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House prices in the U.S have acted in line with expectations, now 29% from their peak. Moderate weakness is expected going forward. In the U.K. house prices have been buoyed by a false sense of buyer urgency but this strength is not supported by underlying fundamentals. Vast amounts of residential and commercial real estate debt need to be refinanced over the next two years, much of which is experiencing material difficulties. Banks will be forced to write-down more real estate debt, credit will contract and the pool of funding available to the sector will shrink, adding downward pressure to house prices.

Precious metals will continue to rise in an increasingly risk-averse, and inflationary environment. The metals may suffer from volatility over the short-term but excess money printing has already dictated that bullion prices keep rising over the longer-term.

Stock markets on both sides of the Atlantic have risen significantly from their March 2009 lows. A correction is expected at some point in the coming months and we must wait and see how significant that correction is before committing more funds. I am holding back from adding to my precious metals and commodity stock positions until a more favourable entry point is offered by the market - I am choosing to sacrifice some gains in the months ahead in order to keep my risk to a minimum.

I am avoiding all Treasuries, Gilts and bonds which are in a giant bubble. I am not tying up my cash at bank for periods more than 3-6 months in order to remain flexible when opportunities arise.

I continue to diversify my cash holdings into hard currencies including the Australian dollar, the Canadian dollar, and the Euro.


First a quick recap of how we got here, since we must keep this in our minds at all times.

Following years of overspending, in 1971 the U.S. suspended the convertibility of dollars into gold. By 1973 all major industrial nations had agreed to end the Bretton Woods agreement which bound them to the discipline of a gold-backed monetary system. From that point on the major currencies were no longer backed by gold, or any other store of value.

As the requirement to peg their currencies to gold was lifted, countries began creating un-backed paper money at an unprecedented rate. This had two principal effects: (i) the value of money decreased as the amount of paper money in circulation increased, thus causing the price of goods and services to rise; (ii) the flood of money found its way into the capital markets, fostering all manner of investment bubbles in the stock market, the emerging markets, the real estate market and presently in the bond market.

The credit collapse which started in 2007 is the latest puncture in a long series of bubbles caused by the continuous inflation of the money supply. Yet governments around the world responded to the crisis by printing even more paper money. The size of the current government spending and bailouts is staggering and sets the stage for my 2010 outlook.

Review of 2009 Market Outlook

As I predicted in last year’s outlook, the precious metals continued to perform extremely well in 2009. In the table above I have highlighted gold, silver and platinum for ease of reference. Bullion appears to have performed better when priced in dollars, but we must remember that the value of the pound fell significantly last year, yielding substantial gains at that time.

House price performance diverged between the U.S. and the U.K. House prices in the U.S. acted exactly in line with my expectations, falling gradually over the year to end 7% lower and 29% off their peak. House prices in the U.K. rebounded slightly, driven only by the British propensity to assume that house prices will go up forevermore. U.K. expectations are currently far removed from economic reality and I expect to see renewed weakness between now and 2012.

One thing which has surprised me is the ongoing rebound in the stock markets. I expected to see them roll over by now and to re-test the March 2009 lows. I examine the factors influencing equities in more detail below.

A Better Comparison
For a more accurate comparison of the performance of the above markets we must compare them all on a consistent basis. For example, a U.S. citizen who put all of his dollars into the S&P500 at the start of the year will be pleased to see that is investment grew by 25% in 2009. However, this does not take into account the fact that the value of the dollar fell significantly in 2009, eradicating the entire increase in the S&P500.

To ensure we compare all of these markets on a consistent basis we are going to compare them to the price of gold. For example, we compare the number of ounces of gold you could buy with the S&P500 at the start of the year to the number of ounces you could buy at the end of the year, with the difference being the performance of the S&P500 relative to gold. Market Outlook

Here a truer picture of performance emerges, one of currency depreciation, with the dollar losing 27% of its value during the year and the pound losing 14% of its value. The currency depreciation makes it appear that stocks and house prices are rising more than they are in reality – which is exactly what our governments want us to think. Needless to say, in 2009 I was happier to own precious metals rather than buy a house or hold dollars and pounds. The same is true for 2010.

2010 Outlook


The Fed and Bank of England are using monetary policy to try to force people out of cash and to deploy their money into riskier markets. They do so by holding interest rates close to zero in the hope that the public will take their money and push prices back up in the equity or housing markets.

To an extent, this has worked. But economic indicators and public sentiment are based on faulty data and optimistic assumptions. The financial sector is still deleveraging, economic growth is weak, profits are low, unemployment is rising and consumer retrenchment continues unabated.

