themusingsoffritz March 2, 2007

Equity Markets

The corrections seen this week did not really come as a surprise. They only surprise is that it came out of China. The drop in China is not significant in and of itself. There have already before been some 5% reductions in a single day. Taking into account that the Chinese market has been inflated by speculative buying a correction is certainly healthy. According to some reports the government itself was very much concerned about the enormous amount of money flowing into the stock market and projects and the respective speculation. Their measures to curb speculation caused the correction in the 2 overbought markets (Shanghai and Shenzhen). Will they do it again? Most probably yes.
That the other markets did follow the Chinese sell off shows that there was already certain nervousness in mostly overvalued markets. The only surprise may be the fact that the US markets did hold relatively well. It must cost a lot of money to keep this market under control. Money that has to be created and certainly will end up in much higher inflation.
China does not seem to be a problem. With a money supply increase of approximately 20%, a recession is probably not around the corner. With such a high increase in money supply I would rather expect to see further growth and demand for commodities, at least for the near future.
Is the correction over? Possibly not yet. As I believe we will see more money created in order to keep the markets from crashing, I do expect higher prices towards the end of the year. However in the short term market might go down further, which would provide excellent opportunities to buy stocks at much better prices. Which stocks do I prefer, definitely the stocks of companies that produce real “stuff”. Favorites are unhedged gold and silver producers, oil&gas companies and companies active in service to these companies (drilling).
An interesting quote from Marc Faber on Bloomberg
Quote
He recommended investors buy commodities such as gold, oil and copper.
``I think we're in the middle of the biggest asset bubble ever,'' said Faber, who oversees $300 million in assets at Hong Kong-based Marc Faber Ltd., in a speech at the CLSA Japan Forum today in Tokyo. ``This asset growth has been largely responsible for driving economic growth, especially in the U.S.''
Unquote
Please check the webpage and the interesting comment from Richard Russell “Great Balls of Fire”
For those being on the sidelines I suggest to wait until the dust settles. Those holding good real “stuff” producing companies, I would hold on or maybe in the case you have already very high profit, take some profit. Taking profit is certainly not a bad idea. So far I never have heart of anybody getting poor due to profit taking. Not taking profits leads certainly more often to regrets


Derivatives
To my “gusto” there is simply too much money invested in derivates. Particularly I do not like that approximately 80% is invested in derivates that in some way are related to interest rates. This in my opinion is pure Casino. Unwinding existing derivative structures is not easy in a moment when everybody wants to leave. The much higher volatility might have caused some problems for some of the holders of derivative positions. It would not surprise me to hear in some weeks of some Hedge Funds being in trouble.
Bonds
This week we have seen a flight to quality. However I do not see how the very low yields really do show quality. The yields are simply too low even for lower rated bonds. Being invested in bonds does not pay sufficient to make up for the high inflation.
Precious Metals
I still believe that we will see much higher prices in gold and silver at the end of the year. My personal target for gold is somewhere between USD 850 – 1,000 oz. and for silver USD 20 oz. fundamentally nothing has changed. There is still a deficit in physical gold and silver production. In gold for example the deficit is around 1,500 tons. There are more and more news about major precious metals producers having their production decreased due to various reasons. Furthermore it seems that the Central Banks that did sell gold before reduced or even stopped their selling considerably and that some Central Banks started to buy gold as a diversification to their other currency holdings.
Oil
In the oil market we have basically two important factors. One is certainly the Peak Oil. As you know I am strong believer of Peak Oil Theory and I believe that most probably we are already past Peak. The big oil fields are either already officially (Mexico’s Cantarel) or not officially yet put possibly (Saudi’s Al Gahwar) in decline. Of course the data from the M.E. producers are not reliable but the signs indicate that several producers possibly are already past Peak. It certainly does not make much sense for the Saudi’s to spend billions for drilling looking for new reserves if they really do have all those nice reserves they claim. Furthermore it does not make much sense that lately they are selling more and more heavy crude if the sweet light crude can be extracted much easier, with less refining costs and higher prices. A producer extracts the heavy crude only when there is no sweet crude anymore. By the way the Saudi’s imported last year for the first time in the oil history heavy crude in order to refine it. Strange indeed.
The second important factor is the actually geopolitical situation. I do see the same dark clouds over the horizon that Puru Saxena sees in his essay “Calm before the Storm” (interesting read). My feeling is that something is in the brewing and that we will see unfolding in a very short time (maybe we see the Ides of March). I truly hope that I am wrong with my feelings.
Anyway I think it is safe to be invested in Oil&Gas and not to worry about the volatility we have seen in the past. I would rather use corrections to increase positions

Other commodities
Correction or not I do see much higher commodity prices by the end of the year. The growth engines like the BRIC countries will grow further. That will keep up the high demand for commodities.
Environment
The draught in Australia, warm winter in Europe and cold winter in the US can clearly be attributed to the Nino effect. Once this effect stops (April this year), we can expect to go back to “normal”. Which apparentely means a stronger hurrican season than last year, very hot summers in Europe and so on. The weather is definitely changing and nature is showing us that we have gone to the limit if not already passed the limit. From an investment point of view there are some clear trends. A) water, especially drinking water, will be less available and more people will have problems the get water and b) land, due to overfarming and the respective soil depletion will become less productive. This fact in combination with less land due to more golf courses, highways, houses etc, will lead to less food production.
The water problem, more difficult weather conditions, lower soil quality, less arable land, higher productions costs (due to higher oil prices) and now the demand for ethanol will result in much higher food prices. Investments in Water, Soft Commodities, Real Estate holding Farm Land (eg CRESY), Timber, Fish Farms should do well in the future.
Due to the demand to produce Ethanol from grains (which in fact is a bad deal as more energy is needed to produce energy and therefore is energy negative) has already resulted in higher Corn, Wheat and Soy Bean prices. Expect this to go on and to see further situations where governments start to freeze the prices of the basic food for the major part of the population (Mexico’s freeze for Tortilla).