'Tis Only My Opinion!

January  2004 - Volume 24, Number 1

Looking at the Crystal Ball for 2004

Why forecasts of gloom and doom are often incorrect about the U.S. economy.

The U.S. economy has two strengths that most investors, academics and analysts fail to consider.


The first is the entrepreneurship drive that invades the economy and copes with problems outside forces throw at it.


The second is the innovation and technical leadership which has dominated scientific and engineering developments for much of the 20th century. 

Failure to understand the dynamics of these two strengths can lead analysts and investors to make conclusions which later prove to be in error.

Take a look at the great inventions of the last 200 years that have materially affected mankind.  Whether we are talking the railroads, automobiles, telephone, telegraph, radio or television, lasers, rocket technology, geo positioning systems, or nanotechnology, a major portion of the development was the initial output of American innovation.  Sure, some of those inventions were made by immigrants.  But those immigrants often became U.S. citizens.

The rest of the world spent a fortune trying to reverse-engineer or outright steal the ideas which were put initially into profitable production in the U.S.

Unless I miss my guess, the future will be more of the same.  Of course, as jobs are out-sourced to lower-cost countries, people in the U.S. are going to be laid off and many will only find jobs at less pay at which they were formerly employed.  Until about 15 years ago, we trained a substantial number of foreign-born scientists and engineers in our best colleges.  For years, most of those graduates ended up working in the U.S. and the majority of them eventually became U.S. citizens.

Today, about 60% of the students in our engineering schools are foreign-born.  Since about 1987, an increasing number of these graduates have returned to their countries of birth.  You might say that we are now truly educating the competition. 

Finally, the development of various programs at the elementary and secondary school levels are enticing more of the top students to enter the scientific and technical fields of study.  In fact, in consideration of a $300 million grant, the University of Texas at Dallas made a promise to decrease the number of foreign students during the next 10 years. However, until the number of foreign-nationals employed as faculty members decreases, the overall problem won't be solved.

But recognition of a problem is the first step in solving the problem.  For information on just how poor our elementary and secondary schools are, you should read the article containing excerpts of a speech by Pascal D. Forgione, Jr., Ph.D. former U.S. Commissioner of Education Statistics.  As a government researcher, he tries to put the best possible spin on the academic failure of American schools.  The problem is not the amount of money which the citizens of this country spend on education.  The solution is also not one of spending more money.

The second step is for control of the elementary and secondary schools to be taken away from the academic educators.  While part of the problem can be traced to lack of parental involvement and elimination of methods for controlling behavior, e.g., corporal punishment and expulsion, the graduates of today's public secondary schools have less knowledge and understanding of the basics of reading, writing, arithmetic, history and civics than almost at any time in this country's history.  It simply amazes me that an organization which insists that money and teacher certification solves the problem just has no real idea of what the problem is!

If you want to find out the historical perspective of how our public schools got in the current state of affairs, the article by John Taylor Gatto should enlighten you.  Mr. Gatto was the Teacher of the Year for three times in the New York City school system.


The U.S. Economy in 2004

As we analyze the current state of the economy, we find the jobless recovery showing faint signs of increasing strength. However, most of the new jobs are in the temporary or service industries which do not pay high wages. Production is increasing as the inventory/sales ratio is about as low as it can go. Yet, capacity utilization remains near the 75% level.

One of the strong areas of spending during 2003 and continuing into 2004 will be the costs of the war on terrorism as well as the buildup in the military expenditures.  Federal Government spending has been increasing at a torrid rate during 2003 and despite a Republican majority in Congress, it will probably increase further in 2004 as the election approaches.  Tax cuts have stimulated the economy somewhat but the deficit growth will continue in 2004 and will probably approach the $750-$800 billion mark.  During the second quarter of 2004, Congress will have to address the debt limit ceiling once again.

State and local governments, however, are facing an economic crisis as most can not utilize deficit financing to meet current needs.  As a result, many state and local programs are facing funding cuts and freezes. 