Government involvement in the economy will remain high for the foreseeable future and such increased involvement and regulation always retards economic recovery.

Furthermore, government deficit spending, bailouts and money printing mean that rising inflation and falling currencies are a certainty. Moody’s reports that total global debt will exceed $49 trillion by 2010. $9.2 trillion will need to be refinanced between now and 2012, double the amount refinanced between 2007 and 2009. Questions arise as to whether there is enough investor appetite or capacity to fund such large amounts.

Governments will have to compete with the private sector to borrow money and such huge demand will drive up long-term interest rates as borrowers are forced to compete for whatever cash they can get their hands on.
Governments cannot afford for interest rates to rise since the interest payments on the massive government debt will rise, and because rising interest rates will kill the economy and the real estate market. The only option, therefore, is to monetise the debt – i.e. print money out of thin air to pay for the new debt. Thus, the depreciation of the dollar and the pound will accelerate, stocking the inflationary boilers.

None of these factors make risky assets such as equities or real estate particularly attractive right now. They make the outlook for Treasuries, Gilts and bonds outright terrible. They do however, make precious metals and commodities look attractive - in an inflationary environment, cash, bonds and most stocks rapidly lose value; commodities, gold, and other tangible assets gain value.

House Prices

A New Wave of Residential Mortgage Resets
House prices started to crash in 2007 because millions of homeowners with sub-prime mortgages saw their mortgage interest rates jump after the initial 2-3 year fixed-rate loan term came to an end.

The leap in mortgage interest rates meant that mortgage repayments jumped, causing a large number of homeowners who could no longer afford their payments to default. Financial institutions were suddenly hit by a wave of foreclosures and were forced to write-down the value of the loans on their balance sheets, leading to massive losses, bankruptcies and government bailouts. You can see the tide of mortgage resets rising on the left hand side of the chart of U.S. mortgages below. The picture is similar for the U.K. market. So we might ask, what comes next? Market Outlook

You can see from the chart that between 2010 and 2012 the number of mortgages resetting leaps once again. This time it is “Option ARM” mortgages in the U.S. which will dominate. An "option ARM" is typically a 30-year adjustable rate mortgage that initially offers the borrower four monthly payment options: a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment. In short – it lets people get themselves into deep trouble.

Option ARMs are often offered with a very low teaser rate and thus very low minimum payments for the first year of the ARM. This allowed borrowers to qualify for much larger loans than would otherwise be possible. Where borrowers elected to pay the minimum in the initial phase, any accrued interest was added to the outstanding loan balance, causing their debt to grow. Since house prices have fallen over the last couple of years, borrowers’ equity has decreased while the debt has grown – a sure recipe for a new wave of defaults, foreclosures, loan write-downs, credit contraction and falling house prices.

Commercial Real Estate Woes
Banks’ exposure to commercial property will remain a material credit issue in 2010 and become a particular concern in 2011 and 2012, when a high volume of property loans fall due. The biggest concern arises for U.K. and European banks whose exposure to property remains very high.

Despite the fact that commercial real estate values have declined sharply, many banks have not yet reported sufficient losses on their commercial real estate portfolios - as long as the loans are being paid the banks are unlikely to report the loan as non-performing. However, as we have already seen in the 2010 Overview, $9.2 trillion will need to be refinanced between now and 2012 and questions arise as to whether there is enough lender appetite or capacity to fund such large amounts. Real estate borrowers will have to compete with governments and all other borrowers for money, so expect more loan write-downs and weak commercial real estate prices as the overall supply of credit to the sector shrinks.

House Price Outlook
Much of the fall in U.S. house prices has already been priced into that market. I do foresee further weakness as the mortgage resets kick in and as the amount of available credit reduces. It is difficult to know how much further prices will fall but this should become clearer in the months ahead. If you do not yet own a property, I wouldn’t be in any rush to jump into the market just yet.

The U.K. is a different story. British house prices are perched precariously on the verge of the unknown and all of the risk is to the downside. There is nothing anyone could say right now to get me to sell precious metals and to buy property. I have been told several times over the Christmas period that I have missed my chance to buy a home in the U.K. at a reasonable price, evidence that the cause of the credit collapse has been lost on the British public. On New Year’s Day, one of the major newspapers here had a front page headline proclaiming that U.K. house prices are up over 100% in the last decade. What that has to do with the celebration of a new year I’m not sure. It does show how obsessed we British are with house prices. To my disappointment, none of the newspapers noted that gold was up 298% over that same period!

