|Looking Forward: 2011|
January 2, 2011
In my yearly forecast letter last year, "Looking Forward: A Year In Transition," I expected the shape of 2010 to be up better than most expected in the beginning of the year, and tail off by the end of the year. I stated: "I believe the recovery will be cut short as the artificial government stimulation ends, which could only be temporary at best by any economic theory anyway. This, together with higher taxes, inflation, and interest rates, will lead to a double dip recession in 2011, in my view. At best we should be left with an L shaped recovery for as far as the eye can see. Whether we have a double dip recession or an L shaped economy, there is no getting around the fact that we are about to hit a mountain of debt accumulation that will serve as a wall against any return to the robust growth of the last 25 years. That era is over."
The L shaped scenario was what we were set up to go into in 2011, (in fact I was going to entitle this article "Looking Forward: A Year Of L"). I assumed a possible double dip in 2011 if we were dealt a really bad blow from housing, or another round of banking and financial problems. But given the extension of the tax rates, as is, the defeat of the omnibus spending bill, which opens the door for more immediate government spending cuts, the revolutionary result of the November elections, and the free trade agreement with South Korea, with several other treaties possibly to come, I am more confident that we can avoid a double dip recession.
The purpose of projections is to try to anticipate the shape of the economy ahead. With a good idea of the shape of things to come we can invest with a general game plan. I anticipated a strong surge in the economy tapering off as the year progressed. That did happen as we went from an initial 5% growth rate down to a 1.5% rate. What did NOT happen is rising inflation and rising interest rates. That, I believe is still to come, although at somewhat moderate rates. This is mostly due to the fourth quarter of 2010 which will probably end up strong due to the unexpected passage of the tax and spending bills described above.
The fourth quarter of 2010 could have been declining dramatically, with the imposition of new taxes and higher deficit projections on an already frail and precarious economy. The 90 degree turn in policy has taken that scenario off the table, and has led to the rally in the stock market we see today. The wealth affect that has resulted from higher stock prices has help bouy the economy as consumer confidence has increased.
But the biggest factor that has the greatest potential to influence the financial and economic direction of this country in 2011 and beyond, is the Tea Party movement, as manifested by the election results last November. It was not really even in existence when I wrote the above forecast. It is the influence of the Tea Party that has served to keep taxes lower than anticipated, while providing hope for rational change in the future. The Tea Party and their newly elected leaders, all eighty of them, are the random factor in the future of America.
The Tea Party represents a new and formidable force for eventually reducing the size of government, deficits and debts, moving toward fundamental tax reform, increased free trade, and monetary reform. 2011 will be mostly a year of playing political defense, but with the elections in November 2012, 2013, could well be the year of major fundamental change. It is the possibility of this kind of change that has changed the market action from bearish to bullish and allowed the economy to lift a bit. Changing expectations moves markets; and markets move economies.
However, any attempt to predict 2011 is impossible until we see what kind of legislation actually comes out of Congress between now and about April/May. Ideas move the world, and today we have many excellent ideas being proposed and debated that can move this country back toward freedom. What political and economic shape they take (or fail to take), will help define the path we will take toward -- or away -- from a free market economy.
The direction we need to take is toward a smaller central government, and toward a nation of states and localities, once again, which will allow diversity in governmental policies. We need decentralized health care instead of the centralized monstrosity we just passed into law. We need only those laws and regulations that defend individual and property rights, and we need them stated clearly, simply, and objectively. We need pro free trade initiatives to stimulate exports. And we need a simpler, flatter broader tax system with a lot less deductions, subsidies, and corporate welfare, and lot lower rates. This will increase revenues, through incentives that increase production as it always has.
And finally, and most importantly, we must have fiscal discipline. I hope this will result in claw backs of pubic union employees pay and benefits that, in many cases, amount to twice what is provided by the free market and who are provided benefits for which they pay nothing, and which are completely subsidized by the American taxpayer. To the degree we move toward these goals, America will prosper.
