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Longboat Global Advisors CrossCurrents 5/12/4


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#1 TTHQ Staff

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Posted 12 May 2004 - 09:01 AM

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HOME OF "PICTURES OF A STOCK MARKET MANIA"

May 12, 2004
Longboat Global Advisors CROSSCURRENTS
Alan M. Newman, Editor

A few days ago, we published a new update of Pictures of a Stock Market Mania titled "Double Bubble." Truth be told, the evidence offered on those pages could be expanded upon infinitely. How the financial industry does not see or chooses to ignore the perils at hand borders on criminal, in our view. It's bad enough that Morningstar shows the P/Es of tech sector funds have ballooned to 42.5, three times the normal level, but we see further confirmations of lemming like activity wherever we look. We're not trying to pick on Fidelity but we’re illustrating our arguments using examples from the company, since they are so typical of the industry. Fidelity is the second largest family of funds, just behind Vanguard. Our question: if tech is so overvalued, how overvalued is the category known as “Aggressive” growth? The Fidelity Aggressive Growth fund became our proxy and delivered the following: the top ten issues in the fund comprise nearly 20% of assets and have an average market cap of $21 billion, not too shabby. Three of the ten are losing money and if we treat their P/E as "200," the average P/E for the group is 91! The average price-to-sales ratio is 9.2, which we also view as egregious. Well, maybe they have a ton of cash on hand to take advantage when the high-flyers eventually correct. Whoops, just 1.3%. Worst of all, insiders at the ten companies number zero buyers and 226 sellers. We can only wonder why the Fidelity Aggressive Growth managers are so confident in their top ten choices. Could it be a mania in progress? A double bubble?

For many months, we have presented the chart below, both on the website and in the newsletter, detailing resistance for Gold at roughly $423 per ounce. The resistance level was recently achieved (almost exactly) and the precious metal dutifully backed off and raised speculation that the nascent bull market had ended. Even some gold bulls are projecting corrections down to the low $300s for bullion. We don't quite understand the fuss. After 34 months on the upside, a bull market correction was clearly in the cards. Our view is that since the market for gold bullion has been relatively quiet, a larger correction than that suffered to date is not needed. Price has succumbed sufficiently to scare away many of those who were climbing aboard gold shares, witness the 34.9% plunge in the HUI Goldbugs index and the 31.3% decline in the Philadelphia XAU Gold Index. The XAU correction is an exact 50% retracement of the gains since 911. Given currency concerns for the dollar plus the budget and trade deficits, Gold should find solid support. If that were not enough, we consider that the most powerful driver of the precious metal, inflation - is clearly back, despite what we are told by the "official" government statistics. As shown by guest commentator Richard Benson, President of Specialty Finance Group, LLC. at ww.prudentbear.com, "What you should find unsettling and fraudulent are the ways that the CPI is manipulated to ensure there is no inflation, regardless of how high the prices rise for things we must buy to live." Strong words! But Benson backs up his convictions, pointing out that by manipulating the CPI, the government does not have to keep the promises it has made to Social Security and Medicare recipients. Also, the government uses "hedonics" to ridiculous extremes, making assumptions that are simply not borne out in real life. Perhaps most importantly, Benson says "...it is not a coincidence that the CPI assumes that everyone in the country rents their home." As mortgage rates have declined, housing boomed, ensuring a soft rental market. Thus, even though housing prices have gone through the roof in many metropolitan areas, the ease in rental prices has caused the CPI to remain flattish, in obvious contradiction with the real trend in prices. Deficits like those suffered in some areas such as New York's Nassau County, where your Editor resides, and in California, have caused property taxes to skyrocket. Yet these aspects appear nowhere near factored into the CPI equation but the costs to live in the same manner as before have escalated dramatically in just a few years, facts that absolutely belie a CPI of 1.7%! Benson actually prepared a monthly "nut" spreadsheet to tally his family's expenses and found that their inflation was rising at 8% to 10% per year. That estimate sounds closer to the truth than the government's low ball monthly guess. Benson also comes to the very interesting conclusion that the consumer is providing a substantial portion of his own hedonic benefit via what are supposedly the productivity gains we've all been told about endlessly. "Everywhere we look, the consumer is now providing a portion of the labor in order to receive normal services. Yes, this holds measured prices down but the downside is the loss of the purchaser’s valuable time." If you're puzzled about this rationale, just remember your last phone call to customer service, how long it took you to get a human being on the phone or to make travel arrangements, Yes, there has been a price benefit but at the cost of the consumer "providing a portion of the labor." Finally, Benson shows how the BLS intends to use an "Expenditure/Chain-Weighted Index," which will under-weight some items as they go up in price and therefore over-weight items the government presumes will be suitable alternatives. The changes can result in a lower cost of living, despite consumers' intransigence in changing or adapting to the circumstances and actually spending more. The official tally of 1.7% consumer inflation over the last year seems so grossly inaccurate that it is no wonder that Gold continues to confound the metal bears. We believe Gold is acting as if the cat is out of the bag and further, will continue to reflect the truth about inflation as time passes. In our view, it's still a baby bull.


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