Financial Apocalypse by Bert Dohmen Dohmen Capital

KNEE-JERK REACTIONS ARE OFTEN WRONG

By Bert Dohmen
Monday, April 4th, 2011

By Bert Dohmen

March 14-2011

How will REVOLTS, RECORD EARTHQUAKES & TSUNAMIS, RECORD FLOODS, SOVEREIGN DEBT, etc. effect your investment? 

We can’t remember a time when so much global turmoil occurred all at the same time. Perhaps during the Great Depression years we can find some similarities. This brings challenges to investors and investment professionals. Let’s try to figure this out. 

The strongest earthquake in Japan’s 140 year history of recording quakes set off a 33 ft. tsunami. The destruction is incredible. Our well-wishes go out to the victims. How will this calamity affect your investments? 

The first instinct is to sell short the casualty & property insurance firms because of the upcoming multi-billion dollar claims. But the fact is that after a catastrophe, these companies do very well. Insurance firms have reserves against claims, because that’s their business. Insurance firms see a surge in new business as firms increase their coverage. This might be a good time to buy the big reinsurance firms which plunged on March 11.  

Immediately after the quake, the Yen plunged. But then the smart money entered the market and the yen soared. Why? The large, international Japanese firms will now sell their credit market investments abroad which are denominated in other currencies, primarily the dollar. They need the money at home to rebuild their facilities. That money has to be converted to yen, thus leading to a higher yen price. The smart currency traders figured this out quickly. 

What is the impact on the dollar? If the dollars are sold for yen, then it would produce downward pressure on the dollar, not just against the yen, but also against other currencies such as the Swiss Franc, which is now the “safe haven” currency. The dollar should decline versus the Swiss Franc. 

Many investors now think that the quake will cause a sharp setback in Japan’s economy. Actually, after a catastrophe, the economy usually picks up strength as all the damage is repaired. However, foreign companies which sell to the Japanese consumer will see a decline in business, especially for luxury brands. On the other hand, Japanese durables, like cars, may see reduced demand from abroad, first because of supply problems, and secondly because concerns about availability of parts. Selling short the Japanese auto parts makers should work out well.  

Another impact will be on alternative energy stocks. Nuclear energy was considered a good alternative to oil. With the nuclear meltdowns in Japan, that will be seriously questioned. The movement against nuclear reactors is already being resurrected like Lazarus. That makes other alternatives, like solar, oil, and gas much more attractive. Uranium stocks will now have severe difficulties. Remember the Mexican Gulf blowout which has stopped offshore drilling just because one well of many thousands had a problem. Solar stock should rally along with natural gas stocks.

 How about the Middle East? Often it’s difficult to figure out if the positive effect is greater than the detrimental one. For example, higher oil prices lead to higher gasoline prices. That could be inflationary. However, if consumers reduce driving, don’t go as often to a restaurant or to the shopping mall, then the higher prices are deflationary as it reduces spending. That makes selected U.S. retailers risky.

The answer to the inflation/deflation question is very important. The best clues can be obtained from the charts of U.S. T-bonds. But market expectations can change quickly. For example, in October 2010 the Fed announced its massive QE2 program to buy $600-900 billion of Treasuries. On the surface, that appeared bullish for T-bonds, unless you considered the inflation implications. What happened? From October to February this year, U.S.T-bond prices actually declined. But if deflation expectations return, then T-bond prices will rise.  

The market considered the potential inflation effect over the long term more important. This was the opposite of what the Fed had wanted. 

But since February, T-bond prices have risen in spite of the soaring oil price. U.S. corporate bonds should be a good buy

Commodity prices are declining. Copper, one of the best indicators of global economic growth, appears to have made an important top. This is a change in character and could be very important. The entire commodity sector, with the exception of oil and precious metals, may be good shorts. 

The excessively popular view of analysts is much higher inflation. However, the charts say there could be a deflationary scare before the higher inflation shows up. That of course would trigger the next QE3 program of the Fed and more artificial money creation later this summer. 

But most important for U.S. investors is the impact on the local markets. My view is that at a time of unprecedented turmoil, the big investment flows go to greater safety. Instead of looking for new stocks to buy, money managers may now look for which stocks to sell in order to raise cash levels. The charts confirm this. 

What would I buy?  Silver and gold related assets, in that order.

CONCLUSION:  Figuring out the markets, the real and the psychological aspects, is not easy. Inter-market correlations are not static but change. Analyzing the charts is the only way to get early warnings of changes in these correlations. And that’s what I have been doing for the past 35 years. 

Bert Dohmen, Editor & Founder

Bert Dohmen’s WELLINGTON LETTER

www.dohmencapital.com

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