Review 4 Q 2007 14th January 2008

“Gold is in a bull market. Stocks are in a bear market. That is all ye know…and all ye need to know. Stocks are being driven down by the market, in a natural, ordinary, inevitable correction. And gold is being driven up by the central banks’ attempts to stop it. Buy gold on dips. Sell stocks on rallies.” –Bill Bonner of The Daily Reckoning January 2008
I hope you have all had a merry xmas and may I wish you a prosperous new year. I’ve spent the past two weeks thinking of how to start my 2007 year-end review and how to convey a prosperous picture for 2008, but I regret I can’t register a prosperous outlook for western stock markets. The old adage, buy on bad news, coined perhaps by the most famous of these market catchphrases “Vickers (who were making machine guns at the time) falls on fear of peace” are being matched today by traders cries like…”buy on the dips, it’s going up” except of course in a bear market it’s very short-lived. This is a bear market; I have no doubt.

As per my last summary in October my favourite stock picks are BP, Royal Dutch Shell ‘B’, Aviva, Reuters, Hochschild, Randgold and adding Anglo American (having made a poor decision to sell these over a year ago), BT Group and British Airways to the pretty narrow list. I would like to add Tullow Oil (if they ever retreat) and the banks if and when they show their hands (I suspect they are as much as 30-50% over-priced, possibly more). The volatility and newsflow in the stock market is breathtaking. It may not have the see-saw gyrations that we saw in 1987 when markets tended to move huge percentages (as much as 23%) almost hourly (due to programme trading which was in it’s infancy then) nor the acute stock movements that we saw during dot.com but the struggle today between the bulls and bears is something that I haven’t seen in my business lifetime. I say business lifetime because when I was 17 y.o. Hoblyn & Co ceased trading in the most vicious bear market ever seen in UK. Stocks then were trading in low multiples, taxes were crippling and the unions ruled. Today it would appear that as the Daily Reckoning has highlighted there is a massive disparity between the rich Londoners and the rest of the country. London is and has always been a cosmopolitan place but describing it as an “attractive global village for the internationalati to alight upon” does leave a bad taste in the mouth. Asset values (other than commodities) do look overpickled and it’s important to stress that the accounting universe looks unstable with far too much creative accounting and hidden debt and dubious director’s earnings to boot (Bob Diamond at Barclays earned £28m last year on a £250,000 basic against a Barclays share price that performed -34% over the same period). As Jim Rogers (the legendary investor who used to work with Soros) has said repeatedly the growth statistics remain very doubtful for US and UK economies which both have a bias towards financial services and financial engineering. There are tough times ahead for UK as US struggles to come to terms with the weakened industrial performance that has been genuinely on the slide for years (Detroit is never mentioned these days in business news).

Much has been said in UK about housebuilders, developers, and the impact that the 2012 Olympics may have on the UK economy. With the budget being stretched it remains to be seen how housebuilders perform over the next few years but in the past year they have underperformed as follows; Barratt Developments -74%,Bovis -58%, Persimmon -56%, Taylor Wimpey -69% almost tracking retailers such as M&S -45%, Debenhams -66%,Woolworths -67%. Both sectors need to be avoided for the foreseeable future I think.

You’re all going to hate me for saying it but as many of you know I’ve been bearish for some 7 years now regarding UK property. I have heard varying reasons for the astounding price rises and for reasons for investing in property. Here are some of them; city bonuses, housing shortage, demographic shift, nowhere as safe as houses, dot com implosion, huge investment driven climate, higher population, Russian buyers, footballers, it’s going up, please buy my property tear it down and put a housing estate in my garden, let’s paint it white it’ll sell easier and it’ll add £10,000 to the asking price (for a few pots of paint), there are 2 million poles here (and I’m not referring to scaffolding) and millions of other immigrants, my estate agent says it’s worth it and finally Mr.Brown (when Chancellor) encouraged us to buy by keeping interest rates artificially low. According to GB now there’s still a housing shortage. So GB where are the 3-4 million people that need these 2m new houses? The Empty Homes Agency (www.emptyhomes.com) states that there are circa 650,000 empty homes and these properties have been empty for years reducing from 772,000 in 1999. In addition the buy/let market has been propping up the market by forcing tenants to pay extortionate rents for years now. These tenants inability to save so as to invest in pensions, purchase their own property, invest in the stock market, etc is incredibly damaging to the infrastructure of the economy. The repercussions for the “phoney boom” since late 90’s are going to reverberate for years yet. I estimate that retail prices in UK South-East could decline by as much as 70% at today’s prices excluding inflationary indexing especially if the employment outlook for immigrants disappoints and many of the eastern Europeans return to their roots. With household mortgage debt in the UK being more acute than the US (126% of GDP against 104%) the gap between total mortgage debt (£3tn) and last years highpoint value (£3.6tn) can only narrow dramatically as foreclosures escalate.

For those of you holding oil shares and precious metals shares let me now give you some comforting news. An oil option contract with a strike at $200pbo has been set recently and one bank, Saxo Bank has published a 2007 oil target of $175pbo (not good if you own 4x4’s as I do). The heavy demand from the emerging nations, the BRIC’s (Brazil, Russia, India & China) and the emergence of Africa as an investment theme for 2008 (an estimated £500m has been raised in London by PLC’s and specialist African funds such as New Star and Arch,etc recently) is causing this rise as bio-fuels and alternate energy sources fail to impact on demand. The 3 w’s, Wind, Water and Wood are my favourite alternative themes going forward in the alternative energy field but it would appear it is still early days. In brief the market commentators and press have failed to recognise last week's significant shift in sentiment for precious metals as gold settles above its previous all-time high (was $850 in 1980) and presses on to the magic $1,000. Further reports on gold in the last Q reflected on the current gold price adjusted for gold since its previous high of $850 suggesting that an inflation indexed price of $2,200 is fairer value so gold is still at a significant discount it would seem as the recession clicks in, with $ weakness, compounded by excessive western debt and eastern trade surpluses based on average growth rates of 8% (four times that of the main western nations for 2008). The risk profile has changed and one Emerging Market fund manager this week suggested that Emerging Market's were lower risk, albeit on higher multiples reflecting their wealth, versus our own traditional investing universes (UK, US & Europe). I would not disagree. I am looking at Templeton Emerging Markets Investment Trust as an alternative investment theme; the trust is at a discount of 15% to NAV and is capitalized at £2.1bn and helmed by Mark Mobius, the recognized leader in emerging markets.

And finally, who could have predicted that the Northwest Passage would finally open up the Europe/Asia shipping route as the ice cap melts? When businesses can work out a way to profit from green eco environmental issues the investment universe might get interesting in the next few years….just might. For now stick to oils and metals, and possibly emerging markets! As the Sunday Telegraph article headline said on 23rd December, “This could make 1929 look like a walk in the park” referring to the financial mess in the banking system and it’s effect on world economies.