February 17, 2008

Words from the (Investment) Wise for the Week That Was (Feb 11 - 17, 2008)
by Prieur du Plessis

Financial markets ended the past week on a subdued note as economic data, credit concerns and recession talk dominated investors' mood.

The Fed kept itself in the headlines during the week. Ben Bernanke spoke before the Senate Banking Committee on Thursday morning and reiterated that the Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks". He also noted that "the outlook for the economy has worsened in recent months, and the downside risks to growth have increased". Bernanke's comments caused renewed worries among many pundits.

The rather disturbing developments in the bond insurance market also gave investors food for thought, pondering the outcome of Warren Buffet's "rescue offer" to the monolines, and New York governor Elliot Spitzer's deadline for them to find fresh capital within three to five business days in order to avoid a "tsunami-like disaster".

Before highlighting some thought-provoking news items and quotes from market commentators, let's briefly review the financial markets' movements on the basis of economic statistics and a performance chart.

Economy
The economic news during the past week saw an unexpected rise in retail sales last month, industrial production for January back at the record level of September 2007, and the trade deficit falling by 6.9% in December - a bigger improvement than expected.

On the other hand, manufacturing activity in New York recorded its biggest decline on record, the University of Michigan's consumer sentiment dropped to its lowest level in 16 years, and import prices surged by 13.7% from a year ago - the highest reading since the start of the data series in 1982.

The combination of these reports was interpreted by many as a deterioration in the US economic outlook. Reacting to President George W. Bush's statement that the economy remained "structurally sound", Bill King (The King Report) remarked: "If things are so structurally sound, why all the Third World bailouts of leading US financial institutions, a stimulus package and 125bps of rate cuts within 8 days?"

WEEK'S ECONOMIC REPORTS

The next week's economic highlights, courtesy of Northern Trust, include the following:

1. Consumer Price Index (Feb 20): A 0.2% increase in the CPI is predicted for January following a 0.4% gain in December. The core CPI is expected to have moved up 0.2% compared with a 0.2% increase in December. Consensus: +0.2%, core CPI +0.3%.

2. Housing Starts (Feb 20): Permit extensions for new homes fell 7.1% in December, which leads us to conclude that there was a large drop in housing starts during January (965 000). Starts of new homes fell 25.8% in 2007. Consensus: 1.01 million as against 1.0 million in December.

3. Leading Indicators (Feb 21): Interest rate spread, stock prices, and projected orders of durable goods posted declines in January. Initial jobless claims, consumer expectations, vendor deliveries, and real money supply made positive contributions. The manufacturing workweek held steady in January. The net impact is a 0.1% drop in the leading index during January following three consecutive monthly declines. Consensus: -0.1%

4. Other reports: NAHB survey (Feb 19) and Philadelphia Fed Survey (Feb 21).

Markets

The performance chart obtained from the Wall Street Journal Online indicates how different global markets fared during the past week.

Source: Wall Street Journal Online, February 16, 2008.

Equities
Global stock markets closed the week broadly higher with the MSCI World Index gaining 1.9%. Japan was the star performer among mature markets and rose by 4.7% on the back of better-than-expected fourth-quarter GDP data.

Investors were relatively upbeat during the first three trading days of the week and US stocks recorded their first three-day rally since December 27, 2007, but the mood turned for the worse after Ben Bernanke's testimony on Capitol Hill. The net result was nevertheless still a gain for the leading indexes, with the Dow Jones Industrial Index and the S&P 500 Index both improving by 1.4% and the technology-heavy Nasdaq Composite Index edging 0.7% higher. Gold and silver stocks (-2.2%), financials (-1.1%) and retailers (-1.1%) were the notable decliners for the week.

Emerging markets in general outperformed developed markets, with Russia (+6.3%), Brazil (+3.7%), India (+3.7%) and Hong Kong (+2.9%) all chipping in useful gains. The New Year celebrations resulted in the Chinese markets being closed for the first two days of the week.

Bonds
The yields on longer-dated government bonds were pushed higher as a result of mounting inflation concerns, whereas shorter-dated maturities fared better on the expectation of rate cuts. The US 10-year and 30-year bond yields closed the week 12 and 14 basis points higher respectively, but the two-year yield declined by 3 basis points. This resulted in a gap of 187 basis points between two- and 10-year yields - the widest since July 2004.

