Speculative-Investor.com

-- 2010 Forecast

Yearly Forecast

Random Thoughts

*When we penned our 2009 forecast at around this time last year, our expectation was that the first half of the year would encompass a general post-crash recovery (we called it an "economic false dawn") characterised by strength in the broad stock market, strength in industrial commodities relative to gold, and weakness in the US dollar, whereas we expected to see the return of deflation fear (but not actual deflation) during the second half of the year. Almost every year contains at least one big surprise, and from our perspective 2009's big surprise was that the post-crash recovery extended through to year-end.

*Similarities between the stock market's current situation and its situation during the early 1930s have been eliminated. To put it another way, the performance of the Dow Industrials Index during the early 1930s is no longer a useful model as far as the broad US stock market is concerned.

*The single most important difference between the early 1930s and the current situation -- and very likely the main reason why today's stock market is following a different path -- is the monetary backdrop. Specifically, there was massive monetary deflation during the early 1930s and there has been massive monetary inflation over the past 16 months. Although it has helped to support equity and other prices in the short-term, the post-September-2008 surge in money supply will have very negative long-term consequences.

*What we have seen over the past 10 months is a rebound within the context of an economic depression. Due to the responses of governments and central banks throughout the world, a sustainable economic recovery is not possible and the depression will continue for many years.

The US Stock Market

2010 is the second year of the current 4-year Presidential Election Cycle. The average for the second year of the Cycle entails an upward bias through to April followed by a downward trend through to early October and then a rebound into year-end.

Our best guess at this time is that the stock market will roughly adhere to the pattern described above. Such a pattern meshes with the idea that by the second quarter of this year there will be undeniable evidence that the economic rebound has ended.

Note that although we are anticipating a tradable multi-month stock market decline during the second and third quarters of this year, we do not expect the senior stock indices to trade anywhere near their 2009 lows during 2010. On a longer-term basis we expect that the 2009 lows will be tested, but, due to the effects of monetary inflation, not breached. In other words, we think that the March-2009 lows will prove to be the ultimate bear-market lows in nominal dollar terms. However, a lot more weakness will be seen when performance is measured in gold terms.

The US Dollar

There has been a strong inverse relationship over the past two years between the perceived strength of the global economy -- as indicated by the performances of equities and high-yield bonds -- and the US dollar's value relative to most other currencies. This inverse relationship is clearly illustrated by the following chart comparison of Hong Kong's stock market and the Dollar Index.

Why does this relationship exist? Our guess is that when global growth is widely believed to be strong or on the rise, investment demand shifts towards the geographical areas that offer the most concentrated exposure to the growth. For many years, the most concentrated exposure to economic growth has been provided by the "emerging markets" and the countries that supply these markets with commodities. Furthermore, it makes sense to fund investments/speculations in the high-growth regions by selling investments in slower-growth regions and/or borrowing in terms of a liquid currency that offers a comparatively low interest rate. During the global growth periods of the past few years, interest rates have been lowest and growth has been slowest in Japan and the US. It has therefore been logical -- from the perspective of, say, a hedge-fund manager -- to borrow/sell the Yen and the US$ to finance speculations in emerging markets and commodity producers. The demand for Yen and US dollars thus rises whenever these speculations are unwound.

We expect that conviction about the sustainability of the global economic recovery will begin to waver during the second quarter of this year and fall apart during the second half of the year. This should prompt a general unwinding of speculative positions, putting irresistible upward pressure on the US dollar's exchange value.

Our currency market forecast, then, is for the Dollar Index to test its 2009 low by April and then trend upward for several months.

T-Bonds

We expect that a T-Bond bear market will be one of this decade's dominant trends and that this expectation will generally be supported by the price action during 2010.

During the second half this year there could be a multi-month recovery in the T-Bond in response to renewed signs of economic weakness, although at some point we are likely to get the dreaded combination of economic weakness and rising goods/services prices. That is, at some point it will not make sense to turn bullish on Treasury bonds simply because the economy and the stock market are in decline.

Gold and Gold Stocks

In the yearly forecast posted at the beginning of 2009, we wrote:

"The gold price will probably make a new high this year and finish the decade on a strong note, but we don't have any particular target in mind. Relative to industrial commodities we expect gold to give back some of its recent large gains during the first half of the year as hopes of economic recovery take root, and to resume its advance later in the year as these hopes are dashed."

The following chart showing both the gold/CRB ratio and the gold/SPX ratio reveals that this forecast wasn't far from the mark in that gold pulled back relative to commodities and general equities from late February through to mid August and then began to strengthen. However, more than half of the August-November gains made by gold relative to commodities and the stock market were given back during December, so it is questionable as to whether the next major advance in the REAL gold price has already begun.

With regard to gold's likely performance over the coming year, our expectations are similar to what they were at the start of last year. The fact that gold did not experience an upside blow-off during 2009 means that 2010 should be another good year in US$ terms, with a move to new all-time highs following the completion of the current correction. Volatility will probably be a lot greater, though, because the general level of nervousness -- within the ranks of speculators, investors and policy-makers -- will increase after it becomes clear that the economic rebound has ended.

Relative to industrial commodities, we expect that gold will 'mark time' during the first half of the year and achieve substantial gains during the second half.

In last year's forecast for the gold sector of the stock market we said that a new multi-year bull market had probably begun in October of 2008 and that the sector was poised to make substantial upward progress during 2009. This forecast was accurate, but there were, of course, a few surprises along the way. The main surprise was that the upward trend extended throughout the year with no large downward moves. This was a little surprising because the gold sector experiences a large downward move during the course of almost every year.

We expect that the gold sector, and especially the stocks that reside at the junior end of the sector, will again do well in 2010, but the lack of an intermediate-term correction during 2009 greatly increases the probability of such a correction occurring this year.