With this in mind, and with the usual caveat that no major events come along such as a major terrorist attack, or trade war, or huge spike in oil prices or interest rates, a major double dip in housing, or a breakdown of the world monetary and financial system, (the list is admittedly long) I see the following:
I think the economy will grow at about a 2.75% rate for all of 2011, ranging between 3.5% and 1.5%. This is below consensus, as most others have raised their estimates to the 3.5% area. Inflation should be about 1.5 to 2.5% for the year, a doubling of the present rate. And interest rates should move moderately higher due to the higher inflation and growth rates. I believe that austerity will begin in earnest this year with more to come in 2012 and 2013; and this is the main reason why I remain under consensus. I think this will create a long term drag on the economy.
I think we will make convincing progress against our debt and deficit problems beginning this year; mainly because we must. Some of the proposals will be serious attempts to cut government spending. I have little doubt that we will hear a lot from people like Paul Ryan who will head the budget committee this year in the House of Representatives. And I think we will be surprised at the tenacity of the Tea Party freshmen. They, I believe will be the real movers of the agenda of America.
Other proposals however, will be attempts to, once again, kick the can down the road. These will come from the establishment, both left and right. I think we will start hearing a lot more about debt reorganization or debt restructuring this year, both here in the US as well as abroad. This could be a major story in the future as cities and states, as well as countries, are forced to deal with their debts and use this refinancing method as a way of trying to buy time. And a new issuance of SDR's may be attempted in order to absorb sovereign debt, in a kind of international restructuring.
Some are suggesting that we will revert to massive inflation to deal with our debts. Any form of progressive inflation to solve our debt problems, which is often assumed by many gold bugs, is not an option, in my opinion. The reason is that everyone is looking for it; and at its first appearance the government will be forced to deal with its ramifications immediately. And that means fighting inflation, not creating it. Before the inflation can even really take hold, the consequences of inflating will outpace the inflation itself. This is beginning to play out in other countries around the world, and should be another continuing factor that places limits on growth.
The consequences of inflaing as we are seeing in other countries are higher interest rates, which lead to a falling GDP, which will lead to higher unemployment, which will lead to further voter and civil unrest. That's what's happening in China and Europe, today. They are being forced to fight inflation rather than perpetuate it. There is no way they can get any "payoff" from inflation, because the market moves ahead of the inflation and results in more penalties than benefits. The government can only benefit from a hidden inflation and those days are over. Everyone knows about the potential "inflation card." That's where I disagree with those that think we will go into an inflationary depression. We can't get there from here. We can have a monetary collapse and depression caused by the complete rejection of fiat money, but progressive inflation is no longer feasible and hasn't been for many years. We all know how to defend ourselves against it.
Bottom line... all roads lead to Austerity. Because of this, I think 2011 will be a year of L, but a higher level of L than before. The new attempts to deal with our structural deficits and the new attempts to undo the negative effects of past legislation will reinvigorate the economy somewhat. But I cannot envision any real traction in the economy.
This is not to say that the stock market and other investments can't go up. They can, and they have. This was the case in 2010 -- a year of slow growth and high unemployment. Innovation didn't stop; nor creativity; nor the success of businesses and in some cases record business profits. Even given slow growth for some time to come, there will be those that get rich in this country. It's just that fewer will get rich than normal.
The key to this rather mixed and sanguine scenario panning out is the bet that what can go wrong won't go wrong. It is a bet that the above short list of catastrophes won’t happen. It is a bet that the housing industry will not fall much further. If it does, it has the potential of creating more price declines, more foreclosures, more defaults, and more contagion to the rest of the economy. Tell me what housing does and I will tell you what the economy will do. A serious double dip in housing puts the double dip recession back on the table. It has the potential of reinstating the deflationary/recessionary bias we just emerged from. My bet is that the market holds and prices and foreclosures level off. I believe that there is about a three year work out period before we as a nation, work through our most severe problems, and housing is right at the top of the list.
