Markets
US stock markets have exhibited a huge rally of near 20% since the lows of early March. I stated earlier in the month that a rally of 10% was possible but it wouldn’t be sustained. The strength of the move has been surprising. My view is unchanged. I see no support for the stock price level. Keep in mind, that my stock model does not predict stock prices, only the broad direction. That direction remains down. I don’t see any evidence to support current valuations.
What’s causing the surge? Reported earnings estimates for the year ahead bounced off their lows because the major banks have improving cash flows. No kidding. They’ve received billions of taxpayer money. Other factors are that money is moving out of long term bonds due to fears of future inflation and is moving into stocks. Some investors and mutual funds are moving into stocks because they feel the need to “do something”. I don’t know what motivates people to make bad decisions but I accept that emotions and herd movement can cause such events.
Based on reported earnings, the S&P500 has a PE ratio of 23. The long term average is closer to 17. At the recent market low the PE never fell below 19. Bear markets usually end with the PE under 10. It’s possible a lot more money will be lost before the bear is done feeding. On the other hand, stocks could sit at this level until earnings catch up but that’s not too likely.
NOTE: This version of the newsletter is for indexing purposes and omits the graphics and formatting. To read this document properly go to the formatted newsletter.
It will be interesting to see how this evolves. I believe that if small investors follow the crowd into the surf they’ll be swept away by a riptide. They will soon regret placing their precious wealth into what will be seen as a destructive current. There’s no need to rush to get back into the stock market. I advise extreme caution and patience.
As for the broad economy, the leading economic indicators are very low but floating off their bottom indicating that overall conditions are not getting worse over the last few months but the improvement isn’t impressive either.
The best way to view this is by looking at the year over year growth rate of the leading economic indicators (LEI). The chart below is for March 2007 to March 2009.
Stocks peaked in June of 2007. You can see that the rate of economic decline was turned back after December 2008 by massive financial stimulus into the banking system. Still, the stock market hit a new low in March 2009.
Look at March 2008 in the middle of the chart. The leading indicators were plummeting and the year over year rate of decline hit -10%. By June 2008, the indicators had improved to -7% only to again plummet and hit a new bottom near -30% in December 2008. The year over year rate of decline moderated to -24% by March 2009. But that’s compared to the already steep decline of a year earlier.
This indicator forecasts the economy out about three months from a trough. The government knows it must spend heavily avoid another decline after the recent pause. They’ve made the decision to adopt “quantitive easing” or money printing since they can’t sell any more debt. At all costs, the economy must not be allowed to begin another decline phase. The lows must not be broken or we could enter a depression.
At this point we can safely say that the economy isn’t sliding into a depression. The government’s actions are working for now. The rate of decline has been broken. It’s too early though to say the economy is improving or that we won’t have a relapse.
Keep in mind that the leading indicators include the recent action of stock prices. Stock prices are a component of the LEI. Since my model says the action in stock prices appears to be speculative then what would happen if stock prices fell by 20% which I believe is very possible. Would that be enough to break the back of the government’s stimulus efforts? What if the government is buying stocks? With this much at stake, it can’t be ruled out and I can’t say they’d be wrong to take extreme actions. We don’t know where the digital money is going.
The LEI does not lead stock prices but is important for possibly forecasting employment and general business activity. The recession is worldwide so unless business activity improves I don’t think commodity prices will rebound with much strength. They may not fall a lot more but a strong recovery in pricing isn’t likely either.
A Turn in Commodities?
Commodity prices are firming and appear to be bottoming. Oil is leading the pack. I’ve been using USO to track the price of oil. I follow year over year growth rates.
On its own oil prices aren’t enough to convince me since OPEC is cutting production and supply constraints will support prices.
Let’s look at agriculture as measured by RJA. The bias is still downward.
Metals are measured by RJZ. There’s a bit more strength here.
There’s several commodity index products and I’ll use Pimco’s PCRIX fund (next page) to show the broad trend which is still a bit downward.
Here’s an interesting fact. It’s unusual for commodity prices to rise across the board before an increase in general business activity. Rising commodity prices don’t lead the business cycle but usually occur late in the cycle. Therefore, to assess the likelihood of commodities going up and providing us an entry point to buy the asset class we should first determine if the economy is improving.
I’ll wait to see if the weakening in stock prices that I expect causes a downtick in the leading economic indicators. Likewise, I want to see if commodity prices will move lower if stocks drop.
Bonds
I sold VFICX this month for a net loss after dividends of -.4% (less than ½ of 1%). This assumes you bought and sold the day after the buy and sell alert. I held this for only two months. I bought VFICX because of the large spread between treasuries and corporates expecting it to close. It didn’t and the announcement of money printing by the government caused me to abandon bonds entirely.
I issued the following alert on March 18th.