Retail sales are up this holiday season thanks to last-minute discount sales and an increase in internet shopping.  Discount chains and upper-end retail outlets were the best performers in the retail sector.  The Consumer Confidence level fell in December adding to fears that the economic upturn might be an short-lived.  Durable goods orders during November fell 3.3% which surprised many economists who were expecting a continued increase. 

Low interest rates have fueled the demand for new home sales and boosted sales for home builders, furniture and consumer hard-good manufacturers.  Refinancing of mortgages during 2003 added substantial cash to consumers pockets.  Although some of that cash was used to reduce credit card debt by year's end, consumer credit debt was still expanding.  As delinquencies on mortgages and consumer credit continue to increase, this source of consumer spending will decrease.  As a result, increases in consumer spending which account for 70% of GNP may be under pressure during 2004.

Personal income growth during 2003 grew at a slow rate and probably won't increase much during 2004 as few union contracts expire.  With the government's CPI reporting inflation at low levels, the increase for social security recipients in 2004 will not meet their requirements thanks to the increase in Medicare and living costs.  During the last three years, holders of bank CD's and laddered Treasury bills or notes have seen a significant drop in their income as the Fed has slashed interest rates.

Despite low interest rates, corporate loans have continued to decline during 2003.  Until corporate loans begin to increase, any economic recovery will remain suspicious.  Also, we have seen a continued increase in the deterioration of bond ratings.  The number of bonds rated AA or above is now at record lows.  That is not a good sign of a healthy economy.  While many investors have managed exceptional returns in junk-bonds during the past year, the risk/reward ratio remains high.

Interest rates will have to increase to entice foreign investors to continue to support the trade deficit.  If the Federal Reserve opts to not increase interest rates in the near future, the current slowdown in the rate of net foreign capital investment in the U.S. will become negative.  To offset that the Fed's only alternative is to increase the number of printing presses since they currently are running 24 hours per day 7 days per week.  The spread between what investors can earn in the U.S. market and overseas markets is increasing almost on a daily basis.

The decline in the dollar represents a major stumbling block to the economic recovery.  While the dollar decline is supposed to help our exports, the prime beneficiary will be the multi-national companies with large overseas operations.  The U.S. has become largely a service economy and unlike manufacturing which has been declining since the 1950's, the service economy does not have a large export impact on our trade deficit.

During 2003, we have seen an increase in the number of jobs being sent overseas for lower wage costs. In a few cases where customer service is considered an important component of the job description some companies are reconsidering the off-shore trade-offs.  However, up to now, very few jobs have returned to the U.S. and in fact, the outflow will continue.  Many corporations are not announcing plans to move jobs to off-shore locations.

A large number of the jobs which were found during 2003 were at wage levels below the earnings level of the previous job. A high percentage was in temporary jobs also. While surveys suggest that companies may increase their hiring levels during 2004, the rate of increase does not suggest an extremely buoyant economy.  The more detailed of these surveys indicates that manufacturing jobs will remain under pressure. 

During the current quarter production levels have been increasing although durable goods in November fell. World semi-conductor sales also slowed in November indicating that possibly the recovery in the tech area was less than expectations. But with the inventory/sales ratio near record low levels, it does not surprise me to see orders increasing somewhat.  The big test will be whether retail sales during the Holiday season remain below expectations.  Hence, the order level for shipment in the first quarter should be closely watched for an indication of strength or weakness.

Companies and sectors that could do well during the coming year:

Companies that supply raw materials and/or transportation services to the Chinese economy,


Defense contractors and suppliers


Homeland defense companies


Nursing care providers


Medical products manufacturers


Oil and gas exploration companies


Gold and silver companies

The stock market had a good year during 2003.  However, as Mike Bolser points out in his work on the Federal Reserves repo pool, a lot of the recent increase in the averages (Dow to near 10,500 and the NASDAQ to 2,000) was based more on the growth of the repo pool than to an improving economy.  The increase during December was particularly troubling to me as the volume propelling the shares upward was relatively light.

