The outlook for 2011 is principally the same as for 2010.
Home prices still face headwinds as vast amounts of residential and commercial real estate debt need to be refinanced over the next two years. Longer-term, house prices will swim against a tide of
rising interest rates.
The Western central banks will maintain their easy monetary policies, allowing the stocks to continue their current advance. Furthermore, the money being printed as a result of quantitative easing has to flow somewhere and it is my belief that it will flow towards commodities and stocks, including select emerging market equities.
Treasuries and bonds will continue to be bogged down, offering low returns and nil protection against the erosion of capital through inflation. Gradually market consciousness will awaken to the disadvantage of holding wealth in paper instruments and the pool of money which previously occupied these investments will gravitate towards stocks and commodities.
Precious metals continue to be my favoured assets, providing a hedge against inflation and a tangible store of wealth. I also like uranium related stocks in anticipation of an energy crisis in the years ahead, plus rare earth element stocks nurtured with a conservative position sizing approach and disciplined position management.
Let’s take a quick look at the winners and losers in 2010...
The WhichWayHome portfolio performed well in 2010. The long-term performance of the portfolio now stands at 34% per annum, during a period which included the biggest financial market dislocation since the Great Depression.
Every year I receive feedback from readers that my performance would have been better had I just held silver (or silver and gold as was the case in 2009). Well, first of all it is impossible to know that in advance, obviously! That is the beauty of the investment game! Second, the WhichWayHome portfolio contains holds some cash as a performance stabiliser and has equity investments across various sectors in order to mitigate risk. In 2010 a stellar performance from my uranium and rare earth stock positions allowed me to keep up with runaway silver prices.
During my review of the year I also found the following charts interesting. They summarise the premise of WhichWayHome.com perfectly (sell real estate and buy precious metals), illustrating how much U.S. and U.K. house prices have crashed in terms of gold...
House prices will face headwinds for years, if not decades, to come as we embark on a new era of rising interest rates. The following chart shows the last 60 years of interest rates, as represented by the 10 year U.S. Treasury rate.
Interest rates move in long-term cycles and we saw 30 years of rising interest rates followed by 30 years of falling interest rates. I will leave it to you to deduce what is likely to happen for the next 30 years!
Another consequence of a rising interest rate environment is that Treasury and bond prices fall as interest rates rise. Taking a look at the following chart of global financial wealth allocation we see that the vast majority of global wealth is tied up in paper debt and cash instruments. Also, note the tiny proportion currently invested in gold.
So, as interest rates rise, the money previously occupying Treasuries and bonds will flow out of those instruments. I believe that one of the key beneficiaries will be precious metals.
The final nail in the bond coffin is the erosion of paper assets through inflation. Why hold paper assets denominated in US Dollars or British Pounds when the central banks print money through quantitative easing? One of the most notable developments at the end of 2010 was China’s moves to prevent inflation in their own country. Previously China has soaked up much of the excess money coming from the West, but that trend has now changed as the Chinese authorities clamp down on domestic inflation. This will likely mean more paper money staying in the West, making the extent our governments’ inflations more apparent – the result being rapidly rising prices.
Once investors understand that their bond portfolios face a fall in value as interest rates rise and an erosion of value through government induced inflation there will be an exodus from bonds into more favourable asset classes. I am not saying that will take place in 2011, but it is coming.
We can see from the following charts that there has been a recent rush into bonds as the financial crisis played out. By contrast, equity funds experienced withdrawals. Even when the equity markets recovered equity funds saw little money flow back into the market. It is my belief that those bond inflows will reverse and that, alongside precious metals, the equity and commodity markets will be beneficiaries of the exodus out of bonds.
Net Inflows into Bond Mutual Funds (2000 - 2010)
Net Inflows into Equity Mutual Funds (2000 - 2010)
Book Recommendation | "Trade Your Way to Financial Freedom" by Van K. Tharp is one of the best books on investing I have ever read.
I first discovered the author in another of my favourite books, "Market Wizards" by Jack Schwager. Mr Tharp is a consultant and coach to many top traders and investors. He models their behaviour and in this book he sets out the building blocks of a successful trading system.
The first part of the book covers the extremely important psychological elements of trading, before going on to explain the foundations of trading system development. Importantly, he covers the rare but valuable topics of position sizing and expectancy, with many great analogies to help you grasp the concepts involved.
This is probably the best book I have read in some years, and I learned a great deal from it. If you are going to read any book in 2011, this should be it! |
Final Thoughts...
Teach your kids Mandarin - the balance of power is shifting from the West to the East.
Have a prosperous 2011,
WhichWayHome.com