The yield curve also steepened in the UK, Germany and France, albeit on a more modest scale than in the US.

Currencies
The US Dollar Index declined by 0.2% for the week on Ben Bernanke's grim economic outlook and the prospect of further rate cuts in the US.

Elsewhere, the Swedish krona appreciated by 2.3% against the US dollar and 1.1% against the euro after the Riskbank's surprising increase of the Swedish base rate by 0.25% to 4.25%. The British pound (+0.9%) also gained against the US dollar as a result of poor UK inflation data tempering expectations for aggressive rate cuts by the Bank of England.

Commodities
The Reuters/Jeffries CRB Index (+2.3%) powered ahead during the past week, resulting in an all-time high.

Leading the pack was platinum that jumped by 9.6% to a record level of $2 060 as investors remained concerned about electricity rationing in South Africa - which represents 80% of world production - adversely affecting global supplies. The gold price was less fortunate and declined by almost $20 from Monday's high.

US wheat also experienced significant interest last week, necessitating the doubling of the trading band before limits up or down are triggered. Hard red spring wheat jumped by 28% to a record of $19.88 a bushel.

The West Texas Intermediate oil price rose to a one-month high of more than $95 a barrel on supply concerns of refinery problems and Hugo Chavez threatening to cut off sales of Venezuelan oil to the US. Cold weather in the US also supported the prices.

Now for a few news items and some words (and graphs) from the investment wise that will hopefully assist to make sense of markets' action during the shortened week ahead.

What's subprime debt worth? Ask Einstein ...

Hat tip: John Hussman, Hussman Funds

Barron's: Interview with Jeremy Grantham - This credit crisis has a long way to run

"People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' - when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.

"The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50% and the Nasdaq - which was all anyone talked about back then - went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market."

Please click on the following link for the complete interview: grantham-interview.pdf

Source: Sandra Ward, Barron's, February 11, 2008.

Financial Post: Interview with Warren Buffet

Source: YouTube.com

Goldman Sachs: US recession pulling rest of world down
"Markets continue to trade down and express concerns about world economic growth. Several weeks ago we described our changed view that the global economies and financial markets would 'recouple'. Initially recoupling started in Europe and Japan, but now we are seeing evidence of this in Asia, particularly China. Several indicators we use to gauge future economic momentum show a strong downward trend.

"We believe that in the coming months we will see increasing signs that the US recession is having a broader impact on the rest of the world: Eurozone growth has been dependent on exports which makes the economy vulnerable to external shocks; Japan suffers from weak domestic consumer spending and is exposed to the US and China; and Chinese GDP growth slowed from 12% in Q3 to 8% in Q4 of 2007, and we have cut our growth forecast for 2008 to 10% with risks to further downgrades.

"Markets have sold off considerably but we still feel that many macro economic issues still have to play out, particularly outside the US. Policymakers in the US have reacted aggressively which, combined with the falls we already have experienced, has improved the outlook for risky assets, but negative macro-economic data releases such as the weak ISM numbers show that markets still react very strongly to negative surprises."

Source: Leo van der Linden and Frederik de Nerée, Goldman Sachs, February 11, 2008.

Financial Times: G7 leaders say world economy vulnerable
"The world economy remains vulnerable to downside risks stemming from tighter credit, a deterioration of the US housing market, higher oil prices and rising inflation, according to G7 finance ministers gathering in Tokyo on Saturday.

"Although 'long-term fundamentals remain sound' and recession in the US and elsewhere could be avoided, according to the final communiqué, the world's richest nations said they stood ready to 'take appropriate actions, individually and collectively, in order to secure stability and growth'."

Source: David Pilling and Jonathan Soble, Financial Times, February 9, 2008.

Bill Cara: G7 meeting spells stagflation
"The reports from the G7 meeting in Tokyo seem to be saying that stagflation is enemy #1, which is another way of saying slowing economic growth and possible recession is problem 1a and inflation is problem 1b.

"Like the 1970's that followed the Vietnam War, stagflation has reared its ugly head again. During those years, neither equities nor fixed income markets were healthy. It wasn't until 1982 when global economic factors coalesced to underlie the 20-year period of global expansion. The only question now is whether the BRIC emerging economies need the engine of a strong US economy or whether they can do it on their own."

Source: Bill Cara, February 11, 2008.