The Presidential Election Year, Democrats and the Patriot Acts

As the coming year is a Presidential Election year, Congress which is controlled by the Republicans will continue to enact measures that will attempt to put more money and jobs into the economy.  The Federal Reserve will also attempt to hold down interest rates to facilitate the economic recovery prospects despite the damage that low interest rates may cause to the dollar.

The recent Medicare bill providing drug benefits to senior citizens is an example of bills that will be passed during 2004 to attempt to curry political favor.  While some senior citizens might benefit from this bill, the cost to many senior citizens will come as a surprise as well as to the multitude of voters under the age of 65 who will get stuck with paying for these benefits.  So what, it will only cost $100 Billion . . . and increase the federal deficit. And when was the last time, a government program's cost estimates were on target . . .  social security, Medicare, Medicaid, welfare programs, and education initiatives.  Of course, we can just keep raising the debt limit until the house of cards comes tumbling down.

On the Democratic side, we had nine candidates (maybe more) who are scrambling for position in the Iowa caucuses and the New Hampshire primary this month.  At least, Bob Graham had the good sense to withdraw.  The DNC continues to curry the Hollywood crowd and special interest groups as they attempt to overcome the huge political war chest advantage of the Republicans.

The Democratic Party with Howard Dean as its front-runner will either turn to Hillary Clinton or continue to self-destruct and alienate many of the special interest groups that have dominated it for the past 50 years.  It no longer truly represents the left-middle of the political spectrum. 

We may well see a major fight in the Senate over judicial nominations if one of the Supreme Court justices retires. President Bush has just begun to use his recess appointment power to seat some of his nominees to positions who have been held up by the Democrats refusal to either schedule a hearing or to bring up a vote. 

The current redistricting effort in Texas along with the retirement of five long-time Democratic Senators versus two Republicans means that the political landscape could be changed dramatically in Congress after the next election. The Republicans barely hold a majority and under the super-majority rules find it difficult to get many of the President's judicial nominees confirmed.  If the election gives the Republicans a solid majority, expect to see the super-majority rule to end filibusters gone.  As a result, judges who are not inclined to change the Constitution may well be seated on federal benches.

Many constitutional lawyers are concerned about the two Patriot Acts which have materially expanded the powers of law enforcement since 9-11.  The rationale for the passage of these two bills was to prevent terrorism but law enforcement is beginning to use the Patriot Act provisions in investigations that have nothing to do with terrorism either real or perceived.  In effect, the Patriot Acts strip away many of the protections contained in the Bill of Rights and various Amendments to the Constitution.  Law enforcement can now detain people accused of "terrorist beliefs" indefinitely. They now can enter your home without a search warrant and place software on your computer that records every keystroke.  Privacy of medical records used to be sacrosanct but no more.

Unless we elect to Congress, Representatives and Senators who actually take the time to read bills before voting, the only hope to eliminate the provisions of the two Patriot Acts is to have the U.S. Supreme Court declare them "unconstitutional."  In fact, the initial Patriot Act was voted upon without it having been printed for review by those voting upon it.  Now if that is not unconstitutional, nothing is.  Talk about blank checks.

Now, I will probably be considered to be an enemy of the state because of this paragraph.  Governmental  bureaucrats believe that putting names on a list makes us safer (thus subjecting a person to additional security checks several times a month if you are Don Carter or your name is on the list), or having a 90 year old grandmother remove her shoes and being strip-searched because she has an artificial hip.   Despite all the "added security" precautions which have impeded our freedom to travel people have found ways to sneak through security and get aboard airplanes within the last two months.  But of course, the public feels safer, doesn't it.  That is the dumbed-down effect of our education system which regurgitates information rather than encourage critical thinking.


Interest rates, and the U.S. dollar

The Federal Reserve will continue to postpone an interest rate increase.  This chart shows the Fed's cut in the discount rate since 2000.  Easy Al and his cohorts at the Fed have stated several times over the last year that since inflation is not a factor, they can keep interest rates low.  We have argued that if the Fed was to increase interest rates, it would be a positive step.  But alas, the view from those ivory towers is different.

