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Thoughts for 2002Craig Harris As we start off the year in 2002, there is a substantial amount of uncertainty and turmoil in the world. Many investors are still waiting for the return of the double digit returns they got used to in the "roaring 90's." I'll argue that people should be concerned with a return of their capital going forward rather than a return on their capital. In the final month of 2001, we witnessed a complete collapse of Enron, the 7th largest US fortune 500 company worth over 80 billion dollars at it's peak... now all but worthless. This was an unprecedented event... one that was unthinkable as the year began in 2001. Currently we are witnessing a complete economic collapse in Argentina along with a default of 140 billion or so in sovereign government debt. Again... unthinkable... Argentina was not a third world economy. Japan is in trouble, and there is no clear or easy fix in sight. It is in no way clear how Japan is going to clean up the bankrupt banks and it is within the realm of possibility that the situation in Japan could deteriorate from here and become a serious global financial crisis. Unthinkable? India and Pakistan are on the verge of a war which could cause the worlds first nuclear exchange. The Israel Palestine conflict is threatening to spiral out of control and could provoke a regional war that could escalate into WWIII. Unthinkable? The US is fighting a war on terrorism at a cost of 1 Billion dollars a month with no clear or easy victory in sight. Is it possible that the war on terror is not winnable? Unthinkable! I think you get my point. In this environment it is critical not to get your thinking stuck in the box so to speak. It's also critical to think independently and not to be part of the herd. The herd will ultimately be wrong... they always are. There are serious risks in the world right now that are being downplayed and distorted in the media in the name of patriotism and public good... but it isn't reality. Against this ominous backdrop, the world central banks have embarked on a financial engineering program designed to bolster the financial markets, control the currency markets and print paper money with reckless abandon in a noble effort to "save" the financial system. The hope of the Financial Engineers is that all of the "inflation" being created by the huge increase in the money supply will be directed into the equity markets. I have been saying for the past few months that wherever this box of money lands is where the inflation will show up. Interest rates in the US have hit 40 year lows. For fixed income investors, it is now nearly impossible to earn a positive real return without taking on additional risk. After 2 years of declining share prices, the equity markets are still priced at the extreme high end of historical valuation levels based on PE ratios, Dividend Yield, price to book and price to sales. What is an investor to do? Clearly, in an effort to save the global economy, the financial engineers of the FED and the G7 have targeted the equity markets. Every possible effort is being made to prop up share prices because if they didn't, it's likely that the global economy would collapse. Based on valuation, it's very difficult to see how one could expect the equity markets to rise but if you understand what's going on underneath the surface it's clear to me that every effort will continue to be made to keep share prices up. I was recently quoted on CBS Marketwatch as saying that we are building a new equity market bubble but from lower levels. I think that's a good way to look at it. So, I'm not opposed to the idea of trading this sponsored market, but the idea of a buy and hold strategy from these levels is a prescription for disaster in my opinion. If you buy a company like AOL Time Warner at 70 something times earnings expecting to hold it for the long term, you aren't likely to even earn your original investment back before you are dead. People have gotten used to the idea that public companies are like lottery tickets... well, they aren't. Taking the AOL example, you are paying 34 dollars for 43 cents in earnings with no dividend. Even if you assume a healthy 10% growth rate, you'll probably be dead by the time you've earned back your original investment. Why would anyone in their right mind see this as a reasonable investment? Well, because the public (who don't understand things like valuation) blindly invests their money with mutual fund companies whose charter it is to stay fully invested in stocks. The financial engineering program encourages this "dumb money" to flow into the mutual funds by many, many mechanisms. The physical Euro got off to a good start in 2002 with no glitches reported. The Euro gained vs the US dollar on optimism about the smooth transition. The Euro is now poised to offer competition against the US dollar... really the only competition except the Yen. I was talking about this financial engineering strategy a lot last year... although the Euro is poised to offer more competition vs the USD, overall the competition has decreased. The financial engineers are in the process of eliminating alternatives. So now we're down to 3 choices (USD, Euro, Yen) and the financial engineers do not want ANYTHING to compete with these fiat currencies for investment dollars... that is the biggest reason that suppression of the gold price is critical. Gold (or oil