The Wall Street Journal: Bernanke open to a sizable rate cut
"Federal Reserve Chairman Ben Bernanke warned that intensifying credit and financial-market pressures are likely to restrain economic growth and left the door open for a sizable interest-rate cut next month.

"Mr. Bernanke, testifying at the Senate Banking Committee, said he expects 'sluggish growth' in the economy and a 'somewhat stronger pace' later in the year, thanks to rate cuts and fiscal stimulus. But he cautioned that housing and labor markets could deteriorate more than anticipated, emphasizing that 'downside risks to growth remain.'

"Treasury Secretary Henry Paulson, at the same hearing, said the government's recent actions - including the $168 billion economic-stimulus package and efforts to modify homeowners' mortgages - would help soften the housing-market correction. But he warned that 'those programs alone will not be sufficient ... It's going to take time and some pain before we work through this.'

"Mr. Bernanke said market worries about mortgage defaults and the ripple effects of bond insurers' woes are contributing to tighter lending standards. 'More-expensive and less-available credit seems likely to continue to be a source of restraint on economic growth,' Mr. Bernanke said. Declining home values and a softening labor market - along with higher energy costs and lower equity prices - are likely to affect consumer spending, he added.

"Mr. Bernanke hinted that officials may soon start discussing an endpoint to the rate cuts. He said the Fed would have to assess whether policy is 'properly calibrated' and whether the recent rate cuts 'are having their intended effects.' Because interest-rate changes take more than six months to work through the economy, Mr. Bernanke said the Fed's near-term policy decisions must take into account improvement expected in the economy later this year."

Source: Sudeep Reddy, The Wall Street Journal, February 15, 2008.

Asha Bangalore (Northern Trust): Disappointing tidings from small business sector
"Small businesses aren't quite pleased with the state of affairs. The Small Business Optimism Index fell 2.8 points to 91.8 in January, the lowest reading of this index in the current cycle and since January 1991 when the index held at 91.4. From the chart, we can see that readings of this magnitude are associated with recessions. In the last recession of 2001, the index hit a low mark of 96.3 in October 2001."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, February 12, 2008.

Asha Bangalore (Northern Trust): January retail sales point to weak Q1 performance
"Retail sales increased 0.3% in January after a 0.4% drop in December and 0.8% gain in November. Changes in retail sales in November and December were previously estimated as a 1.0% increase and a 0.4% drop, respectively. Excluding autos, gasoline, and building materials, retail sales in the fourth quarter show a 2.2% annualized increase previously estimated as a 3.0% gain. This implies a downward revision of fourth quarter GDP (+0.6%), holding other things constant. In the addition, the 1.5% annualized gain based on the January data for the first quarter suggest a weak quarterly performance that is consistent with our forecast of consumer spending (-0.6 %) for the first quarter."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, February 13, 2008.

Bill King (The King Report): US housing will require long period to recover
"Goldman Sachs' Ed McKelvey: It is already clear that the current recession in US housing activity resembles, in depth and duration, the deep cycles that were de rigueur up through the late 1980s rather than the minuscule ones that have occurred since then.

"However, the dynamics of the current cycle are much different than those older ones. Whereas they featured a buildup of pent-up demand, leading eventually to a sharp and sustained recovery, this one features pent-up supply, the correction of which will require lower levels of production for a long period. This may frustrate market participants who contemplate housing investments that may look like bargain basement opportunities, as they are less likely to be bargains than to stay in the basement, at least if our view of the sector is right."

Source: Bill King, The King Report, February 14, 2008.

Bill King (The King Report): US economy structurally sound?
"Bush acknowledged that problems exist but reiterated the same trite bromides, 'the economy remains structurally sound' and GDP will soften in the first half of 2008 but accelerate later in the year.

"If things are so structurally sound, why all the Third World bailouts of leading US financial institutions, a stimulus package and 125bps of rate cuts within 8 days?"

Source: Bill King, The King Report, February 11, 2008.

The New York Times - DealBook: Buffett's bond backstop not a cure-all
"In offering to reinsure the nation's troubled bond insurers, Warren Buffett is not proposing a bailout of Wall Street -- it's more about Main Street.