 First, any increase will be immediately seen to increase the federal deficit as interest rates on the debt will rise.  Second, as long as the dollar decline does not turn into a rout, the government printing presses can pump out enough fiat money to cause most citizens to believe that their dollars have not depreciated.  Third, it is in the best interests of the world's central banks that the dollar decline not get out of control because it could create a financial panic and the aftermath would have severe repercussions on the world economy.

Japan and China as well as many European nations depend on their exports to the U.S. to prop up their own economies.  In effect, the trade deficit is a form of vendor financing.  Of course, the real crunch will come when one vendor decides not to accept those fading dollars but demands payment in either Euro, yen, Swiss francs, Malaysian dinars, or, heaven forbid, gold or silver.

As interest rates throughout the world continue to increase (Australia, Great Britain and Germany among those increasing their bank rates in recent months), the spread between investment in the U.S. and elsewhere grows.  Foreign investors are getting hit with low interest rates as well as depreciation of their dollars.

Since January 2002, the value of the U.S. trade-weighted dollar has fallen by about one-third. As the chart above shows, the Bank of Japan has spent $168 billion through December 15th to support the dollar.  One can only guess at how low the dollar would be if the intervention had not occurred.

At interest rates under 4%, it will take a long time to recover the capital loss incurred on the investment principal.  Beginning in early 2003, the trickle of investment dollars flowing out of the U.S. has increased as well as a decline in the dollars being re-invested here by foreign investors.  In the next year investment dollars should continue to leave the U.S. at an increasing rate if the dollar slide continues. Net foreign investment in the U.S. has been falling since June 2003 as shown in the following table.

Period Net Foreign Investment
June $87 B
July $47 B
August $27 B
September $ 4 B
October $ 27.7 B

The dramatic decline in Net Foreign Investment will have a major impact on both the U.S. dollars value versus other currencies but will also create major problems for the U.S. Treasury and the Federal Reserve in their funding operations.  It takes about $50 Billion each month to finance the trade deficit at current levels.

The reserve currency role of the U.S. dollar is under attack.

  The risk/reward benefit ratio which the U.S. dollar enjoyed as both a safe-haven and the world's reserve currency is ending. As a result of the dollars devaluation, the role of the dollar as the only reserve currency may well end.  The Euro, yen, Malaysian dinar and even gold could well begin playing increasing roles as world currencies.  The Malaysian dinar which is being promoted by many Islamic nations as an alternative to the U.S. dollar and is partially backed by gold reserves may well become a major player in international trade in Asia.

The European Central Banks, Japan and the Federal Reserve believe in fiat currencies.  However, countries like China, Russia, the oil producing countries, and Malaysia have undertaken steps during the past two years to increase their currency reserve holdings of gold and currencies other than the U.S. dollar.  Countries with trade surpluses with the U.S. other than China and Japan are becoming less receptive to holding U.S. dollars.  With almost 50% of all U.S. dollars in circulation held outside the U.S. and the roughly one-third depreciation of the dollar during the past two years, investors and governments who are unwilling to suffer further depreciation will turn to other assets for their reserves.

Deflation, inflation or hyper-inflation . . .

  The Federal Reserve and U.S. Treasury is balancing on a knife-edge. For most of 2003, the Fed governors were concerned with the prospect of deflation and continued to lower interest rates and to pump more money into the system.  Beginning in mid-August, the major money supply indicators, M1, M2, and M3, began to decrease. About this same time, the Fed communiqués began to adopt a more neutral stance but were ambivalent towards the prospect of inflation returning.

Since the August meeting, the money supply has been dropping as shown in the following chart.

As commercial paper and commercial loans continue to drop, only consumer loans mostly auto, credit card and mortgages are showing an increase.  Consumer credit has exploded since 1990 as shown in the following chart and is now closing in on $2 trillion.

Personal income, however, has not keep pace so that the relationship between consumer credit and personal income as shown in the following chart is at all-time highs.

As a result, consumer delinquencies are rising to record levels on all types of consumer loans.  Moreover, since Fannie Mae and Freddie Mac along with some large banks have modified their definitions of past-due accounts from 30 days to longer, the real delinquency rate is even higher.  Sears is reported to have over 20% of their credit card customers more than 30 days past due.

