January 2017

WindRock Roundtable:

2017 Predictions www.windrockwealth.com

Most financial publications have an annual roundtable of Wall Street economists or mainstream financial commentators, all of whom share very similar viewpoints. We have chosen to do something different by

featuring independent investment minds.

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The roundtable discussion is moderated by Christopher Casey, Managing Director at WindRock Wealth Management.

Brett Rentmeester President of WindRock Wealth Management

Bud Conrad Author of Profiting from the World’s Economic Crisis

Axel Merk President and CIO of

Merk Investments

Rick Rule President and CEO of

Sprott US Holdings, Inc.

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CASEY: With the election of Donald Trump, U.S.

equity markets moved markedly higher. A lot of

people attribute this to a newfound economic

optimism and are making comparisons between

Trump and Reagan, especially citing their positions

on cutting taxes and deregulation. Do you think it is a

legitimate comparison?

RULE: I think most of the euphoria is related more to

the narrative than to the arithmetic. It’s difficult for me to

understand how anybody, including Trump, can

overcome $20 trillion in on-balance sheet obligations for

the U.S. government, particularly when they propose a

$2 trillion deficit. Deregulation would be good. A tax cut

would be good. Without dramatically reducing the size of

government – which he is not proposing to do – Trump’s

ability to change things is limited.

MERK: No. The key difference between Trump and

Reagan is the economy, which Trump is inheriting. In the

early 1980's, we had high unemployment and high

inflation. Today, we're coming out of an environment of

low unemployment and low inflation. That's a huge

difference, because if you now institute fiscal stimulus,

as is widely expected, you're going to ramp up inflation.

They’re really two ways this economy can go. We can

have higher real growth due to some sort of deregulation,

or we can have high inflation. Because of the policies

being implemented, the financial markets see the glass as

half full and anticipate significant real economic growth.

But I believe it’s going to be a far more mixed picture

and I definitely believe the inflation scenario has been

severely underpriced by the financial markets.

RENTMEESTER: To the extent that Trump is

successful in broadly reducing government via less taxes,

less regulation and less bureaucracy, we could see

positive developments. However, the economic situation

Trump inherits is a difficult one and quite different from

that of Reagan. First, the Washington “swamp” that

Trump inherits has gotten substantially deeper since

Reagan’s era and may prove more difficult to drain

despite best efforts. Second, Trump takes over during

one of the longest recoveries on record at 91 months

versus the average of 69 months. This begs the question

of how much longer this aging expansion can continue

without a hiccup, irrespective of policy. Also, while

Trump has the benefit of working with Republican

majorities in both houses of Congress, but he is largely

an outsider within his own party.

As it relates to the financial markets, the fundamentals

when Reagan took office were ugly, but offered a huge

tailwind for investors when the tide turned. Inflation

was high, but then subsided; the 10-year Treasury was

at 13%, but then declined; and the stock market was

unloved and trading at single digit price-to-earnings

ratios. All of this allowed massive moves to the

upside. Regardless as to Trump’s policies, investor

returns over the next four years are more likely to be

impacted by interest rates and valuations, both of

which are near extremes.

Source: Board of Governors of the Federal Reserve System

Source: Board of Governors of the Federal Reserve System

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CONRAD: I completely agree that the economic

environment for Trump is vastly different than that for

Reagan. This allowed Reagan to get away with cutting

the taxes. I think today’s higher debt levels and anemic,

projected growth are a disaster – and I don’t see any way

out of it. Worse, combine debt levels with Trump’s

spending plans and tax cuts, and the deficit is going to go

through the roof. Which brings up the problem as to

whom will the U.S. government sell their Treasuries?

Historically, we had a wonderful symbiotic relationship

with foreigners where we bought more goods than they

purchased from us, so we had a trade deficit. They got

extra dollars and they recycled those into our government

deficits, keeping everything afloat. Foreigners have

stopped doing it. They’ve lost confidence in investing in

our Treasuries for various reasons. China doesn’t need

over $1.5 trillion Treasuries, they’re selling them off and

will continue to do so. The question then is, who buys it?

My answer is the Fed.

CASEY: Trump’s election has already brought some

rather tense moments with a major trading partner,

China. For example, his recent Tweet about their

currency devaluation. How significant will any

protectionist policies be under Trump?

