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Tuesday, April 30, 2013

Notes from the USA – a guest post

Of late, reports coming out of the USA point to a jobless economic growth rate that is lower than the rate of Quantitative Easing, low inflation, greater propensity to pay off debts and add to savings, a ‘sequestration’ that may cut government jobs and benefits. In other words, not a drift down into another recession, but certainly slower than healthy growth.

In this month’s guest post, KKP provides a ‘ground zero’ view of the state of the US economy from the point of view of a consumer and investor, and strategies that he is adopting to negotiate the likely pitfalls in the days to come.

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Macro Economics from the US

It’s time we look at the forest from the trees and evaluate where we are going….

From a bigger picture of our global economy, we heard a lot of buzz on the bearishness of Emerging Markets, which started with the corrections in China and Brazil, followed by India and other countries in the developing markets. Of course, one cannot avoid the negative buzz on gold also, where brokers and analysts are piling on with a feeling of relief that gold/silver/platinum are finally correcting after huge run-ups.

For equities and gold, the underlying theories that people talk about are based on lots of media and print accounts (whether true and not) that are driving part of market behavior.  Lots of those accounts cannot be proven, and there are often 'opposites written up' that counter those theories.  So, as investors, how do we decipher all of that stuff? The simple answer is: ‘charts’. Conspiracy theories have been going around for a long time, talking about what Obama is secretly doing and how the US Gold ETF vaults are filled with zinc bars coated with fine gold foil. Don’t believe any of it, and don’t even waste a lot of time investigating it, since price discounts almost 99.5% of those theories.

All of those stories are like the health care news that come out talking about "goodness or harm of caffeine", "goodness or harm of artificial sweeteners", "goodness or harm of weight loss with a protein filled diet" etc. I am a health-nut now, and read all of it. When you do, find out both sides of it, and there are usually caveats on BOTH sides of the equation, and without those caveats, it is “information out of context” (like you hear about what spouses do to their better halves!).

So is the case with Gold Bulls and Gold Bugs.  There are two sides of that gold coin! In a bull market forums print all of the positives and ride on the wave, and now that we have a correction (not a crash), we have the opposite side of the story being printed.  In BOTH cases mind you, we are trying to justify.  Why?  Because we are humans and like to justify the emotional behavior of the masses.

Best approach is to look at the macro element of gold and recall the folks talking about the extremes: gold is a useless investment instrument - all the way to gold being the currency of choice by 2020. The ride from $300 to $350 to $250 to $500 to $750 to $900 to $1100, back to $900 and then off to the races to $1900 (fast forwarding) proved this fact, and now it is the turn of the nay sayers to remind us that gold is a useless investment instrument. In Fibonacci terms, we are seeing the correction after the huge move from $750 to the $1900 levels, back down to one of the support levels. Being that gold holds a high beta, we might see a correction to $1000 (or the nearest support), to shake off the weak holders. Very simply, the correction that we need in any big move is now happening in gold, and we are justifying it with rationale that it is because we will not have inflation or hyper-inflation, or Obama is doing really well, or Central Banks are starting to unload, or the US Govt has started to sell gold in massive quantities.

Let’s get to US equities now. One needs to look at the USA as a “stock” and understand that this stock is generating Revenue, has Debt and Expenses, results in Net Income/Deficit and has issues related to Growth, Loss of Market-share and "Free Money" handouts.  Once we analyze this and realize that this is not a good “stock” to put money into, we get to understand that this is not a “stock” that one should count on long term unless it goes through a major restructuring of some kind. Put that into the perspective of lower job growth and early retirements, and you will start to understand the loss of Super-Power or  Monopolistic status of this “stock”. It is like GM or Chrysler from their hey-days. With Obama being the current CEO of this “company”, with responsibility for increasing the debt to the HIGHEST level ever relative to any other CEO in the history, one has to wonder what has he really accomplished with $6 Trillion in debt, or what is he going to realize from that debt in the next 3 years. $6 Trillion of additional debt can run entire economies of over 100 small countries.  Well, has he got the results to show in the USA? In my opinion, he let the US float and not sink, but the Titanic still has a crack in it and water is pouring into the bottom of the ship, albeit a bit slower than 2008-09-10.  With this being a known fact, how much of our portfolio do we want to ride on this optimism?