As the economy continues to muddle-through without significant job growth and mortgage refinancing being reduced, many consumers will find it increasingly difficult to continue to service their consumer debts.  Without the infusion of cash from refinancing and with consumer credit at all-time levels, it would appear difficult to continue the current economic growth without a significant pickup in employment and personal income growth.


Whither gold?

  During 2003, we have seen the price of gold climb to near 14 year highs, silver to 5 1/2 year highs and the un-hedged gold index (the $HUI) make major advances.

The supply/demand factors, the movement away from fiat currencies, the increasing difficulty of discovering and mining ore bodies suggest that the price for gold will continue to increase in the coming year despite the attempts of the European Central Banks and other institutions to hold the price of gold down.  While I am not as bullish as Jim Sinclair who believes that gold can climb over $1,500 or Richard Russell who foresees $3,000, it appears possible for the price of gold to see above $600 during the next year if the U.S. dollar goes under 70 on a trade-weighted basis.

Silver has a more critical supply/demand component at the moment than gold.  As supplies of above-ground metal find their ways into vaults and production processes, the stage is set for a possible explosion to the $10 level in the next few years. 

During the past year, we have seen gold producers reduce their hedging positions to take advantage of the increasing price for gold.  In fact, Barrick (ABX) the largest gold producer hedger announced in December that they would not increase their hedging position in the future and would begin to reduce their current hedges.  Despite Barrick's announcements, the sale of Goldcorp's inventory in the market during December as well as about 22 tons of Gold from European Central Banks during December, gold continues to climb as the physical market is so strong.  If gold tops $500 in the near future, look for the HUI index to climb over the 300 level.

Gold and the gold stock traders run the risk of missing a huge move.  We will continue to use the dips to add to our positions.  We have a great reluctance to trade but rather prefer buy and hold for the gold and silver stocks.


Our gold and silver stocks

In response to many requests, the stocks held in our gold portfolio are shown below:



As 2004 will be an election year, we expect to see significant efforts by the Administration, the Federal Reserve and the U.S. Treasury to keep the economy rolling ahead although growth may be in the 3-4% range.  We expect the trade deficit to continue to increase and the federal deficit to reach the $700 billion level.

The risks to the economy are several. If we fail to have continued success in Iraq and against terrorists, things could change. For example, if several terrorist attacks occur within the U.S. and/or even one that caused major damage where more than 100,000 people are injured, then anything can happen.

Deaths of major world leaders in China, Germany, France, Saudi Arabia, Pakistan and/or the US either naturally or via assassination could disrupt things quickly.  For example, if the Saudi royal family is overthrown, the President of Pakistan assassinated, or the mullahs are overthrown in Iran, the geo-political situation becomes very sticky and could lead to the Iraq conflict widening.

The failure of a major financial institution via the derivatives mess and/or another scandal might create an implosion of the world fiat financial system.  J.P. Morgan Chase has to be bleeding from its derivative losses as do many other major bullion banks.

As a nation, our great strengths have been our ability to cope and innovate.  And remember, that innovation creates wealth!

We believe that the U.S. dollar will continue to fall in 2004 and hard commodities will rise.  Our investment strategy is outlined below:

bulletContinue to invest in performance-oriented equities while maintaining trailing stops.
bulletBe alert to take advantage of short-selling and swing trading opportunities.
bulletMaintain and increase bullion and un-hedged equity positions in gold, silver and platinum.
bulletHold only non-mortgaged real estate while reducing exposure to the commercial and industrial markets.
bulletLiquid cash reserves should be held in currencies other than the U.S. dollar.
bulletEliminate holdings of fixed-income bonds as interest rates are likely to begin to increase.

While there are problems facing the U.S., there are always great opportunities.  The challenge is to find those opportunities and take advantage of them.


But then - 'Tis Only My Opinion!

Fred Richards
January 2004

Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27

This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in 2004.
All rights reserved. Quotation with attribution is encouraged.
'Tis Only My Opinion is intended to provoke thinking, then dialogue among our readers.


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