MERK: Well it's very difficult to know what Trump is

actually going to do. I encourage everybody to watch the

1987 interview Trump gave to Larry King on CNN.

There he displays his consistency on two topics: trade

and the military. Trump thinks the U.S. gets a rotten deal

on trade and also gets a rotten deal on military defense,

meaning he feels allies are not paying enough to support

U.S. engagement and defense abroad. I do think trade is

important to him. Here is how I think this will play out;

he is going to cross some line, perhaps by insulting the

Chinese, and it will start some tit-for-tat retaliation. So,

who benefits and who is hurt by such retaliation: those

folks who import a lot from China or more importantly

wish to sell a lot in China. Take a company like Apple,

their growth market is China. Apple is a high-profile

target, so they might directly experience repercussions if

the Chinese choose to retaliate against them. Many

similar, high-profile firms may be at risk.

RULE: If he’s able to get away with instituting

protectionist policies, I think they’ll be very damaging.

The truth is that trade is good. Managed trade is less

good. Less restriction is good. More restriction is bad.

My only hope is that the Deep States and the Republican

establishment, and the Democratic establishment,

despises him so much that we’ll have four years of

nothing. That would be a wonderful outcome: stasis.

RENTMEESTER: Before Trump actually enters office,

it’s hard to separate the hype from reality. Some point to

insights from his 1987 book “Art of the Deal” and

suggest he likes to take an extreme position, but that he

intends to negotiate more moderate solutions. Regardless,

in today’s world, any protectionist policies such as tariffs

are likely to negatively impact global economic growth.

Just look at the passage of Smoot-Hawley tariffs in 1930

at what was the beginning of the Great Depression. The

tariffs didn’t cause the depression, but were certainly a

contributing factor in accelerating the decline. Our view

is that tariffs are bad policy and likely to prompt

retaliation that can escalate until it negatively impacts

global trade.

CONRAD: Yes, protectionist policies are a real concern.

Trump has vowed to renegotiate NAFTA, cancel TTIP

(the Transatlantic Trade and Investment Partnership) and

the TPP (the Trans-Pacific Partnership), and will

probably work on raising tariffs. It could lead to higher

prices for us as we pay for the tariffs or have to

domestically produce these goods with higher cost

profiles. And I think this can contribute to inflation.

When you have higher inflation, and higher inflation

expectations, it leads to higher interest rates. With these

debt levels, higher interest rates lead to even higher

interest rates. I think it’s a potentially disastrous

situation.

CASEY: It’s not just in the U.S., but worldwide that

nationalistic, protectionist policies and movements are

taking over. Recently we had a referendum in Italy,

which many believe is the first step in Italy leaving the

European Union. Between this and the upcoming

2017 French elections, do you see the E.U. surviving?

RENTMEESTER: We see the E.U. surviving, but likely

in a different state than today. The E.U. is dealing with

three major structural issues that they are unlikely to fix:

regulation, debt, and unemployment. Too much

regulation has contributed to stagnant growth while

generous social programs have led to massive debts

which in turn limits growth. Stagnant growth has led to

high unemployment, mainly in the Mediterranean

countries where youth unemployment is as high as 44%

in Spain and 36% in Italy – compared to only 7% in

Germany. With high unemployment comes enhanced

criticism of the E.U.’s policies. History suggests that

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countries with high youth unemployment are likely to see

a growing restlessness until a crisis unfolds.

With their member nations in less control of these issues

as part of the E.U., there is growing resentment toward

Brussels and the group of unelected bureaucrats pursuing

interests that may not be aligned with their citizens. The

failure of the E.U. to fix these issues has bred a strong

nationalistic tide that is currently sweeping Europe. We

think this tide will be hard to contain. We’ve already

seen Brexit in England and a failed Italian referendum

potentially putting Italy on a path to leave the Eurozone.

France and others aren’t far behind. Unlike in the U.S.,

nationalism in Europe brings the risk of splintering their

shared currency and creating chaos in their banking

system. 2017 is a critical year where we could see one or

more countries vote to abandon the euro to avoid a fate

like Greece, which is now a permanent debt slave of the

E.U.

