The River Of Losses

Dr Steve Sjuggerud - Thu 22 Apr, 2004

"...The trends that could put oil at $50 per barrel this year havent gone away. But the risks created by the "reflation rally" threaten EVERY asset class today. Beware you dont get wiped out in 2004/05..."

"I was leaning toward the view that some assets would continue to increase in value in 2004. I am now increasingly concerned that sometime soon 'everything' could begin to unravel. When interest rates rise, it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time."

- Marc Faber, in the Financial Times


This is the most important advice I’ve ever given. And, chances are, you don’t want to hear it.

In fact, after you read this essay, you might never want to hear from me again. But it’s a chance I’m willing to take.

So here it is: Very soon, you could lose a lot of money.

Right now, the way I see it, it will be extremely difficult over the next year - at least - to make money ANYWHERE in investing.

I think Marc Faber is right. The fact that interest rates have been at multi-generation lows for a very long time has caused investors to chase anything and everything higher. The obvious result is that everything has been bid up. Shares and bonds were first. But now commodities and property have been bid up as well.

As I'll show, I think many markets are close to their peaks. I now see the stock market (and most investable assets) like a river, working its way from the mountain peak to the sea. There are occasional "flat" sections of the river, where things appear calm and the current isn't very strong. And then there are some wild rapids heading down. There are even the occasional eddies along the riverbanks...that flow against the grain.

But while the river has all three of these states - flats, rapids, and eddies - the inexorable flow is down. I see investments as that river today. The inexorable flow in investment values is down. I want to show you how difficult it could be over the next year...or couple of years...to fight that current.

Let's consider some of the major asset classes, and see what may happen in the coming months and years. And then we'll talk about the eddies - namely, which investments, if you're ambitious enough to try them, might flow against the current.

By most measures, US stocks are expensive right now. That doesn’t bode well for other major stock markets in Europe or Asia, either. But the Fed is still accommodating investors by keeping rates low, and the overall trend in stocks still seems to be up - for the moment. However, the writing is on the wall. At least right now, it appears fairly certain that the Fed will raise rates by the end of this year. When it does, stocks will likely take a significant hit - everywhere.

At the same time, in the Western world’s housing markets, the fundamentals I've written about for years are still in place. With today’s extremely low mortgage rates, property still looks "affordable" when you compare monthly payments to family incomes. So I still believe in the bullish case I've made for years now.

But there is a major change. I believe an international housing bubble is finally getting underway in the rich countries of the world. Like all bubbles, this one started out on a solid premise. Enjoy it while it lasts, but be aware...know that a speculative bubble is being created, on a pile of debt, and the end will likely be ugly.

Meanwhile, the sales promotions for commodity-related investments pile up in my mailbox..."Why Natural Gas is Hotter than Ever" is the cover of one. "New Oil & Gas Discovery Rewrites the Energy Story for 2004" is on the cover of another.

I am very bullish on commodities over the rest of the decade. But I'm starting to think that the story is getting too popular. You know it's getting overheated when CNBC TV reporters are taking helicopters out to the oil sands area in Canada. CNBC is just going where the hype is, as usual. Remember, it is giving the advice you want to hear...

Earlier this month, I touched base with my most trusted contact in the commodities business. Simply put, nobody trades commodities better than Canadian broker Chris Foster of Scotia-McLeod in Toronto.

Chris eased my fears. "The hype is worrisome," he told me about oil. "But the story is simple, and real...there is simply more demand than supply."

Chris explained that, contrary to popular opinion right now, "the Saudis are maxed out" in their oil production. The Saudis are already using output-enhancing techniques just to keep their production up.

Chris went through a laundry list of other oil-producing countries, and why their production can't keep up either. It sure is a motley bunch...including Venezuela, the fourth-largest oil producer, and Nigeria, where political unrest threatens supplies almost daily.

Making matters worse, there is apparently not enough exploration - the source of future supply - going on. Chris wondered aloud what price oil would have to reach to get exploration in high gear again. Then he said, "It wouldn't surprise me to see the market meander its way to $50 a barrel."

In the near term, Chris is probably right. Nevertheless, if you want to play the commodities bull, caution is in order. There is a big story hidden in here...the story of a bubble in the midst of bursting, that could possibly drag commodity prices down with it: China.

The Chinese government now admits it has a credit bubble on its hands. But China has made the mistake that Japan made in the late 1980s, of not acting fast enough to slow the growth of the bubble. It may already be too late.
 
The bust of China could lead to a bust in commodity prices as well, for a while. To compound the probability of the commodity boom, it appears that hedge funds have been big buyers of commodities over the last six months or so also. Hedge funds can, and do, dart in and out of positions. If hedge funds are moving out of commodities at the same time the China bubble is bursting, it could be ugly. The moves could be exacerbated, as hedge funds often make leveraged bets.

Given the conditions I've outlined above, and to reiterate what I said earlier, it will likely be extremely difficult over the next year to make money through investing. Today’s markets are like a giant river flowing downhill, sweeping up unwitting investors - and their money - in the process.

You might choose to simply get out of the river. Then you won't go down with it. The other, more ambitious, and more risky, approach is to try and find the little sections of the river, right on the edges, where the water occasionally flows in the wrong direction. There, you might find a pocket that will rise, maybe for a brief moment, against the current.

Admittedly, the 'eddies' I'm talking about are hard to find. You’re not likely to hear about them from your broker. His main concern, of course, is selling you shares and investment funds...and taking a healthy commission.

But I don’t work on commission. I don’t have an interest in whether you buy, sell, or hold. And so, unlike your broker, I am free to tell you - this next year could be devastating to many “traditional” investments.

If you do nothing else, I recommend you get out of the equity and bond markets right now. Cash may turn out to be the best performing asset of 2004-2005.


Regards,

Steve Sjuggerud,
for The Daily Reckoning