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Why The Davos Crowd Is Delusional

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You've got to hand it to Ben Bernanke and the world's central bankers: they've succeeded in driving many assets to record or near-record highs. Stocks, bonds, commodities - all are at elevated levels versus history. The trouble is there's no evidence that reigniting these asset bubbles is improving the economic picture. The high priests of Davos may tell us the worst is over, but if they're right, the trillions of dollars printed in recent years will filter through to economies and create skyrocketing inflation that they'll be powerless to stop. My base case though remains that they're wrong (again) and the massive credit bubble of the past three decades will deflate despite their best efforts to prevent it happening.

For investors, the trick will be preserving wealth by picking assets that are the least frothy. In Asia, Japanese stocks certainly qualify, still down around 75% from 1989 highs. In my view, investors will get a better opportunity to buy Japan equities and possibly short the yen over the next 4-6 weeks. In this issue, I’ll also look at why Korean stocks are best left ignored (or shorted) and why gold, while not cheap, remains a sound bet despite India’s latest attempt to quell demand for the yellow metal.

Bizarre signals from Japan

In the past week, Japan has almost set a record for mixed signals. Despite all of the hype, the Bank of Japan (BoJ) meeting failed to deliver what investors had been expected.

By a vote of 7 to 2, including Governor Shirawaka, the BoJ voted to raise the inflation target to 2%. Recall that the previous target was 1% and the now new government had campaigned in the recent election for a 2% inflation target.

However, on the same day, the BoJ released an inflation forecast, with inflation expected to rise to 0.9% by March 2015, from current levels of 0.8%. So, the BoJ has set a 2% inflation target but forecasts 0.9% inflation by 2015. It has to be asked when it exactly intends to get to the 2% target?

The second key announcement from the BoJ meeting was that a 13 trillion yen asset purchase program, aka stimulus, would start in January of next year. Increased stimulus starting next year rather than now was not what investors were anticipating, after the recent rhetoric of the Prime Minister.

Soon after the BoJ meeting, Japan's Finance Minister released a statement suggesting there'd be fiscal tightening next year and in the years thereafter. Tightening via increased government spend and/or increased taxes completed contradicted the looser policies announced by the government thus far.

Then to top it off, the Japanese Vice Finance Minister Takehiko Nakao came out and said that the government would take "appropriate actions if necessary", after the yen had gained: meaning, "we'll do what it takes to get the yen lower again".

It's clear that investors had under-estimated the ability of the central bank governor to resist government pressure to engage in major stimulus. The current governor's term expires in April and it's then that the Prime Minister should be able to get someone who has views more in line with his own.

At that time, stimulus should begin in earnest and further yen depreciation will take place. This will be positive for the stock market. Until April though, there will be lingering uncertainty as to future government policies, particularly if there are more mixed signals from various ministers.

Given the yen remains over-bought, this should bring some sharp movements in both the currency and the share market. This should provide some better entry points to buy stocks and possibly short the yen, for those who've missed out on these trades in recent months. My long-term target for the yen remains 200 to the dollar or lower.

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