RULE: I’m afraid I do see the EU surviving in some

form, probably the worst rather than the best. I think that

an important part of the reaction you see from ordinary

people is an anti-elite, anti-establishment reaction, which

is a good thing. I think the opposition of the voters to a

fourth level of government that is a different level of

parasites in Brussels is a wonderful thing. I think the

xenophobic nature of the campaign; the frankly racist,

fascist nature, is problematic. Sadly, I don’t see this

global trend being a libertarian trend. I see it being a

trend where the electorate acknowledges, cynically, that

the purpose of government is to steal – but they want

themselves to be the beneficiaries rather than other

people.

CONRAD: Europe is tremendously burdened by this

immigrant situation and the people of Europe are quite

unhappy. They’re voting the bums out where they can,

and I think we could soon see the French equivalent of

Brexit. Certainly, I could see Italy moving to control

their own debt with our own lira. I do see the peripheral

countries falling out of the euro. I’ve been predicting that

for a few years now ever since they papered over Greece

with an awful lot of money. I think there are some very

serious problems in Europe.

MERK: It’s also important to remember that we also

have an election in Germany. Political stability

throughout the globe is on the decline. You have a lot of

people who are not happy, mainly because their real

wages haven't gone anywhere. These people tend to lean

more towards populist politicians. The one common

theme amongst populist politicians is that they never

blame themselves – they tend to blame minorities and

foreigners. Can the E.U. survive? The E.U. has always

been a mess and will continue to be a mess, and I don't

think that's going to change.

CASEY: What does this mean for the euro?

CONRAD: The euro was a great thing for Europe for

many years. The euro/U.S. dollar exchange rate has

declined from 1.60 to very close to parity today, I think

it's going to go below that. It’s as weak as any currency

and the European Central Bank is printing more than the

Federal Reserve as they continue to bail out their weaker

countries. There are two possibilities: one is that weaker

countries are forced out or decide to leave the Eurozone,

or it could be that the stronger economic countries, such

as Germany and maybe the Netherlands and a few

Scandinavian countries say: “Hey we’re going to have

our own currency, we don’t want you guys.” There’s

been no indication they want to do that latter, so I think

the former is more likely path. Even if the latter situation

develops, there’s an argument that the euro is better

without its weaker siblings, but I think the turmoil would

still drive the euro lower. The one thing in favor of the

euro is they don’t fund a lot of wars that are undoubtedly

expensive and destructive, but on the other hand they are

funding a lot of refugees. Refugees can be good for an

economy once they're integrated and can be productive

but for now they are a drain due to social programs.

RENTMEESTER: In the near-term, expect continued

uncertainty in Europe as their entire overleveraged

banking system and low interest rate structure are

contingent on holding the member countries together.

The euro has lost nearly 34% against the dollar from its

high, so we may see some stabilization, but we expect

more weakness in general. Longer-term, I agree with

Bud, the future of the euro currency depends on who

leaves and who stays. If some weaker countries leave to

return to their local currencies and Germany and other

stronger blocs remain, perhaps the euro actually

strengthens. Thus, the euro likely survives, but its value

will be a function of the ultimate member states, so

expect a bumpy ride until there is more visibility.

CASEY: The dollar has continued to experience a

dramatic appreciation relative to other currencies.

Do you see this continuing?

RENTMEESTER: In short, yes, we see dollar strength

continuing. For the direction of currencies, it is

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imperative to watch the relative money printing actions

across countries. When the U.S. was heavily engaged in

quantitative easing, the dollar weakened substantially.

Recently, Europe and Japan have fired up their printing

presses and are seeing currency weakness versus the

dollar. In a world where everyone is printing money, the

country that is printing less on a relative basis should see

its currency rise, all else equal. Today that is the U.S.

Also, if a global recession develops, the U.S. dollar will

likely benefit from a safe haven effect. I’ll reiterate

something we’ve said for several years now – that the

dollar has the most to gain in the near-term, but likely the

most to lose in the longer-term as its role as the global

reserve currency comes under pressure.

