look for end of debt super cycle

8/3/2019 Look for End of Debt Super Cycle

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01/10/2012

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What do investors need to be watching out for in 2012? More Eurozone

drama? Record gold highs? A hard landing in China? The U.S. Global

Investors team addressed these questions with Endgame: The End of the

Debt Supercycleauthor John Mauldin in a Jan. 5 Outlook 2012 webinar. The

Streetwise Reports editors highlight some of the expert insights.

Source: Streetwise Editors

John Mauldin: Instead of doing an annual forecast, I'm going to look out about five

years, which may be five times more foolish. What I want to do rather than try andfigure out where the stock market is going to be at the end of 2012 or what gold is

going to do, is look at the choices we have around the world.

In most cases, political events don't change the economic world all that much. It'll

probably annoy partisans on both sides, but if Clinton had lost to George Bush

senior the first time, we would have still had a bull market. We were already in

recovery. Yes, we would have had different Supreme Court Justices, but that's not

the economic world. We were set on a path. If Gore had beaten Bush 2,

economically I don't think much would have changed. We still would have had the

end of a bull market and a recession in 2001. We would have had a housing

bubble. Greenspan would have probably been reappointed either way. We would

have had a credit crisis because we were in the process of building up debt that

started in the '50s. Europe was building its debt up. Japan was building its debt up.

That is the reality.

Now the private sector is deleveraging, but sovereign debt is in a bubble. The air is

coming out. My view is that the wheels are going to fall off Europe this year. I have

been researching the Mayan codes and I have determined that the ancient Mayans

were not astrologers; they were economists. They weren't predicting the end of the

world; they were simply predicting the end of Europe. That is a humorous way of

saying this is the year Europe is going to have to make some very difficult choices.Greece gets to choose what kind of depression it wants, hard and fast or slow and

long. It can't avoid depression completely. It has borrowed too much money. The

government is too big. It has come to the end of the ability to raise money at low

rates. Italy and Spain are well on that path along with the rest of Europe. So, they

have to make a decision, a political decision that is going to have major economic

consequences.

Does Europe want to be a political union that looks more like the United States,

where the individual entities have to run balanced budgets and can't print their own

money and have some kind of fiscal controls or they go back to a two-tiered Europe

with multiple currencies. One way or another, this is the year that Europe is running

out of road to kick the can.

Fortunately, in the U.S. we are not there yet. We have some room to make a

Look for End of Debt Supercycle: Thoughts from the U.S.

Global Investors 2012 Forecast

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decision. That decision is going to be made in 2012 because by 2013 we are going

to have to decide how we deal with the deficits and debt. After 2014, the bond

markets will start to raise rates. Total U.S. debt is continuing to grow because

governments are growing debt faster than private citizens are decreasing debt. The

bond markets are starting to rebel long before you would think they would for a

country that's the world reserve currency. The key is whether debt is excessive

relative to income. If you can make your debt service, people will still lend you

money. When they don't think you can, they will stop. That's when you have a crisis.

It's a debt super cycle. And, when you reach the end, you have to deal with the debt.You can pay i t down. You can default on it. You can print the money, extend it out

with lower rates or financial repression, which are all other ways to look at default.

But, nonetheless, that debt is there.

The problem we are facing in the U.S. is that gross domestic product (GDP) is

consumption plus investment plus government spending plus net exports. If we

decrease government spending over time, we decrease GDP. That's the problem

that Greece is going through right now. It has to decrease government spending by

4.5%, thus shrinking the economy. But it can't increase government spending

without increasing debt or taking taxes away, which decreases consumption.

Nothing the government does wil l make things better. The U.S. is on the same path.

We can become Greece by continuing to borrow or be proactive and say we are

going to get our deficits under control over a period of five or six years. The

economy is still going to be slower than we would like and unemployment higher

than we would l ike. That's just the rules. We're at the end game. We are at the end

of the debt super cycle and that's what happens.

Printing money doesn't increase the GDP in actual real terms, but it makes

everyone holding gold happy because the value of natural resources goes up. That

is why I buy gold every month. I take those coins, I put them in a vault and I hope I

never need them. I quite frankly hope gold goes back to $300/ounce (oz) becausethat means the economy is in wonderful shape. I'm actually afraid that gold is going

to go up in value, which means we are not getting our act together.

That leads to questions about fault. Did the banks do things they shouldn't have?

