What goes up must come down! (page 2 of 2)

The commodity bulls believe that we are at the beginning of a long-term secular bull market for raw materials and precious metals, while the stock bulls believe that the rise since October 2002 is the first leg in a multi-year stock bull market.

Home buyers believe that the housing industry will continue to thrive and expand and never again be a cyclical industry in the way it has always been, and at the same time the 'deflationists' remain convinced that deflation will lead to a resumption of the bond bull market. So, wherever you go and to whomever you speak, everybody around the world is very optimistic about some asset class or some kind of 'very special situation.'

In addition, every investor you speak with is convinced that he is savvier and smarter than the public, and that he will know, just minutes before it turns down, when to get out of his favorite market, stock or commodity! In other words, every investor seems to be suffering from the massive delusion that he is an above-average investor who will be able to 'beat the crowd.'

Yet it should be clear to any rational thinker that commodities, and especially the precious metals, cannot forever rise in price while at the same time interest rates decline and bonds continue to appreciate.

At some point, continuously rising commodity prices must lead to higher inflation rates and depress bond - and probably also equity - prices. Conversely, bond prices can only continue to rise if global economic growth disappoints and deflationary forces reassert themselves.

The year 2003 was unusual in as far as all asset classes rose in price - that is, with the exception of the US dollar. In 2004, we expect asset markets again to show diverging performances, as has always been the case in the past, because every major up-trend in one asset class was also simultaneously accompanied by a major bear market in another asset class.

Take the 1970s: commodity prices including precious metals and oil rose more than 20-fold in price, but bonds and the US dollar collapsed and equities performed miserably. Or look at the 1980s. Japanese stocks went through the roof, but commodities collapsed.

Finally, in the 1990s, we had huge bull markets in the stock markets of the western industrialized countries, but devastating bear markets in Japan and, after 1997, in Asia.

I wish to emphasize that the simultaneous occurrence of bear markets in one asset class while another one is in a steep up-trend, is a very important insight into the long term behavior of investment markets. A 'Win Win' type of environment such as we had in 2003, when every investment market moved up is exceptional and totally a-typical.

So, what kind of investment markets should we expect in 2004? In my opinion, the surprise of 2004 could be renewed economic weakness in the US and a weakening of the torrid industrial production and investment growth in China, which would be temporarily negative for commodity prices and likely also for extended stock markets (developed and, especially, emerging markets) and sectors, which in 2003 performed superbly, such as US home builders and semiconductors.

On weakness, I would, however, accumulate oil and oil servicing stocks, as the fundamentals of the oil market look very promising. Oil consumption, not only in China, but throughout the emerging economies of Asia is likely to double from 20 million barrels per day, today, to around 35 to 50 million barrels over the next six to 10 years.

That such an increase in demand on a total current global crude oil production of daily 78 million barrels will drive prices in the long-term higher should be clear.

I would also add that the necessity of China to secure reliable oil supplies, which cannot be interrupted by the US, will add to international geopolitical tensions, and could put some day pressure on equity markets. Don't forget that one of the main reasons the Japanese entered the Second World War was the drive to secure its supplies of oil and other resources.

Lastly, the US dollar has become very oversold and sentiment is as negative about the US dollar as it is positive about the US stock market. Time for a contrarian to take the other side of the trade - that is, go long on the US dollar and short the US stock market?