MERK: The market appears to believe U.S. interest rates

will go to the stratosphere and European rates will go

down to negative infinity. Inflation is creeping higher in

the U.S., even as rates have been inching higher. I think

inflation pressures are moving at a faster pace. Now take

Europe. Recently the European Central Bank announced

they reduced their monthly bond purchases. Now in the

press conference right afterwards, Mr. Draghi, the head

of the European Central Bank, was adamant that this is

not tapering. The reason I'm saying all this is that the

market is expecting the U.S. will be so much tighter than

Europe, and I think the reality is going to be more shades

of gray. 2017 may well give us some surprises. I

wouldn't be surprised if that dollar rally is going to run

out of steam.

RULE: I see the dollar doing very well for the next 12

months. Not as a consequence of any particular strength

in the U.S. economy, but more so because the U.S. dollar

is the prettiest mare at the slaughterhouse. Our European

clients tell us that there are between 16 and 18 trillion

euros in investable assets in private hands in Europe.

They expect about 10% of that to flee Europe and come

to the United States in the next 12 to 18 months, which

should be relatively good for the U.S. dollar.

CONRAD: It’s funny for a guy who’s a gold bug to be

the predicting a strong dollar. Here is my scenario: the

dollar stays strong for a quarter or two, but then I think it

turns around with a vengeance on the other side. If we

start putting up trade barriers, foreigners aren’t going to

want to hold dollars because they can’t repatriate them as

easily. I think we get a currency crisis out of this, in

which case the bottom line is: buy real assets such as

gold, oil, real estate, agricultural land.

CASEY: Some people would think that in a rising

dollar scenario you should avoid commodities in

general. Do you agree with that?

CONRAD: I’m in the camp of saying there’s probably

some good buys. I keep looking at the agricultural

commodities and expecting something to happen and not

much has happened, but my view is that any surprises

will be to the upside, not the down side.

RULE: I think it’s a function of the duration of the trade

that you’re considering. As an example, the global, total

cost to produce a barrel of oil, including the cost of

capital, is $60 as suggested by Exxon. If you make the

stuff for $60 and you sell it for $45, loosing $15 a barrel,

98 million times a day, then ultimately the industry

cannibalizes productive capacity. When you have

destroyed enough productive capacity and the price

begins to move up, the uplift is pretty long-term because

the market doesn’t have the productive capacity to

respond to price signals. It was precisely this situation in

the 2000 to 2002 timeframe that saw the beginnings of

the last commodity bull market. The oil price, you will

recall, went from $18 to $103. Uranium from $8 to $130.

Copper from $0.95 to $4.50. I’m looking for moves like

that irrespective of the near-term impact of U.S. dollar

pricing.

CASEY: Gold saw a lot of action in 2017; first rising

dramatically and then falling since the summer.

Where do you see precious metals headed? A lot of

people believe gold doesn’t perform well in a rising

interest rate environment. If rates do rise, do you still

like gold, and if so, why?

MERK: The prime competitor to gold – which doesn't

pay any interest – is cash that pays a real rate of return.

And that is really what we have to watch. If people

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Trade-Weighted U.S. Dollar Index

Source: Board of Governors of the Federal Reserve System

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believe that the Federal Reserve is going to be ahead of

any inflation, then I think gold is not going to do well.

However, if the Fed is going to be behind the curve,

meaning that prices are going to creep higher, then I

think gold plays as good a role as it has always. Currently

the markets are pricing in an optimistic scenario that real

growth is going to pick up without inflation. Former

Federal Reserve Chairman Greenspan gave an interview

with Bloomberg in December where he said that inflation

will go up. If that is correct, then I think gold is going

up. As a diversifier in a portfolio, it has a very important

role.

RENTMEESTER: We view precious metals as the only

global currencies without an associated liability. As such,

they are the purest investment that investors throughout

history have turned to when confidence has been lost in

governments, banking systems, or central banks. Most fiat

currencies have a massive outstanding debt obligation

attached to them. For that reason, precious metals are a

must to own. Today’s world of monetary instability – where negative interest rates are the modern-day

equivalent of Frankenstein experiments – will likely

culminate in a currency crisis somewhere down the road.

The end of 2016 has seen instability in India as well as

increased capital controls in China, leading more foreign

investors to the safety of gold despite some government

efforts to curtain it. From a U.S. investor perspective, a

strong dollar has muted some of gold’s benefit, but gold

remains a unique hedge against future currency issues.

