Sometimes, it takes a catastrophe to force more focused attention on serious, intractable issues that continue to worsen without resolve. The Japanese tsunami may be one of those defining moments.
The shocking Japanese tsunami has brought violent changes not only to Japan itself but is also bringing changes to global markets by causing a greater focus on the tsunami of issues with which the broad global economy is being inundated. It is not only the devastation that the current tsunami has caused (and continues to cause, as the aftershocks repeatedly hammer that beleaguered country), but the realization that this time, one Japanese tsunami is up against another Japanese tsunami, the staggering burden of the Japanese national debt (200% of GDP and rising) which threatens to wash away what remains of Japanese private savings and certainly will hamper the ability of its government to reenact the kind of recovery programme that followed the Kobe disaster 16 years earlier. The realization that there are consequences to insolvent national balance sheets is coming as a bit of a shock – an eye opener – to many who have never before seriously thought about those kinds of issues. The Japanese may be diligent, innovative, well prepared, and ready for disaster but the massive costs of clean-up and rebuilding have yet to be faced. They are, however, on everyone’s mind.
In the heat of the excitement inJapan, overlooked for a moment or two are the growing challenges being faced in the Arab world where an ossified political system is facing a stunning flood of criticism, all enabled by modern communication technology. Whether the armed force ‘sea walls’ that surround their leaders can withstand this deluge remains very much up in the air. And whether or not those sea walls do hold for the moment and the challenges beaten back – under the guise of labeling them ‘terrorists’ and/or religious fanatics which thereby justifies armed warfare against their own citizens – is hardly the point in the longer term. The flood of democratic yearnings may yet be beaten down inLibya,Bahrain,Yemen and elsewhere but I cannot help but suspect the resultant resentment will simmer and erupt in the period ahead. Unfortunately, the “West” will not emerge looking good out of all of that. The West cannot overtly support the “rebels” with anything other than placebo-like words lest the existing governments remain in power, but Western sentiment towards all of this is clear. And so with one blow, both the rebels and the existing governments are alienated towards us.
The focus on theMiddle East is a focus on oil, and the Japanese nuclear reactor explosions have raised yet another issue. In the race for more energy, does the nuclear option make sense? To judge from the markets’ selloff in Cameco (CCO) and Uranium One (UUU) for two, fear of nuclear is going ballistic. (To be honest, however, this is not a concern that I believe to be long-lasting as there are really few good energy options if the nuclear option is taken off the table.)
On the home front in the US, there is another flood of resentment in full tsunami force, the mounting concerns over the level and extent of US indebtedness, and the lack of any political leadership in dealing with it. The dikes which surround entitlements including social security, medicare/medicaid, and a host of well-entrenched programmes including currently totally unnecessarily agricultural subsidies, are facing that tsunami-like wall of debt. The US, too, is as insolvent as Japan, and American citizens are increasingly fed up with the increasing level of inequalities that that debt has spawned. How far the rising flood of Tea Party sentiment will go is yet to be seen, but given the inability of the current Congress to get anything done on the deficit issue, the collapsing condition of state and local governments, one would be shortsighted to expect that it has reached anything like a high water mark.
So…three tsunamis for the price of one! And all coming nicely together, coalescing around the Japanese catastrophe.
Against this background, what should one do? Our portfolio advice is currently quite defensive, and I firmly suspect that “doing nothing” is about as good as anything. Against the very clear potential for a larger market setback, given the massive run – overshoot, in my opinion, given the underlying solvency fundamentals – that it has already had, letting things settle makes more sense than trying to be clever while things are still in a state of extreme flux.
I don’t know whether the analogy of trying to catch a falling knife is entirely apt because the decline thus far has not been all that severe. But the situation in the Middle East remains in extreme flux, the devastation in Japan has yet to be fully reckoned, not to mention its effect on global growth for the remainder to 2011, and finally, the question as to what will happen now that the QEII programme is wrapping up in the US, a programme which has done so much to bring markets to their current over-extended condition. In other words, I think that we should watch and wait, comfortable with an ultra-conservative portfolio mix.
The question of gold also comes to the foreground. In previous market selloffs, bullion prices, along with commodity prices in general, have sold off, in some cases sharply. The reasons, which I have outlined before, are largely due to as much to speculators who are now treating commodities as another “asset class”, regardless of their inherent non-revenue generating characteristics. What makes gold different from most commodities is its scarcity and long term positive correlation with inflation – of which there is lots of around no matter what the economically ignorant try to tell us. The general cataclysm in Japan and the Middle East, coupled with attention being paid to insolvent governments, may – may – cause gold bullion to hold more of its strength this time around that the last market selloff in 2008-9.
Two things could happen in a market selloff to bullion and the gold shares.
First, they could act as they did back in 2008-9 and be quite weak. However, bullion and the gold shares were also the first group to recover virtually everything that they had lost in the selloff, with the TSX Gold Index rising 125% within three months of the October 2008 lows, and 150% by October 2009, one year later. I deem the real longer term capital risk to good quality gold shares to be minimal regardless of what happens in the very short run. I am are also still of the opinion that sooner or later, a highly speculative run will occur on gold shares as they catch up to their fair market value potentials (in line with what has occurred with some frequency in the past).
Second, gold share and bullion could hold up rather well this time around because the realization that inflation is now intractable as long as we continue to have two major countries, the US and Japan, in serious financial difficulties. In this case, my potential ‘explosive catch-up’ with the fundamentals remains a clear probability.