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Daniel Zurbrügg
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Daniel Zurbrügg is the Managing Partner of Swiss Infinity Global Investmetns GmbH(, a Swiss based independent asset management firm. The firm provides clients with independent investment research, asset management and asset protection services. With a global network... More
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  • A debt deal that will not change anything
    In early August, the U.S. Congress, after weeks of intense discussions, was finally able to agree on a debt deal. The deal will raise the U.S. debt limit by at least USD 2.1 trillion and significantly cut federal spending in coming years. Agreed spending cuts will amount to at least USD 917 billion over the next ten years. On top of that, a congressional committee will work out a plan that would cut the deficit by an additional USD 1.5 trillion. The additional funding provided with the increase of the debt limit should give the U.S. government enough funding to operate until 2013, this means that after the next election a new debt deal needs to be made. It was a very intense battle between Democrats and Republicans and the possibility of a debt default created a lot of uncertainty in recent weeks. This uncertainty was felt very directly in financial markets and caused global stock markets to move lower and the U.S. Dollar to lose further ground against most major currencies. With the debt deal now in place, can we expect a recovery rally in the weeks ahead and hope that everything will be just fine again? What is needed to improve things to the better in the long-run?
    US Dollar Index
    Unfortunately, there are a lot of factors that suggest that we have to be prepared for more market volatility and economic uncertainty. The problem is, in my opinion, not so much the debt limit and the spending cuts that now have been agreed. The main problem is that the latest battle about the debt limit has caused severe damage to the confidence international investors have in the U.S., this comes at a time when the need for foreign investment and capital is bigger than ever before. Also it seems that neither Republicans nor Democrats are truly happy about the deal negotiated, although each party tries to sell it as a victory, but clearly for Republicans the spending cuts are not enough and Democrats are not happy because there are no tax hikes included in the deal. While the problem can be viewed from different angles, it was the actual public debate about how to solve the debt limit problem that is causing real economic damage. For a few weeks, investors around the world kept their eyes on the U.S. debt crisis and the political fight about it. Raising debt limits is something that has happened many times in the past few decades. Just since the early 60’s, this happened more than 70 (!!) times and most of the time it was not a big deal…BUT…this time it is a different situation. The sheer debt number, which has now exceeded USD 14 trillion is scary enough, but it always needs to be seen in the overall context, that means in comparison to the size of GDP and here the story gets really alarming. The size of the overall federal debt has now exceeded the size of GDP and continues its strong upward trend and is now approaching levels not seen since the late 40’s. In the 50’s, 60’s and 70’s the size of the debt burden fell to levels of less than 40% of GDP but since the early 80’s, this trend has reversed. The only time since then when the debt level (as percentage of GDP) was falling was in the late 90’s, primarily driven by strong economic growth.
    The current debt level ranks among the highest in the world, of course there are other nations which look even worse, for example Japan (225%) or economic heavyweights such as Saint Kitts and Nevis (185%), Lebanon (150%) or Jamaica (123%). Other major economies such as Germany and France do not look much better with debt levels of around 80%. The difference to a country like Japan is that most of their debt is being held by Japanese investors, therefore they are able to finance that debt domestically. Also recently, China has started to make significant investments in Japanese government bonds while cutting back heavily on its purchases of U.S. treasury bonds, a further indication that investors are becoming reluctant to buy additional U.S. debt. Despite the fact that the U.S. debt deal is a step in the right direction, the problems are far from over. The deal reached now is not perfect, it seems like neither Republicans nor Democrats are really happy with the deal, but it was the best possible compromise that could be made given the current circumstances, but in the future further spending cuts will need to be made and the debate about future tax increases will most likely be the next big battle in Washington. The problem now is that the increased spending cuts will hurt the economy even further at a time when the economy is not able to generate enough jobs and prevent the jobless claims from going up. Also private households are in a long-term process of deleveraging, which will keep consumption growth at moderate levels. In order to bring down the unemployment rate, the economy would need to grow at a rate of at least 3.5%, right now it looks like GDP growth is going to drop below the 2% mark in the near future, possibly dropping back to zero later next year. A lackluster economy will also result in lower tax income which will make it harder for the government to service their debt.
    So how can this problem be solved? Is it even possible to do something about it? In my opinion the answer is YES. This situation can be improved dramatically in the next ten years, IF Republicans and Democrats work together to define and execute a plan which makes sense economically and truly works in the best interest of the people. The problem with the current discussion is that very few people differentiate between spending and investment. Investment means spending money on something that adds true economic value over time. People are willing to pay taxes, but they need to see benefits for it in return. Foreign investors will keep lending money to the U.S., but they need to see that this money is spent wisely and not just wasted. Let’s for example look at the enormous cost of defense. The U.S. is currently spending about USD 700 billion per year for its armed forces. In total, the wars in Iraq and Afghanistan have cost almost USD 3 trillion in recent years and as per the end of 2010 almost 5% of GDP were defense related spending.
    Figures based on 2010 budgets (SIPRI)
    It is more than 10 times what Russia spends on defense, although in terms of percentage of GDP, also Russia spends more than 4%. Most major countries today spend between 1.5% and 2.5% for its armed forces.
