Sunday

Investment Update

Post a Comment March 27, 2011 – 10:50 am |   | Permalink |  Print This Post |

It has been quite some time since our last update. This is because we have not altered our strategy during this period, which in hindsight has hindered returns. We did not expect the Federal reserve to commence QE2 late last year. We thought Bernenke was bluffing. We were wrong. This puts our past thesis in question. With the continued money printing and lack of any restraint by the US government, the Zimbabwe scenario has become a possibility. However we think this possibility is still minute, mainly because the US is a democratic society. Which means the Feds will get abolished and the government who endorses the Feds will get kicked out before hyperinflation will occur. High inflation yes, hyperinflation no. In fact high inflation is likely the trigger for revolutions and change, as we are seeing in the middle east currently.

It defies believe that the markets continue to rise despite risks all over the globe; from the earthquake and tsunami and nuclear crisis in Japan, to sovereign debt crisis in Europe, municipal debt crisis in US, to inflation in China. Fundamentally the most important of these is China, because it is China that has kept the world going for the past 18 months.

We don’t buy into the miracle of China in the short term. There is little doubt the 21st century will be the century of China, but the current rate of development is unsustainable. They want to restrain the property bubble whilst maintaining growth, and at the same time control inflation. So what do they do? They continue to force banks to lend out massive amounts of money for growth, which is increasing the M3 money supply leading to inflation, whilst at the same time raising interest rates and capital reserve ratios, hoping the money goes into productive growth rather than speculation and dampen inflation. That’s akin to what the US companies did during 2008, they kept paying dividends whilst at the same time having to keep raising capital. It just doesn’t make sense. If they want to control inflation they’re going to have to reduce lending, which will slow growth. You can’t have it both ways.

Our core portfolio has not changed. We’re still only invested in metals and agricultural commodities, which are fully hedged with short indices. The most immediate problem we have is which of the following will come first. Collapse of China leading to a tumble in commodity prices, or continued money printing leading to a parabolic rise in commodity prices. Which occurs next is crucial to determine the level of exposure to commodities we want to retain. In the first instance we want to reduce our exposure to commodities and have a high level of cash, in the second we want to be fully invested.

Whilst the stock market is defying all fundamentals and technicals, we stay rational. We are finally starting to see a divergence between commodity returns and stock markets returns, which we have been expecting, with higher input costs causing margin compression as companies are unable to pass on price increases due to the state of the economy. However our returns over the past year has been sub-optimal due to our over-contrarion stance and we are adapting our trading portfolio to balance that with trend-following. We hope to be able to enhance our returns even through times of irrationality, as the Feds try to push the markets to infinity and beyond.