A Time To Pause And Look Ahead: Precious Metals, Emerging Markets And The Macro Situation

by: Emmet Kodesh

There is a time for every purpose under heaven. But aside from doubts about the correlation of divine blessing and economic-market-fiscal matters, the main issue of the day, indeed for the past four decades, is uncertainty. Timing is more important than ever, so how does one approach various sectors and allocation when the ambiguities of policy unsettle even cash-rich mega-caps?

The allure of foreign investments is significant now and going forward. But the timing and near term outlook for overseas markets, developed, emerging and 'frontier' rest heavily on political developments and agendas in the world's mightiest economy: the United States. Here the situation is, alas, unclear, except perhaps to the extent that it is ominous. The potential for a major recovery is clear but political goals may preempt it at least during the next two to four years.

America's economy is unsettled by more than negotiations regarding major tax increases (the 'fiscal cliff'). Beyond the braking effect these will have on the economy is the immense and still imperfectly understood (perhaps not understandable), impact of the "Affordable Care Act." The drive to raise tax rates on capital gains and dividends, a refusal to cut corporate tax rates which would boost growth and repatriate capital and jobs; the looming increase of payroll taxes when the workforce participation rate is at a sixty-four year low (for men) and, overall, barely more than 1981, makes it seem at times as if the government is at war with the economy. Or, if you will, is engaged in radically restructuring America into a very different kind of society than it has been since inception.

Remember that "unemployment rate" and "inflation rate" are terms of art that have been jiggered by politicians and government bureaus to disguise the magnitude of America's structural problems. The major indices performed very well this year; the economy is trying to recover and could do so but it appears that government policies may preclude this. Further "easing" and bond purchases by the Fed have the stated goal of reducing unemployment but absent business and investment-friendly tax policies, this will not occur notwithstanding what government stats derived from estimates claim.

A few months ago one would have urged establishing or increasing positions in foreign equities like the China small cap ETF (NYSEARCA:HAO) or for its major companies (NYSEARCA:FXI) or Vanguard's Emerging Markets ETF (NYSEARCA:VWO). Despite many reports by established analysts that China had overbuilt, that substantial informal capital outflows are ongoing and that its major customers in Europe and America were struggling, HAO has surged 25% in the past four months; in the past six months the large cap FXI is up nearly 20% and VWO about 18%. Frontier markets (NYSEARCA:FRN) are promising but fragile and there is no clear trend discernible in them as a whole. Those who chase individual nations, whether developed, like Sweden (NYSEARCA:EWD) or the Philippines (EPHI), may arrive just as the coach turns back into a pumpkin. For all the media hype on top of Europe's genuine problems, the Nordic Region ETF (NYSEARCA:GXF) is up 25% in the six months since the June low and over 30% on the year. Pearls abound but many now seem overpriced for the macro context.

In this lengthening era of currency devaluation, commodities may seem a prudent avenue and indeed most portfolios should have a weighting there, but can one expect that the next six months will see even so basic a product as timber (NYSEARCA:CUT) sustain its six months surge of 25%? Those following weather, climate and demographics might have been savvy enough to enter the Grains index (NYSEARCA:JJG) in early June but how many can be equally shrewd to exit in late August? And while a 14% appreciation in agribusiness (NYSEARCA:MOO) since late spring is solid and food issues suggest continued long term gains, the main datum in the macro environment is uncertainty deriving from Central Government geopolitical and financial policies. If you consider these somewhat inflammatory you are not alone. Watch the historical charts on the commodities to enter a position suitable to your risk tolerance. The basics remain essential; although a period of significant impoverishment is in the cards, some areas will generate gains.

Precious metals and commodities like rare earths (Molycorp (MCP) has become a value play) and graphite and its derivatives remain important as stores of value, alternative currencies (indeed, the non-Western world increasingly treats them as such) and technological advances. But the volatility of precious metals, however counter-intuitive it may be given accelerating devaluations of fiat currencies and industrial uses, makes that dicey for many investors.

Europe will continue to be problematic because the policy imperatives trump economics and social well-being. Indeed, they seem designed to undermine it in a quest to establish a tri-polar and impoverished world like that Orwell described in his famous dystopia. In the mid-term and long-term, at least, bet on the Emerging and Frontier markets, especially but not only in East Asia. Those who desire confirmation of this policy - trend may consult the IMF's brochure for its summer 2010 conference, "Asia 21." Despite the recent surge, therefore, it would make sense to establish positions in East Asian ETFs and funds on pullbacks which, given the current uncertainty on taxes, growth, deleveraging and employment in the West, are certain to occur even if 2013-14 is to be a strong period for the markets. Remember that the markets relate to but are different from the economy, up to a point which will impress itself on us perhaps as early as March.

Resolution of the fiscal cliff will boost markets and, perhaps, investment if only by providing some clarity for all concerned, from shoppers, to accountants, to CFOs and investors. It is prudent to maintain and, on dips in the interim, add to positions in equity indices. Companies like TJMaxx (NYSE:TJX) embedded in core cultural trends and wealth location also seem like solid choices though it would be remarkable, not impossible, to duplicate the growth of the past four years.

In closing, a few words on cash and precious metals and materials: the latter mostly have suffered since early October, retracing in many cases 50 - 80% toward their lows in May and again in late July. There are good buys here and this writer believes everyone who has more than a very short-term focus should have 10-12% in this area. Silver Wheaton (SLW) is an outstanding company with a proven, winning model and has retraced to the point that it is a moderate to strong buy. The same can be said for Goldcorp (NYSE:GG) and others. Those who believe that experience and a successful track record are essential might look at McEwen Mining (NYSE:MUX) in the junior gold area. The junior ETF also has re-traced to a level (below 20) that it is a strong buy. A portion of your holding in this sector should include owning physical metal, either on your own and/or through precious metal trusts like Sprott Gold (NYSEARCA:PHYS) or Silver (NYSEARCA:PSLV) ETFs. Buy in gradually: the present seems a good time to initiate or add to a position.

These are harsh times for those who circumstances mandate over-weighting in fixed income securities and being fully-invested or close to it. If at all possible, re-allocation to some high dividend equities (Altria (NYSE:MO)), funds or ETFs is prudent though one must attend to signs of significant unsettling in the markets. A position of 10-20% cash is wise for those who don't need immediate weekly or monthly returns because bond prices, as a result of Central Bank purchases and interest rate suppression, are volatile and likely to remain so. Look for lower entry points than today's artificially inflated bond prices. A meaningful cash position can be maintained in short term investment grade corporate bonds.

The times are challenging and punitive for small investors particularly. Research has never been more important (always check 1-3-5 year history on all individual issues and funds and keep abreast of geopolitical trends). Diversify, including precious metals as noted above and via historical charts be alert to year-on lows for entry points. The trends urge you to look to emerging and frontier markets for significant gains going forward. Reports of a major breakdown in China are overstated. The Chinese want to grow and Western leaders want East Asia to grow. Study history and watch what the diplomats do and the results; discount their rhetoric and that of the central banks with whom they work closely.

Disclosure: I am long VWO, FRN, GG, SLW, MUX, GDXJ, MCP, ]]PSLV]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.