"At first blush, Mr. Buffett's proposal, which he made public on CBNC Tuesday morning, might have seemed to be a cure-all for companies such as MBIA, Financial Guaranty Insurance and Ambac, which have either lost or are at risk of losing their precious AAA ratings. But look closer and you will see that the billionaire investor is prepared to provide an extra safety net only for insurance policies covering municipal bonds - debt issued by cities, sewer authorities and the like, which rarely default anyway.

"His offer doesn't extend to collateralized debt obligations and other risky securities linked to subprime mortgages whose value has plunged in recent months. That may by why one firm has already rejected his offer. Mr. Buffett is still waiting to hear from the other two.

"Bond insurance is not a sexy business, but it is proving to be a market-moving one these days. Wall Street is watching carefully to determine the fate of companies such as MBIA, which has insured billions of dollars' worth of securities held by top securities firms. If these insurers, known as monolines, should become unable to pay out on their policies, the effects would ripple through much of the financial industry."

Source: The New York Times - DealBook, February 12, 2008.

Financial Times: Monolines given five days to find funds
"Eliot Spitzer, New York governor, gave bond insurers three to five business days to find fresh capital, or face a potential break-up by state regulators who want to safeguard the municipal bond markets."

Source: Aline Van Duyn, Financial Times, February 14, 2008.

Ambrose Evans-Pritchard (Telegraph): US credit crisis escalates as defaults spread
"Defaults in the US housing market are spreading from sub-prime to the much larger stock of top-grade housing debt, threatening to set off a wave of even bigger losses for banks and investment funds.

"The Mortgage Bankers Association says default rates on all outstanding home loans in the US have reached 7.3%, the highest level since modern records began in the 1970s. Arrears on 'prime' mortgages have reached a record 4%, confounding expectations that middle-class Americans with good credit records would be able to weather the storm.

"While sub-prime and close kin 'Alt A' total $2 000 billion of debt, the prime market in all its forms is roughly $8 000 billion. If prime default rates rise on their current trajectory, they could ultimately cause huge financial damage."

Source: Ambrose Evans-Pritchard, Telegraph, February 13, 2008.

The Wall Street Journal: Lenders step up effort to avert foreclosures
"Prodded by the Bush administration, six major mortgage lenders are due to announce today a stepped-up effort to rescue homeowners on the brink of foreclosure. Under the latest plan, dubbed Project Lifeline, the lenders promise to seek contact with homeowners who are 90 or more days overdue on their mortgages. In some cases, homeowners will be given the chance to 'pause' their foreclosure for 30 days while lenders try to work out a way to make the loans affordable.

"Unlike the plan announced in December to freeze interest rates at current levels on certain adjustable-rate loans, this latest effort is to involve all kinds of home loans, not just subprime mortgages, a higher-cost variety for people with blemished credit records or high debt in relation to income.

"The participating banks, which service about half of the US mortgage market, are Bank of America Corp., Citigroup Inc., Countrywide Financial Corp., J.P. Morgan Chase & Co., Washington Mutual Inc. and Wells Fargo & Co. - all members of the so-called Hope Now Alliance. They are working with the US Treasury and Department of Housing and Urban Development."

Source: Damian Paletta and James R. Hagerty: The Wall Street Journal, February 12, 2008.

John Parry, Reuters: Depression risk might force US to buy assets
"Fear that a hobbled banking sector may set off another Great Depression could force the US government and Federal Reserve to take the unprecedented step of buying a broad range of assets, including stocks, according to one of the most bearish market analysts. That extreme scenario, which would aim to stave off deflation and stabilize the economy, is evolving as the base case for Bernard Connolly, global strategist at Banque AIG in London.

"'Avoiding a depression is, unfortunately, going to have to involve either a large, quasi-permanent increase in the budget deficit - preferably tax cuts - or restoring overvaluation of equity prices,' Connolly said.

"'If conventional monetary policy is not enough to produce that result, the government may have to buy equities, financed by the Fed,' Connolly said.

"Legal changes would be needed to give the Federal Reserve and the US government the authority to buy stocks. Currently the Federal Reserve can buy only debt issued by the Treasury, as well as US agency debentures and mortgage-backed securities."

Source: John Parry, Reuters, February 12, 2008.

GaveKal: Government bonds overbought

Source: GaveKal - Checking the Boxes, February 12, 2008.