Yes. Were they the cause of it? No. Was Greenspan the cause of the bubble? No.

He was part of the cause. I mean, we did a lot of things as a country that weren't

good choices. Should we have allowed our banks to go to 30 and 40 to 1 leverage?

No. Should we have repealed Glass-Steagall? No. The problem is that real median

household income hasn't moved for 15 years because real private GDP hasn't

changed. The only thing that has grown is government spending.

John Derrick: In 2011, the European financial crisis moved from the periphery to

the core. Central bank policies were big drivers of the decline. The European

Central Bank and China raised rates early in the year and again in July as fears of a

China slowdown grew. That early tightening to fend off inflation had a big impact on

the course of events throughout the year. The other big events were the U.S. credit

downgrade in August and currency intervention, particularly in the Japanese yen.

Frank Holmes: There is a huge amount of borrowing around the world in Japanese

yen because it is so inexpensive. That includes investing in commodities,

resources and emerging markets. And, every time we see this huge signal move by

the yen, you get this rippling effect that takes about six weeks to resolve itself with

commodities being sold down. Therefore, a lot of fund managers borrowing in

Japanese yen are long energy stocks, resource stocks and emerging markets,

which leads to a lot of selling.


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JD: The second half of last year was very volatile, but the market ended essentially

flat. In fact, much of the volatility was concentrated in the last month, which made for

a very difficult psychological environment, as the market has been somewhat

schizophrenic wi th weekly rallies and selloffs.

Spikes in the yen caused market selloffs. This hit commodities especially hard. So

the secret for 2012 is to use the volatili ty. Buy on the volatili ty spikes. Unfortunately,

what most people do is just the opposite. Another thing to look for in 2012 is a

positive fourth year of the presidential election cycle as the government tries toimplement policies that will get them reelected.

Brian Hicks: There has been a lot of concern about money supply growth in the

emerging markets, particularly in China, which reduced bank reserve requirements

last year. A reacceleration of global money supply can be particularly constructive

for commodities going forward as there has been a high correlation between money

supply growth and commodities.

If you were to take all the global money and back that by gold, the price of gold

could go to $10,000/oz. If you just use half of the global money supply, gold would

trade at about $5,000/oz, up from approximately $1,600/oz right now. The more U.S.

dollars in circulation, the higher the price of gold. This has been the main factor

increasing the price of gold since 1998 and wil l continue to be the case in the years

to come. Gold has a lot of running room to go.

Another driver for the price of gold has been federal deficits. Government spending

is way above revenues. We hit a point in 2000 where spending as a percentage of

GDP greatly exceeded taxes as a percentage of GDP. This could be a point of no

return and could potentially drive the price of gold even higher. There has been a

large bifurcation between the price of gold and gold equities, particularly in the last

couple of years as risk aversion has prompted many investors to buy the bullion asopposed to gold equities. This is creating opportunity. We feel like there's going to

be a catch up in gold equities, many of which are trading at very low multiples to

cash flows and earnings. Stocks such as Newmont Mining Corp. (NEM:NYSE) look

like value stocks now paying high dividend yields and trading at sub 10-times price

to earnings ratios. This could really present an attractive opportunity in 2012.

JD: Just a comment on all the takeovers. We were seeing 6% premiums on

takeovers in '06. Now we are talking 60+ premiums. That's another reflection of how

undervalued the stocks are relative to commodities.

BH: That's a great point. We have seen tremendous value creation based onmergers and acquisitions.

Shifting gears a li ttle bit, crude oil and refined product inventories ended the year at

the lowest level on record (about 685 million barrels). That's 6% below the prior

year. It's particularly interesting when you consider some of the geopolitical factors

that have arisen with Iran talking about blocking off the Strait of Hormuz. This is a

primary factor behind oil price supports despite the tenuous economic environment.

Many investors don't realize that Russia is very important for non-OPEC

(Organization of Petroleum Exporting Countries) supply, a key factor in containing

oil price spikes. Russia is increasing production while other non-OPEC production

in Mexico or in the North Sea have been declining significantly, which has helped

to bolster OPEC's market share. It has also limited the ability of oil markets to

increase production out of the Middle East due to the inability to invest in those

troubled areas. In fact, Russian production has been quite steady since 2006,
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increasing anywhere from 100 to 400,000 barrels per day (bpd), mid-single digit

growth. But, forecasters predict in 2012 we wil l see flat production growth, which is

troubling given the fact that we continue to see demand increase in other areas of

the world, mainly out of China. This wil l be a driving factor going forward for crude

oil prices.

