will grow slowly.  We have known this for some time, but the confirmation by the Fed’s economists is sure to drive the point home.

Here is a quote form the minutes of the meeting. “Overall, participants continued to expect the pace of the economic recovery to be held back by a number of factors, including household and business uncertainty, persistent weakness in real estate markets, only gradual improvement in labor market conditions, waning fiscal stimulus, and slow easing of credit conditions in the banking sector.”

Translation: slow growth ahead.  For more information please click on this article from the Wall Street Journal of July 14, 2010 entitled Fed Sees Slower Growth by Jon Hilsenrath.  It can be found at:

Wall Street Journal Online

As we stated last week, growth will be strong in China, India, Brazil, and selected well managed countries like Germany, Canada, and Singapore.  If war develops in Iran gold and oil will get particular attention, however, even without war in Iran, both still are attractive long term in our opinion.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

Earlier this week, the markets cheered the announcement out of Europe of a bailout package by the European Union nations and the International Monetary Fund, and a decision by the European Central Bank to begin buying sovereign debt of weaker states.  This bailout plan protects the sovereign bond markets for the short term, but does not solve any of the longer term problems in European bond, stock, and currency markets.  In fact, they allow the problems to grow and fester without being addressed.

As we have repeatedly stated, the answer to the European problem is simple.  Do not allow any social programs, especially entitlement programs to begin or continue unless there is money in hand to pay for them.  The ability to borrow is NOT money in hand.

The specifics of the three-year aid package consist of €60 billion of emergency lending available quickly from the European Commission, €440 billion pledged by the finance ministers of  sixteen Euro nations, plus a commitment from the IMF of at least half the European contribution (€250 billion).

A European government struggling to refinance its debts could first tap into the €60 billion Euro emergency fund.  If that proved insufficient, it could borrow from the €440 billion fund guaranteed by other euro-zone governments.  The IMF’s pledge of €250 billion is viewed by many as a last resort.  In addition, the ECB began buying debt of weaker euro-zone countries in bond markets on Monday.

Even the U.S. got involved.  The Federal Reserve reactivated a program that allows foreign central banks to swap their currencies for U.S. dollars, thus giving European nations access to more liquidity.  Also, as the largest shareholder of the International Monetary Fund, the United States can also participate indirectly in loans the IMF makes to Greece and any other European country.

The nearly $1 trillion EU and IMF safety net announced has another name.  It’s called quantitative easing…whatever the cost.  In our opinion, the costs will be huge.  The policymakers’ message is, to borrow from Marie Antoinette, “Let the future generations eat cake.”

OIL AND GOLD

Why is oil falling while gold is rising during the European sovereign crisis?  Gold is rising because the quantitative easing is long term highly inflationary and destructive to the standard of living of every citizen of the developed world, especially Europe.

Oil is falling as investors fear the austerity measures that are required in Europe will shrink economic demand.  No one disputes that oil is volatile, but it will in the long term rise very high from the current levels.  We have a view that there is plenty of reason to use any short term decline to your long term advantage.  Buying oil on dips below $70 per barrel seems wise in our opinion.

Demand for oil will not slacken in Asia.  Demand will continue to grow rapidly. New autos, new electrical facilities, new heating, transportation, new construction and new manufacturing all require energy in China, Brazil, India, and many other locales.

This European episode only hastens the handover of economic power and influence to the Chinese, Indians, and others in the developing world.

IN OUR OPINION, THE RECENT EVENTS IN EUROPE ARE:

I.  Bullish for gold short, medium, and long term.
II. Bullish for precious metals including silver, palladium and platinum short, medium, and long term.
III. Bullish for oil in the intermediate and long term.  Investors should use the short term price declines to buy. 
IV. Bullish for the currencies and stocks of countries which have strong and conservative fiscal policies over the intermediate and long term.

Why is the above bullish short term for everything except oil, currencies and stocks of conservatively managed growing countries?  THE MARKETS TODAY ARE DOMINATED BY COMPUTER MODELS, WHICH LACK THE CAPACITY TO THINK.  THEY ARE PROGRAMMED TO REACT BASED UPON PAST PATTERNS AND EVENTS, THEY ARE NOT PROGRAMMED TO ANTICIPATE FUTURE ECONOMIC EVENTS.

Over the short term, many quantitative / technical / derivative traders who lack a long-term analytical framework will sell oil, foreign markets, and currencies; while buying U.S. dollars or U.S. treasuries.  They believe that the U.S. dollar is a safe haven and that economic growth in much of the developing world will stop when Europe has a problem.

