Our Annual Forecasts

First, we’d like to wish a Happy New Year to all our dear readers.

“Through the years, we all will be together…if the Fates allow.”

Will it be a happy year in 2007? Everyone thinks so. But what do the Fates think? Here at The Daily Reckoning headquarters, we try to do our part to make sure it is happy for you, mostly by trying to anticipate the misfortunes, bumbles and illusions of others…and what the Fates may have up their sleeves.

The more others are mistaken, the greater the opportunities for us to amuse ourselves.

And who knows? You might even make some money by taking the other side of their dumb trades. But the trouble with trades is that you never know which side is the dumb side. Modest as we are, we don’t like to gamble on the premise that we are any smarter than others. We only count on the fact that others hold their illusions more surely…more resolutely…and more confidently that we do. After all, we only have two secrets. One is that we don’t watch television. Those who do are more easily bamboozled; they become convinced that something is so merely because so many people seem to be saying so.

Our other secret is a virtue so extreme it borders on pathological – humility. Don’t bother to tell us how dumb we are, dear reader; we know we are dumber than you can imagine. Besides, we’ve proved it a number of times. And if we forget, we have plenty of family to remind us.

But as to this virtue, we admit, we are insincere. We believe our modesty gives us an advantage…a little edge. In fact, yes, our humility makes us superior! We think we are spotted a point or two in the game of life, merely because we recognize how lame and foolish we actually can be. Others, less well informed as to their own infirmities, tend to overstate their cases and overplay their hands. They bet too heavily on things they know nothing about. We don’t know how to build a Western-style democracy in Mesopotamia; we wouldn’t even try. Nor do we know which investments will go up; we just try to find the ones we want to own even if they don’t.

Often, our modesty pays off. The gods look out for us, as they do for drunks and madmen. As the great mass of cocksure investors pile onto one end of the teeter-totter; lo and behold, we are lifted up on the other end by the weight of their numbers.

At least, that is the theory of it. But how did our approach serve us last year? Let’s begin by taking a deep gulp of air and looking back at our forecasts for last year. We began our forecasts for 2006 with one that had little to do with money:

What should we expect in Iraq, we asked? And our answer: “More bad news is our guess. Psychologically, the nation is sliding down from the peak of ‘bring ’em on’ optimism. It is becoming obvious that the war benefits only two groups: Osama bin Laden and his gang, who were happy to see the posse head off in another direction…and certain well-placed defense contractors. The former, bin Laden’s bunch, are presumably holed up in a cave somewhere. But the latter are living it up in New York.”

We went on to report on a $10 million birthday bash thrown by Mr. David Brooks, who made $256 million from military contracts.

We were right about the ‘more bad news.’ Now the death toll has reached 3,000 Americans. And the price tag reaches $8 billion every month. Of course, there’s good news too – for people like David Brooks. The money and blood keep flowing. And who doesn’t like a hanging? But the bad news keeps coming too, and we doubt there will be any let up in 2007.

Turning to the economy, we predicted slower house sales…and we predicted a higher gold price.

On both points, we were correct. Gold proved just about the best place for your money in the year just passed. The price settled at $638 per ounce on the last trading day. That is about 20% above the price a year ago. Where else can you get that kind of money, dear reader?

But beyond those simple forecasts, our look ahead was, in retrospect, far too gloomy. We did not anticipate how the ‘flood of liquidity’ would continue to wash over the world…or how some of the biggest bubbles of 2005 would become even bigger bubbles in 2006. A couple of high-profile real estate transactions in New York, for example, became the most expensive purchases in the city’s history. The art market – already at giddy and preposterous levels – grew even more absurd. Worldwide, housing prices continued to rise, though they definitely cooled in the hottest U.S. markets. Corporate profits continued to go up too, something that has led many analysts to the predictable conclusion that we have reached a ‘New Era’ of permanently high corporate profit margins.

Last week, we described where all this money comes from.

“M&A activity at record $4 trillion in ’06,” notes the Associated Press.

“U.S. High-Grade, Junk Issuance Break Records,” adds Reuters.

The market of U.S. mortgage bonds passed the $1 trillion mark in ’06.

And as for the market in derivatives…it is a beanstalk that has quickly grown up through the clouds almost overnight. Richly fed on debt and delusions, it now scratches the face of the moon every evening.

As to all this booming, bubbly and bodacious activity – we were not surprised. We were merely shocked. It’s what you might expect from so much liquidity. The world has not seen a wash like this since The Flood. Naturally, every Noah in the financial market is taking advantage of it…mortgaging, borrowing, and leveraging every penny to get his boat on the water. And as long as the money keep flowing, the leveraged players in hedge funds and investment houses will keep getting rich.

But what is ahead for 2007? More of the same, say the papers. Almost all the commentators are predicting higher seas. “Wave of liquidity to continue in 2007,” was a headline from the Financial Times last week. Few investors seem to doubt it. The Dow ended the year down a few points, but near an all-time high. The VIX, measuring investor’s worries about the future, lay as flat and lifeless as a celebrity’s brain scan. And the spread between junk bonds, and bonds from issuers with the means to pay you back, likewise signals complacency bordering on coma. If investors continue in this direction, soon they will have to be fed with tubes!

Most likely, the commentators, pundits, economists, and analysts will turn out to be right. Most likely, 2007 will turn out to be a lot like 2006. Most years generally imitate the years before them. We are far too modest to know and different. But here is our guess:

Will 2007 be the year that the flood of liquidity begins to recede? Whatever the odds, they are probably greater than most people think. We haven’t seen a dove with a sprig of holly in its mouth. But our dear readers are advised to keep their eyes open.

Here at The Daily Reckoning, we have gone to ‘Crash Alert’ status. A yellow flag, with a big red question mark in the center, flies from our mast. We are not fool enough to predict the end of the liquidity bubble in 2007…but nor are we so smart that we think we know what the Fates will allow. So, we are not about to set sail this January without a little protection.

Advice for 2007: Sell debt. Buy gold. Don’t worry. Be happy.

Bill Bonner
January 1, 2007