August 2008

Yields at the longer end of the yield curve have been kept in check as the flight to safety continues to ensue. Similarly, the Federal Reserve has been successful in influencing shorter-term interest rates lower with the Federal Funds target rate pegged at 2%, down 325 basis points from a 52-week high of 5.25%. The flow of funds into the fixed-income arena continues in spite of negative real (inflation-adjusted) yields. We believe that one of the primary reasons for investors to accept a real negative return on fixed-income investments at this time is the fear of a deepening banking and housing crisis and, subsequently, a prolonged economic downturn. We concur. However, we believe that interest rates will rise at some point in the not-too-distant future as un-abating monetary inflating gives rise to further price inflation.

A recession, technically defined as two consecutive quarterly declines in GDP (Gross Domestic Production) issued by the Commerce Department, has been narrowly avoided, to date, according to reported and admittedly backwards-looking GDP figures. In fact, the latest reporting of the GDP for the second quarter of 2008 mounted an impressive 3.3% annual rate, following 0.9% growth in the first quarter. However, a closer look at the components of GDP indicates that the economy may be may be much weaker than shown. Specifically, one of the components of GDP is Gross Domestic Income (GDI), which sums up things like personal income, corporate profits, and the like and is primarily “income-based”. Gross Domestic Income advanced just 1.9% annual rate in the latest quarter after contracting in the previous quarters. GDP is primarily consumption-based, summing up components such as consumer spending, business and other spending and investment, as well as exports. It is likely that this last component, exports, which has been growing due to a weakening dollar, distorts the actual level of domestic economic activity as recorded by GDP. Gross Domestic Income is included in quarterly GDP, but not in the “advance” readings which are subject to substantial revisions. Admittedly by some Fed officials, GDI is a better measure than GDP and has done a better job in accurately forecasting recent recessions.

To touch on gold, precious metal prices bounced nicely off the psychologically important $800 per ounce support level recently. August has again proved to be a month of pressure on precious metal prices as most of Europe is on vacation and not trading. We suspect that metal prices (and commodities in general) will again resume an upward trend during the months ahead as long as the $800 per ounce or thereabouts level holds. We are watching the situation closely.