This developed country centric model is incorrect today, as it was in 2007 through 2009 when China and India grew very rapidly while the U.S. and Europe declined.   This developed country centric model is the underlying thesis for most derivative driven trading models. We predict that once again this quantitative/technical/derivative model will prove incorrect.

IN OUR OPINION, HOLDING GOLD IS VERY WISE

Point #1:
There will be no economic meltdown.  Quantitative easing, which is being implemented in Europe, supplemented by the QE which is already taking place in the U.S. and many other parts of the developed world has highly predictable consequences. 

When banking systems begin to perform their normal functions, the supply of money in circulation and velocity of money rise and the risks of deflation diminish.  In the world outside of Europe, a resurgence of inflation is much more likely than an economic meltdown. As we write this memo, inflation is appearing in fast growing Asian countries.  India currently has inflation in the high single digits.  Brazil is fighting inflationary trends, and China has seen resurgence to nearly 4 percent in recent months.

Point #2:
The public is catching on to the old and oft-repeated notion that you have to pay for what you get…and that borrowing from future generations to spend lavishly in the current period is irresponsible, unwise, and even inane.

To confirm this point, I am including a link to a thoughtful and lengthy article from the May 12^th NY Times. The article is entitled “Greece, Debt and a Lesson”   by David Leonhardt.

New York Times Article

The New York Times has been seen by many to be a bastion of liberal economic thinking.  This is one reason that we find the article interesting.  It mentions repeatedly that the U.S. must come to grips with its deficits, and it further mentions that even liberal thinkers are aware of the need to cut spending.  The writer favors higher taxes most voters prefer decreased government spending.

Mr. Leonhardt points out that Robert Greenstein, who is a leading liberal budget expert is recognizing this necessity.  Here is a quote from the article.  “Mr. Greenstein’s politics make him sympathetic to the worry that all the deficit talk will become and excuse to pull back on stimulus spending while unemployment remains high or to gut social programs.  But he also knows the numbers well enough to understand that our Greece moment, whether it takes the form of a crisis or not, is coming.”

Clearly, the message is getting through to the public.  More austerity and much more rationality in spending will be coming to a country near you.  However, it may be some time before the needed rationality reaches even the august halls of the U.S. Congress.  Senator Gregg of New Hampshire stated yesterday on TV that Congress did not yet understand the severity of the problem.  Once they do awaken to the problem, further months or years will be wasted while they dither and debate before they take action to cut deficits.

In the interim, may we make a suggestion to you?  HOLD ON TO YOUR GOLD, and buy more on any dips.  The other parts of Europe and the U.S. will all have their ‘Greece Moment’ in the coming months and years.  When they occur, you will be very grateful for the gold holdings that you possess.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

GREECE WILL RECEIVE A BAILOUT, AND THE BAILOUT WILL BE AIMED AT STRUCTURING FINANCIAL SECURITY FOR EUROPE AS A WHOLE

European financial officials from sixteen nations and some supra-national organizations met last weekend and announced that Greece will get a package of loans to be delivered to them over three years.   Why is this happening?  This is happening because if Europe does not support Greece, the government debt contagion that we have been discussing in recent memos will continue and spread. It will spread to Spain and Portugal and later to many countries in Europe including Italy and possibly France.  Because they fear the spreading contagion, Europe wants to stop the crisis as soon as possible.  In other words, Europe is getting a bailout, not just Greece.

In addition, Greece already owes several European nations a great deal of money, and they do not want Greece to go bankrupt and renege on all of their debts.

For an illustration of Europe’s motivation, please click on this link, and use a full screen to view the chart:

The New York Times "Europe Web of Debt"

This chart is stunning and speaks eloquently to the need of Europe to get their fiscal house in order, and to stop living beyond their means before the entire system, (not just Spain, Greece, Italy, Ireland and Portugal) collapses.  It is no secret that France is also indebted, and Britain, although not in the Euro Community, is equally poorly positioned for the future.

THE CITIZENS IN EVERY COUNTRY SHOULD RECOGNIZE THAT UNFUNDED PROMISES BY SHORT-SIGHTED POLITICIANS TO SHORT SIGHTED CITIZENS ARE RESPONSIBLE FOR THE DECLINE IN THEIR STANDARD OF LIVING.  The root of the problem is that promises have not been backed up by the money to pay for them.

Europe is not going to be healthy and secure just because some irresponsible European governments get temporary bailouts.  No problem is solved by these actions…the problem is just extended.  Europe will eventually renege or pay back these debts by: 1) devaluing the Euro, 2) implementing quantitative easing thorough government purchases of the debt of the weak countries, and 3) possibly by nationalizing employee pensions and forcing the pensions to hold government debt.  It is an age-old scam that politicians and kings have imposed upon the taxpayers and serfs for centuries.

