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Markets: Interesting Times
New York: October 29, 2007
By John R. Stephenson

"May you live in Interesting Times."

--Chinese proverb and curse

Political risk looms large. The world is constantly changing as nations and regions move from political stability to instability and back again. When things change, and they always do, the changes create shock waves that have huge implications for investors and business people alike. Investors and businesses prize stability. Get the politics right and you can prosper. Get hit with a shock wave and things can get ugly in a hurry.

Last week, was all about oil. Turkey decided to authorize the use of force against the Kurds in northern Iraq. The U.S. decided that Iran needed to be brought to task over its nuclear program and Alberta decided that oil sands players owed ordinary Albertans more.

Oil, the most geopolitical of commodities was riding high on the simmering tensions in the Middle East. Even stable Canada got into the game of generating some political shocks of its own, as the government of Alberta decided to rescind long-standing agreements with Suncor and Syncrude over their oil sands leases and to jack-up the royalty payments to the province. The result? The province of Alberta is no longer a politically secure region of the world.

Gold is on a long march higher as it has become obvious to investors that the only way to stave off recession in the U.S. is to lower interest rates and orchestrate a bailout of Wall Street's leading investment banks. The reason? A subprime mess that is nowhere near to being resolved that has frozen the credit markets and is causing the U.S. consumer to scream for mercy.

Consumers in the U.S. are a lot less confident than they used to be and with good reason. Food and energy prices are rising at precisely the same time as house prices are falling. The University of Michigan consumer sentiment poll registers a confidence level of just under 81, marking the 17 th month of declining optimism.

New homes for sale rose to 10.5 months of supply while the existing homes for sale fell to an annualized rate of 5 million. Overall, U.S. home sales are down 19% from a year ago, but much of the drop has occurred over the last few months. For condominiums, the news is worse. There is a 12.6-month supply (number of condos for sale divided by the average number sold in a month) of condos on the market. In Florida, some homes have been on the market for three years or more.

The stock market has shrugged these problems off. Technology stocks have been on a tear. For now, the faint hope that earnings will surge, the Fed will continue to cut interest rates and all will be well has been enough to placate investors on Wall Street.

But, for how long can it last? No one knows. Consumers are reigning in their spending. Technology stocks, with few exceptions, face nearly perfect competition and yet they trade at premium multiples. Bank stocks continue their slide. Foreclosures on homes in the U.S. are set to accelerate rather than decelerate with prices tumbling on homes in foreclosure some 30 to 40 per cent. Paper assets of all types are all of a sudden suspect. Merrill Lynch, AIG and others are in big trouble, with a bailout the only sensible solution. Bear Stearns and Co. Inc. has already learned the hard way what risk can do to you when it is not respected, even feared.

Food prices are on the rise everywhere. Gold is surging and oil is on fire. The U.S. dollar is under-loved and no one believes that better days are ahead for the greenback. Hard assets of all types are being prized and why not? Paper assets have lost their luster as they represent mere promises rather than something solid. Unfortunately, the institutions and governments (Wall Street banks and the U.S. Treasury) who have issued the most paper assets have a lot of explaining to do. Most likely, these explanations will fall on deaf ears as there are no more "greater fools" to sell repackaged loans on Alabama trailer parks to.

Citigroup, Bank of America and JP Morgan Chase have banded together to create a $100 billion fund to buy some of the better subprime loans. Good luck. With credibility and cash in short supply, the likelihood that this fund will be enough to stabilize a mess that has been brewing for years and will eventually cost millions of people their homes, just strains credibility a little too much.

So what's a savvy investor to do? Invest in things that can't be inflated away. Hard assets such as gold, base metals, food and energy or the companies that produce them should be good places to hide. The reason? No matter what happens to the U.S. dollar, the subprime mess or inflation in general, these real things should continue to outperform the broader stock market. What is old is new again.

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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