    It is therefore not surprising that a big portion of the now agreed spending cuts come from defense but even after these cuts the amount of money spent here are enormous. It is understandable that a growing number of Americans are not in agreement with this spending policy and feel that money should be better used to improve things at home rather than spending it on wars in countries like Iraq and Afghanistan. While the U.S. is spending too much in some places, it is not investing enough for other items, especially infrastructure related projects. Infrastructure is the kind of investment that tends to truly add economic value in the long-run and provide benefits for everybody. Clearly, looking at the condition of today’s infrastructure (roads, bridges, electricity grids) it becomes obvious that there is tremendous need for such investments. Also, finding investors for such projects will be a lot easier.
    What the United States needs is a sound long-term economic development plan, much like the Marshall Plan in the late 40’s. It has got to be a sound economic development plan that cuts spending in areas that do not make sense economically and encourage spending in areas that result in true economic value long-term (infrastructure, education, etc.) and such a plan needs to be supported by both major political parties. The investment spending created through such an economic development plan would immediately provide benefits for everybody, increase economic activity and therefore also create jobs and eventually increase tax revenues without the need to hike rates. In order to work out and implement such a plan, Republicans and Democrats need to work together for the benefit of all Americans.
    Sep 21 5:11 AM | Link | Comment!
  • Gold & Silver Update - More volatility ahead
    During the recent equity market selloff in early August, gold hit a new high at USD 1’900/ounce. In our last update in late April we said that gold needed another driver to continue its strong upward trend. The equity market correction proved to be the triggering event for another jump in gold and silver prices.
    Since that move in August, prices have consolidated somewhat and are currently trading around USD 1’820/ounce. The long-term upward trend remains in place, however, we expect higher volatility of precious metals in coming weeks. The reason for this is that we currently have a market environment, where people are very unsure about what happens next. From a macroeconomic point of view, we don’t know whether we are going to find ourselves in the midst of a recession next year or whether we are able to muddle through somehow, this is what the Federal Reserve refers to as “soft patch” economy. A recession would cause some deflationary pressure initially and we would expect this to be bad for equity markets, bad for precious metals (although not as bad as for equities) and probably U.S. Dollar positive. On the other hand, if we continue to see modest growth in the coming 12 months, I think that equities will do very well eventually, despite the risk of a further selloff in the near future. Under such a scenario, precious metals should be well supported and gold will most likely approach and possibly exceed the USD 2’000 mark/ounce, with silver being strong as well. For the U.S. Dollar, this would probably mean continued weakness versus most major currencies (Swiss Franc = special case). Despite the fact, that the longer-term outlook for precious metals remains in place, short-term there could be significant downward pressure, especially if economic momentum turns out to be more positive. Also external factors, such as increased margin requirements or speculation about a gold tax, could bring the gold rally to an abrupt end. Given the increased uncertainty in coming months, we think investors should still hold a significant position in precious metals, but also look to take profits on rather extreme moves to the upside. Cash generated through such profit taking can be invested in stocks of large precious metals mining companies. These companies are trading at compelling discounts to the spot metal prices and these stocks have recently started to outperform the broader stock market. The reason for this is very simple, in a time when equity markets are correcting, the increased correlation of gold mining stocks will cause prices to fall as well. At a later phase, however, investors are starting to realize that higher gold prices lead to a significant increase in profit margins for those companies just as we are seeing now. Also, gold companies will most likely increase their payouts significantly in coming years, therefore make a gold investment more interesting, because investors also get paid attractive dividends. So we don’t make a call to significantly reduce precious metal exposures but we do think about alternative ways to profit from the high prices we are seeing. 
    Sep 21 5:10 AM | Link | Comment!
    We believe that the coming months and the next year will be a real turning point for the global economy, global financial markets and world politics. The recent equity market selloff was only the first phase of a longer-term process. Economic growth in the western world is likely to remain weak and possibly remain so for a longer period of time. Asset prices have seen extreme moves in the recent past with gold moving to USD 1’900/ounce, interest rates are virtually zero in a number of western markets and equity valuations have fallen dramatically in the lastdecade. The same can be said about currencies, as illustrated by the extreme weakness of the Euro and the U.S. Dollar inrecent months. We are dealing with economic and political imbalances, also prices of certain financial assets, such as gold and bonds,havegone to extreme levels. We believe the near future will bring some large adjustments in the areas mentioned. These adjustments can take different forms, maybe we will seea real change in U.S.elections next year, maybe a surprise comeback rally of the U.S. Dollar, a severe recession in the western world or even a sharp correction of precious metals? We don’t know yet, but we will try to answer these questions on the following pages.
    The month of August was the most volatile month so far this year. The equity market selloff seen in the first half of the month was severe but not unexpected.