In the years following World War II, the decision was made to provide much of western European’s citizenry with many entitlements…without setting aside the money to pay for the entitlements.  The bill for those entitlements is currently coming due.

EUROPE IS NOT ALONE

The U.S. also suffers from a similar problem.  Politicians play an old and shopworn game in the U.S.  Currently the U.S. has over $12 trillion of national debt.  There is about $54 trillion unfunded liabilities for Social Security, Medicare, and other healthcare.  The politicians try to ignore these facts.  They do not include the unfunded liabilities in the federal budget.  Many politicians think that the public is distracted and caught up in the ephemeral handouts that they receive, or the politicians deflect voter attention from their failures by laying blame on others [currently bankers].

Over the last few decades and looking into the future, in order to insure the best interests of the political class in Europe and the U.S., the public on both continents has been and will continue to be duped and penalized.  Until the unfunded liabilities are handled, and a plan is engendered to create a positive resolution to these problems, no major new entitlement programs can be responsibly legislated.

Until a plan to admit to the imbalances and to systematically set aside money to correct them is instituted, the public’s standard of living will continue to fall and their children and grandchildren will live a much less secure and comfortable life. This is because in lieu of repaying debts, politicians will depreciate currencies and raise taxes to pay for their folly.  The solutions employed, currency depreciation and higher taxes, diminish the standard of living of the public in any country.

U.S.  FINANCIAL REFORM BILL

Both U.S. political parties are working to weaken the Federal Reserve as a result of rising financial populism.  In our opinion, without an independent Federal Reserve, the safest investment that one can make is to buy assets that benefit from inflation such as gold, oil, real assets, etc.

INFLATION WILL ARRIVE IN LATE 2010 AND 2011

We do not see rapidly rising inflation for the next few months, and as a result many people will forget about the longer term problem that we expect will rise in late 2010 and in 2011.

There are two reasons why we believe that inflation will rise.

Reason One:  Corporations are cutting costs and in doing so they are limiting the supply of certain goods and services that are offered for sale.  This has the effect of causing prices for these same goods and services to rise.

Reason Two:  Government stimulus and liquidity pumping will cause capital to flow into commodities, which are rising in value.  Oil, gold, and food should attract this liquidity.  This liquidity injection combined with foreign demand will cause an increase in prices for food and raw materials.  Higher raw materials prices will gradually be passed on to prices at the retail level, causing inflation at both wholesale and retail levels to rise in 2011.

By 2011, we may be experiencing a world where supply of goods is decreasing, while demand is increasing.  This combination will lead to higher prices.

SUMMARY

THE CURRENT MELT DOWN IN EUROPE IS CREATING SOME SPILL-OVER PANIC IN ALMOST ALL MARKETS, CREATING GOOD BARGAINS IN STOCKS, OIL, AND GOLD

We believe that in the next few weeks we will be able to buy good companies in several fundamentally strong markets at lower prices.  If the markets which we favor fall due to the side effects of the panic that has been induced by the European sovereign debt melt down, we will use our substantial cash balances to buy good companies at lower prices.

We do not see any change in fundamentals for strong Asian countries or for the U.S., Canada, Brazil, and Australia.  The melt down is strongly positive for gold and strongly negative for the Euro.  We also favor Singapore, Korea, Indonesia and possibly Thailand in Asia.  If Indian and Brazilian markets fall by enough, we will be active buyers there.  In short, we see the crisis as an opportunity.  It has been created by a panicky atmosphere and good companies are currently available at lower prices.  The economic backdrop in most of the world outside of Europe is strong and this pull back may give us a chance to find bargains in coming days and weeks.

Finally, because the melt down is due to fiscal irresponsibility by several  European nations, the price of oil and gold should benefit as European, Chinese, Indian, Japanese and other buyers seek safety and diversification out of the Euro, British Pound, and other weak currencies.  These commodities are widely fungible and traditional havens during times of uncertainty.  Havens can also be found in the Australian, Brazilian, Singaporean, U.S., and Canadian currencies which are rising versus the Euro and Pound.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com

THE EUROPEAN DEBT CRISIS KEEPS EXPANDING

Greek debt has been rated as junk quality.  Spanish and Portuguese debt have undergone downgrades and there are rumors circulating of a possible Italian debt downgrade.

This reminds us of the so-called Asian Contagion of late 1990’s during which bank and government debt contagion sent Asian markets down dramatically and caused the value of several regional currencies to fall.  At that time, the U.S. and European markets, which were not part of the crisis, corrected by over 10 percent, then quickly recouped and were followed by market rallies.  If the current European debt contagion follows the same pattern as the Asian debt contagion of the late 1990s, which we believe it will, we expect a possible 10-12 percent correction in U.S. and Asian stocks followed by continued rallies in both regions. We do not know when the corrections will take place, but we expect them to create buying opportunities.

