Indeed this is a time unlike any we have seen since WWI, perhaps even earlier. A time so full of economic and political tribulations of worldly proportions that has left the best and brightest of Wall Street and World Street scratching their heads trying to make sense of it all. It is never an easy task to rationalize market movements because investing is not an exact science. Rather it is a behavioral science, sometimes with the logic of exact science. In this behavioral science the numerical value of "1+1" doesn't always have to be "2". A change in the value of any of the components of the equation "1+1+1=3" may or may not maintain its equality, yet it would still make perfect sense. The reason for that is the unpredictability with any certainty of the actions and reactions (+ and -) of the different components of the investment equation and of market forces that are sometimes hard to identify. Investment books and literature, as well as CNBC, tell us that the existence of certain elements guarantees a specific outcome such as when the dollar falls the price of oil goes up, or an increase in supply leads to lower prices, etc... in other words 1+1+1 must equal 3.
Here are the reasons why the "trinity of investment plus one" make perfect sense even though they may seem, at times, contradictory. One has to sidestep the CNBC conventional wisdom for a second and engage in out of the box thinking in these unusual times.
GOLD
Gold prices continue their climb on a path charted by the world central banks in an effort to stimulate economies that pulse only because of governments borrowed money . Despite QE2 and the purchases of the Federal Reserve of government bonds interest rates continue to rise in the U.S. The tragedy in Japan increases the likelihood of a QE3 by the Fed further debasing the dollar and cementing the role of gold as a reserve currency. Inflation is popping out everywhere, in China, in India, in Brazil and in the U.S. Inflation was the spark that launched the rolling revolutions in the Middle East and will catapult gold to its destined status (see previous posts on gold).
OIL
The unthinkable has happened. People in the Arab world have finally said enough is enough. And while democracy does wonder for a free economy this is not the case here. For starter we don't know yet if the Middle East is going to adopt democracy (there are hopeful signs but nothing more). Tonight we hear that the cries for freedom have taken four lives in Syria ( a very serious development). The rolling revolutions in the Middle East are not what will cause the price of crude to go even higher from its currently decried levels. The actions of Iran to counter Saudi presence in Bahrain will be the main determinant of higher oil prices. By creating uncertainty and a perception of a potential oil supply disruption through attempts to destabilize regimes in the region Iran can enjoy a much needed higher oil revenues while scoring a political point or two.
I am at a loss to understand the prediction that the unfortunate events in Japan will be a drag on oil prices. While this may be true in the very short time, absent the events in the Middle east, I see the Japan situation very bullish for oil. Not only is the rebuilding going to require a lot of energy but also the drop of the dollar and the strengthening of the yen (not necessarily against each others) will encourage more oil buying. Once the nuclear reactors problems are under control Japan will embark on a rebuilding campaign that will be very bullish for oil. The intervention of the G7 to halt the appreciation of the Yen is meant to ensure a robust recovery for Japan.
Short Treasuries
Everyone seems to be concerned about the repatriation of Japanese money to pay for the costly rebuilding. But what worries me is the possibility of non-Japanese money leaving U.S. treasuries in search of a better investment opportunity in Japanese equities. No matter how you look at it Japan is going to further add to its debt, which stands at 200% of GDP, to finance its rebuilding. In this case additional debt is a good thing because of the immediate return on investment that will be measurable and productive. If this shift of non-Japanese money from treasuries takes place it will indeed be a negative for U.S. bonds. Couple this with inflation and larger and larger debt as a percent of GDP (in many countries) and you can see the effect on bonds prices.
Plus One
Sometimes the components of the investment equation must be looked at individually and in isolation in order to understand the risk reward ratio. While together they may not maintain the integrity of the equation, individually they make perfect sense. Food is the "plus one" in this equation. Despite all the worries facing the world economies, despite debt and inflation, despite wars and revolutions, or perhaps because of all of that, and despite the lack of wage increases people of the world will consume more food and nations of the world will rush to buy more agriculture products to make sure their populations are fed. Does China want a food revolution? Yet because of the world limited resources (see the post about Financial Pies ) higher food prices are inevitable irrespective of a broader inflation.
so in this perspective 1+1+1 equals 4. Go figure, who says there is no new invention in math?
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