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Japan Shakes the Markets



March 15, 2011 – Comments (0)

Board: Macro Economics

Author: washcomp

There are some periods of time when examining market behavior can be illuminating.

Let's start with the obvious problems in Japan (where Godzilla movies now seem optimistic).

One of the world's major economies has suddenly plunged into the abyss. This has, I'm going to suppose, caused a liquidity crisis. Money is required to sustain and then repair the damage. Huge money. While this event is vastly different in nature than we suffered in October 2008, some of the symptoms are parallel. "Good" investments must be sold in order to meet immediate goals.

In addition to that, the shutdown of a major portion of Japanese industry through damage, shortage of electricity, fear of radiation, etc. has not only reduced their company's profitability, but will shortly impact multiple supply chains worldwide. Memory chips will increase in price due to shortage of supply (causing increased prices in electronics of all types), Boeing will have their plane build outs disrupted by parts no longer coming from Japan, etc., etc.

So what does this mean? Gold and silver, generally a place where wealth is stored is being sold. The Australian dollar which has been used by Japanese to gain interest income in a zero interest domestic environment is being sold. For those looking to protect cash, the US dollar is increasing and the Swiss franc retains its near all time high position.

In a global economy, where everything is linked, a major failure of one of those links is being felt in the world's equity markets.

I'm going to classify the recent event in the Black Swan category as a significant order of magnitude which was unexpected and will impact the global economy in ways,, yet to unfold, for a significant period of time.

While I feel uncomfortable about making predictions, this is a time to throw away our "knowledge" and reevaluate our investment objectives on an objective basis. Things have changed and remaining static in our views of what works and what doesn't may be dangerous to our financial health.

So, what will "win" and what will "lose"? Over the short term, there is likely to be a lot of volatility. Over the long term, there will be rebuilding, medical supplies will be needed, fuel will be used and so on. Depending on the finances of the parties concerned, gold and silver may be sold to pay for some of this as they may be more liquid than other holdings. Those companies with exposure to the nuclear industry will, at least for the short term (and maybe long term) be adversely impacted.

The US event of 2008 is still with us three years later. The Euro stress has been smoldering for a year and will likely get worse before it gets better. The Japanese event has suddenly made the investing environment even more complex. While there are small pockets of developed countries left that have not suffered trauma recently, they are few and far between. The emerging markets of China, Brazil and India who depend on the consumption in the developed markets may develop internal consumption capability, but unless they shift into assisting the developed world in rebuilding, their economies will also be impacted.

How do we protect ourselves in this environment? While we each choose our own swords to fight with, the underlying basis of our asset value is our currency (for most of us, the US dollar, but others should think along parallel lines from their standpoint). Precious metals are simply proxies for what we use as money and can be considered as a parallel currency class.

We are clearly (though not by government metrics) in an inflationary environment from the standpoint of our personal expenditures. That would be an indication that holding cash is not wise, in our nearly zero return environment, unless we realize that alternatives could lose that cash basis, rather than it being eroded by inflation. The protection of that cash basis (of our "balance sheet" for those who might have plowed through one of my recent posts) involves both the short term psychology of the market and our long term expectation of our nation's financial health based on the discussions we generally have on Metar. While my personal approach has been to hedge the value of the US dollar with what I calculate are likely stronger alternatives, there are, no doubt, other approaches that are equally valid. For those who have preferred precious metals in this context, it is important to view the position of gold and silver from the standpoint of those who "use" this parallel "currency" and the purposes they use it for. Personal "logic" is important in investing as long as it parallels market logic, but I fear too many small investors have little understanding of the purpose that other larger fish hold this asset class for. It is a highly liquid "emergency fund" and a "holder of value" rather than an investment for profit. As I have mentioned before, I hold a moderate physical metal cache for this purpose (say 1% of assets +/-), but do not evaluate it as part of my asset tabulation. If I ever need to tap into it, likely its value will be priceless (as it may save my and my wife's heads), but until then, all it is is an expense to properly store and protect.

Over the short term, I fear, many asset classes will lose value and US government bonds may retain theirs longer than we previously expected.

The above doesn't necessarily mean that we should fold our tents and ride off into the sunset, but it does mean that, until things settle down, there is extreme risk in many of the markets. Do not take the complacency of a two year bull market for granted. Think about whether you are holding value or growth (or just wishful thinking for a time when things might get better). Remember that cash is also a valid asset class.

Pay attention and do not let stagnant thinking or emotions take the place of careful consideration of what you are doing.

Macroeconomics do count.


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