ASSET ALLOCATION MODEL
FOR THE FIRST HALF OF 2005

By Thomas G. Cloud – February 7, 2005

In adjusting our asset allocation model for the first half of 2005, it is very important that you, the investor, be willing to carefully monitor and watch your portfolio closer than you have done in many years. There will be many opportunities during '05 to make money, but trends that have been developing over the last several years will become quite prevalent by the third and fourth quarter. As these indicators become clearer, you will see changes that will occur swiftly. As the year wears on, we expect interest rates to rise, the value of the dollar to take a big hit, and equities to start off strong yet turn down sharply by the end of the year. Inflation will also increase during 2005 and the secular bull markets that are now four years old in precious metals, oil, and commodities will once again be the major movers. Bankruptcies in both governmental agencies and private businesses will also be more prevalent than at any other time over the past five years.

Recently John Dickerson, a highly respected money manager from San Diego , wrote the following, “Sprott Asset Management is an established and respected investment management firm in Toronto and is not a firm which is given to making impulsive statements or ill founded comments. To us this gives added weight to their recent article which states the following, ‘The net liabilities of the U.S. government now stand at $46 trillion, an increase of $11 trillion over fiscal 2004. To put this in perspective, the GDP of the United States was about $11 trillion all of last year. To wit, the deficit that was incurred by the U.S. government in one year was equivalent to the entire economic output of the U.S. last year. This puts a whole new meaning to the word recklessness. To put another perspective on how unfathomable this sum is, it amounts to almost $2,000 for every man, woman, and child on the planet.'”

Couple that with the information that over the next fifteen years, the work force will go from five workers to each retiree to a ratio of one to one as baby boomers begin to retire. As we all know, retirees need social security, pensions, and health care. We also know that the government will have to do everything possible to make these programs continue to be solvent. It does not take a genius to figure out that we are going to see soaring deficits which will lead to higher taxes and inflation, and ultimately lead to higher prices for precious metals and commodities. If you are not familiar with the markets of precious metals and commodities, you should be doing your homework as there will be many, many opportunities in these areas over the next few years.

Richard Russell, one of the most respected newsletter writers in stock bulls throughout the 1990's, expressed his opinion recently noting that the DOW Jones and the gold price will be equal at some point in the next ten to twenty years. If you consider that the DOW is over ten thousand today and gold is over $425 per ounce, there is a lot to think about. Yet the way government spending is out of control, we know our debt will not continue to be purchased for long when our currency is falling. Interest rates will have to go up to attract foreign investors who are currently financing over 80% of our debt.

Europe which stated five years ago they would sell 500 tons of gold annually for the next five years has stalled sales while Japan which has backed the dollar for the last few years announced they now have enough buying power to purchase 1800 tons of gold per year just from the interest they receive on their foreign exchange reserves. There are very strong indications that Japan, China, and other Asian countries will be adding to their gold reserves. In fact, this writer knows one of the consultants being used by an Asian country to purchase large amounts of gold.

In an effort not to appear that I am beating you over the head with regard to the direction of the dollar, I do want to elaborate on one final statement that was presented by respected money manager, Adrian Day. In October at the Cambridge House Investment Conference, he mentioned that to finance the deficits of the United States, we need to attract more than 80% of the world's net export capital. Think about it…80% of the net capital invested worldwide or our currency fails! It is no wonder that on September 26, 2004, the G-7 asked the United States to devalue its currency by 20% to help rebalance the global economy. Of course, being an election year nothing was done. What would you like to be holding if the dollar does have a swift and large devaluation in 2005 or 2006?

With the larger economic picture in mind, below is our hypothetical asset allocation model for the first half of 2005. As you review our recommendations, keep in mind that it is probably more important than ever before for all investors to adopt a strategy of stretching their assets over many investments and investment categories:

• Stocks (U.S., foreign, and hedge funds only) – 15% to 25%
• Gold Mining Stocks - 5%
• Fixed Income (bonds and annuities) - 5% to 10%
• Foreign Currency (foreign bonds and physical currency) - 15% to 20%
• Tangible Assets (precious metals, gemstones, rare coins and historical documents) - 25% to 33%
• Cash - 25% to 30%
• Real Estate - 5% to 15%

*While the above asset allocation model is designed to help balance risk and give investors security, we strongly recommend consulting with your own personal financial advisor before making any type of change to your personal, retirement, or profit sharing portfolios.

FURTHER CLARIFICATION

• Stocks: While we are increasing our stock recommendation for the first six months of '05, investors should play close attention to interest rates and the value of the dollar. Corporate earnings are improving and these should translate to higher stock prices in the first half of the year. But, it is also important to remember that we are now half way through the decade and stocks still have not gone up in five years. Recently, Harry Schultz cut his stock recommendation to five to ten percent. I am a bit more aggressive as I feel there will be some good opportunities both in U.S. markets and select foreign markets. We continue to recommend the RYDEX funds ( www.rydexfunds.com ). In particular, we like their URSA fund and their Juno fund as hedge funds in case the market moves lower in the first half of the year due to uncertainty in the value of the dollar and interest rates.

