Holding Out Hope

I hope you all had a Merry Christmas, or at least enjoyed the free break for those who do not celebrate.

The unprecedented actions of the Federal Reserve have changed my mind. My fears of the demise of the world economy need to be adjusted for these new facts on the ground. This is not childish interest rate games they are playing. The rules are being changed, and anyone caught looking at their old playbook risks being swept aside.

The initial reaction of the Fed to the Great Recession was interest rate adjustments around the time of Lehman. These had no real impact on the crisis.

The second reaction was to directly purchase the distressed assets. This act led to the bottom of 2009, in my opinion. It was this direct devaluation of the currency that led to the rapid price reflation.

Then, QE2 was announced. However, the purchases were sterilized with sales of offsetting treasuries. In this regard, QE2 was vastly different from QE1.

Which brings us to QE3 and the hastily announced (and almost ignored, it feels like) QE4. These two actions are monumental in scale. And they look almost exactly like QE1. We are about to have immense, unsterilized purchases of treasuries and, likely, other assets by the Fed.

Ben does not seem to be playing around here. I understand the dangers of the US budget all too well. I also remain convinced Europe will continue to sink all economies into a global recession.

But I am floored by the numbers being tossed around. And now Japan is jumping onboard also?

My belief for the next year is this; currency destruction is the name of the game, and it’s being kicked into high gear. It’s still football, but not like your grandparents used to play. The players are professionals, on steroids, and they’re going to start setting new records.

The damage of the economic realities that are being fought will shift where they materialize. Deflation threats and exploding bond markets will be replaced with money primer that will eventually run away from the officials who are unleashing it, leading to inflation. The bond markets will not be allowed to sell off; but nor can they be used to control the outstanding money supply anymore either.

It was always a cruel, false choice between these two outcomes, but knowing which one would ultimately happen was a matter of what choices those sitting at the head of the table decided to make.

There’s only one way to position yourself – full long, but NO MARGIN.

Precious metals are a must here. However, I view industrial commodities like oil to be a trap. My expectation is that economies will continue to contract even while the numbers involved grow. Real unemployment remains elevated, GDP and tax receipts increase, and people become furious at the $100 tomato.

Commodities like oil or copper will be subject to immense volatility, as they have been. Since I envision economic activity to continue slowing, demand for oil will weaken and stockpiles will grow substantially. This will create an environment of “reflation” where these commodities rise in price trying to pace the precious metals, only to hit the “flush out” moments where they crater 30% inside of a few weeks. Then repeat the process.

Taxes are about to rise on everyone. Consumption will likely slow.

I’m inclined to believe that the US consumer will fair better than expected. I’m also of the mind that, with recent price decreases, such as gasoline, the country can absorb a good swath of a broad price rally before it starts to stall out again.

Stay away from companies with soft balance sheets. Large cash positions are a must. It’s time to start picking out the long term survivors; the guys with 20% of their books in cash, waiting for a chance to seize market share.

Then sit back and hope business productivity is enough to offset the currency destruction and slowdown.

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