Perspectives - Personal Finance Blog

Linda says:

The average central banker is usually the last person to admit to the obvious- namely inflation is going out of control. Which is strange since the wanton printing of money, is the prime contributor to the aforementioned inflation. And most ordinary people are prohibited from printing their own or likely to be jailed for successful efforts. But it certainly is the province of central banks.

While Western countries certainly have their problems, the degree of inflation is considerably worse in Asian economies. Figures for some of these countries include about 8%in both China and India with a horrendous level of 25% in Vietnam. Vietnam is trying to stop imports of gold, which are in great demand by a populace witnessing a major fall in their paper currency purchasing power.

While perhaps seized upon by all forms of speculators, inflation destroys the purchasing power of average wages and the savings of average householders. It is generally bad for stocks and business, since it cuts the profitability of companies and therefore stocks.

The major way of controlling inflation is to raise interest rates, so even if it is not happening everywhere yet, the likely “cure” is going to inflict pain when it comes. If you can reduce debts- do it now, before higher rates hit.

Some central bankers are still of the belief that the financial system is too fragile to inflict the pain of higher rates. But that pain will still be necessary at some point, if inflation is to be brought under control.

Linda says:

The financial headlines have moved from the business pages to the FRONT PAGE.
But every worrying headline that you read, tends to benefit mortgage holders and precious metals.

If the US economy is on the brink of recession, other countries may be also in trouble. Four economies already showing signs of a slowdown are Japan, Britain, Spain and Singapore. Pressure is now mounting for interest rate cuts from central bankers in countries other than the United States. Even where the central bank is threatening to raise interest rates, as in Australia, more shock headlines and stock market wobbles hold a glimmer of hope for embattled mortgage holders.

The worse the news gets, the less likely that any central bank will actually dare raise mortgage rates. Those bankers still talking tough, may actually be forced eventually, to cut rates to stimulate their economies. Thus, the ill wind that is blowing on the stock markets and credit markets of the world, may be a blessing for mortgage holders, who are being already hit by rising food and oil prices.

Negative comments on world growth are coming from multiple sources, including top bankers and brokers. Mr Strauss- Kahn, the new head of the IMF has called for both lower interest rates and government stimulatory policies, from many countries in addition to the United States. Warnings on further banking problems spreading from sub-prime loans, to credit card and consumer loans, has come from John Thain, the new head of Merrill Lynch.

There has not been good press recently, for the entire banking industry. How some “rogue trader” can have liabilities that equal the capitalisation of the bank itself is amazing and downright scary. If it can happen in Paris, it unfortunately can probably happen in your bank. No wonder gold bullion looks good and solid by contrast. As opposed to some concocted derivative strategy, that might just blow your money up somewhere in cyberspace.

What is becoming readily apparent is that the volume of complex financial products is out of control. How many gung-ho traders are out there playing games, and taking colossal risks while sitting at a computer screen??? Unfortunately, your savings and investments might be a casualty; it is unlikely that problems are confined to Societe Generale.

Warren Buffet has called these derivatives “financial weapons of mass destruction.”

The size of these markets is far larger than the GDP of the worlds’ economies. By contrast, the supply of gold is finite and mining output is actually falling. And you can’t just print it or manufacture it out of thin air, as paper currencies can be and are.
In South Africa itself, production of gold has been cut since a major crisis in electricity supply hit the gold and other mines. Since the electricity supply is unreliable, miners can’t go down to the mines because they can’t guarantee power supply to the lifts to get them out again.

Several countries are now experiencing ” negative real interest rates”, meaning the bank rates of interest are less than the rate of inflation. Countries affected include the United States and the Persian Gulf countries. Thus, you are guaranteed to lose by leaving money in a bank deposit, in these countries.

A traditional inflation hedge such as gold looks good by contrast. Wealthy Arabs (and Chinese) are choosing to shift some of their assets, which were based in US dollars, into gold.

Supply problems will only accentuate the rush

Linda says:

Look beyond the headlines to help you decide what to do?

How do you figure out whether a recession is likely when governments, central banks, newspapers and other groups are often lying to you?

In the field of commodities, 2007 was a very good year with increases in grains, metals oil and gold.

But what does the future hold? If you try to get a picture of future economic activity, you can look at measures such as housing starts and building approvals. In the resources industry, with mega takeovers proposed, it is hard to get an unbiased and accurate picture as opposed to spin, and public relations statements.

One infrequently reported, but extremely important measure is the Baltic Dry Index.

This measure is actually London based, and measures the cost of moving bulk goods around the world by sea. It deals with cost of carrying materials such as ores, coal and grains but does not measure the carriage of manufactured goods.

In the last couple of years, being in the bulk goods business has been highly profitable, with the Baltic Dry Index rising 150% last year. But in the last week, there have been 3 major falls, with a Plunge of 5.7% in a single day. The index has fallen rapidly and is now 37% off from its highs.

When there are more goods to ship, than ships available, the cost goes up and this, of course, also works in reverse. Thus, if the cost of shipping is falling so rapidly, the demand for shipping is falling and there will be fewer bulk goods to transport. And, eventually, a decrease in manufactured goods as well. The shares of shipping companies are busy falling too!

Thus commodity prices and the economies dependent on them, may not be as insulated from global woes as they might like to think they are! In other words, mining and other commodity related stocks are likely to go DOWN if the demand for their products is falling. Instead of the crystal ball, keep an eye on the Baltic Dry Index.

Linda says:

Financial and political crises are benefiting the price of gold.

With an ongoing crisis in the banking system, no shortage of political upheaval, especially now in nuclear armed Pakistan, 2008 is looking like a good year for investing in some gold. Precious metals were the investment darlings of the early 1980’s, but then lost money for investors for decades. The Bank of England and many other central banks sold down their gold reserves, and gold seemed archaic and only suitable for jewellery.

However since about 2003, gold has been making a comeback as an investment class. Gold may pay no interest or dividend, but it has been a store of value since the days of the pharaohs. A gold mining company may declare bankruptcy, but a gold bar cannot. And it does not have any hidden sub-prime loans on its balance sheet. It is not going to inform the market of a slowdown in construction activity. Thus it is a tangible asset and is seen as a traditional inflation hedge.

In the unstable Middle East, and among the newly prosperous classes in India and China, investment in gold is rising both as an inflation hedge and a traditional store of wealth. After losing money on complex mortgage related investments, the appeal of precious metals is also expected to rise in Western countries.

The US at the moment has negative real interest rates (treasury bond 2 year rates are less than the rate of inflation), which traditionally favours gold. Even one of the US presidential hopefuls, Dr Ron Paul, has been advocating returning the currencies to the gold standard.

If you are interested in putting some money into gold, it is prudent to start building a position shortly, before the rise is in the gold price is on every magazine cover. Gold shares are correlated to the price of physical gold, but also negatively impacted by any form of stock market correction. Rising costs for machinery and labour are impacting the gold mining shares adversely.

And Osama Bin Laden putting out a “Christmas message” urging more mayhem and strife, benefits the precious metals dealers (as well as the arms dealers, of course.) Gold was up 30% in 2007 and 2008 is likely to be a very good year.