No Battle Plan Survives Contact With The Enemy

I have been posting to this blog (originally titled Mentatt) since 2005, primarily for the benefit of friends, family, Wall Street associates, and investors in our funds.  Prior to the blog I published a white paper newsletter that began in 2004.

I was inspired to write to express my concern that certain imbalances in our economic system, particularly in energy, real estate, and banking would lead to a crisis of sorts.  That crisis is here, and is well underway.

(Give me a moment, I am going somewhere with this.)

While fully admitting that forecasting is failure prone, I felt there was little to lose.  I began by telling my investors in late 2005 early 2006 that in real terms they should focus on losing less than everybody else - that we were ALL going to be made poorer over the next decade due to a collapse in the value of everything.  We had a lot of it right, and some of it wrong.  I do not write this to "toot my horn" if you will, only to lay out what strategies we took then, what worked and what didn't, and what to do NOW.

Unlike some of the other sites dedicated to "Peak Oil" mine was not a "doomer" position.  I targeted my commentary to middle aged family men with a net worth between $2 and $20 million, which pretty much describes my investors and Wall Street acquaintances (if you are a woman, single, gay, extremely wealthy or dirt poor, etc.. you are more than welcome to communicate with me - you just were not my target audience).  After all, I view the decade 2005 to 2015 as TRIAGE.  Most folks are in no position to do anything about it (expectant); the top segment has enough resources to get to the end of their lives without going hungry or homeless (routine); but the middle group, the 50 year old professional with a $3 million net worth, 2.3 kids, wife, dog, etc... (priority) he CAN do something and he NEEDS to do something.

Back then I thought that the best approach was to sell the family home and rent, hold Gold and Silver, Energy Equities, Farm Land, Crude Oil, and to pay down any debt.

Well, it was not the perfect portfolio, but it would have held an investor's head above water, and you would have missed the collapse in housing prices.  Energy equities have retreated back to their 2005 prices, so if you bought in 2006 you lost money (what's worse, the exploration & production companies look a bit rich with the commodity price being where it is, so those losses might get worse before they get better).  Silver and Crude Oil are right back to where they were in early 2006, so nothing much to take a bow about there either.   Gold and Farm Land have risen in price.

On the other hand things could have been worse.  By going long Gold and short their house and breaking even on the balance, one would have been much better off than holding your house and keeping your life's savings in stocks and corporate bonds.  Also, my readers were implored to stay clear of banks and financials, retailers, home builders and the emerging markets.  Avoiding loses is the name of the game.

As I said, no battle plan survives contact with the enemy.  The performance of the US$ has been, to me, somewhat surprising.  Or at least it was.  Some of the "deflationists" correctly called the impact of the dramatic contraction in credit - Deflation (hence their name).  So, my view of the US$ was a fly in MY forecast ointment - on a price adjusted basis the US$ finished 2008 roughly where it finished 2005 and 2006.  The again, versus Gold the US$ has performed as I expected.

I would call the 2005 - 2008 period Phase I (How many phases we have depends on how you want to define them).  Phase I displayed the inability of the system to provide a return on capital.  Phase II, circa 2009 - 2012 will, in my opinion, display the inability of the system to continue to expand in real terms.  

Think about what I just said - the period 2009 - 2012 will "display the inability of the system to continue to expand in real terms."  That is not to say that nominal "growth" cannot occur, nor that real growth off of a steep drop cannot occur.  It DOES mean that 2007 may have been the peak for world economic production.  

Because our system is so complex, the end of future growth has dire implications for ALL of our society's Ponzi/Madoff schemes - Medicare, Social Security, Medicaid, the Food Stamp Program, Temporary Assistance to Needy Families (commonly called Welfare), Unemployment Insurance, Farm Subsidies, State Social Services, Student Loan Programs, to name a few sponsored by government, but also the U.S. Financial Markets.  (By far the most important complex system that could really get kerbolixed in all of this is the production of food.  I have covered this ad nauseum in many previous posts, so I will spare you the repetition.  The risk is real, and inevitable.)  

Money is politics and politics is money.  Who prints money anyway?  Governments!  The U.S. economy, 25% of the world's economy, is in full scale meltdown - and our political and business leaders are hanging their hat on $750 Billion - $1 Trillion in a stimulus package to save/rescue a $14 Trillion economy with $4 Trillion in mortgage write downs alone?  What do you think?

What if the stimulus package doesn't work as promised?  Have you heard of any "Plan B"?  All I have heard is "its got to work" or "it better work".

I won't bore you with WHY I think the stimulus plan will not work as promised.  Suffice it to say that I believe the plan will fail.  Medicare will fail.  Social Security will fail. The Pension System will fail.  Unemployment insurance will fail (actually, unemployment insurance is already failing).  Maybe Natural Gas will take the place of Heating Oil.  If not, one winter soon we will have to contend with insufficient supplies of heating fuels.

One or more of these will likely fail before the end of 2012 (my bet is on the Pension System).  

This brings me to where I am going with this post.

The U.S.$ will become more valuable for as long as deflation lasts.  The questions are:  When will the U.S. Federal Government get desperate enough to monetize its debt?  How much "Stimulus" and "Bail Out" money will the government print?  There are only 2 ways to pay that back:  Raise taxes or devalue the currency.

The runaway train that is the U.S. entitlement system is going to crash headlong into the Oil import crisis, if you doubt this just take a hard look at California. Most of the assets that comprise our "wealth" are going to depreciate further (some assets will appreciate, at least nominally).  Unfortunately, if you did not make your move in 2006 you lost most of the equity in your home, and if you held corporate bonds and stocks you lost roughly 40% of your financial assets.  If you HAD a $2 million net worth then, you are lucky if you have half that now.  This process is going to continue until, over the next 10 years, you have little to nothing left if you do not make some adjustments.  If you are going to do nothing, you would be better served (IMHO) to take your life savings and spend it all on wine, women, and song - since you are going to be broke anyway might as well have a good time.

A currency crisis, a political crisis, an energy crisis, and a food crisis are, in my opinion, a foregone conclusion over the next 5 years or so.  I wish I had a better word than "crisis", as it gets so overused that it loses its descriptive powers.  

I skipped my usual prognostication on energy prices and precious metals prices for 2009.  In the environment I just described I find doing so superfluous.  Same with the US$.  We will all have to react to the data as it comes in, and then not deny what our eyes are seeing.

Mentatt (at) yahoo (d0t) com