Monday, January 04, 2010

So where are investments headed in 2010?

There are four investment issues on my mind as we start this New Year:

1. Commodities and specifically gold.

I believe that there are macroeconomic supply and demand issues which will continue to press commodities higher over the course of this year. Soft commodities, like coffee, tea, sugar, all increased over 25% in 2009. Metals in general had a very good year, and food as a whole should continue to rise. The one glamour play (pun intended) which confounds me is gold. I must admit that have successfully invested in gold this year via GLD, but now wonder if we are at the top. What would make gold go up? Not demand -- industrial and jewelry demand is sated. One reason would be a weak dollar (see below). General fear could drive gold higher. And then there is everyone sees the new highs and rushes in. What could make gold go down? No real demand, stable to appreciating dollar, no fear and fewer fools rushing in. Gold is sideways to down in 2010.

2. The U.S. Dollar.

The dollar has been in a decline because of the current account and trade account deficits, and the very loose monetary policy of the Federal Reserve. Basically, we spend a lot more than we bring in via taxes, and we buy more foreign goods than we sell. To fund our government, we issue debt, and when the debt comes due, we issue more debt. To stave off the financial crisis of 2008, we have expanded the amount of U.S. dollars (not by printing currency) by making interest rates near zero for banks to borrow from the government, and by allowing the Federal Reserve to purchase U.S. Treasuries (to fund the budget and trade deficits). When there is too much supply (too many dollars denominated bonds and bills) then demand goes down. When you earn zero interest, demand also falls relative to other currencies. This is the weak dollar scenario. The question is, are we at the bottom? What would lead to a higher dollar? Well, if the dollar is seen to be better than the Pound, Euro and Yen, that's a start. Remember, all of Europe is in more or less the same boat -- deficits and financial market problems. Japan has had no growth for 20 years. But what should we think about the BRIC nations? Yes, China has had a big year -- leading the world out of recession -- but now it seems strained to continue to lead. Russia continues to appear less stable and oil dependent. India is a great ally, but not without structural problems. Brazil seems like a winner, along with Mexico, but again is a very small part of the world currency market. When we think about the dollar, the two opposing forces are 1) do we have too many which will ignite inflation in the next decade and make the dollar worth less? or 2) Given we will be a democracy in 10 years, and every other polity is less certain, do we remain the foundation and therefore stable to appreciating? I say the dollar is stable to appreciating in 2010.

3. U.S. and Global Equities.

Honestly, I just don't see a lot of upside. The earnings for 2009 were driven by cost cutting. If we don't see 1) higher and sustained employment growth and 2) a return to rising home prices, then I don't see any increase in demand (e.g. revenue growth). The P/E will not rise if the earnings don't rise, and cost cutting (especially job cuts) won't get us there. The S&P 500 will be up 5-10% this year at best and volatility will be the rule.

4. U.S. and Global Bonds.

I think that safe investors are in fixed income securities, and this is still a wise place to be. The risk is whether interest rates either go up in 2010, or the markets think they will be rising steadily in 2011, 2012 and beyond. This could hammer bonds and hurt all the "safe" investors. Now, the one way to avoid this is to hold bonds until maturity, and to renew your holdings as rates rise (buying lower and getting a higher yield). This is not for the faint of heart, but I believe in this approach. What I'm saying is that we should not see big gains in bonds anywhere in the world in 2010 because rates are too low (no inverse leverage). I want to be in fixed income, but I fear the best scenario is flat to 5% total return. So where can money be made? I wish I knew. Emerging markets appear strong, but don't be fooled by their new independence from western demand -- without it; their recent growth is a house of cards. Perhaps individual sector plays, and specific stocks. I'll let you know if I figure it out...

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