We see precious metals substantially higher five years

from now, although timing on how we get there is

uncertain. In short, keep accumulating as a long-term

play, not a short-term trade.

RULE: If the arithmetic wins out over the narrative, then

yes, gold will move higher. The U.S. ten-year Treasury is

now yielding about 2.4% which, adjusted for inflation,

puts it at a mildly negative real return. The experience we

have over the last 40 years has been when the U.S. 10-

year Treasury does well, gold does poorly, and vice

versa. There have been two exceptions to that. One, the

latter half of 1975 which I remember well. The other, the

first six or seven months in 2002, which I also remember

well. In both of those situations, the U.S. dollar and U.S.

securities did well in a sort of flight-to-safety trade. In

both cases, ultimately the dollar rolled over and gold

continued higher, which I suspect may be the situation in

the second half of 2017.

Also, I think investors need to remember that in the

greatest gold bull market of my life, the market of the

1970’s, the interest rate on the U.S. 10-year Treasury

went up five-fold. What really matters is the reason that

the interest rate goes up. If the interest rate goes up

because investors perceive that their purchasing power is

declining, then gold will do very well in a rising interest

rate rise environment.

CONRAD: We have to distinguish between nominal

interest rates and real interest rates. The last peak in gold

came in 1980 when inflation peaked. Nominal interest

rates hit records, but real interest rates were actually

negative. Gold doesn’t do well in a high real interest rate

environment because of two things. One is that you get a

real return, which gold doesn’t pay and the other is that a

high real return usually is supportive of the currency. I

see inflation rising as fast or faster than interest rates so I

see inflation adjusted (real) interest rates falling, even

while nominal interest rates are rising. I think of gold as

an actual currency. It's the anti-dollar in my view. If the

dollar is rising, that’s not so good for gold. I see gold as

the safe haven against the increasing deficits, which drive

money printing by the Fed. I'm very bullish on gold in

the long term.

CASEY: Interest rates have risen significantly since

the summer. Where do you see them headed?

MERK: I can’t tell you where rates will be in 2017, but I

do think that inflationary pressures are going to move

higher, and with that the rates are going to continue up.

RENTMEESTER: Over the last several years, we

expected interest rates to decline due to central bankers

suppressing interest rates. We thought the risk of an

upside break-out was limited, but now the risks are

rising. We’ve said for a while now that when rates turn

higher we may be in for a multi-decade bear market.

Something akin to the 1950’s to 1970’s period where

investors lost money in bonds versus inflation for three

decades. That’s literally a lifetime of investing.

If we experience a global recession, there could be one

last hurrah in bonds and the 10-year Treasury could trade

under 1%. It got to 1.5% in the summer of 2016 without

a recession. However, we must ask the question of

whether we are at the turning point after 36 years of

declining rates? If not, we may be close. The rise in rates

in being driven by a lack of foreign demand. Countries

such as China and Saudi Arabia are selling their dollar

reserves for domestic uses. It is likely that rates on the

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10-year Treasury stay range-bound in 2017 between 2%

and 3%. They could go below 2% if we have a recession,

but a rise above the psychologically important 3% level

could also trigger an accelerating sale of bonds and a

further spike in rates.

CASEY: Interest rates, while rising, are still low from

a historical viewpoint despite record levels of debt,

which calls into question the credit worthiness of

many economic actors, including countries. Where do

you see debt levels headed and how will this affect

rates or the financial markets in general?

MERK: In the long term, I just don't see how the Fed,

the European Central Bank, the Bank of Japan, or the

Bank of England for that matter are able to impose

positive real interest rates over an extended period. To do

so just makes it very, very difficult to sustain debt levels.

Ultimately, a central bank is only independent as long as

fiscal policy is sustainable. Once fiscal policy is

unsustainable, central banks lose their independence.

CONRAD: We are not the only government with large

deficits. We aren’t the only ones printing money. In fact

that’s the issue worldwide, right? It's the race to debase

between all the different currencies. They used to use our

trade deficit to finance our government debt. Effectively

it was a vendor finance program. But they’ve got their

own issues and things they’ll spend their money on, so

will other countries continue buying U.S. Treasuries? I

doubt it.