USD plays a very critical role in part of the sell-off in Gold.  The fact that shale oil might strengthen the USD in future is a potential strong variable that is predicting the upward move in USD and hence a downward push to the metals (inverse relationships). In fact, while all of that talk on oil is going on, we are paying above $4 per gallon of gas in the US (this week), which is higher than what it has been for months!

Gold is very widely considered as an inflation hedge, as well as a hedge against risk of the unknown. In reality, inflation is already here, although headlines in US newspapers will not agree.  We might not have hyper-inflation in the traditional sense of economic definition, but it is hard to understand why cost of grains, cereals, construction materials, tools, contractors, auto-parts, repairs, paint, utensils, electrical goods, decor, some clothing, furniture etc have all gone up every year for the last 5 years.  I measure these things by roaming around the stores quite a bit to get a first hand sense of it.   For example, I just bought a new property and got it fixed up (Jan 19th to Apr 28th).  I had to buy lots of materials, and I almost paid 2x of what I paid 3 years ago in the US.   And, for each property I buy (every 4-5 months), prices keep going up, and hence I now have a storage shed, where I buy and store materials when they come at a deep discount (dry wall, 2x4 wood, nails, screws, paint, doors, glass, screens, handles, shower-heads, faucets, glue, caulking etc).  I used to buy paint for $10 to $20 and now it is $30 to $40 per gallon, in just 3 years timeframe.  I have almost 34 gallons of paint sitting at home for the next job, and it will only last me one home, so I am still collecting and buying more.  Today, I bought 31 boxes of cereal based on an introductory price by a new chain of products introduced. These are prices that I used to pay in 1996-99 and I loaded up on it, and stored it in a well maintained temperature zone. How is this inflation going to play out in the next few years? And, what are you doing about it for your own personal situation?

Finally, EU and US still have 'structural issues'.  As soon as we get back to facing these head-on, we will once again have reasons to get out of Equities and back into Bonds, Cash, Gold, Silver and Platinum safe havens.   In the meantime, personally, I am going to continue to acquire of bit of gold and silver as “option” contracts as I have been doing, which allows me to invest small money with huge leverage (expiration 2015) in the US.  Risk of holding option contracts is limited to the premium paid, but the upside is huge, and can be converted into gold ETF shares at contract expiration. I still hold the view that we can see $1000 at the low in Gold (as I have for 3 years or so), but it is yet to be seen how gold reacts to its lower support levels based on the economic forecasts unfolding.  The possibility of it going to $1000 is less than 50% now (based on the recent correction), but I could be proven wrong, although I would be glad to double my position in gold at $1000, if it gets there.   In the meantime, equity markets in the US can go up temporarily, but with IBM and Caterpillar breaking some bad news and showing structural damage, Apple sinking to the $400 levels and the upcoming summer (“sell in May and go away”), the likelihood of Dow going to anything beyond 16000 is unlikely. A correction mode is around the corner (as seen in the RSI/STOC divergences and the Volume shrinking on up-days) in another 2 weeks to 2 months and it might affect the global markets in a similar manner (bearish). The ‘Sell in May’ theory is about to be proven right although the moving averages and price points have not shown clear signs of a break down as yet!

Bottom line, the macro picture shows that markets are climbing the proverbial wall of worry and has done a good job of doing that in Q1’13. Gold, which was overvalued, has done a good job in finally correcting (been expecting that correction for a while), and now, it will be the turn of equities to show its last hurrah by either going up to Dow 16000 or just going down from here into the summer. Hence, gold and equities might be good to buy in the correction mode this summer, and until then just trade in and out, or hold onto to your dry-powder until things settle down.

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

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