April 22, 2009

Paradigm Shift: Fundamental unperceived change in
an individual's or a society's view of how things work in the world

The bears where out in full form last week in Toronto. Papa Bear himself, Eric Sprott, gathered Meredith Whitney of Meredith Whitney Advisory Group, Nouriel Roubini of New York University and Ian Gordon, author of The Long Wave Analyst newsletters, to tell us how the world we know is over and of how from the resulting Armageddon a new reality will reshape our world. As a friend commented, the message was so gloomy that if they had passed out guns we would have had another Georgetown Suicide in Toronto that night. As much as I would agree with many of these bearish projections, I must also warn you that it serves no productive purpose to dwell on the half empty bottle and fight the inevitable changes. My experience in this business has taught me that the direction of the changes does not matter as long you position in a way to benefit from the changes. The main obstacle that the average investor will have to overcome is the recognition that change is afoot so that he can reposition his assets in a beneficial tack as soon as possible. This is particularly important in view of the "rear view" mentality of the investment industry.

The years ahead can be best described by the two Chinese symbols which when used together make the word danger; crisis and opportunity. Three trends will greatly influence investment considerations during the next decade; the current financial mess, agriculture, and energy. It is essential to understand how they are interconnected in order to position your portfolios to benefit. I must also note that of these three themes only one has an immediate solution, and that solution is inflation.

Financial crisis.

The policy response of Central Banks to the current financial crisis has been money creation in order to generate inflation. Calls for deflation are abetting as some begin to realize that these reflationary policies (inflation) are working, we don't even talk in terms of billions anymore, everything thing is in trillions. Germany understands the inflationary consequences of this policy, having suffered from hyperinflation twice in the last hundred years because of it. Germany's response, which has been to begin to restrain both it's bail outs and money creation, is been followed by an increasing number of G20 nations also questioning the rational of current US policy. The US's biggest European supporter, the UK , is also being criticized in the European Parliament. Look up Daniel Hannan on You Tube and watch the "Devalued Prime Minister" to see how some European politicians feel about Gordon Brown's fiscal policy. At the same time we are starting to hear more chatter about the need for a lower the US $, even the IMF has called for the consideration of a new basket of currencies to include gold for global trade. To top it all of the US needs to borrow at least $US 5 Trillion this year, this is highly unlikely without the printing press. The devaluation of the US $ is inevitable as the $US needs to inflate to keep up. Up to now the pundits on Wall Street and the media do not talk about the resent rise in hard assets because they are looking at the relative values of their own currencies, not noticing that all hard assets are rising in tandem against all currencies. Yes the $US might be high right now but they are all sinking in tandem, this just what I expected in the fall as we begin to witness the transfer from paper assets to hard assets, an exact replay of what has historically taken place. Like the lack of movement noticed when all vehicles move forward at the same time, the rise of hard assets since October has been almost unnoticed; gold is up 32% since it's October lows of $681, WTI is up 41% from it's December low of $35.13, and it's same story with the grains. Going forward I expect that this rise will become more noticeable as currency values start to diverge between the fiscally prudent, hard asset based, and economically viable ones. This is just being witnessed by the resent rise in the $Cdn, $Aus, Brazilian Real, and others.

On the political front the new US Administration does not seem to understand that you do not cure a hangover with more alcohol, or the fact that you do not make the fox the foreman of the chicken coop. As President of the Federal Bank of New York , Secretary Geithner would have been an integral player in developing the regulatory environment that got us in this mess, and we should not expect much change from him. Here is a man who was delinquent on his taxes for many years until he was offered the job, he denied in congress having any say on regulatory measures while at his post with FBNY which is highly unlikely regarding his position. In my opinion integrity is not part of his character. Furthermore, he has not even hired anybody for the 12 positions under him, he is doing it all himself. Look up Bill Moyer's interview of William Black, former S&L regulator, on You Tube to get a true picture of the banking regulatory environment and Mr. Geithner. Not only are we witnessing increasing concerns from outside the US but also internally. Look up Tea Party on You Tube and witness the increasing level of frustration being felt by American tax payers being asked to mortgage their unborn grand children for the sake of the financial institutions. Concerns are even being at the State level, as witnessed by Texas Governor, Rick Perry, backing a resolution affirming the sovereignty of the State as guaranteed under the 10 th Amendment. As stated in the resolution; " our federal government has become oppressive in its size, its intrusion into the lives of our citizens, and its interference with the affairs of our state due". Again, not a good sign for the US $.