The amount of Treasuries bought by foreigners is

declining and the Federal Reserve has already jumped in

to replace them. What would happen if the Fed actually

tried to go into the market and sell them? At that point,

there'll be a big spike in interest rates. It creates a

feedback loop, which was actually the subject of my

2009 book, Profiting from the World’s Economic Crisis.

Then I predicted that the Federal Reserve would buy $4

trillion dollars of assets because foreigners weren’t going

to buy it all, and that was exactly what happened with

QE. Going forward, the Fed will have to be a big buyer

with newly created money, which is inflationary, which

pressures interest rates higher.

RENTMEESTER: Expect debts everywhere to rise. The

reality is the world is too burdened with debt to grow

quickly. We simply can’t grow fast enough to meet our

debt obligations, so the world will continue to print

money, at some point creating an inflation outbreak.

Since the 2008 recession, “official debt” in the U.S.

doubled to nearly $20 trillion, all during a period of

“recovery.” As bad as that sounds, it is really just the tip

of the iceberg as many debts and obligations of the U.S.

are not included in that official figure. If the U.S. really

reported its debt under GAAP accounting, like

corporations are required to, that figure would look more

like $120 trillion. This includes the present value of

unfunded obligations related to pensions, Social Security,

and Medicare. This is an amount that would take over 30

years of tax revenue to pay-off if we devoted 100% of

our taxes to paying down debt. It’s not just the U.S., but

also Japan and Europe, so this is a global ticking time

bomb.

In the U.S., spending is not slowing down. In fact, the

2016 fiscal cash deficit was $590 billion, up significantly

from the previous two years. We are at a point where this

debt will never be paid down and is only sustainable due

to artificially low interest rates. Higher interest rates

would be a catalyst to see this issue become the main

global issue. At a 5% interest rate, debt-servicing costs

increase by over $600 billion, which is about equal to the

2015 defense budget. (See, The U.S. Government:

Adding Illiquidity to Insolvency). We expect debts to

continue to rise and for central banks and governments to

get more aggressive in trying to create inflation as a way

to minimize the debt burden over time.

CASEY: We are not only looking at one of the longest

bull markets history, but one of the longest so-called

recoveries since the last recession. If rates go up, do

Source: Board of Governors of the Federal Reserve System

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you see that potentially plunging the U.S. into a

recession? Should we expect a recession in 2017?

CONRAD: I have to say, I'm less negative than I was a

year ago. If Trump can eliminate some regulation, if he

could give a boost to domestic businesses through the

slowing foreign imports, then I think there's a path,

which avoids a recession. But my gut is saying we’re

close to a cliff. I’m not feeling like I’m about to be

pushed off of it, so I’m not as negative as some other

people might be about the probability of recession. I will

say there’s much more unpredictability than we've ever

had, at least in the last decade. I worry more about the

world geopolitical changes—like a European break up;

China’s assertion of its territorial rights; and continued

African and Middle Eastern conflicts—than I do about

financial instability. Wars are much more destructive

than financial collapse, although they are related.

RULE: I honestly don’t know what rising rates will do to

the underlying economy. I suspect that it will be bad for

commercial real estate and single family residential.

Probably bad for the equities markets if people begin to

avoid large cap stocks, which they had been buying for

yield, in favor of bonds.

RENTMEESTER: Over the last several years, GDP

growth has come in well-below estimates, company sales

have been flat, and earnings have contracted for one of

the longest periods on record. The near-zero percent

interest rate policy in the U.S. over the last 8 years has

pushed off the pain, but has led to massive

malinvestments which will be in full view when interest

rates rise enough to trigger a downturn. A recession is

long overdue in the U.S. We believe there are two

potential recession triggers to watch closely in 2017:

political change in Europe leading to a banking crisis or

U.S. interest rates rising much above 3% on the 10-year

Treasury.

MERK: I don’t see a recession, but it is possible. One of

the reasons why we have this recent interest rate hike is

because the market allowed the Fed to have a rate hike. I

phrase it this way is because the Fed bases economic

recovery on asset price inflation as induced by

extraordinarily low interest rates. So, if the Federal

Reserve raises rates, it risks crushing asset prices. I just

don't see how the Fed wants to risk this. It would simply

prevent a fragile recovery to continue.

