Already into 2009 we are experiencing trend-threatening moves in various markets. Should we believe that the markets are directionless? Can we rely on the charts to give us direction? What of the fundamentals of markets are they reliable guides? Most important of all, are investors capable of responding to the directions given by fundamental and technical indicators? Are these ridiculous questions? They would have been a couple of years ago, but now need to be considered carefully.
What we do expect in these initial days is a search for a clear direction forward by the markets. They have to decide whether we are set for deflation or whether this will turn in response to the massive monetary stimuli the global economy has and will receive from the central banks and governments, back to inflation. Bernanke and friends have made it more than clear to us that they will do all it takes to halt deflation and turn economies back to growth. We accept that this will happen. Consequently we face a clear direction preceded by heart-stopping volatility in all markets.
After current market indecision has given away to acceptance of an inflationary future, expect to hear the popping sound of the bond market bubble bursting and currency market volatility reaching new highs. The rush into assets that will follow, as cash appears to lose its crown, will be a sight to see. But cash in the form of gold will be one of the most popular homes for paper cash for you just can’t inflate gold. That’s apart form its attraction of having no counterparty.
Overlaying this ‘big picture’ is volatility; shocking, persistent, unrestrained volatility. How does an investor cope? Last year we experienced for the first time, “investor meltdown” which took the certainty out of all our worlds, but now we know this can happen. So we now face a relatively simple choice; we can refuse to invest [?] but that is more than a defeat, or we can brace up and tackle the most difficult investment scene we have likely experienced in our investing lives? In short, we have to gather ourselves together and to set a policy we can hold to in the storms that lie ahead. We have to be decisive on the back of a clear workable set of conclusions garnered from careful research. Once complete, we have to set our resolves as solidly as a sailor does at the wheel of a ship ploughing through rough, stormy seas. Here are a few of the steps we must take: -
1. Is the world going to experience deflation from here onwards? Or, do we believe that deflation will be defeated by inflation? This conclusion is the foundation of our investment policy for 2009 / 2010. Whatever our course on this is, will take us to success or failure.
2. In deflation cash is king and asset values decline. However, this leaves a twilight zone for gold, which in deflation is a haven from uncertainty and is a form of extreme-times cash. Its performance in the recent months has testified to this, as it dropped back somewhat but nowhere nearly as much as equities or commodities. Indeed, in currencies that experienced weakness against the U.S.$ gold has hardly fallen at all and in some has risen soundly.
3. In inflation asset values rise and cash value declines taking the value of savings with it. Debt loses its sting and the velocity of money accelerates as people run from cash into assets as fast as they can. Again, gold has to be separated from paper cash as it sits in its twilight zone again, as an asset that is unprintable, has no counterparty, while remaining a form of cash? As we watched the consumer bubble rise and house prices seemingly sailing up unstoppably, gold rose as if to warn of the coming credit crunch. It thus served as an excellent haven from the unreality of the seemingly endless rosy future that house prices had discounted.
4. These two points show us that our investment decisions need not be one or the other, but that desirable place of both, taking us to a safe place. How much better the helm feels when one can be sure of this direction. How much firmer our grip on our investments when we be certain of preserving and increasing real wealth this way?
5. But the storm we sail through could be the worst known to modern markets, possibly making us easily distracted, uncertain and capricious, losing our grip on the rudder. That brings us back to ourselves and our ability to hold the course we set? One of the best ways to do this is to ensure that any change of direction should be as well researched and meet our first high standards as our initial course was. Failure to meet those standards should mean a rejection of alternatives and retention of the first course set.
6. But we will inevitably find that our emotions pull us this way and that. The best way to tackle emotional battering is to decide how we are going to handle it in the first place. In the calm days when we set our course we decide what we will do in the face of uncertainty and set standards for how we will allow these to affect our initial decisions. Thus we also reduce the likelihood of those emotions proving overwhelming.
7. The clearest mistake that led to investor meltdown was the failure to take into account the damage that could be done if markets fell unexpectedly. Had these been factored in, leveraging would have been either limited or unwound at the first sign of market meltdown. Indeed, we doubt that there is an investment manager out there that has not revisited the policy of leverage and time limits.
8. This has not been simply a matter of quantifying expected cash flow from investments, if capital values drop, but of setting strict criteria for leveraging and setting time period for investments. We don’t mean limiting the period investments will be held for but removing any time restraints. For instance how many unsuccessful investors were wiped out by limiting the time there investments could perform in? How many were wiped out by having to sell when prices dropped?
9. For those with no leverage and capable of riding the storm to its conclusion, those losses can be lived through until they turn to profits in times that lie ahead when global stimulation has turned markets around if the market prospects warrant such a course? Those unable to hold during the storm simply become its victims? Such flexibility reduces risk!
When we set our minds to these values in the volatile days of 2009 and 2010, we can be solid and clear on the way forward. We reduce risks by doing so and we believe we will see outstanding profits that can be retained. But we must have a strong resolve and a tough attitude to battle the massive waves of volatility we see before us.
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