Evan Smith: Oil supply threats include geopolitical problems at a time when oil

supply and spare capacity at OPEC is rather lowa li ttle over 2 million bpd. Nearly

40% of global supply is under autocratic rule. Iran has threatened to disrupt thesupply of crude oil and products through the Strait of Hormuz where about a third of

global oil supply passes. So, any disruption, even temporarily, would cause a

severe spike in oil prices. We think oil prices could support $100/barrel. One of the

things we like in 2012 is higher exposure to master limited partnerships partly

because of their steady cash flows. They are becoming a growth business now.

The capital expenditures here in the United States have grown from $3.5 bill ion (B)

in 2005 to nearly $16B this year. This is partly because of the growth in many of the

shale plays, which require increased infrastructure. We think this is an excellent

investment opportunity. We also see a big opportunity for the global oil services. We

can see that capital expenditures have been rising. We expect them to rise from

about $500B to nearly $.5 trillion this year, an increase of 15%. So, we see

tremendous opportunity for some of the oil services contractors and equipment

providers. Another key driver is the impressive amount of money that has been

invested in North America. Just over the last three years nearly $129B in mergers,

acquisitions and joint ventures has occurred. Global companies are coming to

North America to invest in these shale plays because the economics are so

attractive due to improved technology. They want to learn that technology and take

it home. So, we think there is continued opportunity for investors in the resource

play here in North America.

Shifting gears, one of the base metals we will target is copper. It is our favorite basemetal. The demand side is holding up relatively well compared to some of the other

base metals. Even in China, which is the largest market for copper growth, the build

out of the grid is really a key driver. That is holding up quite well. On the other side

of the supply/demand equation, supply has been a problem. Through most of the

boom in copper prices, mine output has lagged forecasts. Causes included

weather, labor strikes and just poor grade. The bottom line is that supply has not

kept up with demand. We have not solved that problem so we think 2012 should be

a relatively good year for copper prices.

Another theme we like is the agricultural space. Global population continues to

grow. The emerging middle class continues to consume more grains, principallythrough the production of more meat as people consume more protein in their diets.

There has been a huge surge in the need for the production of grains, yet no more

land is being created. One of the key ways we're seeing increased yields out of

croplands is through higher applications of fertilizers. That has created a fairly tight

situation for potash, specifically. But, other fertilizers such as nitrogen and

phosphate are also benefiting from this trend.

FH: I would just add that the world's population has doubled from the '70s when we

had rising commodities. There's a very different factor and China and India have a

global footprint that they didn't have.

Xian Liang: China remains the biggest driver of world demand for energy due to a

rising middle class, but it is in a very early stage when it comes to discretionary

spending. Take for example passenger cars. Despite a tremendous growth in auto


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consumption in the last decade, only 18% of Chinese households own a car. Car

ownership in China is just one-tenth of U.S. levels or the same level it was in the

U.S. in 1914. Air travel remains at the U.S. equivalent of the 1950s. This illustrates

a great growth potential going forward. Urbanization is one of the most significant

trends driving consumption. In 2011, the number of urban residents in China

exceeded rural residents for the first time in Chinese history. But, China won't stop

at this 50% urbanization rate if the historical trajectory of its richer neighbor, South

Korea, is any guide. We could have another 30% of growth by the year 2013. SouthKorea outgrew its urbanization rates in a 40-year time span. And, if China continues

to urbanize, there will be about 200 million new urban households in China, which

creates enormous demand for consumer staples, durable goods and housing.

China's government policies signal the trend will continue. China raised reserve

requirement ratios 12 times since January 2010. We view that as an early signal for

the next easing cycle. The last time China eased reserve ratios in October 2008,

that triggered a big market rally in Chinese stocks. This should bode well for stocks.

We don't think the Chinese auto boom is over. Actually, in the last couple of days,

officials in China hinted that new measures may be introduced to support auto and

home appliance sales.

Outside of China, we see government policies remaining very positive in southeast

Asia, especially in Indonesia and Thailand. The money supply in the past two years

has not deteriorated in these two countries, in fact, it is growing at a healthy 16%

year over year. This is part of the reason why we remain positive on southeast Asia.