Richard Russell (Dow Theory Letters): US bonds are smelling inflation
"The bonds appear to have topped out. This occurs when the bond market senses an expanding economy ahead or rising inflation ahead. So what are the bonds sensing? Something 'changed' on January 23, shown by the black reversal day on the chart. Today the long bond broke below its red 50-day moving average, indicating that rates are turning up. My guess - the bonds are smelling inflation."

Source: Richard Russell, Dow Theory Letters, February 14, 2008.

David Fuller (Fullermoney): Government bonds could be hit hard
"The chart patterns of bond futures are an inverse mirror image of stock market indices. In other words, the selling climax in stock markets on 22nd January was matched by a buying climax for long-dated government bonds, which are taking their cue from the equity markets.

"If stock markets continue to steady on diminishing concern over global GDP growth, long-dated government bond prices will be hit hard. The Australian government 10-year bond price gives a preview of what could happen in the UK, Continental Europe, America and Japan."

Source: David Fuller, Fullermoney, February 15, 2008.

John Hussman (Hussman Funds): Stock market - remain fully hedged
"The strongest factor driving market returns here is the unfavorable condition of market internals including price/volume behavior, breadth, leadership, industry action, credit spreads, and other factors. Meanwhile, it's important to reiterate that P/E ratios based on 'forward operating earnings' and even our own 'price/peak-earnings' measures are somewhat corrupted here by the fact that the earnings in these ratios implicitly assume the continuation of record profit margins about 40% to 50% above long-term norms.

"As a result, we are also attending to measures that take profit margins into account more explicitly. To the extent that profit margins are not likely to be sustained indefinitely, P/E ratios are likely to be a poor metric of valuation, encouraging investors to believe that stocks are cheap on the basis of recent earnings, when they are not at all cheap on the basis of long-term earnings power.

"Again, my guess, and it's just a guess, is that a sustained rally - if only a sustained bear market rally - will be more likely a) at the point that investors fully accept recession as common knowledge, so they can start putting 'recession' behind them without fear that it's still ahead, or b) at the point the S&P 500 declines a full 20% from its high (anywhere below 1250) - again, so they can start putting 'bear market' behind them without fear that it's still ahead. Strangely, the market often responds well when investors recognize that their fears have become reality, because at that point investors can at least begin to believe that the worst is behind them.

"That doesn't mean that things won't, in fact, deteriorate beyond a 20% market decline or a shallow and well-recognized recession. But as I've frequently noted, most bear markets are not simply one-way movements. Bear markets typically comprise two, three or more separate 10% to 20% declines, punctuated by fast, furious rallies. It's easy to forget that the 2000 to 2002 bear market included three bear market advances of 20% from intra-day low to intra-day high, as well as numerous smaller advances, all of which were surrendered in subsequent plunges to new lows.

"For now, we remain fully hedged."

Source: John Hussman, Hussman Funds, February 11, 2008.

Richard Russell (Dow Theory Letters): What is the stock market saying?
"The market continues to hold up in the face of rotten news. The stock market isn't falling apart, but it's not rallying that much either. What could the market be "saying?" My guess, and it's strictly a guess - difficult times coming, but only in certain areas. In other areas the living will be easy. The Midwest will be having a ball with agricultural crops bringing in top dollars. Conditions will be spotty across the nation, but it may be hard to call it a real recession. Housing to remain a weak spot. No across-the-board great times, but no disaster either. Keep your stock-market powder dry, profits may be hard to come by.

"The dyed-in-the wool bears will be frustrated. The good-time bulls will frustrated too. And inflation will be in the saddle."

Source: Richard Russell, Dow Theory Letters, February 15, 2008.

David Fuller (Fullermoney): What some smart investors are doing
"First, a drama review. We had a repeat of August's shock and awe last month. Practically everyone expects a threepeat (an American portmanteau word). George Soros has become the high priest of US bashers, predicting a road to serfdom. US banks, issuing bearish reports on each other, propelled short selling on the New York Stock Exchange last month to its highest levels since 1931! Even Asian investors have been quaking recently.

"These are reasons enough for investors to despair of worldly goods and head fatally for the window ledge, except gentle reader, they are contrary indicators.

"Let us now consider what some smart people are doing: Monoline bond insurers meltdown? You have almost certainly heard about it but guess what - Warren Buffett wants to assume their liabilities. Banks are Devil's spawn, right? Well, that may be an exaggeration and Bill Gross of Pimco said 'Citigroup, Bank of America and Wachovia Corp. were appealing'. Mortgage meltdown? Sure, but this is an election year, so look at Hank Paulson's latest effort. Lastly, Barton Biggs, who has seen a few market cycles said yesterday that the market is 'at or very close to an important bottom'. That remains the Fullermoney view."

