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Commodity Investing Shell Shocked
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New York: March 28, 2011
By John Stephenson

A political void in Portugal has put the country and possibly the whole Iberian Peninsula on a path towards crisis—one that could threaten the entire euro zone. A debt crisis in Portugal quickly morphed into a political crisis as Portuguese Prime Minister Jose Socrates resigned after a failed vote in parliament on his government’s latest austerity measures. With its economy contracting at 3 percent a year and borrowing costs at 7.7 percent, Portugal was on a path to economic oblivion and last week Fitch Ratings Service downgraded Portugal’s credit rating citing “increased risks to policy implementation and fiscal financing.” But while a bailout and a restructuring of Portugal’s economy seem almost certain, investors and economists have turned their attention to Spain.

While the cost of an eventual bailout of Portugal is likely to be north of 80 billion euros, it will come with a lot of strings attached. And while a bailout of €80 billion would be massive for Portugal, roughly equivalent to 47 percent of the country’s gross domestic product, it would be an amount that the European Union could afford. A more practical problem is the mechanics around negotiating a Portuguese bailout when the country lacks a government.

Against this backdrop of repeated European bailouts is a political climate that is muddied as support for the necessary belt-tightening has waned and richer countries in the European Union have become frustrated with the single-currency experiment. German Chancellor Angela Merkel has faced increasing scepticism from her party’s conservative supporters over underwriting other euro zone members’ profligacy. Finland has dissolved its parliament ahead of the April 17 election, essentially putting a freeze on further sovereign bailouts since they require the full support of all members of the euro zone.

With lenders growing more reticent to support the political union at all costs, they are increasingly demanding that tough austerity measures be implemented as a condition of a bailout. But this less forgiving climate of lending stands in stark contrast to the political reality in Europe. Political power has changed hands in Ireland and Portugal’s government has collapsed making it clear that stern deficit reduction amidst high unemployment is at best, poor politics.

But the ultimate test for Europe’s leaders may not be long in coming. Already, investors and bond vigilantes have set their sights on Spain—a country with the fourth biggest economy in Europe. Spain had an even bigger housing boom than America, leaving the country massively overbuilt, a situation that has hobbled the country’s banks with losses on real estate loans. Spain’s banking system is a mix between banks and cajas, which are the equivalent of credit unions and make up close to half of Spain’s financial system by assets. Many of the cajas are poorly managed and undercapitalized, a situation that has already led to mergers and industry consolidation. But even this may not be enough to save Spain from a sovereign debt crisis that is beginning to wash up on its shores.

Spanish bank capital needs may be as much as five percent of the country’s gross domestic product or more and rating agencies are beginning to take note. Last week, Moody’s downgraded the credit rating of 30 Spanish banks, further underscoring the dire fiscal situation. Spain’s unemployment rate is hovering around the 20% mark and fierce competition for deposits and contracting credit will make a bad situation for the country’s banks even worse. Further complicating matters is a European Central Bank (ECB) that is determined to boost interest rates to contain inflation, slamming poorer countries in the union with higher borrowing costs and increasing debt burdens.

Attention is beginning to focus on a long list of what’s ailing the European Union and its common currency and the euro is likely to weaken in the months ahead. The U.S. shows little appetite for tackling its debts in the short and medium term. The White House and Congress are having trouble passing a budget bill and higher bond yields are the likely outcome over the next two years as it becomes obvious that in the run-up to the 2012 election there will be a lot of talk, but no action on the U.S. deficit issues.

A growing debt burden in both the euro zone and America has seen policy makers turn increasingly to the printing press to address their fiscal ills. Data from the St. Louis Fed shows a dramatic increase in the U.S. monetary base, a fact not lost on the gold and silver markets. Gold hit an all-time record high this week as investors reasoned that before all is said and done, the major world economies will have debased their currencies in an attempt to avoid the tough choice of implementing sharply higher taxes and slashing services.

As I mentioned last week on Bloomberg Television’s Taking Stock with Pimm Fox, I believe that the perfect storm of a weakening U.S. dollar and solid fundamentals have set the stage for a multi-year bull market in commodities. In my view, commodities are simply the best investment class for the next decade.

One book that I am enjoying reading is from my good friend Jack Plunkett of Plunkett Research. Jack’s new book The Next Boom: What You Absolutely, Positively Have to Know About the World Between Now and 2025 is required reading for all the optimists out there who are searching for the silver lining in a world where worries are looming large.

Savvy investors will recognize that what ails the euro zone and the U.S. are not problems where the solutions will be easy and painless to implement, but there is a way to prosper. For my money, the trade of the decade will be in silver. Gold was the best investment over the last decade, but in the future, silver will be the go-to investment for investors looking to ride out the current storms in the global economy.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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