    (Major equity markets in 2011)
    After a very busy and eventful first half of the year, most investors were hoping for things to get more stable but as we now know, things even got worse last month. Global markets experienced a severe correction with most global equity markets falling between 15% and 25% in early August, since then we have been seeing a recovery which has so far cut the losses of equity markets to around 10 percent or even slightly less. The August correction did not come out of the blue but is the logical consequence of a series of events that happened in the last couple of months. I would like to repeat some of the comments that were made in our Q2 update in April 2011:
    Quote: In our Q1 report at the beginning of the year we said that we expect the liquidity driven market environment to weaken and that investors should be prepared to hedge or sell some of their positions…we have implemented active hedges for some of our equity exposures in mid March…the coming weeks will see an intense debate about the U.S. deficit situation…we expect the debt limit to finally be adjusted and moved upwards, but this will hurt the creditability of the U.S. and further weaken the position of the U.S. Dollar…
    In the meantime, markets did correct and it was wise to hold less equity exposures or hedge existing positions.The U.S. debt downgrade was not the main cause of this correction, it was just making things worse and was just the spark that started the fire. We too were surprised to see this downgrade come so quickly, although, based on fundamentals, we think this should have happened a long time ago. The fundamental problems that caused this market crisis are the huge debt problems in Europe and the U.S. The fact that there was an intense battle in U.S. politics about raising the debt limit only added fuel to the fire. The last minute deal achieved in the end was too little too late and the worst possible scenario for investor confidence. The whole world was watching the political debate in Washington, this made everybody realize how big the mess really is. In a time when a country is so dependent on foreign capital, it should make sure to build trust and confidence among international investors.The August correction in global equity markets is different from the correction in 2008 when most major equity markets fell by 30-40%. In 2008, the main problem was the global banking system and excess leverage by companies. This time, the main problem is that the sizes of government debt has reached and exceeded critical levels, in some cases the debt burden is as big as GDP and keeps growing. While governments still need to figure out how they can balance their budgets, households in the western world are already in a process of deleveraging, therefore adding to the overall weakness in the economy. This will result in a further rise of unemployment numbers and continued weakness in real estate markets in coming months.
    Many western households and governments lived above their means for a long-time.Eventuallydebt problems need to be addressed and adjustmentsto spending and/or income need to be made. A very good example is the crash in real estate prices in the U.S. in the recent past. In reaction to the market crash and the recession in 2001, the Federal Reserve, as well as most major central banks,lowered interest rates significantly and created a lot of liquidity. Banks too, were willing to lend money and give mortgages to people even when their financial standings would clearly be insufficient to qualify for a mortgage. This created an enormous bubble in the housing market that burst at the onset of the 2008 crisis. The correction we have been seeing in recent years is now reversing this excess, leaving millions of households with large debt burdens. Many people even used money from home equity loansto support their consumption spending, a situation that was simply unsustainable. Governmentsaround the world are not doing a better job and also behave in a similar, unsustainable manner. Administrations around the world have a tendency to overpromise (in order to get elected), to overspend (to remain in power) and to under-deliver (often making political compromises with special interest groups). Governments in the western world have extended current and future social benefits to the point where countries eventually have to get in trouble. In the U.S. a lot of baby boomers are starting to retire and there are more than 70 million following in coming years. The situation in many European countries looks even worse. This change in demographics and the fact that social welfare costs are exploding is a recipe for disaster.
    So is there a way out of the current misery? Can we solve the enormous economic challenges we have ahead of us? I think that we can make the outcome less painful, but, the economic adjustments have to be made. Governments will try to balance budgets in coming years through significant spending cuts and measures to increase tax revenues, however, this will not be enough in my opinion. In order to carry the heavy debt burden, countries in the west will need higher levels of inflation. This will be like an extra tax on everybody, reducing the net worth of people’s savings and making it harder for people who are already living at the absolute minimum. I don’t think that any western government will go bankrupt in coming years, but there will be a lot more money printing in the future. The Federal Reserve and the European Central Bank can print money forever and this has already started in recent years. The consequences are visible today, with the U.S. Dollar and the Euro falling sharply, a long-term trend that will not be reversed anytime soon, although temporary recovery rallies are always possible.
    What should investors do in this challenging environment? First of all, I think everybody needs to realize that the time of “buy & hold” is behind us, at least for the foreseeable future. Western equity markets have not goneanywhere in the last ten years (!!) and interest rates have been falling for most of that time and are now trading at record lows. Keeping a lot of cash longer-term is not wise either since the ongoing currency destruction will likely result in a loss of purchasing power.  Investors also need to compare different assets prices on a relative basis. We strongly believe that global equities are becoming much more interesting now that interest rates have fallen to historically low levels. Compared with fixed-income related investments, stocks are now offering significant value because many companies look much healthier than a few years ago with stronger balance sheets, higher profits and a better market positions. In our view, only a globally diversified portfolio with a good mix between international equities, foreign currency bonds and a reasonable allocation to precious metals has the potential to generate real returns. Investors need to think very carefully about their strategic asset allocation. Also, investors need to be very flexible and review and adjust their tactical asset allocation on a regular basis. When it is hard to find compelling investment opportunities in the west, one needs to start thinking global.
    We feel that investors have to get ready for real change in 2012, both politically and economically and, last but not least, in the way investments are being made.
    Sep 21 5:08 AM | Link | Comment!
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