Waiting for
the sky to fall: Asia and gold at
$500 By Keith W Rabin and Scott
B MacDonald
With gold approaching US$500
and silver above $8, there is a tendency to wonder
whether the long awaited "end game" is now before
us.
Gold gained almost $17 an ounce last
week - on par with levels not hit since late 1987.
Silver reached prices not seen since April 2004.
We share a bearish posture, particularly
in respect to US equity markets. However, before
adjourning to the bunker in anticipation of
massive social and economic breakdown, it is
important to note
the
odds favor a more protracted adjustment than the
possibility things will spin quickly out of
control.
While one cannot totally discount
the potential for a crash and major spikes in
volatility or dispute the excitement forecasts of
this kind provide, recessions are far from
everyday occurrences and depressions even rarer
events. Reality tends to be much more mundane and
there is little incentive on the part of the
world's central banks and political leaders to
allow the global economy to slide into a massive
meltdown.
So what is the outlook moving
forward? The trick for global economic
policymakers is to maintain stability as they
steer the world away from its excessive dependence
on the US economy. The US has substantial economic
problems - a massive current account imbalance, a
sizeable though falling fiscal deficit, a lack of
household savings and a consumer on his last legs.
As a result, one has to ask how the US can
continue to progress with an exhausted consumer
and cooling housing market.
The pressures
of economic globalization also make it highly
unlikely the US and other developed economies will
be able to achieve the productivity gains they
need to sustain a cost structure and standard of
living that is so much higher than that of the
developing world.
Over the long term, the
US simply cannot maintain its position as the
consumer of last resort. This means the Federal
Reserve and corporate and public sector managers
cannot rely indefinitely on ever-increasing real
estate and other asset values as well as other
questionable financing vehicles that enable
Americans to accrue the ever-higher levels of debt
needed to feed their voracious propensity to
consume.
Other than hoping there is
sufficient room to keep pumping up the bubble and
hope it does not blow, the only real option is to
shift demand to Asia. In particular, this includes
the trio of China, Japan and India as well as
other economies in ASEAN (Association of Southeast
Asian Nations).
What is the worst-case
scenario? Our biggest worry is that central banks
overreact to inflation risk by raising interest
rates to the point where they kill off growth. In
the United States, the Fed could overshoot raising
rates, sending an already retreating consumer into
a tailspin and making the downturn in the housing
market a rapid plunge as opposed to a more orderly
retreat from its current heights.
Translated into real gross domestic
product (GDP) growth, this could result in a
slowdown in the first half of 2006, followed by a
steep decline in the second half of the year,
setting the state for an actual recession in 2007.
It would also, despite their far better
fundamentals, at least over the short term, cause
panic and fear in Asian and other markets that are
believed to remain highly correlated to the US.
In our view, however, while we do not
doubt this sell-off would occur, the surprise will
likely be how quickly these other markets then
recover while the US shows at best more lackluster
performance.
Fortunately, there are whole
legions of people around the world - rising out of
poverty or shifting from a predominantly export
orientation - who are only too happy to "catch the
American disease" that manifests itself in the
aggressive accumulation of material possessions.
This is not to suggest the US will no longer
remain an extremely important market, but rather
the most important drivers of marginal growth will
occur offshore.
In unit terms, China alone
is already said to constitute a larger market than
the US for steel, TVs, refrigerators, radios,
motorcycles and cellular phones. If one adds in
India, Japan, Korea, ASEAN, Central Asia, Africa,
Latin America and the rest of the developing world
it appears inevitable that the US portion of
global market share will decline on a percentage
basis though not as radically as a demographically
challenged Western Europe.
Indian credit
card usage, for example, rose from 4.3 million to
9 million from 2000 to 2003, and ICICI (India's
second largest bank) alone issued about 100,000
cards every month in 2004. Only 53 million people
- less than 5% of India's population - are
estimated to have mobile phones. Indonesia's
mobile market is also growing dramatically - at a
more than 70% compounded rate over last six years
- yet still has one of the lowest penetration
rates in the region.
