Financial survival in 2002 (page 2 of 2)

From here on, interest rates will be in a bottoming phase and sooner or later show a rising tendency, as inflation will accelerate as soon as the economy picks up. Of more concern to me is that inflation could accelerate even before the economy does pick up, as recent rapid money supply growth in the US could lead to a period of stagflation.

After all we ought to be aware that Mr. Greenspan and other American policy makers will - in desperation - not hesitate to flood the system with more and more money in order to stimulate the economy and, therefore, lay the foundation for an inflationary spiral in the years to come.

I also feel that the days of a strong US dollar are numbered. In due course the US dollar will weaken, as foreigners lose their appetite for US dollar assets. The only question is against what the US dollar will weaken? It is difficult to imagine how the US dollar could weaken much against the Japanese Yen. Similarly, it is improbable that the Euro will appreciate by more than 10% to 20% against the Greenback.

However, I believe that the US dollar will begin to depreciate against Gold and Silver, as the world begins to realize that the excessively expansionary monetary policies of central bankers will lead to inflation sometime in the future. Thus, I still recommend investors to allocate some of their financial assets for the purchase of gold bullion, physical silver and gold shares.

I may add that since the beginning of 2001, gold shares have begun to outperform equities and in particular financial stocks. The market, therefore, seems to indicate that there might be something rotten in the financial system. Consequently, while we recommend the purchase of mining stocks and physical gold, we also suggest investors to liquidate US financial stocks such as banks, consumer finance, credit card companies, sub-prime lenders, and the highly leveraged government sponsored enterprises such as Fannie Mae and Freddie Mac.

In the course of 2001 another important change occurred. For the first time in many years, emerging markets began to outperform the US stock market. Consider the following. Since 1990, US stocks are up by about 5 times - even after their weakness over the last 18 months - whereas most Asian emerging markets are down in dollar terms by 80% from their highs. But, there was a sea change in the trend in 2001. While the S&P and the NASDAQ declined, the Shenzhen B and Shanghai B markets rose by 85%, South Korea by 38%, Taiwan by 5%, and Thailand by 12%.

At the same time Russia was up by more than 60%. So, if we compare the performance of the Asian markets with the US stock market, we can see that, from 1990 until 1998, the Asian markets were in a steep downtrend against the US market. However, since 1998, the Asian stock markets have built a longer-term base against the US stock market, from which I expect a powerful breakout on the upside in 2002.

Thus, I recommend investors to take long positions in depressed Asian stocks and hedge this exposure by shorting the US stock market whose valuation is still far too high. As a proxy for the over-valuation of US stocks, investors should consider shorting IBM, which has so far held up better than the market.

In Asia we like depressed Indonesian, Thai, Philippine and Malaysian second line stocks better than the Hong Kong, Korean and Taiwanese stock markets, all of which are much more closely correlated to the S&P 500 and the NASDAQ in the US. So, in simple terms, go long Asia and short the US!