This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Sunday, May 10, 2009

Determining the future before it happens

For years to come, people will write books about the events of the last year or so, trying to piece together the puzzle to determine what exactly happened, and more importantly why. Included in those books will be explanations of how things played out; events that we have not yet seen.

Unfortunately, by the time those books are written, even those events still to come will be old news. The opportunity to profit from them will be past. As investment advisers, it’s our job to use our knowledge of history and the markets to predict those events before they come to fruition. After all, that’s the only way to benefit from the future. So, the following is the shorthand version recounting events that lead us here, a summary of where we stand now and our prediction of where we go from here.

By now it’s common knowledge that the collapse of the housing market triggered the bursting of the credit bubble in the summer. After the collapse, the financial system grounded to a halt and new loans essentially ceased. In response, the Fed, along with the U.S. Treasury, flooded the financial system with “liquidity,” in this case a fancy term for new money.

All this was done in an effort to maintain bank solvency and keep the system moving, but the result was that taxpayer dollars were used to prop up big banks, many of which had poor policies and bad management. Moreover, this bailout craze totally wiped out consumer confidence in the financial system.

At present there is tons of new money sitting in the big banks that comprise the global financial system. With the economy beginning to turn toward recovery, particularly in the housing sector, loans are finally picking up again as the system slowly comes back to life. And while many around the world are still skeptical of governments and their collusion with big banks, there is some cautious confidence returning to the markets.

The beginning stages of this recovery can already be seen in the bursting of the recent bubble in Treasury bonds. For example, take investors who purchased the most recently issued 30-year Treasury bond at its issue in February. Because of bond prices falling as money re-enters the stock market, these investors have lost more than 10 percent of their investment in the past three months.

The way we believe that things will play out in the coming months and years is as follows. First, as the economy continues to improve, loans should accelerate. As the velocity of money in circulation increases, the massive increase in money supply caused by the past six months of Federal Reserve policy is going to be realized in the marketing and inflation is going to quicken.

With inflation running wild through the global financial system, the natural tendency of the Fed will be to raise rates in order to keep inflation in check. Unfortunately, unemployment will still be too high for the Fed to raise rates, as doing so would slow down the economy, which will still be early in its recovery.

With the Fed caught between the rock (unemployment) and a hard place (inflation), policymakers will have no choice but to allow inflation to continue until economy mounts a sufficient recovery as to permit interest rate hikes.

All this basically creates a good-news-bad-news scenario. The good news is that the economy will recover. The bad news is that when it does, the U.S. dollar will be worth a small fraction of what it is now, in terms of real value (relative to hard assets, e.g. gold).

Some are undoubtedly skeptical about our assessment of how things will play out. Unfortunately, we are not alone in our stance. I refer you to the following YouTube video of Ron Paul questioning Fed Chairman Ben Bernanke during congressional testimony. Pay particular attention to the question and note how Bernanke skirts the issue.

In conclusion we would like to emphasize to readers that inflation, despite its significant impact on the economy, is not inherently bad. There is nothing wrong with inflation, provided investors are able to hedge against the declining value of their currency by owning real assets like gold, oil and real estate. Further evidence of the coming inflation can be seen in the recent price movements of all three of these commodities as housing prices have risen lately, gold has topped $900/ounce and oil on May 6 pushed through the $55/barrel level.

Inflation is on its way. Those who are prepared stand to benefit greatly, while those who aren’t will likely suffer when the purchasing power of their dollars declines substantially. If you feel you are unprepared, speak with a financial adviser about how to position yourself for the coming months.

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