The only way I will be wrong – and house prices will rise – is if our governments manage to paper over the economic cracks with more money printing. In this case they will have printed so much of the stuff that it has flooded forth, pushing up prices and easing the tightness in credit. Under such inflationary circumstances however, the price of precious metals would launch into the stratosphere and you will be able to buy an average house with only 50 or so ounces of gold.

Final Piece of Advice
If you already own property don’t lose heart. The high inflation which is coming will erode the value of your mortgage, significantly reducing your debt burden and mortgage payments. I do recommend that you fix your mortgage interest rate when it next comes up for renewal. As inflation permeates through the economy, interest rates will likely rise sharply into double digits. Make sure you protect yourself from this risk by fixing your mortgage rate for the remaining duration of the loan. In the short-term such loans may cost more than the many variable rate mortgages on the market, but the long-term savings you will realise by fixing your interest rate now are substantial.

Precious Metals

Many commentators have explained this year’s rise in the gold price by the fact that the dollar was falling in value. But this year gold has made new highs when priced in a variety of major currencies: Canadian dollars, Swiss francs, Euros, British pounds, Indian rupees, Japanese yen, Mexican pesos, and so on. Silver and platinum have also performed strongly. So what is powering the advance in precious metals? Here’s my take on the factors influencing the bullion markets...

1. The value of the dollar and the pound have fallen around 98% over the last 100 years. There is nothing to suggest that this trend has reversed, especially in light of ongoing money printing.

2. The amount of gold, silver and platinum available for investment is tiny at $800bn, $8bn and $5bn respectively. Conversely, the value of the global stock, bond and cash markets is north of $164 trillion. If only a small portion of this $164 trillion were to feed into precious metals when inflation accelerates, it will push the price of bullion skywards.

3. Investment demand is currently strong and will increase going forward. Several of the most successful, well known fund managers have recently been increasing their portfolio allocations towards precious metals, or have started new gold funds. It is foreseeable that this strategy will be mimicked by other fund managers who wish to “follow the leaders”, and by an array of investors lured in by rising bullion prices. This will, in turn, lead to a broader awareness of the precious metals markets and to increased institutional and public demand.

4. In a major shift in policy we have seen central banks turn from net sellers of gold to net buyers for the first time in two decades. India’s recent purchase of 200 tonnes of gold from the IMF followed China’s announcement earlier in the year that it had increased its gold reserves significantly. With little central bank gold likely to come onto the markets, much of the downward pressure on gold prices has been removed. The reversal of policy also signals a vote against the dollar as reserve currency, as the credibility of the greenback withers.

5. The supply of new precious metals from mines is inelastic. The long lead time between finding a deposit and developing a mine through to production is around 10 years. With few major discoveries, any future increases in supply are limited.

6. Government over-spending and money printing have set the stage for inflation. Further currency debasement will follow in order to ensure that the government debt load and unfunded liabilities become manageable. Such an environment is extremely bullish for precious metals. Furthermore, we do not need to wait for high inflation to become evident before the price of bullion rises. It is the fear, or anticipation, of inflation which will launch precious metal prices higher.

Stock Market

After collapsing for the first three months of 2009, the stock markets rallied hard for the rest of the year, finishing in lofty territory. Easy policy measures from the Fed and the Bank of England gave investors the green light to plunge back into equities. In response to the credit crisis, corporations cut costs hard and fast, laying-off millions of workers and aggressively cutting expenses. Such measures have temporarily improved their reported profits and analysts have been impressed that earnings have held up well in such a weak economy.

However, taking a closer look at the numbers suggests underlying problems in the months ahead. While costs have been cut, sales have not grown - businesses have been cutting back on investment and consumers have tightened their belts. Since costs have already been pared back as much as possible, and turnover has failed to increase, we will see earnings start to disappoint.

The stock markets have rallied uninterrupted for nine months now. Soon a correction will come. Perhaps earnings will disappoint. Perhaps there will be another Dubai. Whatever the reason, at some point a correction will come and we will need to pay close attention to the speed and ferocity of the selling. My initial view was that we will retest the March 2009 lows, but the flood of newly printed paper money may buoy the market somewhat. We will have to wait and see. As a result, I am not adding to my equity positions at this time, but continue to maintain a watchlist of businesses I am very keen to own as soon as the market offers me some compelling prices.

Have a great 2010. Market OutlookGoldMoney. The best way to buy gold & silver

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