And it is a bet that the Euroland contagion that has plagued Europe ends at the doorstep of Spain. If Spain goes, all bets are off. Also, it is a bet that the financial vulnerability of cities and states will not be sufficient to cause a crisis. There will be defaults and de facto defaults that require the restructuring and re-organization of debts; but this should remain contained. And it is a bet that we will not have a trade or currency war. Protectionism is the one policy, if increased, that has the potential of pulling the entire world down into recession or worse.
Interestingly, the question is not whether or not we will have prosperity or a recession -- that equation has now changed. The real question now is whether or not we will have prosperity or an economic or monetary collapse and depression. The odds are now greater (although low) that we will have structural damage leading to a systemic meltdown, than of having a recession. And the odds are far greater that we can have a monetary breakdown leading to hyperinflation than any form of progressive inflation.
The middle roads of inflation and recession are being taken away from us, and being replaced with an either/or economic and monetary set of alternatives. Either we get our deficits and spending under control or we face monetary and economic collapse. The crisis we face is not a matter of liquidity. It is a matter of solvency. We passed the liquidity crisis long ago.
All of the potential problems cited above have the potential to create systemic damage, not only to the US, but they threaten the underpinnings of all world institution, economies, and currencies. The world has reached a crossroads; either it moves toward fiscal responsibility, or it spirals downward out of control and destroys both its money and its economies.
My bet is that we all go kicking and screaming down the austerity road. The fact that our problems are major is no big secret any longer. It is being trumpeted loudly in and out of government and on every news show in the world. This gives me hope that we, and I mean the entire world, will finally move to address our problems in a fundamental way. The deficit commission, which was bi-partisan, kicked off this theme. They laid out our problems and what they believed need to be done to deal with them.
President Obama has said that 2011 will be the year when we will debate our fiscal problems and decide how we will deal with them. Paul Ryan has developed a blue print to recovery that addresses most of what we need to do to return to normalcy. And the new Tea Party freshmen elected to the House and Senate are ready to fight to implement their radical policies of change. We are now being told on a weekly basis that we have to get our financial house in order. The question being posed everywhere and by almost everyone is, “If not us, who? And if not now, when?"
Let me cite an astounding figure. In a poll just released by Fox News, they asked the question "Should the US pass the upcoming national debt increase?” The poll revealed that 94.6% of American's said "NO”! If that doesn't give one cause for some optimism about where we are and where we are probably going as a nation, nothing will.
What will the best investment strategy be, given this "cautiously optimistic" scenario? I think a continuation of my previous strategy: Invest in gold and silver coins as insurance against the worse happening, and resource stocks that are in the early stages of exploration and development. These new mines will be the mines of the future. And the future I envision will be one of great demand for resources, world wide.
I am not counting on extraordinary growth, progressive inflation, a crashing dollar, or even higher gold and commodity prices. These mines will rise or fall on their own merits regardless of the economy or price movements. If world growth continues, the demand for rare resources will increase, and the mines I have chosen to invest in will be the new suppliers of those resources. Gold, silver, copper, oil, uranium, potash, agriculture, etc., will be in constant demand and short supply.
With world growth will come higher interest rates. And if and when the financial crisis starts to drift into the background, interest rates will rise on sheer normalization. A 5 to 6% 30 year bond is normal. Hence, TBT should do quite well in this environment. And if for any reason the worse case scenario should develop, this portfolio should even do better.
My bet going into 2011 is that this is an investment strategy for all seasons.
Notable movers last week were Copper Fox, up over 16% Friday alone, and VG Gold up over 7%. VG Gold's symbol has changed to LEXV as it has merged with Lexam. All stocks are still exhibiting an up trend, except Rochester, which I will continue to hold a while longer.
Portfolio by weight:
Copper Fox Metals
Coeur D'alene Mines
US Silver Corp
Rochester Resources LTD