Review 1 Q 2012 11th April 2012

“Gold has worked down from Alexander’s time…..

When something holds good for two thousand years, I do not believe it can be so because of prejudice or mistaken theory.”

Bernard Baruch, Wall Street legend & friend of Jesse Livermore

The over-exuberance in blue chip equities in the 1 Q 2012 has, as I write, stalled. A reality check is now taking place.

It has not been an easy market so far this year with virtually all the bull commentators being paraded up and down on our screens with hopes for growth and recovery. Fortunately many clients and market professionals that I communicate with have taken these prophecies with a pinch of salt. There are many causes for my extreme caution but at the forefront it must be the state of the EU as more pressure is applied to (10 year) bond yields.

Austerity measures may be good for politicians but the real effects are that there can be little job creation without substantial investment, better tax incentives for businesses and taking a scythe to red tape and regulation. The latter in particular has been ignored by politicians as SME’s and self-employed (“libres professionnels”) struggle to actually do what their skills are designed for.

No-one has broadcast any statistics on how much time is spent per day on all this red tape but my guess is that it is now around 30% of everyone’s day and rising inextricably. In essence thousands of wasted man hours are unproductive which in the end cannot be good for the recovery phase or capitalism per se. The completely ineffective attempt to cut the Public Sector purse in the UK is just an example of the ineptness of the western systems that everyone knows are now creaking at the hinges.

From an investing standpoint it would appear that CASH is KING at this critical time as the impending Sputnik Moment for bond markets approaches. It amazes me why so many are scampering for 2% yields (in a universe where inflation is 4 to 5% official) and why so many market people seem to think that Italian and Spanish bond yields in the 6% area are already so damaging (going much higher). Was it that long ago that War Loan yielded 10%+ or that mortgage rates in UK were in the mid-teens? It does seem that traders and their trading mentality appear to be ruling markets still and now the heads of many investors too.

My own view is that equities may yield 3%+ in places right now, with large int’l companies throwing off cash at almost unprecedented levels, but this is NOT a good enough reason to chase current share prices against a potentially cataclysmic debacle that might occur in the (f/x, bond & equity) markets gyrating into much much higher bond yields (my own forecast for Italy/Spain 10 year bond yields is 20%+ this year). The risk/reward ratio is just too imbalanced for me at this stage of the QE/Operation Twist process(es) and I’d rather hold precious metals and oil stocks despite the pain that they have suffered to date.

As I write FTSE100 is around 5,630 (c.300 points off the high) and the DJIA at 12,715 (from c.13,000). This is hardly a big correction so far so there’s quite some downside if things in EU do get worse hereon.

The China slowdown is not helping either with current GDP growth of c.9% forecast to drop to 7½% but the real problem there is the construction/property bubble which has got to epic proportions. With over 500 million in the Chinese workforce there are just too many properties constructed and being developed. The over-supply has already led to some spectacular falls in prices (-35% in Beijing last November) and further pressure is predicted. In fact elsewhere Citibank has just suggested that US prices are also 25% over-valued today even after severe falls there.

You don’t need me to tell you how I feel about UK property prices.

Did I mention the geopolitical developments in the Middle East? Syria, Turkey, Iran, Egypt, Bahrain, Yemen…..well, the list goes on and on. There’s no need to mention the ‘c’ word in Africa either. They’ve been having ‘coups’ there for decades since the imperialists departed. Just in the last year Randgold Resources has had its share price slump at the mercy of shenanigans in the Ivory Coast and more recently Mali where it has 2/3 of its gold operations. But of course the terrain and behavioural patterns are the norm for the Dark Continent. Not so elsewhere in the more developed universe. It wouldn’t surprise me if the Colonels have the last say in Athens or even Madrid.

Reminding ourselves of Bernard Baruch’s famous quote for a minute only leaves me to continue to focus on gold (Randgold, African Barrick, Shanta are all trading too cheaply), oil shares (Royal Dutch Shell at 2180p is getting close to sub-£20 and I’d like to see BP nearer to £4), the old frontiers of Africa (although it’s RISK OFF right now) and other emerging markets (I still prefer Russia and Brazil), solid international investment trusts on pull backs and up to 25% holding cash (in a mix of currencies in addition to £stg & US$) but avoiding the Euro (still). The oil price is still impossible to predict as it appears to have found its range for the short-term but shortages at the pumps are going to become the norm I suspect.

With regard to other specific stock selections I like the look of mid-tier oils such as Premier Oil, Heritage Oil, Hardy O&G, Soco Int’l, Exillion, Chariot O&G and Genel who remain out of favour. In FTSE I’d prefer to look at BAE Systems nearer 260p, GlaxoSmithKline nearer £13, Sainsbury nearer 265p, HSBC nearer 460p and Standard Chartered nearer £12. My 2012 tip Tullett Prebon now near 350p is getting overbought (prefer to buy below £3) although is still a HOLD on takeover hopes. Amongst investment trusts I think purchasing the following on a 10%+ markets correction may be prudent; JPMorgan Claverhouse, Henderson Far East, Schroder Oriental, Securities Trust of Scotland, Merchants Trust and JPMorgan Global Emerging Income. As far as the rest of the UK market is concerned I’m being very selective and prefer international equities but it’s important to avoid those with too much exposure to China, general commodities and anything financial or consumer related. With around 30% of FTSE100 constituents exposed in China it may be prudent to avoid those with connections there. Who knows but the China slump could be the big surprise around the corner.

I continue to encourage portfolio weightings such as 0% Fixed Interest, 20-35% cash, maximum 80% equities (overseas earners mainly incl. 25%-40% in precious metals stocks, a spread of investment trusts). Much has been discussed recently regarding safe havens and the safety of ETF’s and I continue to avoid these vehicles for private investors as I believe there are major regulatory concerns in this area. The level of the coming correction is the key and I still feel that 10-30% is possible which implies 4,776 (20% from 5,970 recent high) on FTSE100. Looking at what happened in the mid-1930’s it’s interesting to note that US$10,000 invested in DJIA in Oct 1929 would have turned into US$3,600 by Dec 1935 whereas the same amount invested in Homestake Mining, a gold miner, grew to US$62,000 i.e 6.2x. During the 1973/74 slump when stocks depreciated over 50% the large gold cap stocks increased 260%+. If the precious metals shares bull does return then spectacular returns could be achieved in the foreseeable future with some of the gold shares already purchased. Many are suggesting that comparisons are unfair with the ‘30s but history has a funny habit of repeating itself. GFMS, the precious metals research group, have just predicted that a looming flare-up in the Eurozone will propel the price of gold towards $2,000 an ounce this year. Exactly!

“Hasta la vista”…….as Spain (it’s debt dwarfs Greece, Italy and the other fringe players) gets nearer to the markets sights the phrase seems more than appropriate.

Let’s hope that Spring doesn’t disappoint.

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