CASEY: How will rising interest rates or a recession

affect stock markets worldwide?

RENTMEESTER: Our view is that we are in a

massively leveraged world where financial engineering

and money printing have delayed – but not solved – problems. We’re in a period of heightened systemic risk.

Investors with equity exposure should consider methods

to hedge risk despite rising bullish sentiment. It’s

important to recall that investors are most bullish near

market highs and most pessimistic near market lows. In

fact, a December 2016 survey released by Forbes

showed that consumer sentiment was higher than the

level reached in 2006 – which was the height of the

housing bubble. In hindsight, that was a time when

everyone should have started taking cover. We are not

ruling out that the equity bubble could grow larger first,

but we now have a feeling of déjà vu with the years 2000

and 2007.

Over a market cycle, investors have never been rewarded

for buying stocks at these valuation levels. Future

projections of returns at these valuation levels suggest

investors may face a decade of near zero real returns in

both U.S. equities and bonds. If investors could learn one

lesson from financial history, it would be that valuations

ultimately matter. Another sobering thought for equity

investors: the risks in the world are increasingly

interconnected and systemic, so traditional diversification

in equities, like small cap versus large cap versus

international, is unlikely to provide much cushion in a

downturn. Therefore, investors should consider some

fundamentally different investments such as hard assets.

One last thing, the stock market has absorbed roughly

half a trillion dollars a year in stock buybacks for some

time. Will companies be buying back stock during a

recession or when borrowing costs rise? I suspect not.

That will take some huge demand off the table.

CONRAD: One of the basic theories of investing is that

you invest to get a return as adjusted for risk. The return

on stocks is to me the earnings divided by the price.

That’s sort of like yield for stocks. Right now, 2½ % on

the ten-year Treasury is about half of the earnings on the

S&P 500, so for the current moment it’s still better to be

in stocks. What rate of interest would cause that to flip?

Obviously at least once you get to 5% because you would

be assured of getting 5% from a bond versus 5% from

riskier stocks. Alternatively, a recession with an

associated earnings collapse would crash the stock

market.

9

CASEY: Why do you look at earnings and not

dividend yields when comparing yields on Treasuries

with the stock market?

CONRAD: Earnings are more important than dividends.

Management decides how much to pay in dividends.

Some technology stocks pay no dividends but are good

investments because they are generating earnings and

investing their profits in growth. The wild card, though,

is that today earnings may be exaggerated by cutting

back the number of shares through stock buybacks as

well as too-lenient accounting regulations, so 5% is

probably overstating the reality. Which means we’re

closer to parity than it looks when comparing yields

between the bond and stock markets.

CASEY: What investment themes do you like in

2017?

MERK: I mentioned earlier that, due to protectionist

policies and retaliatory measures, high-profile companies

selling into China may be at risk. Let me expand that

theme into an investment thesis. While large,

international companies may suffer, smaller,

domestically focused companies might be unaffected.

Combine this with the fact that regulation is going to be

cut. This largely benefits smaller companies since

regulation is but a barrier to entry. So, small companies

may outperform large cap companies.

Regarding the political instability we discussed, to me

this means greater volatility in the markets. It means a

greater dispersion of risk. It means a greater role for

active management and that's very much contrary to what

we’ve seen in recent years.

So, how do you invest in this sort of environment? Let's

keep in mind that asset prices are not cheap, equities

aren't cheap, and bonds aren’t cheap either. So, the

question is: what does one do to diversify your portfolio?

One way to do that is, of course, to move to cash, but

most people don't like sitting on cash for too long. I think

that as volatility rises in the equity and bond markets,

gold will prove to be a valuable diversifier. It's not a

perfect diversifier, but it is the simplest one. You like it

or you don't like it. You can understand it.

Other diversifiers tend to be more complex. Consider

long/short equity or long/short currency strategies. Any

of those strategies tend to be more complex and that's the

downside. The upside is that they might do well in an

environment that's more volatile.

I can tell you that in my personal investments, I have

pretty much neutralized my equity exposure to the extent

possible. By neutralizing, I mean I try to take out the

equity risk by shorting S&P futures. On the bond side, I

try to be positioned for rising rates. There are a couple of

ways you can do that. One is of course you can short

bonds. I think shorting bonds may well be one of the

more profitable investments in 2017. If you cannot or

don't want to do that, another thing you can do is to buy

financials as they tend to do well when interest rates

move higher. However, they are not cheap, so keep that

in mind.

