Felix Zulauf: excerpts from Interview

When you're doing your day-to-day work, what are you looking for? What is a day in the life of Felix Zulauf when he gets to the office?

Well, I'm a believer in cycles. I strongly believe that an economy -- all economies -- do not move in linear but in cyclical fashion. And so do financial markets. And my goal is to catch most of the up cycles and most of the down cycles, because assets are priced based on where we are in the cycle. So I do a lot of cyclical work. I do not moon cycle but the classic business cycle. There is the 3-5 year inventory cycle that they teach in basic economic theory, then there is the investment-related cycle which lasts 9 years. And then you have the 18-20 year real estate cycle and etcetera. I try to get a big picture of where the major economies of the world are moving and where the risks and pitfalls will be in the next six to 12 months. That's my work -- to find out where we are in the business cycle. And then I apply classic tools like monetary analysis, I do valuations because capital markets go from one extreme to the other. They never go in between and reverse to where they come from -- that's important to understand. Once it hits an extreme (like in 2000), it does not go to a new level in the historical range in terms of valuations and then goes back to overvaluation again. It always goes from overvaluations to undervaluations.

Felix Zulauf was born 1950, and is the owner and president of Zulauf Asset Management, a Zug, Switzerland-based hedge fund. Felix has worked in the financial markets and asset management for almost 40 years. Mr. Zulauf has been a regular member of the Barron's Roundtable for more than 20 years.

Felix Zulauf: Rally Will End in March, No QE3 Soon

The rise in risk assets will last until the end of the first quarter, then declines eventually 

will set in.

And while he doesn’t see an immediate third round of easing by the U.S. Federal Reserve, known as QE3, monetary authorities here and in Europe are likely to continue to print money to stave off deflation, which will in the end mean higher prices for oil and gold.

I think the rally will continue into the end of the first quarter or maybe a little bit further. 
And this flood of money means my original scenario could be pushed out further in time.

I had been expecting that problems would start in the second quarter of this year, and 
there would be a correction. But now this cyclical rolling-over could be pushed out. 
From this summer to fall of 2013 seems to me the most vulnerable period for markets.

Investors should prepare for a long period of share value “compression,” one likely to last 
until the middle of the decade. This current one started in 2000, and will probably last 
into the second half of this decade. And it’s very similar to what you saw in Japan, with cyclical run ups and cyclical corrections. And these cyclical moves are usually triggered 
by government programs — both monetary and fiscal.

The U.S. Federal Reserve will try that gimmick when the economic numbers deteriorate, because central banks are in a hopeless situation. Everyone thinks they’re the ones that can save the system. But by printing money, you don’t make the world wealthy, you make a few people wealthy, and you increase the disparity in society. You push the top 20 percent further up, and you push the other 80 percent further down in prosperity. And eventually that will lead to a social backlash, which could be very bad. Such turmoil supports the price of USD, Oil and Gold.

In my view, gold is a currency. Central banks — in the United States and Europe — have no choice. They have to continue printing money to prevent their systems from collapsing, and this will debase their currencies.

Source: Australia’s Business Spectator

Felix Zulauf was born 1950, and is the owner and president of Zulauf Asset Management, 
a Zug, Switzerland-based hedge fund. Felix has worked in the financial markets and asset management for almost 40 years. Mr. Zulauf has been a regular member of the Barron's Roundtable for more than 20 years.

The second installment of the 2012 Barron's Roundtable with Felix Zulauf

Last year China's GDP grew by 9.1%. This year they will publish something like 7.2%, but the slowdown in reality will be more pronounced, and it will affect those who depend on China. The U.S. economy could grow by 1% or 1.5%. In Europe, I expect the next stage of the crisis -- the ratification of a fiscal agreement -- to be critical. I can't believe all the countries in the euro will ratify it, because it would lock them into a depression for five years. There will be exceptions, and that will trigger the next crisis.

We remain in a deleveraging world, and the deflationary process is intensifying. In them stock market, valuation compression has been at work since 2000. Occasionally we have had bull-market rallies when stimulus has been applied in major quantities. The last fiscal stimulus was in 2009, because all governments have realized they have too much debt. Fiscal stimulus is the only thing that works in this economy, and that will come later. We have to fall into a crisis that triggers a policy response. Equity markets around the world will top out during this quarter and then enter the next down leg in the cyclical bear market that started last spring.

It could end in the second half of 2012 or in early 2013. The market could drop 20% from the first quarter's high. Therefore we will need ammunition later this year or early next year to buy. My first recommendation is capital preservation, or cash. It doesn't return anything but you'll need it to buy when asset prices become cheap.

You figure it out. The U.S. dollar will strengthen against other currencies temporarily, until the policy response comes. We are at the very end of the secular decline in bond yields. Yields on less-safe bonds, such as those issued by Greece and Italy, have already bottomed. Bonds perceived as top-quality will see a low in yields later this year. Ten-year U.S. Treasury yields will hit 1% to 1.20% before ticking up to 2.10% or 2.20%. There will be a horrendous move down triggered by intensifying deflationary pressures as money looks for so-called safe havens. I recommend 10-year Treasuries as a trade. When the yield reaches 1.20%, sell.

