Liqudity flowing into Asia and western Latin America

Last week, the Merrill Lynch economics team wrote a good paper about liquidity flowing into Asia. Here is a summary of their conclusions: Liquidity will flow into the Asian region raising consumer spending, stock prices and currency values.

We agree with their conclusions, and here are a few of our own. In the following countries: India, Indonesia, Malaysia, Thailand, Singapore, and China much new liquidity will enter. It will be in the form of foreign direct investment and investment money moving into stocks and bonds.

With the exception of China, which is being singled out for a trade battle by the U.S. Congress, all of these countries will see their currencies rise. Their economies will grow strongly as new capital flows to their growing markets from North America, Europe and other parts of Asia. This new capital will increase employment, liquidity and put some pressure on inflation. Most importantly, it will lead to increases in the stock market and real estate valuations in these countries.

The western portion of South America is in a similar position. Chile, Peru and Colombia are in the enviable position of attracting capital historically destined for the more unstable or autocratic countries.

Free markets and the growing middle class in these capital-attracting countries are creating a very attractive environment for stock market and real estate appreciation. As a result, all of the above countries in Asia and Latin America which have not been picked out by the U.S. Congress and administration for attack will prosper as money moves from the less free-market-oriented and low-return Europe and U.S. toward the more open and higher return markets mentioned above.

Former major gold sellers are absent from the market

Gold sales by central banks in Europe fell to a very low level in the twelve month period ending 9/30/2010. The rate of sales was about 95% below the average of the last decade.
Interestingly, over the last 12 months several governments announced that they were open market buyers of gold. These include Russia, China, Thailand, and India.

Food

We foresee higher prices in the long term.

Global agriculture product demand is rising much faster than the available supply of food and will continue to do so for the next decade. Short-term drought or other supply circumstances aside, the inexorable demand curve rise due to the consumption of more meats in the emerging world will increase demand for food and prices on a longer-term basis. This will lead to higher food prices and higher prices for the suppliers for equipment and other inputs to the farming industry.

This ain’t your grandfathers world trade system

The U.S. labels China a currency manipulator. Brazil announces that countries are trying to devalue their currencies competitively. Is a new trade war brewing?

We have long believed that the potential for trade wars increases as economic distress grows in Europe and the U.S. Clearly, Brazil is correct; politicians who do not understand the world trade system are currently trying to devalue their currencies. They are reacting to pressure from the exporting companies in their nation and they may believe that this action will increase exports and discourage their citizens from importing goods from abroad. These beliefs are based upon the naïve and unwise assumption that their domestic consumer will buy domestically manufactured goods.

Although this simplistic model might have been somewhat accurate 50 years ago, today it is sadly uninformed and unrealistic. A global trade machine currently exists which uses components from many countries to make products produced in other countries which are then shipped to other countries still, to be finished. The products are then sold to a new group of countries for various purposes including re-export.

The antiquated and naïve view that a lower currency will improve employment in the home country is generally incorrect.

The lower currency will not necessarily create new jobs, and on the contrary, it may create destructive unintended consequences especially inflation as imported goods become more expensive. Currently, perhaps a dozen countries are trying to devalue their currencies simultaneously.

When a nation threatens that they will “put a tariff on products from country X”, or “force country Y to revalue their currency upward”, or that they will devalue their own currency, we wonder if they have considered all the ramifications of such actions?

Trade wars are always a mistake. Most observers understand that the political posturing by the U.S. congress to their constituents. They also see that those constituents may not be at all well-informed about how international trade is positive for U.S. growth and useful for employment in the U.S. The politicians are making a political statement which is simplistic and which may create unintended consequences including:
1. lower economic growth world wide which feeds back to lower economic growth in the home country.
2. increased inflation as imported goods rise in price.
3. a move by citizens into other asset classes especially gold, other precious metals, commodities in general and common stocks and out of the home currency. The citizens will buy these types of assets in order to protect themselves from the decline of their currency. This forces up the price of commodities and further exacerbates inflation.

Unwise behavior

It is unwise behavior to attack China, which owns a huge percentage of U.S. debt, for its currency policies. This is especially true since the U.S. will continue to float immense quantities of new debt to cover budget deficits in coming years, and an unintended consequence is that China decides to not buy more U.S. paper, or worse, sells their U.S. debt.

Should either of these probabilities occur, the result would be a further weakened dollar. China could easily cause an increase in U.S. interest rates and put pressure on the U.S. Federal Reserve to undertake ever more quantitative easing. In other words, the U.S. Federal Reserve will have to buy the bonds issued by the U.S. Treasury or other organs of the U.S. government. This is printing money to pay bills, and historically it has proven to be an ineffective solution.

An increase in either quantitative easing and/or further declines in the value of the U.S. dollar could have a cascading effect. Quite probably, it will cause the dollar to fall further, and create a spiral of dollar price declines. As the dollar declines, gold and foreign currencies rise. This is one reason why we remain bullish on gold and well-run foreign currencies.

Summary

1. Continue to hold gold and gold shares and begin to trade more as gold reaches the $1500/ oz level. Selling rallies and buying dips. Gold will correct periodically but will move well above $1500/oz over the long-term.

2. Continue to hold oil related shares and use weakness to buy more, especially high-yielding energy companies with oil reserves.

3. Food related investments continue to be attractive and will rise for years.

4. India, China, Indonesia, Malaysia, Singapore, Peru, Colombia, and Chile continue to be attractive. Brazil may also be a good investment destination if the new president, to be elected on October 3, acts reasonably. China and Brazil must be watched carefully; China because of attacks by the U.S. on China’s currency and trade position and Brazil to see how the new administration behaves. It is possible that Canada and Australia will be relatively attractive and will sell many resources to the developing world.

5. Continue to stay long the currencies of Canada, Brazil, Singapore, Thailand, Canada, and Australia versus the U.S. dollar. The U.S. dollar index is making new lows on the charts and this bodes well for the currencies of the healthier, growing, better managed economies, gold and other hard assets.

6. Short the Japanese Yen versus the U.S. dollar.

7. Avoid or sell U.S. long-term bonds: corporate, government, or municipal.

Wishing you successful investing!