The markets have had a very good ride so far as all asset classes have benefited from the effects of the reflationary efforts of global Central Banks. Considering these returns, many clients are wondering if it's time to take profits, or if this is really the beginning of a new bull market as the Wall Street pundits are claiming. I for one think that the correct outcome is somewhere in the middle. For now the trend is up, and should continue until most of the liquidity created by global central bank stops influencing the economy, the shorts, and those still believing in the American Dream. For the near future I expect that the markets will continue to increase, however it will be important to keep an eye on the value of the $US as an exit signal. A good strategy to take during this reflationary period would be to take advantage of these rising markets to raise cash and reposition portfolios to benefit from the next act of this Kondratieff Winter.

The reflation efforts should continue to have their effects for a while. Money creation by central banks always leads to higher asset values. The focus for this next period will be on the declining value of the $US as the US needs to continue to inflate in order to survive. However, unlike Argentina's Peso, the $US is the worlds currency reserve and as such all other countries central banks will also inflate their money supply in order to assist in a moderate devaluation of the $US. Even Canada' Goldman Sachs trained central banker, Mark Carney, is trying to devalue the $Cdn. This global strategy will continue until the world starts to trade in currencies other than just the $US. Many analysts are mesmerized by the increase in the price of many commodities in view of the economic slowdown we are going through; what they are not accounting for is the level of money devaluation that has taken place on a global basis over the last year. Prices are not yet increasing because of greater demand or lower supply but because money is devaluing.

Through this period it is important that a flexible bull/bear strategy be implemented in order to benefit from these currently raising markets, and to prepare for the next leg down. In essence investors should stay invested in their preferred asset classes while maintaining adequate levels of cash to match their own risk tolerance. Cash levels should be in line with each investors risk tolerance, and last years market action should give a very good indication of the level of volatility one can handle. By maintaining a constant level of cash, the rational investor will be forced to sell into this rising market and thus be ready for the next phase of this financial hurricane. The cracks in the system are already starting to show; as currency values are declining the value of hard assets are increasing and inflation is starting to creep into the system. Nobody is noticing inflation because their Keynesian training keeps them looking to the demand side, while in the mean time inflation is setting up on the supply side.

If history is any judge, current events are in line with what transpired in Argentina in the late eighties and Germany in the twenties. As money entered the system the values of all markets increased for a number of quarters, but these rises were negated by the drop in the value of the currency. On the supply side, the lack of credit created a shortage for the things necessary to maintain normal quality of life; food, and energy. As of late, sugar prices are up almost 20% due to low Indian yields as a result of changing weather patterns. In Argentina and Canada crops have been affected by drought and heavy rains, and on the energy side the International Energy Agency is warning of supply problems due to depletion and lack of investment in the sector.

Goldman Sachs latest report of August 5^th, Commodity Prices to Spike, is also warning of coming supply issues due to under investment as a result of the financial crisis;

"As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the market balanced… As the developed world increasingly begins to consume like Westerners the demands placed on the finite resources of the planet increases. This trend of human populations growing faster than the earth's ability to produce not only impacts food production but that of commodity usage."

The contraction in the supply of hard assets is just starting and is setting us up for the final act; supply shortages. Furthermore, economic activity in the developing world is starting to come alive and this will affect both the supply and demand for hard assets. At the same time that the world is devaluing their currencies and increasing the value of hard assets, shortages are creeping in and economic activity is picking up. This is a great setup for the next phase of the commodity bull market that began at the beginning of this century. Canada will do very well as we are rich in hard assets including oil and water.

So far our small cap considerations in lithium, gold, and oil have had the most positive impact in the value of the practice. This should continue as these companies continue to uncover value and demand for their products increases. However, since we must stay nimble and be ready to take profits when this market finally turns, it is recommended that we take some profits and liquidate a portion of these winners. Going forward I expect that at some point the reflationary efforts will be overwhelmed by the true reality of the economic paradigm shift we are living through. The US is suffering from ever growing liabilities to fund a lifestyle that they can no longer afford, and the rational investor is beginning to understand the benefit of a strategy correlated to a decreasing $US and US bond market. To date only 48% of the financial systems' debts have rolled over with the remainder set to come due between now and spring of 2010. As a result, I expect that the Fed will have to sacrifice the $US in order to monetize the US bond market with lower yields for the rollover of these liabilities. Furthermore, I do expect that by next year we will also be hearing more talk of another stimulus package.

Which ever way you slice it, we are heading for an environment of higher borrowing rates for the US and a lower $US. Short term, the markets continued rally should benefit those that stayed invested at the bottom but it is probably time to start to prepare for another leg down.