Friday, December 23, 2011

2012 Outlook

"Don't worry about the world coming to an end today.  It's already tomorrow in Australia." - Charles M. Shultz

Well we have almost made it to the end of 2011 and certainly a year that most of us would like to forget.  Others however would like it to continue on forever, but such is life; there is always someone that benefits at the expense of the rest and 2011 was definitely one of those years.

Heading into 2012 I like to look ahead to see how to position my investments and in all honesty I doubt that I will be making many changes.  My private equity investments are all looking relatively solid and all should continue to prosper in 2012, and based on my outlook for the global economy, my fixed rate deposit investment is looking very good.  So what is my outlook for 2012?

When I was a boy growing up in Cape Town we used to have a "fort" where our neighborhood gang of boys would congregate to plan our next attack on the neighborhood girls.  We were very fortunate that we lived right next to the girls only high school so we could spend tons of time working on plans that usually included insects and mud.  Little did we know that a few years later we would be begging them to take notice of us but at that time the fun was to scare them. 

To get to the clubhouse you had to climb an eight foot high wall, balance along the top for about 10 paces and then climb up the A framed roof of the garage.  The roof was made of metal so when there was due or a rain it could be very slippery.  There were more than a few times that we would slip and would be saved by the gutter at the bottom of the roof!  Once you had navigated the ascent you then walked along the pinnacle of the roof to the edge and swung yourself over the edge lowering yourself down until hopefully your feet touched the hole in the wall.  From there you would swing yourself into the "fort" which was the attic above the garage.  I am still amazed that none of us ever fell the 20 feet onto the concrete below and even more surprised that our mothers even let us use the place, but it was a great place to hide!

So why am I wasting your time with this story.  I think that it is a perfect summary of the market and how 2012 will play out.  The pitfalls are enormous with everything from a collapse in Europe (falling 20 feet from the roof) to another global scare (slipping down the roof to the be saved by the gutter).  It is wrought with pitfalls and the upside is limited.  Undoubtedly there will be massive rallies that will be fleeting and these will be followed by sharp violent reversals.  I would not be surprised by weeks of five plus percent moves in either direction all ending the year either where we started or lower.

Fear is still very much present and Europe is more than likely already in a recession.  Any more slips and it will destroy what little the United States has achieved in the way of a recovery.  Interest rates will remain low and may even continue to contract and it is looking more and more likely that the United States congress will be stuck in no-mans land unable to make any decisions that have a lasting benefit to society.

Not a happy environment to end the year but all of us should give thanks that we missed the mess this year and that we are well positioned for next year.  Remove the stress, stay in cash and enjoy 2012.  All the best for the holiday season and the New Year.

Friday, December 16, 2011

The Dollar Breaks Out

"It's almost like seeing a guy show up at the soup kitchen in high hat and tuxedo. It kind of makes you a little bit suspicious." - Congressman Gary Ackerman

The above quote was said by Congressman Ackerman after Chrysler, Ford and General Motors executives went to capital hill with hat in hand to ask for a $25 billion bail out.  While that in itself was not an issue at the time the problem was that they all showed up in their private jets!

Watching the dollar break out to the upside is similar in nature.  The United States economy is hardly robust but when compared to the mess in Europe it looks like a great place to invest.  The chart below shows how the dollar has recently surged to the upside and has broken through resistance.  A longer tailed chart would show that it recently broke through its 50 week moving average for the first time since mid 2010 a significant achievement.


So what does all this mean to you and me?  Well the first thing to realize is that a strong dollar normally points to a strong economy.  This is not the case and this is troubling.  In order for an economy to cure its ills it is normal for that country's currency to weaken thereby strengthening the export and local economy.  The reason the local economy strengthens is that imports become more expensive making locally produced goods more affordable and with the added push of increased exports the economy recovers.  This is a very basic analysis but for the purposes of this blog that will suffice.

As the dollar still remains the global currency of choice most commodities are traded in dollars.  A strong dollar therefore makes the price of the underlying commodity weaken as it becomes more expensive in global terms thereby reducing demand for the commodity and forcing the price lower.  A look at the chart below shows how the price of crude oil has recently rolled over (for those of you who read my last blog this will not be a surprise).  A lower price of crude should result in a benefit to the United States economy as crude oil is one of the main drivers of inflation.  Contain the price of crude and you have a good chance of containing the inflation rate.


Looking further it appears that the inflation and fear trade in terms of gold purchases has wained as depicted by the chart below.  While gold serves as a gauge of fear it is also considered to be a hedge against inflation.  Based on this chart and the one above it appears that the market is not anticipating inflation any time soon.