Source: David Fuller, Fullermoney, February 12, 2008.

Bloomberg: Pimco shows Alwaleed isn't only one in love with Citi
"Citigroup Inc. has never been held in such low esteem by debt investors, and that's why Prince Alwaleed bin Talal isn't the only one in love with the bank whose looks are deceiving.

"Pacific Investment Management Co., manager of the world's largest fixed-income fund, and Calvert Asset Management Co. said Citigroup and Bank of America Corp. are attractive because yields on US bank bonds are near record highs relative to Treasuries. Alwaleed, the biggest shareholder in New York-based Citigroup, bought more of the bank's stock even as the S&P 500 Financials Index fell 9.1% this year.

"The world's largest financial companies have incurred $146 billion in losses from securities tied to subprime mortgages, and Pimco and Calvert say bond yields compensate for the risk that there's more to come. The firms raised $84 billion selling equity stakes to investors such as Saudi Arabia's Alwaleed.

"'The fact that the banking sector has attracted fresh capital in the last couple of months is huge,' said Mark Kiesel, an executive vice president at Pimco. 'We've been playing defense for the better part of two years, and the question we've been asking ourselves is when to go on offense. In the banking sector, we've started to do that.'"

Source: Caroline Salas, Bloomberg, February 12, 2008.

CNN Money: Earnings - nowhere to go but up
"Yes, banks had an awful fourth quarter. With 77 of the 92 companies in the financial sector having reported, the fourth-quarter results from this group are on track to be the worst for any sector since Thomson Financial started tracking earnings in 1997.

"The sector has been hit hard by massive losses from heavily weighted companies such as Merrill Lynch, Bear Stearns, E*Trade Financial, Morgan Stanley and Citigroup. And because of the losses, Thomson has yet to be able to determine just how big of a percentage drop financial earnings have taken.

"But if you strip out the financials, earnings for the S&P 500 would be on track to rise 11.8% versus a year ago thanks to healthy results from several other sectors. In particular, technology earnings are forecast to have grown 26% in the fourth quarter, while energy sector earnings are expected to have grown 20%. That strength is expected to continue in the first quarter of 2008, with technology earnings expected to grow 10% and energy 24%.

"The performance of tech and energy could add weight to the argument that outside the financial and housing sectors, the economy is holding up better than market psychology would suggest, said Peter Brodie, director of investments at Bryn Mawr Trust Wealth Management."

Source: Alexandra Twin, CNN Money, February 11, 2008.

BCA Research: Euro area equities - further downside ahead
"The correction in euro area equities ... has further to run. The euro area equity market tends to be cyclical in nature, making it vulnerable when coincident macro indicators are weakening (which is currently the case). In addition, restrictive monetary conditions adds to the risk as past rate hikes and euro strength are acting as a drag on regional business activity. While the ECB is starting to shift its tone, monetary relief is still a few months away.

"In the interim, our profit model warns of a further deceleration, at a point when expectations remain elevated. One caveat worth noting is that euro area equities still offer attractive valuations, despite strength in recent years. However, cyclical factors should trump valuations over the next few months. Bottom line: Euro area equities remain vulnerable to further downside. Stay underweight this market relative to the US."

Source: BCA Research, February 12, 2008.

Reuters: G7 approves IMF gold sales
"The Group of Seven rich nations on Saturday approved the sale of gold by the International Monetary Fund from April as part of a broad reform of its budget, Italian Economy Minister Tommaso Padoa-Schioppa said.

"'There was an acceptance among the G7 that resources should be raised by selling gold,' Padoa-Schioppa, who is also the head of the IMF's steering committee (IMFC), told reporters after a meeting of G7 finance ministers in Tokyo. 'The current gold price means a flow of income can be ensured,' Padoa-Schioppa said.

"Morgan Stanley analyst Stephen Jen said the Fund held 103.4 million ounces of gold worth some $92 billion at current market prices. That was up from $23 billion just five years ago. 'The IMF is rich, if it wants to be,' he wrote in a recent note to clients, issued before the G7's approval of the gold sales. 'This is arguably a good time to consider selling some of these gold holdings and investing the proceeds in financial securities with positive yields.'"

