McNay operates on the principle that what is bad for something is good for something else and, in the current environment, believes gold is “the answer.”  He believes the value of the dollar is being destroyed, and cited a 50% decline against the Euro.  “If OPEC decides to stop accepting dollars for oil, we are a dead duck,” says McNay, adding “there will be a day when someone says ‘no’ to more dollars, and that will be a total disaster.”

“Gold is the best hedge against a falling dollar and inflation,” says McNay and he views the metal as appropriate insurance for anyone’s portfolio.

McNay notes it is easier to own gold, through ETFs such as GDX (which owns gold-related industries) and GLD (which owns bullion).  McNay claims if gold prices properly reflected inflation, it would be a $4,000 or more per ounce.  [This is based on a 1980 price of $850/ounce and an average inflation rate of 6%.]   “Gold has not received nearly the public attention that one might have thought,” says McNay. McNay thinks the peak in gold will come when it is widely viewed as a “must own” asset, which is not yet the case.

In the US markets, McNay cautioned fixed income investors to stay in Treasuries, adding that certain currencies – Australian, Canadian, and Chinese – will perform well.  McNay specifically advises against long term debt, and says that short term debt might be acceptable.  “We are heading into a really dicey long term period.”

“The Euro is in trouble, as Europeans have as big a real estate problem as does the US,” says McNay.  McNay believes short positions are good diversifiers in the current environment, and singled out “dynamic growth” companies, such as Google, Apple, and RIMM to perform well, along with companies that derive at least half of their income from exports.

Kass, plugging his own fund, points out that there are only $5.4 billion in pure short funds, and most is in one large fund (not his own).  “This is an unpopulated area, and potential investors are not knocking on our doors,” he says, arguing that lack of investor interest is creating market inefficiencies he can exploit.  McNay countered by noting that current markets have the highest level of short interest ever, and cash in brokerage houses is also at an all-time high.

Kass forecasts “lumpy and inconsistent economic growth” over the next two to five years.  “It will be a hard time for corporate managers to deal with a lack of pricing flexibility, and this will produce substandard returns for investors.  All the tailwinds to growth, including fiscal and monetary policy, are turning into headwinds,” he says.

Impact on the Consumer

While most of the discussion centered on the machinations of Wall Street, Kass and McNay also addressed the plight of the consumer on Main Street.  Overall, Kass believes a number of “prosperity killers” will impair the growth in the economy:

• Despite the Democratic “tsunami” that struck two years ago, the middle class is still being squeezed and there is a lack of job growth
• There is nascent but significant inflation, especially in food and energy
• Higher tax rates are inevitable
• Heavier regulation will occur, especially in the financial sector
• Trade protection will be implemented, which McNay called out as being “particularly scary”

McNay summed up the situation by saying “the US consumer is gradually getting destroyed.”

Kass carefully pointed to a number of positive developments in the economy:

• The process of addressing elements of the credit crisis has been underway for months.
• The housing marketing is “bottoming out.”  When questioned about this assertion, Kass claimed the housing market has already declined by 20-22% and further declines were unlikely, based on an analysis of housing affordability data.  [Note: the S&P Case Shiller housing price index shows a decline of only 12.4% from its peak in June of 2006.  The housing affordability index indicates homes are becoming more affordable.  However, this data is published by the National Association of Realtors and we do not believe they are a source of unbiased research.]
• Corporate balance sheets are in “terrific shape, although the same cannot be said of consumer balance sheets.” [This calls into question Kass’ prior claim regarding the affordability of houses.]
• Sovereign wealth funds, aided by the falling dollar, are eager to invest, particularly in financial institutions
• Stocks are not expensive relative to interest rates

Despite the near collapse of the markets which they describe, neither Kass nor McNay foresee an apocalyptic scenario.  “The world is not coming to an end,” said Kass, “but this is a time to worry about preservation of capital, not return on capital.”

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