Week 31/2011: Gas 'Em Up Benny..... America Needs You!

As stock markets plunge across the globe and the safe havens of bonds and gold rally strongly, pressure is mounting on central bankers to come up with a solution. As interest rates are already on the floor, all central bankers have left in their tool kit is the printing press. We are about to see co-ordinated intervention on a global scale. It may work in the short-term, but will not ultimately succeed. The debt-deleveraging process is a long and painful one that cannot be cured by juicing the money supply.

The model portfolio returned -3.7% last week. Equities plunged -7.4%, bonds gained +0.5% and gold in euro terms rallied +3.0%. I am going to hold off on making a change to the model portfolio this week due to the severe oversold condition of the markets. So, there is no change to the 60% equities / 20% bonds / 20% gold split. In July, the model portfolio returned +1.3% compared to -1.2% for the average managed fund. Equities declined -0.9%, bonds were flat and gold in euro terms soared +9.3%. YTD through end-July, the model portfolio has returned +0.3% compared to -1.6% for the average managed fund. Equities fell -3.1%, bonds rallied +0.1% and gold in euro terms gained +6.5%.

DJIA	11,445	Dollar Index	$74.60	CRB Index	326.80
DJTA	4,694	CAD/EUR	1.4025	Gold	$1,664
DJUA	415	USD/EUR	1.4280	Silver	$38.35
NDX	2,194	JPY/EUR	111.95	Copper	$4.10
S&P 500	1,199	JPY/USD	78.40	Oil WTI	$87.30
ISEQ	2,506	USD/GBP	1.6390	Natural Gas	$3.95
FTSE	5,247	10 Yr. Tsy.	127.05	Soybeans	$13.45
Nikkei	9,300	30 Yr. Tsy.	132.20	Corn	$7.15

EQUITIES:
Another spectacularly volatile week came to a close with a late day rally on Friday afternoon in the U.S. Then, after the markets closed, the ratings agency S&P downgraded America's AAA credit rating one notch to AA+ with a negative outlook, sending futures markets into a tailspin on Sunday night when markets re-opened and trading resumed (US equity markets are scheduled to open down -2% as I write).

Prior to the rally late Friday, equity markets had sold off aggressively all week on fears the States may be slipping back into recession. There were also rumours that Germany was balking at having to open its cheque book once again, this time to shore up Italian and Spanish debt markets, as yields in those countries continue to rise. The Eurozone is creaking and liquidity is drying up. Rumours of a run on bank deposits had many Italians choking on their pizzas on Wednesday. Stocks were halted on the Italian bourse and government bond yields there breached 6%. It was a similar situation in Spain. At least the focus is off us for a while.

What's a central banker to do? While Merkel and Sarkozy are on their five week summer sojurns, a certain US central banker is rubbing his hands. Bernanke believes his time has come. I think he is ready to launch phase three of his monetary experiment to save the world from credit excess. Bernanke is about to gas up the helicopters and launch QE3. Stock markets were sniffing this out on Friday and may be close to turning higher. In fact, I think we are either about to accelerate higher or lower (crash) this week. Much will depend on the extent of government intervention and the ability of traders and investors to hold their nerve. Hopefully we get a rally. It is difficult to pinpoint such a rebound in equities, but in the short-term, markets are ridiculously oversold relative to bonds (see next chart) and due for a bounce. As noted above, the bounce could be quite strong in the lead up to a QE3 event. I don't believe QE3 is a long-term solution, and will only cause further problems down the road when the next recession will be exacerbated by a currency crisis.

Longer-term, the game has changed. I think the market action of the past couple of weeks has confirmed that the 2-year bull market is over and the bear market has returned. I don't expect the next rally will make new highs. We are still in an extended topping process. Remember, equity markets took 15 months to form a top in 2000 before coming crashing down. It took 12 months in 2007 before a similar outcome. This time round, markets peaked at the beginning of May 2011, so we are only three months in. I had previously thought the return of the bear would be a 2012 event, but it might come earlier than I had expected. I will be able to tell more based on the quality of the next rally in stocks.

From a technical perspective, we broke long-term support this week. Since markets are oversold to such an extreme – there are fewer stocks above their 50DMA's now than at the March 2009 bottom – I want to give this market a little more time before moving to a defensive position. Like I said, markets should be close to turning around here and crash-type events are low probability outcomes.

