Investment club: When the economic rules go wrong, it's time to stop playing

A HAPPY new financial year is what the Investment Club is hoping for, given that last year did not end particularly profitably.

We did reach an all-time high of 2.77 in August 2010, before, regrettably, the unit price then slumped to 2.57 in November, and picked up only slightly in December to 2.61. What should the club's investment strategy be in 2011 to make sure of a prosperous year?

Unfortunately it is proving very difficult for the club's paper and pencil (pap) analysis to come up with any clear opinion for the year ahead. This is principally due to incompetent government interference in economies that has altered the normal relationships between economic variables.

Take for example the truism in economics that the supply of money in an economy multiplied by the speed or velocity that money circulates through the economy equals the price of goods in the shops multiplied by the number of times the population of an economy make a transaction buying goods with their savings or salaries.

This relationship can be written MV=PT. Loosely speaking some economists - the monetarists - say that the amount of money in an economy is relatively stable and will only alter slowly over time. This group also postulates that the transaction part of the truism is stable over time too.

So, for instance, if you think how long it has taken society to move from writing cheques as a means of payment to abandoning cheques it is hard to disagree with this assumption. The conclusion is that if money and transactions are stable, any increase in how fast money goes through the economy, i.e. its velocity, will only lead to price increases.

Currently, velocity is decreasing, manifested by the slowing service sector and reduced consumer credit. Prices, therefore, should be going down. Yet prices are skyrocketing. Another section of economists, Keynesians, dispute this, and say money can increase relatively quickly thereby slowing velocity down and pushing prices down, making people richer.

Conversely, if money decreases velocity increases, with prices stable or trending up. However, at the moment money supply has actually gone negative, while transactions are falling - witness the slump in mortgage approvals - but prices are increasing. I give this example to demonstrate how difficult it is to come up with a satisfactory investment strategy when none of the normal economic relationships are working that well.

The club is therefore in a parlous situation with its investment stance for 2011. If the club abandons safe haven investments and risks its funds on the stock market to surf Ben Bernanke's tsunami of dollars it is hard to predict when it will all go belly up, as surely it will, and the club is caught in the Armageddon bear market.

The club has to go for damage limitation in 2011, which means we stay where we are. At least with masterly inactivity we have a chance of getting to the end of the year with some funds left rather than taking an all-in gamble with either safe-haven or stock market and going bust.