The US would be hard
pressed to show similar demand growth in any
sector. Even in terms of luxury goods the US no
longer remains dominant. Japan now represents the
market that defines the profitability for many
luxury goods manufacturers and retail chains. Some
analysts even forecast the luxury product market
in China will be larger than the US in five years.
This is not to suggest a seamless
transition or the absence of extreme anxiety and
tension along the way. Additionally, over time it
may even be possible we will see the dramatic
readjustment predicted by analysts such as Richard
Russell whereby the price of an ounce of gold
ultimately exceeds that of the Dow Jones index.
Rather, it is to recognize that whatever
adjustment occurs, investors are likely to be
better served by strategies that focus on the
greater probability of a (investment writer) John
Maudlin-like "muddle-through" protracted
adjustment than the expectation that a new era of
hyperinflation, end of fiat currencies, breakdown
of law and order and other aspects of life as we
know it lies right outside our door and is ready
to commence at any time.
Perhaps the most
important reason an abrupt adjustment will not
take place is that it is not in anyone's interest
- save perhaps a few highly leveraged speculators.
While developing and developed markets around the
world will ultimately move to decouple themselves
from an excessive reliance on US demand and the
vacillations of Wall Street that are still the
norm this will take time. To do so prematurely,
therefore, is equivalent to economic suicide.
While we are not big fans of the PTB
"powers that be" argument - if for no other reason
than it is impossible for the bureaucracy and
consensus needed to carry out all the machinations
accorded to them in total secrecy for decades or
centuries. That said, it would be a great mistake
to underestimate the capacity of central bankers
and key economic policymakers to maintain the
subterfuge longer - given that aside from a few
major breakdowns they have done so for centuries.
It is also worth noting that aside from economic
concerns, it is potentially destabilizing in a
political and security context as well.
What is the bottom line? For those who
predict that foreign buyers are likely to suddenly
abandon treasury securities, they must recognize
this is not only a US problem but a global one -
as Asia and other markets remain very dependent on
the US both as an export market and an element
within the global security environment. That said,
it is clear these economies do see the writing on
the wall and are making every effort to promote
this adjustment as well - ie building up the
domestic component of their economies and shifting
resources, not so much away from US but to allow a
multiplicity of focuses.
What does this
mean for investors? It depends on the time frame
and one's individual circumstances. Over time, the
underlying trends are hard to dispute. The entry
of large numbers of new people into the world
economy will help to ensure strong demand for
commodities, energy and other resources for the
foreseeable future. Furthermore the strong growth
that will be seen in emerging markets that possess
positive demographics and that are just starting
to develop consumer-oriented cultures offer far
better potential for appreciation than the US.
In addition, Japan and other markets that
are now in the midst of achieving the benefits of
corporate/economic rationalization also have an
advantage as the benefits are before them rather
than the US where they have largely been realized.
Finally, as seen in the recent comments by a
Russian official, the growing need for central
banks to diversify away from the US dollar as a
reserve currency almost necessitates increased
demand for gold over time. This innate demand is
further accentuated by troubles in Europe that
diminish the potential for the Euro to act in this
regard.
Therefore, those who have strong
stomachs and can afford to simply buy and hold are
probably best advised to scale into positions that
will benefit from these trends. Those who are a
bit more aggressive can take on and trade around
core positions, lightening up on strength and
buying back with weakness.
The key point,
however, is that while the train has certainly
left the station, there will be starts and stops
and one needs to resist the urge to leverage up
every time things get hot and everyone starts
crying "to the moon" and doing high fives in the
newsletters and message boards, only to then get
shaken out on the inevitable downturns. On the
other hand, if one is able to hold one's nose,
those gut-wrenching moments that are only likely
to increase in volatility, are more likely to be
buying than selling opportunities - so long as the
underlying trend is maintained.
Keith W Rabin is president and
publisher, KWR International Advisor. Dr Scott
B MacDonald is editor and senior consultant
for KWR International Advisor.
(KWR
International Inc, a New York-based consulting
firm specializing in research, communications and
business development services for the public and
private sector, with a special emphasis on the
Asia-Pacific region. Visit the site.)