Indonesia is rich in natural resources, but it doesn't depend as much on exports. In

fact two-thirds of its GDP is driven by domestic consumption, which is how it

managed to escape a recession in 2008 and 2009. Favorable demographics is a

factor. It is a very young country. More than 45% of the population is under 24 years

old and 2 mill ion people a year are joining the work force. Second, urbanization iscreating new consumer demand. Just like China, Indonesia's household debt is

low. Total mortgage loans outstanding account for only 3% of GDP. Consumer

credit is stil l at a very early state. I see tremendous growth potential going forward.

FH: The money supply is growing very rapidly in the entire region. I think it's not just

a China story. It's a whole emerging market. And, I like to characterize it as the

American dream trade as all these countries want the American dream. They all

want a house. They want a car. They want all the lifestyle that we have.

John Derrick joined U.S. Global Investors Inc. in January 1999 as an investment

analyst for the U.S. Global Investors money market and tax free funds. In March2004, he was promoted from portfolio manager to director of research and now

manages the day-to-day operations of the investment team. Prior to joining U.S.

Global Investors, Derrick worked at Fidelity Investments. He has appeared on

CNBC and Bloomberg TV and has also been a guest on Marketwatch Radio and

NPR. Derrick has been featured in stories forBusinessWeek, The New York

Times, the Associated Press andUSA Today. A graduate of The University of

Texas at Arlington, Derrick earned a Bachelor of Arts in finance. He sits on the

board of directors for the CFA Society of San Antonio.

Brian Hicksjoined U.S. Global Investors Inc. in 2004 as a co-manager of the

company's Global Resources Fund (PSPFX). He is responsible for portfolio

allocation, stock selection and research coverage for the energy and basic

materials sectors. Prior to joining U.S. Global Investors, Hicks was an associate oil

and gas analyst for A.G. Edwards Inc. He also worked previously as an
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institutional equity/options trader and liaison to the foreign equity desk at Charles

Schwab & Co., and at Invesco Funds Group, Inc. as an industry research and

product development analyst. Hicks holds a Master of Science degree in finance,

and a bachelor's in business administration from the University of Colorado.

Frank Holmesis CEO and chief investment officer at U.S. Global Investors Inc.,

which manages a diversified family of mutual funds and hedge funds specializing

in natural resources, emerging markets and infrastructure. In 2006 Mining Journal,

a leading publication for the global resources industry, chose him as mining fundmanager of the year. Holmes coauthoredThe Goldwatcher: Demystifying Gold

Investing (2008). A regular contributor to investor-education websites and speaker

at investment conferences, he writes articles for investment-focused publications

and appears on television as a business commentator.

Xian Liangis an Asia research analyst at U.S. Global Investors Inc. and a

Shanghai native.

John Mauldinis the author of New York Times Best Sellers list four times. They

includeBull's Eye Investing: Targeting Real Returns in a Smoke and Mirrors

Market, Just One Thing: Twelve of the World's Best Investors Reveal the One

Strategy You Can't Overlook andEndgame: The End of the Debt Supercycle and

How it Changes Everything. He also edits the free weekly e-letter Outside the Box.

Mauldin also offersThe Mauldin Circle, a free service that connects accredited

investors to an exclusive network of money managers and alternative investment

opportunities. He is a frequent contributor to publications includingThe Financial

Times andThe Daily Reckoning, as well as a regular guest on CNBC, Yahoo

Tech Ticker and Bloomberg TV. Mauldin is the President of Millennium Wave

Advisors, an investment advisory firm registered with multiple states. He is also a

registered representative of Millennium Wave Securities, a FINRA-registered

broker-dealer.

Evan Smithjoined U.S. Global Investors Inc. in 2004 as co-portfolio manager of

the Global Resources Fund (PSPFX). Previously, he was a trader with Koch

Capital Markets in Houston where he executed quantitative long-short equities

strategies. He was also an equities research analyst with Sanders Morris Harris in

Houston where he followed energy companies in the oil and gas, coal mining and

pipeline sectors. In addition, he was with the Valuation Services Group of Arthur

Andersen LLP. Smith holds a Bachelor of Science degree in mechanical

engineering from the University of Texas in Austin.

Read more about investing in MLPs and potash at The Energy Report.

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look for end of debt super cycle

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