As expected the Wall Street pundits are rejoicing at the recent better than expected earnings from some companies in the US Banking sector. I would not get to exited as this will not last. With $ US 5 trillion currently in the banking system at zero rates being invested at 2.5%, is it any wonder that we are seeing a reversal in the earnings slowdown. However current policy to get the US economy going is focused on getting the consumer spending again. I really do not know were they will borrow from, maybe the credit card. To many are still hoping that the US economy will improve by year end, and as a result I expect that the US market will keep rising higher until the reality of real economic mess becomes apparent later in the year. As expected, this trend is causing a reversal in the low risk trade as money comes out of the US bond market and gold. So far our call to underweight the precious metals is working, only having a position in silver. I expect to rebalance into gold later in the year as we begin to witness greater inflationary pressures, which will be the catalyst for much higher gold and precious metals prices. For now I will continue to overweight the energy sector.

Agriculture.

Currently, the world is using up 98% of arable land and global grain supplies for feeding 6.5 billion people are only sufficient for a month and half. The Southern hemisphere has just undergone one of the worst cases of drought in many years. Similarly, California and Arizona are already suffering from drought, and are now rationing water. Furthermore, heavy rain in the US Mid West are also causing havoc in many parts of the agricultural belt. In late March the US Agricultural Department issued a warning for higher food prices this summer. In a nut shell the global food issues we dealt with last summer seem to be intensifying but the media is again focusing on the wrong issues. Higher food prices will be the norm going forward due to global population growth, weather related issues, and to energy constraints in producing food and fertilizers. Investment consideration in this sector is a must in order to hedge one own food consumption, and to benefit from higher food prices. This is particularly proven by the current increase in Intrinsic value of many of the companies in this sector, right now this sector is offering growing value acceleration of earnings and the stocks are just starting to catch up. This sector will be moved forward by inflation and the continued earnings acceleration due to shortages.

Energy.

The current financial mess has overshadowed the reality that current depletion of oil reserves is tracking 9% annually. According to the International Energy Agency we have to discover the equivalent of one new Kuwait a year in order to maintain current global oil consumption of 87 million barrels a year; this is just not happening. During the last decade oil discoveries have only averaged about 1% of this needed deficit. In addition the sector requires trillions of dollars to upgrade the infrastructure that produces energy, the current financial mess eliminated any excess capital, rigs drilling are at an all time low, and supply destruction is far greater than the 3% expected loss in demand; supply destruction is upon us. The price of oil is finally making it's way back to it's need it fundamental production value of $US60 to $US80, this band will shift with changes in the value of $US. As expected most of this change has been due to changes in the value of currencies, and this will continue as currencies find their individual values. By this summer I expect that we will start to see the effects of supply destruction in the system, and this will be the factor that will once again fuel another rise in the price of crude. What most did not notice was that the industry was unable to bring in new supplies of oil when the price was at $147, and this time around there is no capital for much. I am sorry to say but the next run up will be to much higher values fuel by inflation lack of supply. Even without discussing the geopolitical landscape, declining supplies and the inflation will only lead to higher energy prices.

On the political front the US Administration again doesn't seem to get it. Their solution is to tax the energy complex so that they can use these funds to generate the clean energy promised, this will just not work. What they do not understand, as pointed out in the Hirsh Report prepared for the US Energy Department in 2005, is that this is a race for the replacement of energy output. In order to get ahead we need to encourage both energy generation from traditional sources and new sources, and this policy only constraints generation of energy from traditional sources. Is it any wonder that Halliburton, Dick Chaney's company, has left the US to set up it's head of in a tax free jurisdiction.

I urge you to read Atlas Shrugged written by Ayn Rand in 1957, she nailed it. Highly recommend it to anybody that wants to understand the economic and political environment the US is embarking on.

As you can see these three trends are coming together to setup a great investment strategy for those that set themselves to benefit from the just beginning transfer from paper assets to hard assets. The value of my practice is the know how on how to position one's net worth in a way to benefit from this Paradigm Shift..