or anything else) cannot be allowed to be seen by the investment community as a viable alternative to fiat money for the storage of wealth or else we could have big problems. The financial engineers do not want an anchor from the fiat currencies to anything real. If there was, then they would have to deal with issues like printing too much money, etc. So... that's the plan... prop up the equity markets, restrict investment alternatives... I don't claim to know the next step in this master scheme but I suspect that it will be to continue to eliminate currencies other than the "big three" through more "mergers," with Britain, Denmark, and Sweden being pressured to join the Euro now. The important point is that we are entering new uncharted territory in terms of global financial management. We no longer have free markets... we have coerced, controlled markets. The world has not been technologically and financially sophisticated enough to pull this "financial engineering" off until now. Europe has not seen a shared single currency since the Roman empire. As to whether or not it can work over the long term... there has never been a fiat currency that has survived the test of time and my concern this time around is that there are too many ways and too many incentives for the central banks and counterfeiters to "cheat." Counterfeiting may sound like a lame concern but I suspect that many extremely well organized crime entities will produce a lot of Euro's using advanced technology... hey... they can pay for all the equipment and technology in Euros! The thing is that the stakes are so high... if this plan were to fail somehow it would be a global catastrophe the likes of which we have never seen... like a big global Argentina. For the plan to work, public confidence and trust must be managed effectively. It's really interesting to look at it that way... the actual numbers are really less important than confidence that your paper money will maintain its value and exchangeability because the paper doesn't even have any implied intrinsic value at all any more. Remember when people talked about governments debasing their currencies and it was seen as a central banking sin? Well, now at this point the currencies have been debased... there is no promise that the notes are backed by anything. If you take a step back and think about it, it's amazing that people go along with the idea at all. You are willing to give up something you produced for a piece of paper with some printing on it... and the only reason you are willing to do so is that you believe the implied guarantee that the paper will maintain its exchangeability for things you want and need. It implies supreme confidence and it will be required that the global central banks maintain this supreme confidence... a tall order... especially in these uncertain times. With all that said, I am encouraging my clients to look at investing in real things... to seek value. I'm not that keen on real estate as an investment because real estate prices are still inflated but not nearly so much as share prices. I do believe however, that doing something like paying off your mortgage rather than investing the money in the stock market makes sense. I wouldn't advocate being short the equity markets, for the simple reason that they are sponsored and it's likely that they may get even more overvalued than they are now. The "Don't fight the FED" axiom has new meaning now with the the financial engineering program. Commodities have been in a 20-plus year bear market. Many commodities, including some of the precious metals are selling at or below their production cost. In my opinion this is the area for investors to look for value. I do believe that the price of gold is being manipulated as I discussed above, but I also think it is the best hedge in the event that the financial engineers management plan does not work out. In other words, it's part of my "hope for the best, plan for the worst" idea. I don't expect a lot of downside in the gold price if the financial engineering plan is successful, but if it doesn't work out I think it's likely that there will be a mad scramble for wealth storage with intrinsic value, and a very sharp dramatic shift against financial assets. Do not allow yourself to be lulled into complacency by the stock market cheerleaders on television. Think independently. Don't listen to me or anyone else... take control of your future by using common sense, thinking for yourself and doing your own research. The internet provides a wonderful tool. I wish everyone a happy and prosperous 2002. January 3, 2002 Mr Harris offers a free 30 day trial subscription to his daily market letter. For a free trial please contact bcharris@gate.net. The risk of trading commodity futures contracts can be substantial. You should therefore, carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. If you choose to open an account with Harris Capital Management, a Risk Disclosure will be sent to you. Please read it carefully before you invest. ### Harris Capital Management, Inc. CTA is a futures broker and registered Commodity Trading Advisor, meeting the needs of futures traders worldwide. They provide a high level of personal service to discriminating clients around the world, while offering commission rates comparable to discount brokers. All clients are handled directly by Mr. Harris. Copyright ©1995-2004
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