Daniel Zurbrügg's  Instablog

In our May issue of our newsletter we looked into the changing importance of and outlined our investment case for gold. At that time, we made the following forecasts:

Now, about six months later, these forecasts have become reality

 

Half a year after we made these forecasts, we can tell that they were pretty accurate. As we are writing this report here in early October, Gold has not only broken the psychologically important USD 1,000 mark but has actually moved upwards to USD 1,050 already and continues to follow a strong upwards trend. In our previous reports we have mentioned several times that gold, although it is a non-interest bearing investment, is a very compelling investment case since its relative importance is increasing quickly. The main reasons for this are investors demand for an inflation hedge and as protection against another very severe crisis. Also, in an attempt to diversify investment holdings, Asian investors and central banks are buying large quantities of the yellow metal. Considering the almost chronic supply shortage, we think there are several factors at play which should continue to drive the gold price towards USD 1,500 in coming months.

 

 

It goes without saying that part of the gold price advances were also caused by further weakness of the U.S. Dollar. Is the Greenback now finally finding some support at current levels? We have our doubts and continue to be bearish on the U.S. Dollar for several reasons. Although we think that the risk for strong inflationary pressures have fallen somewhat, it is clear that the U.S. does not have too much interest in a strong currency. With the amount of government debt now at record levels, the last thing the U.S. wants is a strong currency. Also, the U.S. Dollar’s role as the world’s sole leading currency is coming to an end, and, although it will remain an important currency, its share of world currency reserves is going to fall further from here. The recent rumors that the Greenback will be replaced as the “Oil Currency” gives clear evidence that the relative importance of the U.S. Dollar is falling. Although the current amount of government debt is almost mind blowing, we don’t think that it is a hopeless situation. Compared to the size of the U.S. economy it is still manageable but in our view drastic measures to correct the unpleasant situation need to be taken. These measures must include spending cuts and increased spending discipline as well as steps to promote real economic growth since it is unrealistic to hope that inflation and spending cuts alone will rebalance the deficit. Unfortunately the measures taken so far are targeted at either redistributing wealth, increase spending or at protecting the domestic economy. Although probably relatively popular politically, these measures are counterproductive and will not help to improve the situation. We remain bearish on the U.S. Dollar and expect another 5-10% decline in the next six months before it is possibly finding a new equilibrium price around 1.60 against the Euro.

 

Private household consumption is weak among most western economies. While this might only be a temporary situation for some of them, other nations are faced with a structural adjustment of consumption. For example, consumption has been the main driver of the U.S. economy in the past 20 years with consumers buying and spending everything they could get. This has resulted in a situation where excess consumption was financed by rising asset or home equity prices or in many cases even worse, increased borrowing from credit cards and other sources. Long-term, this is not going to work and we are now starting to see this situation getting corrected, for many it is quite a painful adjustment. After a huge destruction of wealth in the past two years, many people are only left with one choice and that is savings from their income, provided that they still have an income. We expect this to continue for a number of years, with the share of consumption as a percentage of GDP falling significantly. So therefore the outlook for GDP growth is very bleak you might say, right? Not necessarily we think. Falling consumption spending can be compensated by increased investment spending and rising net exports. While we are relatively optimistic on net exports (partially supported by a weak and falling U.S. Dollar), we are less optimistic on investment spending. The various economic stimulus packages have in our view failed to address this enough. Economic theory tells us, and historical evidence supports this view, that spending on infrastructure actually can increase GDP longer-term. It goes without saying that the need for infrastructure spending in the U.S. has been neglected far too long and there is an urgent need to upgrade infrastructure. Did you know for example that the U.S. electricity grid is by far the oldest in the western world? So money would be better spent on such investments that provide the basis for long-term economic growth rather than wasting money on simply redistributing wealth, over-regulating the economy or pursuing ‘pet’ political initiatives. With the U.S. having the highest tax burden among western economies, taking into consideration income and inheritance taxes, it would be time to completely overhaul the tax system before even thinking and possibly increasing healthcare programs. Increasing financial pain and worries about how to finance increasing healthcare is a common problem among most developed economies. While many people think that the cost for healthcare has reached a level which is unbearable, we think that the costs will continue to grow for a long-time. The main problems here are changing demographics, improved medical technologies and often wrong incentives within the health care system that keep costs rising. Let’s face it, we all appreciate the fact that our life expectancy has grown so rapidly over the last few decades. Now that we have the medical options to not only increase our life expectancy but in most cases also the quality of our life, we are prepared to spend extra money on health care. The flip side of the coin is that we need to be prepared to work more years before we can retire. We see this as the only way to manage surging healthcare costs and pension liabilities.

 

 

 

The new administration in the U.S. is trying hard to increase tax revenues in any way they can. The war on tax havens which was declared a while ago can be felt by global offshore financial centers worldwide. Switzerland might have received the most attention so far, mainly because of the UBS story, but the situation is very similar for all offshore financial centers. But let me clarify one thing, there really is no such thing as a tax haven –‘haven’ is a relative concept for each of us. In practical tax terms, it simply means that these so called haven countries have their own taxation system and legal and regulatory frameworks. In an attempt to achieve full transparency for financial transactions, and thus tax liabilities, the IRS in the U.S. as well as some of the larger European countries are demanding an increased exchange of bank account and financial transaction information. Politically, it is relatively easy to get support for such aggressive measures during times of financial distress and economic difficulty. Finding something or somebody to blame for the current trouble gives at least temporary relief and probably more votes for politicians that claim to fight that war on behalf of its people. Today’s society and individuals have an almost chronic habit of trying to find somebody or something to blame for its own problems rather than take responsibility for one’s own action. This behavior might in fact be the root of many of today’s problems, and, what might seem an appropriate solution today might be a very serious mistake in the long-term. We believe that the current aggressive measures against offshore financial centers will be very destructive to the economies of countries calling for such drastic regulation. Did you know that under the proposed law even Swiss citizens could become liable for U.S. inheritance taxes if U.S. securities are owned at the time of death? This is a good reason for foreign investors to stay away from U.S. securities in my opinion – a big negative for U.S. investment markets. If you consider the almost “toxic” inheritance tax rates in the U.S., I think this makes a very convincing case against owning any U.S. securities at all. We think that the current administration in Washington is making several mistakes. The bottom line is that this means it will get harder for U.S. corporations as well as the government to attract foreign capital at a time when the need for foreign capital is bigger than ever. A higher cost of capital is the ultimate consequence of such policies and this will in turn decrease competiveness and worsen the deficit of a country.