U.S. FEDERAL RESERVE—PROPOSED ADDITIONS WILL ADD DOVISH MEMBERS TO THE BOARD

President Obama has proposed three new Governors to fill current vacancies on the Federal Reserve Board.  Janet Yellen, the choice for Vice Chairperson, has been a long-time monetary dove.  The two other proposed members, Robert Diamond, a professor at MIT, and Sarah Bloom Raskin, the Maryland commissioner of Financial Regulation, are both unknown quantities.  We expect them to vote in support of the currently dovish Chairman Ben Bernanke until they become more experienced as monetary policy experts.

A dovish Federal Reserve argues for rising gold prices. Why?  Because in our opinion, a dovish Fed will fail to keep inflation at bay by raising interest rates rapidly when inflation reasserts itself in late 2010 and 2011.  The result will be more inflation in 2011 and subsequent years.

GOLD

We were gratified and surprised to see this week that CNBC published a link calling gold the only real currency.  This has long been our opinion and we believe that many times over the centuries gold has worked in this role.  We were shocked to see a mainstream media outlet announce the same, as it is often difficult for politicians to agree with this view.

Gold is often seen as a report card on the quality of governance that the political class provides for any country.  The demand for gold from Europeans during this time of crisis has led to a rise in the price of the metal, which we expect to continue as for the duration of the crisis.  We anticipate that this crisis will continue in stronger and weaker waves or phases for many months and perhaps years as the bonds of Spain, Italy, and Portugal continue to be downgraded by the rating agencies.

Eventually, the crisis will end, as many predict, with a bailout of this debt by European taxpayers through the intervention of specific European governments.  History has witnessed similar events many times.  As currencies become debased, the public moves into gold to protect assets and hedge against the inflation which profligate government spending has created.  We expect this pattern of history to repeat itself with only small variations.

MARKET SOPHISTICATION AN ILLUSION?

Although it appears on the surface that markets are becoming more sophisticated with the advent of mathematically calculated trading and instantaneous, computer-driven execution, the opposite is actually the case.  Markets are becoming more reactive to daily events, and less sophisticated in analyzing and discounting future events.  This is caused in part by the fact that algorithm writers often rely on patterns that can be gleaned from historical trading tendencies rather than in-depth economic analysis.

Let us consider the hypothetical case of semiconductor stocks that generally follow a trend of slower earnings growth during the second calendar quarter as compared to the first calendar quarter of that same year.  As a result of this trend, the algorithm writers will recommend selling semiconductor stocks in April after first quarter earnings are announced.  Now, let us say this trend is consistent for 2003-2008.  During this time, algorithms will do a good job of predicting market behavior.

However, a more sophisticated analysis, which algorithm writers would miss because they are mathematicians and not market players, is that in 2010, semiconductor manufacturers have a unique opportunity to reverse that historical trend due to the fact that last year the world economy was rapidly contracting in early 2009 and demand was low.  Conversely, in the period of April through June of 2010 semiconductor orders and deliveries will reflect inventory restocking and a growth of basic demand due to stronger global business trends.  In the second quarter of 2010, any type of analysis of business facts will confirm that demand and prices are rising and earnings should be strong for the semiconductor group, yet algorithm based trading programs will often miss these obvious facts.

SUMMARY

The current European government debt crisis will continue to wax and wane but stay with us until European governments take much stronger actions to reign in excessive spending of all types including social and military.  The Euro and British Pound will continue to fall in value versus the U.S. dollar and other better-managed currencies such as the Australian, Canadian and Singapore Dollars, the Chinese Yuan and the Brazilian Real.

Short sellers may want to consider selling the Euro, European bonds, and European consumer stocks.  European exporters and commodity producers may be exempt from the problems.

The U.S. dollar will continue to maintain some strength as the U.S. provides the largest and most liquid markets for currencies, bonds and stocks which will attract those fleeing the collapse of their home currencies.

Longer term, the U.S. will be faced with problems similar to those Europe faces today, although in the short term, the European problem will act as a windfall for the U.S. and allow Americans to delay their day of reckoning.

Gold will be the primary beneficiary of the flight from the European currencies and we believe that the current leveling off of real estate prices in China will shift some Chinese demand from real estate to gold bullion and Chinese stocks.

Stock markets outside of Europe will continue to attract European money.  We remain bullish on the strong currencies mentioned above, oil, gold, several Asian markets, and exporting companies around the globe.

Thanks for listening.

Monty Guild and Tony Danaher
www.GuildInvestment.com