Source: Gavin Jones, Reuters, February 9, 2008.

Chris Powell (GATA): Mobilization of IMF gold a sign of central bank desperation
"Before panicking about the Reuters story [above], reporting that the G7 conference in Tokyo likes the idea that the IMF should raise money for itself by selling some of its gold reserves, consider a few things.

1) The prospect of gold sales by the IMF has been hanging over the gold market for years.

2) For almost a decade now central bank gold sales have been accompanied by higher gold prices, not lower prices. Gold demand has been exceeding gold production by about a thousand tonnes per year, the gap being covered only by central bank dishoarding. Even with the rising price gold production is declining, the price still not being high enough to make greater production generally profitable.

3) Mobilization of IMF gold suggests that individual central bank gold reserves are nearing exhaustion or that individual central banks are no longer willing to dishoard what they have left.

4) There's no assurance that the IMF has the gold attributed to it and no report as to where the gold is kept.

5) Though it is never questioned by the financial press, the rationale that continues to be offered for selling the IMF's gold is plainly ridiculous. That rationale is, as the Reuters story here reports, that the IMF gold should be liquidated and the proceeds invested 'in financial securities with positive yields.' But what 'yields' could be more positive than the 'yield' acknowledged for the IMF gold, an increase in value of 400% in five years? Is the IMF supposed to be happier with government bonds paying 4% per year against inflation rates several times that?

6) Those who want gold restored as the independent arbiter of the international financial system should be thrilled if all central banks and the IMF dishoarded all their gold at once and got out of the gold market for good. Until then, there really won't be a market price for gold, just a desperately manipulated one, a price well below the cost of production - still a bargain."

Source: Chris Powell, Gold Anti-Trust Action Committee, February 9, 2008.

Jim Sinclair: IMF has history of selling gold at wrong time
"It is important to note that their sales all have taken place at times when major bull markets were either just beginning or, as in 1976 to 1980, at the start of the major parabolic move to then all time highs.

"That is the only implication IMF sales have to the price of gold. It has been the most powerfully bullish event every time they have done it, and will be again.

"If any newcomer to gold sees the IMF news as a reason to sell gold these newcomers are as DOPEY as the IMF has proved to be every time, time and time again."

Source: Jim Sinclair's MineSet, February 10, 2008.

Goldmoney: Silver set to outperform gold
"The price of gold and silver rarely move at the same rate. The reason for this outcome is that their respective demand is fundamentally different. To put it into economic terms, the demand for gold is inelastic, while that for silver is elastic. In other words, the demand for silver is very sensitive to changes in its price, while in contrast, the demand for gold is relatively insensitive to changes in its price.

"The result is that in precious metal bull markets, the price of silver typically rises faster than the price of gold, and vice versa in precious metal bear markets."

Source: James Turk, GoldMoney, February 10, 2008.

David Fuller (Fullermoney): Caution regarding medium-term prospects of precious metals
"... we remain long-term bulls of precious metals but we are also becoming more cautious regarding medium-term prospects. Throughout their bull move commencing in 2001, precious metals have been prone to medium-term (multi-month) advances, usually led by platinum, which end in acceleration amidst a crescendo of bullish forecasts and price extrapolations.

"Peaks are followed by sharp reactions within the long-term upward trends, and then many months of ranging in a new support building process. During this phase investors become despondent regarding gold's prospects and forecasts for all precious metals are downgraded, only to be raised again in the latter stages of the next advance.

"Meanwhile, platinum's acceleration and the overall strong upward bias since last August suggest that we are now at a late stage of this medium-term advance. Tactics, particularly for futures traders, should be particularly disciplined at this stage of the medium-term cycle. It is impossible to know exactly how and when this leg of the uptrend will end but the first clear downward week for platinum could be an early warning.

"Gold mining shares are unlikely to uncouple from bullion's directional moves but they have lagged recently due to the weak tone of global stock markets. Consequently mining shares could be marginally resistant to the next medium-term setback in bullion, provided equities are firmer generally."

Source: David Fuller, Fullermoney, February 12, 2008.

Ambrose Evans-Pritchard (Telegraph): The price of 'peak oil' is famine
"Vulnerable regions of the world face the risk of famine over the next three years as rising energy costs spill over into a food crunch, according to US investment bank Goldman Sachs. We've never been at a point in commodities where we are today,' said Jeff Currie, the bank's commodity chief and closely watched oil guru.