• Gold Mining Stocks: At present, we recommend that 5% of one's assets be positioned into gold mining stocks. The opinions and articles of many gold experts have led me to believe that the leverage we once had with gold mining stocks is simply no longer there. With environmental problems increasing, with gold being found at larger depths and with higher mining costs, this area should be cut back. The balance of this area should be placed into physical gold which will be addressed in more detail below. We continue to recommend the same three gold funds as before. They are: American Century's global gold fund at (800) 331-8331, Invesco Strategic Gold Fund at (800) 525-8085, and Franklin's Gold Fund at (800) 342-5236.

• Fixed Income: We are cutting the fixed income section by 5% due to the probability of rising interest rates. One should stay in shorter term notes, bonds and annuities due to the strong probability of rising interest rates. When shorter term annuities mature, you will be able to renew at higher rates.

• Foreign Currency: While we are cutting this recommendation slightly, this is still an important part of one's portfolio. I would be happy to discuss the different options available to investors. Generally, I recommend American Century's International Bond fund. To secure a prospectus, phone (800) 345-2001. Other areas that might be of interest include CD's in foreign currencies, physical foreign currencies and two-day call deposit foreign currencies.

• Tangible Assets: Gold has risen 67% over the past five years while the stock market has not moved. In January 2000, I predicted we had entered the decade of tangible assets. We are now poised to see the huge move that has been building over the past four and a half years. While demand is increasing at large rates, the dollar is falling. The only piece of the puzzle that remains so that gold can make those larger jumps is the intervention of the Federal Reserve and the Gold Cartel banks. One can read thousands of pages proving past interventions by the Fed and Gold Cartel banks, but many people just do not want to believe the facts. It is hard to believe after an audit on our gold reserves every other year until 1992 that we have not had one audit under Bill Clinton or George Bush. Driving the explosion in gold will be the inability of these banks to cover their positions. While gold looks like it will be fairly stable for the next several weeks and trade in the range of $418 to $430 per ounce, there is a possibility that it could pull back to $400 per ounce one last time before moving to the $450 to $470 range which we expect to see by early fall. Price prognostications for the year begin with a low of 2% to 5% increasing up to 30% by many respected analysts. I do believe gold will begin its move to its next plateau by March. Again, this plateau should be $450 to $470 per ounce. There are many ways to own gold from physical coins, bars, to fungible storage programs. I would be happy to discuss the pros and cons of each option.

Silver is a metal that after our July '04 newsletter rose from $6.50 up to $8 per ounce. It is now back to $6.75 per ounce. The projections for silver are very strong as many money managers have predicted that silver will hit $8 to $10 per ounce by June. Of all the precious metals, I personally believe silver will be the biggest winner over the next six months. The Chinese have bought contracts to purchase over 70% of the expected reserves to be produced in 2005. This will cause a shortage of above ground silver and this will also impact silver driving it to the levels listed above. Silver can also be purchased in many different forms including fungible certificates for those who do not want to deal with the heavy weight. Please give us a call for silver investment options.

• Palladium continues to be a “screaming buy” even though it has fallen over $30 per ounce since last July. We do believe the next four months will bring sharp movements in palladium. The next four month period has historically been the high buying season for platinum and palladium due to the catalytic converter other seasonal industrial uses. This is also an investment with tremendous potential, but is indeed an area that should be monitored closely. With this in mind, we continue to recommend that palladium be included as a small part of one's asset portfolio.

• Gemstones: Additionally, we are recommending that approximately 5% of one's total holdings be placed into EGL and/or GIA certified diamonds and colored gemstones. The recent tsunamis in Indonesia and Sri Lanka have produced a tremendous interest in gemstones from this hard hit region. These stones include blue, pink, and yellow sapphires, rubies, and all different color spinels. The damage to some of these mining areas has lead many to believe that it will take years to rebuild. Some of the key mining areas for sapphires may never be rebuilt again. Bridges to low lying mining areas are out and mining equipment has been washed away. There are opportunities in gemstones including both jewelry and investment potential. Many stones can be worn and enjoyed at the same time while gaining appreciation. With regard to diamonds, 2004 turned out to be the first year for double digit increases in over 20 years. We are expecting similar increases for '05 as more and more investors (especially in the Far East and India) move money into diamonds and gold and out of paper assets. I am happy to discuss the different opportunities available in gemstones, so please don't hesitate to give me a call.

• Cash: With all the uncertainty, your cash holdings should be increased until a more clear direction is seen in interest rates, stocks, and bonds. As was mentioned in July, one should not use standard commercial paper money markets to get higher rates than are generally offered by Treasury bill money markets. Again, keep that cash basket a little higher for the next six months and be ready to take advantage of any market opportunities.

• Real Estate: While real estate is not climbing at the rates of the past several years, there are still opportunities in REITS, select rental properties along with standard duplex investments and triple net leases. This basket should be purchased only with cash. This will give the investor higher yields than money markets plus equity build-up.

As always for questions or assistance with your asset allocation model, please do not hesitate to phone us at (800) 247-2812

or send us a reply via e-mail. Thanks!