Typically in the situation as described above you would start to see a recovery in the United States however I do not believe that this is happening.  Certainly all the pieces of the puzzle are there to ignite a recovery.  You have low interest rates and limited chance of inflation in the near term as unemployment is high and there is masses of factory capacity.  However the weakness in the United States persists due to a poor housing market that shows no sign of recovery for at least the next 12 months, a weak employment market, high levels of debt and a fragile global market.  All a strengthening dollar is pointing to is that the United States is less weak than Europe not that it is recovering.  In fact a strong dollar could be the final straw that breaks the back of the meager recovery that is in place.

The stock market is looking weak and any more poor news from Europe or China could derail that train in no time at all.  Certainly not a place to be at present.  Stay on the sidelines and if you must go into the market head for the large cap dividend players as they have the capacity to weather the impending storm.  Furthermore with yields as low as they are (and I believe that they will remain low for far longer than anyone can imagine) you need to start to accept that your "safe" money will not earn anything north of one percent unless you are prepared to step outside the box.  A number of you have turned to the fixed rate deposit investment that I have been touting for a year now but for those of you still thinking about it compare the rates at www.fixedratedeposits.com with what you can receive elsewhere and I think you will be very pleased at what you find.

Friday, December 9, 2011

Oil Prices - Where To From Here

"Behind every great fortune there is a crime." - Honore de Balzac

If ever there is a commodity that has its fair share or more of crimes it must be oil.  For the last few months oil prices have been spiralling higher from a low of around $74 a barrel in October to over $100 a barrel earlier this month.  As such it is time to have another look at the commodity that shapes much of the global economy and has a great impact on global growth.

Sometimes I have the misfortune of tuning in to a news cast of the day's market activities and I always have a laugh when I hear the analysts crowing over how high the price of oil has moved that day, or week, or for the year.  It is as if the upward movement in price is a good thing.  Well in all likelihood it is a good thing for the trader if he is long the position.  It is also a great thing if you are an oil producing nation, but what of the majority of countries that are oil importers?  Furthermore is this not a massive sign of impending inflation?

The problem with oil prices is that they are based on very poor data.  On the one side of the equation is the supply of oil.  How much oil is there available and how easily is it accessible?  These two questions are almost impossible to answer as most of the oil lies in fields that are governed by notoriously shady characters in parts of the world that are mired in violence and corruption.  Furthermore as technology advances and techniques for extraction improve, places that were once considered inaccessible are suddenly viable and wells that were thought to be dry can now be re-drilled and provide additional supply.  Finally it is never known exactly how much oil can be extracted from a given well even when the total supply is fairly well known.  Some wells dry up well before they were supposed to while others continue to produce for years after they were supposed to be depleted.  Adding all of this up to determine supply and adding to that an estimate of unfound reserves means that the amount of oil remaining is unknown.

The second problem is that while the oil may be accessible, it can be disrupted by a war or a coup.  As very little of the oil comes from economies that are considered "stable" in western eyes, there is a fear premium attached to the price of oil.

On the supply side things are a little more quantifiable.  A good and growing world economy would drain the supply of oil faster leading to an increase in the price of oil, however as the price creeps up so do the incentives to producing fuel efficient vehicles, machinery and equipment.  This can create a situation where less oil is used even while the economy expands.

So why in this poor of an economy is the price of oil going up so fast and does this point to inflation and an expanding economy?  With new fields being tapped in Brazil and others coming online in Canada and the United States it appears that there is more than sufficient supply to handle the current economy.  Furthermore it is my opinion that with the technological advances in extraction and seismology that we will find massive oil fields dotted all around the world that will become accessible.  It is also my contention that as the world turns "green" that consumers in developed economies will start to rely more and more on alternative energy sources and move away from the toxicity associated with oil burning options.  So that leaves the developing world.

To the developing world the cheapest option is the most viable.  That said the price of oil is rapidly becoming uncomfortably high again so I believe these economies will start to feel the pinch of high oil prices and will begin to reduce their consumption.  Furthermore the current state of the global economy does not warrant the current price of oil and these price levels will start to affect growth as more and more money of an already strapped consumer is swallowed up by the oil monsters.  As such the global economy will not be able to continue to support these price levels.

Looking forward I believe that the current price levels are unsustainable and are set to fall.  Weak global fundamentals and a burgeoning supply of oil from places like Brazil will put a lid on this move and will stave off any concerns that these price levels will start to move inflation.  On the flip side of this, if prices remain elevated for much longer then you will start to see a ratcheting down on economic growth rates as consumer spending will be impacted and company profits will become squeezed.

Oil companies have been a recent benefactor from the rise in the price of oil however their rise has not been in line with the price of oil as the share prices are under performing the commodity move.  Furthermore the chart of oil company stocks is looking decidedly weak.  So while this group of stocks has aided the stock market rise it signals a level of distrust for the recent commodity price rise.  Going forward if the price of oil falls to a more manageable level these benefactors will be levelled and will put a drag on the stock market advance.