BONDS:
German 10-Yr Yield at 2.35% DOWN from 2.83% last week

Irish 10-Yr Yield at 10.00% DOWN from 11.90% last week

Italian 10-Yr Yield at 6.10% UP from 5.65% last week

Greek 10-Yr Yield at 15.24% UP from 14.69% last week

Spanish 10-Yr Yield at 6.05% UP from 5.77% last week

Portuguese 10-Yr Yield at 10.95% UNCH from 10.95% last week



COMMODITIES:
Gold closed on Friday at $1,664/oz, +2.2% for the week in USD. The USD rallied +0.8% versus the EUR over the week, so gold in euros gained +3.0%. Year-to-date, gold is up +9.7% in euro terms.


In the short-term, gold is very overbought and rallying strongly ahead of a QE3-type announcement, I think. We may get such a statement from the Fed this week, which could mark a short-term top in gold, as traders who "bought the rumour, sell the news". I wouldn’t go chasing gold here, even though it is rocketing higher again this morning and currently trading at $1,708. Bull market anyone?

MODEL PORTFOLIO:
The model portfolio returned -3.7% last week. Equities plunged -7.4%, bonds gained +0.5% and gold in euro terms rallied +3.0%. I am going to hold off on making a change to the model portfolio this week due to the severe oversold condition of the markets. There is no change to the 60% equities / 20% bonds / 20% gold split for next week. In July, the model portfolio returned +1.3% compared to -1.2% for the average managed fund. Equities declined -0.9%, bonds were flat and gold in euro terms soared +9.3%. Year-to-date through end-July, the model portfolio has returned +0.3% compared to -1.6% for the average managed fund. Equities declined -3.1%, bonds rallied +0.1% and gold in euro terms gained +6.5%.

TOP 10 INVESTMENT IDEAS FOR 2011:

	Top 10 For 2011	28/01/2011	Comment
1	Long Gold	$1,337	Conservative inflation hedge
2	Long CEF.A	$18.95	ETF backed by 50% gold, 50% silver
3	Long NEM	$55.00	Miner leveraged to rising gold prices
4	Long EGD	$4.20	Mining services company that sells equipment to the sector without taking the exploration risk.
5	Long GDXJ	$34.60	Junior miners ETF – when gold hits bubble territory, GDXJ will best capture the mania that follows.
6	Short 30 Yr Treas.	$121.45*	28 year bond bull market over, with US 10-year yields troughing at 2.4%.
7	Long MSFT	$27.75	The cash machine of the technology sector; single-digit P/E with double-digit EPS growth.
8	Long CAD/ Short JPY	JPY 82.00	JPY must decline so Japan can regain competitiveness and reduce its massive debt burden (200% of GDP).
9	Long Sugar	$0.34/lb	Commodity play with strong supply/demand imbalance
10	Long Soybeans	$14.05/ bushel	Commodity play with strong supply/demand imbalance

YTD PERFORMANCE OF 2011 BEST IDEAS:

		28 January 2011	05 August 2011	2011 Return YTD
1	Long Gold	$1,337	$1,664	24.5%
2	Long CEF.A	CAD 18.95	CAD 23.46	23.8%
3	Long NEM	$55.00	$54.41	-1.1%
4	Long EGD	$4.20	$3.98	-5.2%
5	Long GDXJ	$34.60	$32.73	-5.4%
6	Short 30-Year Treas.	$121.45	$132.20	-8.9%
7	Long MSFT	$27.75	$25.68	-7.5%
8	Long CAD/Short JPY	JPY 82.00	JPY 79.85	-2.6%
9	Long Sugar	$0.34	$0.28	-17.6%
10	Long Soybeans	$14.05	$13.45	-4.3%

PERFORMANCE OF 2010 BEST IDEAS:

		01 January 2010	31 December 2010	2010 Return
1	Long Gold	$1,097	$1,421	29.5%
2	Long Silver	$16.88	$30.91	83.1%
3	Short 30-Year Treas.	$115.38	$122.10	-5.8%
4	Long NEM	$47.31	$61.43	29.8%
5	Long PAAS	$23.81	$41.20	73.0%
6	Long DVN	$73.50	$78.51	6.8%
7	Long CAD/EUR	CAD 1.5100	CAD 1.3356	11.5%
8	Long Nikkei	10,546	10,229	-3.0%
9	Long Sugar	$0.27/lb	$0.321/lb	18.9%
10	Long Soybeans	$10.54/bsl	$14.09/bsl	33.7%