"Global oil output has been stagnant for four years, failing to keep up with rampant demand from Asia and the Mid-East. China's imports rose 14% last year. Biofuels from grain, oil seed and sugar are plugging the gap, but drawing away food supplies at a time when the world is adding more than 70 million mouths to feed a year.

"'Markets are as tight as a drum and now the US has hit the stimulus button,' said Mr Currie in his 2008 outlook. 'We have never seen this before when commodity prices were already at record highs. Over the next 18 to 36 months we are probably going into crisis mode across the commodity complex. The key is going to be agriculture. China is terrified of the current situation. It has real physical shortages,' he said, referencing China still having memories of starvation in the 1960s seared in its collective mind.

"The current 'supercycle' is a break with history because energy and food have 'converged' in price and can increasingly be switched from one use to another."

Source: Ambrose Evans-Pritchard, Telegraph, February 9, 2008.

BCA Research: German growth will continue to weaken
"A sizable decline in the current conditions component of the ZEW survey warns that the German economy will continue to slow. Yesterday's release showed that the expectations component bounced off its January low; however, the current conditions component is more important for policymakers at the ECB.

"At the sector level, turbulence in the credit markets is spreading to cyclically-related industries such as steel, chemicals and technology, while sentiment in interest-rate sensitive areas of the economy such as automobiles, construction and retailing remains poor.

"In addition, record energy prices and the decreased availability of credit are hurting the consumer - sentiment measures continue to deteriorate, and retail spending is contracting. Furthermore, exports have yet to feel the pain of an impending slowdown in the UK, but exports to the US and Japan are already contracting. Consequently, it is no surprise that our industrial production model forecasts a continued deterioration in German growth. Bottom line: A slowdown in growth is paving the way for a rate cut at the ECB by mid-year."

Source: BCA Research, February 13, 2008.

Ambrose Evans-Pritchard (Telegraph): Japan next sub-prime flashpoint?
"Just as battered investors had begun to glimpse signs of recovery in America, the next shoe has dropped with an almighty thud in Japan. Echoes are rumbling across the Far East.

"The Tokyo bourse has crumbled, suffering the worst start to the year since the Second World War. The Nikkei index is down 17% since Christmas, and the shares of Japanese banks are leading the slide.

"The nagging fear is that Japan's lenders - the conduit for the world's greatest stash of savings - have taken on a far bigger chunk of mortgage securities, collateralised loans obligations and other exotica from America's structured credit boom than they have yet revealed.

"Americans and Europeans have so far confessed to $130 billion of the estimated $400 billion to $500 billion of wealth that has vanished into the sub-prime hole. Somebody, somewhere, must be sitting on a vast nexus of undisclosed losses. We may find out soon enough whether the hold-outs are in Japan. The banks have to come clean under the country's strict new audit codes by the end of the tax year in March.

"'Right now, we are in the lull before the second storm in global markets, and Asia is going to be the source of the nasty surprises,' Hans Redeker, currency chief at BNP Paribas."

Source: Ambrose Evans-Pritchard, Telegraph, February 12, 2008.

BCA Research: Japanese economy - more bad news
"Last week's data releases showcase a continued deterioration in the broad Japanese economy. Machinery orders declined for a second month in a row, reflecting weak capital spending plans for domestic firms and softening global demand. Export order growth, which until recently has been the single ray of hope for the ailing economy is now decelerating.

"Moreover, the Economy Watchers index declined further in December to 31.8 (from 36.6), suggesting that a continued retrenchment in consumer spending and overall domestic economic activity is in store.

"Interestingly, policymakers and politicians remain remarkably upbeat about the economy, with Fiscal Policy Minister Ota stating that 'There's no need to be pessimistic about the current state of machinery orders'. Bottom line: The Japanese economy appears to have slipped into recession. Stocks are likely to continue suffering and, once risk tolerance among global investors starts to revive, we expect the yen to weaken substantially. The Bank of Japan will eventually soften its rhetoric and may even ease if conditions deteriorate further."

Source: BCA Research, February 11, 2008.

Dr Prieur du Plessis
investmentpostcards.com

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

Copyright © 2008-2009 Dr Prieur du Plessis

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