Investors should own some gold. But gold also will be subject to deflationary pressure and have a cyclical correction. The first part of the correction was the $400 drop to $1,520 an ounce from $1,920. Gold is now bottoming and could retrace half its losses. Then it could decline again in the second quarter, and you could buy it again in the summer. The low will be lower than $1,520. Then gold will rally in the next two years to a new high. I own physical gold, although you can buy the GLD [ SPDR Gold Trust] exchange traded fund. I hedge my position by selling futures contracts against it, but I closed my hedges recently because a temporary retracement is coming. Some aggressive players are over invested in gold. If some other assets go
wrong for them, they will be forced to create liquidity and sell their gold positions.

My next idea is how to play the slowdown in China. It will dampen prices for commodities, natural resources and Australian exports. China's boom was the main driver for the Australian economy in the past 10 years. Australia's last recession was in 1991. Despite rising exports to China, Australia runs a current-account deficit of more than 2% of GDP. GDP was up almost 2% last year. There is a budget deficit of around 3%. The current account deficit was easy to balance because there was tremendous investment in the Aussie dollar. It was the so-called high yielder among currencies. Carry traders [who borrow in cheap currencies to buy higher-yielding ones] have bought it, along with individuals and even central banks. Holdings of Australian dollars are widespread, but now the Aussie dollar will suffer. The strong investment inflow led to credit growth when interest rates already were too low. That led to a tremendous real-estate boom, with prices tripling. If China slows as dramatically, Australia will be hurt. The Australian central bank started raising interest rates in the fall of 2009. They went from 3% to 4.75% in November 2010. Last November they cut
them to 4.5%. Now Australia is tightening fiscal policy because it has a growing deficit. The government cut spending, and as we have discussed, fiscal policy works much better in this environment than monetary policy. Short-term interest rates have declined to 3.2% and could fall another percentage point.

There are Australian government-bond futures with a three-year maturity. The yield is the difference between 100 Australian dollars and the futures price, which is currently A$96.84. That means the yield in the futures market is 3.16%, and it could rise by another percentage point in the next 12 months. This is a conservative play and you can lever it. It is a liquid market. The Reserve Bank of Australia will have to cut rates a lot more. Therefore, I would short the Aussie dollar against the U.S. dollar. The Aussie dollar has nearly doubled in the past three years against the U.S. dollar, from 60 cents to $1.02. It could correct by 20%.

The global economic slowdown and the shrinking ofbank balance sheets, particularly in Europe, will affect economies that depend on foreign capital flows. Turkey has huge external deficits. There will be a balance-of-payments crisis in Turkey, and one can profit by shorting the Turkish lira against the U.S. dollar. Turkey has been a booming economy for many years. Its leader, Recep Tayyip Erdogan, wanted to bring it into the European Union. The French didn't like that, and the Germans probably were happy the French blocked it. When Turkey's bid failed, Erdogan sought to boost its appeal as the leader of the Middle East.

To do that Turkey needed high economic growth, which required an aggressive and loose monetary policy. That created a credit boom, strong domestic demand and way too low interest rates for way too long. Economic growth was approximately 8% last year. Consumer price inflation is about 9.5%. The current account deficit is 10% of GDP. The budget deficit, despite the boom, is 2% of GDP. Ten-year government bonds yield 9.7%, around the inflation rate. Short-term rates were hiked to 11% from 8%. The 10% current account deficit won't be easy to finance.


Turkey is trying to cool its economy by hiking interest rates. They are trying to support the currency because they believe it is essential to have a strong currency to get continued capital flows to finance the current account deficit. That is a dangerous strategy and will push the economy into a severe slump. At some point this year the government will have to change its focus from supporting the currency to supporting the economy. When that happens, the lira will go down. The dollar ranged from 1.80 Turkish lira to TRL1.15 for 10 years, and only recently broke out of that range. The dollar is trading at TRL1.88. Short term, it might rise, but long term it will drop.

Some investors are attracted, but when the currency falls there will be a new dynamic. Finally, I am bearish on equities this year. It is best to short the EEM [ iShares MSCI Emerging Markets Index exchange-traded fund] rather than individual stocks because it is dollar-denominated. Emerging-market currencies will decline against the U.S. dollar, and emerging-market equities will decline as much as developed markets, if not more. The EEM peaked at $55 in the fall of 2007. It is currently at $38.23 and could fall at least 20% later this year. Next January I hope to arrive with a more bullish message.

Felix Zulauf's Picks for 2012
Investment/Ticker
Cash
LONG
Yield  1/6/12 10-Year U.S. Treasury* 1.96%
Australian 3-Year Bond Future** 3.16 Price 1/6/12
Gold (spot price, per ounce)*** $1,617.95

Short
Australian Dollar v . U.S. Dollar 1AUD=$1.02
Turkish Lira v. U.S. Dollar $1=1.88 lira
iShares MSCI Emerging Markets Index FD / EEM $38.23
* Sell when yield falls to 1.20%.
** March 2012 contract. *** Buy when prices fall below $1,520 probably some time this summer.
Source : Bloomberg

Felix Zulauf was born 1950, and is the owner and president of Zulauf Asset Management, a Zug, Switzerland-based hedge fund. Felix has worked in the financial markets and asset management for almost 40 years. Mr. Zulauf has been a regular member of the Barron's Roundtable for more than 20 years.