Finally, you really may want to consider having a fairly

large portion of your portfolio in alternative assets.

CONRAD: Let’s start with one major theme I see, and

that is interest rates will have to go higher. That’s a

tradable item. There are many ways to do it. There’s a

couple of ETF’s that gain when rates rise. I would stay

away from bonds. I think they’re set for a fall like the

dot-com stocks in 2000. Yields are at a 50 or 60-year

record low, so I don’t want any part of fixed income.

They have default risk, currency risk, and inflation risk.

Another investment theme involves oil. At $53, it is

double last year. With money printing, prices of

commodities will rise. Human wealth depends on energy.

The possibility of war is increasing. So I think energy is a

solid long-term investment. I’m looking at Russia. It is

an energy-based economy, and the oil price is rising.

Combine this with the likelihood that Trump may remove

sanctions and you have an improving situation. The

Russian stock market will likely move up more than it

has.

In conclusion: civil disruptions, populism, Eurozone

destabilization, Chinese confrontation, and changing

world power balance will expand central bank money

creation, currency debasement, and money controls.

These will make careful investment more important and

more difficult. I see world debt and monetary inflation

bringing price rises for specific physical assets like gold,

oil and real estate. Inflation is dangerous for fixed

income investments, so short these. The U.S.’s expensive

wars and military incursions are a drag on our economic

growth so looking for investments outside our country

may provide more return.

RENTMEESTER: Thematically, we see private lending

and the cannabis industry – which is now legal where

65% of Americans live – as attractive growth industries.

10

We also see a particular niche in rental apartments

gaining market share. That niche focuses on communities

that look and feel like single-family homes, but are

rented out. Rising mortgage rates and job mobility will

make rental options more viable than home ownership

for many. Areas of value for more patient investors are

precious metals, farmland, and deeply distressed

opportunities like uranium. We’re also watching areas of

relative value, mainly emerging markets. Compared to

U.S. equity valuations, they are cheap, but they also have

near-term issues such as their sensitivity to a rising

dollar. Combine emerging market valuations with the

near-term strength of the dollar, and we may have a

strong buying opportunity develop. It is really staggering

how much the dollar has appreciated from its lows over

the last decade against various currencies: for example,

it’s risen over 50% against both the Brazilian real and

Mexican peso. So, emerging market assets are high up on

our shopping list in the future, but not just yet.

RULE: I’m positioning my own portfolio and portfolios

of clients who will listen to allocate in 2017 to harvest

returns in 2019 or 2020. There are a range of

commodities that are priced in the market at less than

production costs, which means that either the price of

those commodities goes up or the commodities will

become unavailable to us in future years. Traditionally,

those trades have worked out extremely well for me.

They usually take two to four years to develop. Many

investors don’t have the patience to put on a trade with

the expectation of a profit, even a large profit, in two to

four years out.

I will be looking in 2017 at very high-quality,

undeveloped copper deposits that will come into

production in 2019 or 2020. And very high quality

uranium projects that will come into production two or

three years hence. If oil declines, which I think it will,

and the energy junk bond market begins to blow up, then

I’ll be looking to allocate some capital there. I do that not

so much because I expect those sectors to greatly

outperform other sectors but rather because I have a deep

enough expertise in those sectors that I am competitive in

terms of separating the winners from the losers. So, the

thesis owes as much to my own expertise as much as it

does to my outlook for the economy.

I’m also buying global companies that are perceived to

be slow-growers but are generating lots of free cash flow.

If I find a company that’s generating cash at a level that

allows them to pay off all their debts and take themselves

private in six years or less, and if they have a durable

competitive advantage, I buy the stock in almost any

circumstance. I like cheap cash flow generation.

Personally, I’m also beginning to reallocate to very high

quality U.S. farmland, particularly in the upper Midwest

where there are ample supplies of water. Agricultural

commodity prices are off by 50%. As a consequence,

high quality farmland prices and high quality farmland

rents have fallen. I’m deploying capital to that sector

expecting much firmer markets three years from now.

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