The US government today joined previous actions by England and the IMF in adopting "quantitive easing". This means they intend to print money out of thin air to counter falling asset prices. News story here. This is the beginning of a long process to print the nation out of debt. I intend to sell my holdings of VFICX tomorrow - high quality corporate bonds. The net profit (including dividends) will be about zero since buying this asset in January 2009.
I think it's unlikely that fixed rate, long term bonds will do well over the next few years because money printing will eventually move into wages and prices. That is the objective. In a fiat money system inflation is a much larger long term risk than deflation. I expect the deflation argument to be eventually derailed. Subscribers know that I believe the dollar will lose its reserve currency status and this could happen suddenly or unexpectedly. Focusing only on domestic deflation is the wrong strategy.
Most asset classes rose strongly today - stocks, bonds, TIPS, gold, reits, commodities. The dollar fell sharply. The core CPI today unexpectedly moved higher. We'll have to watch this because persistent and increasing inflation will trigger my move into commodities/oil.
My bond model remains in bonds at this time but I don't intend to hold this asset class. TIPS appear ok and money markets are the least dangerous fixed income asset but pay nothing.
Constraints on World Growth
Commodity prices and especially oil are moving in harmony with stocks. There’s the expectation that an economic improvement (I won’t say recovery) will lead to firmer prices for basic materials. I’m also cautious on oil but, since it’s something real with good fundamentals, I’m not negative on its price move. I’m just not willing to jump on board yet. When stock markets regresses, I’ll look to see if oil can stand on its own two feet or if it’s being propped up by a general euphoria. Furthermore, OPEC has cut back production and the US is filling its petroleum reserve thus adding to market tightness.
Gold is marking time and slowly edging higher confounding the deflationists who insist it should priced at $600. Gold’s restraint is good news for bullion owners. Slow progress makes for a good market. Gold understands what the economic theorists can’t grasp. We’re at the end point of the dollar era. It may be a couple years or ten but the dollar will no longer be the world’s reserve currency. That’s no guarantee that gold will soar in price.
The world economic system is under severe stress and will reshape itself into a new form. It is very likely that gold will have an increasing role and the dollar a diminished one. Expensive oil and the collapse of the debt economy means living standards in the West will decline.
The first transition will be to a weighted currency basket with currency percentages based on various ratios contrived by the major powers. Economic output, inflation rates and other metrics will define a currency’s place in the stack. This evolution is a necessary step but not the final product. Could gold and silver regain their crown as reserve currencies? Not according to the major economists who say gold is 19th century money and the world is too big and complex. I disagree.
Gold could retake its rightful place if it was priced much higher or if world economic activity slipped to a very low rate of growth or even a decline. Slow growth is very likely to happen. The surge in world growth over the last thirty years and longer has been made possible due to cheap energy and massive debt issuance by governments. Debt leverages growth. Without leverage, growth slackens sharply.
Oil is a depleting assets and will only get more scarce. Debt is discredited once again in the mind of the public but this time globally. Without cheap oil and debt pulling the world economy, we’re unlikely to ever witness such torrid economic growth rates again. This has major implications for stock prices in the years ahead.
The watchwords in the future will be “sustainable growth”. This implies a pace of growth in balance with the cost of resources. Natural resource prices will spike with a return to economic growth and will prevent anything approaching the growth rates of the past. A lot of the easy and cheap oil, copper and major industrial ingredients have been mined and used. The only path out is to remake our civilization.
George Bush tried to take oil from Iraq, the Caspian and Iran to prop up US growth for another decade. It didn’t work. The wars are failures and Obama is dismantling the idiotic Global War on Terror and trying to end the occupations. We have no choice now but to move to a different model of energy. We should have done it eight years ago.
The only way that America will prosper is if we change. There is no time to lose and we’ve wasted so much already.
I foresee actually a remarkable future for civilization if we can make it. Scarcity will propel innovation. The biggest gains will come quickly in energy innovation.
President Obama seems to understand what’s ahead. Somehow he must start America on a new path and away from economic militarism and towards sustainability and energy innovation. The answer is not in adopting the Al Gore’s mankind-caused climate change theories (which don’t have me convinced despite his Oscar). We should transition away from oil because it’s in depletion and a dead end - there’s a more intelligent and pragmatic path.
Obama believes we must resuscitate the big banks and maybe that is a required step toward stability. I have my doubts. But, it’s only a step and not that difficult to achieve in a fiat money system. The far bigger problem is propping up the pension plans, 401k plans, Medicare and the promised entitlements in a zero growth world.
Trouble is, very few people in government or the press grasp our present place in economic history and how this must be the point where we change direction and reform our society.
Two bear markets since 2000 and the collapse of America’s banking system should make anyone question the economic status quo. Something is changing and it is big. As individuals, we must make a bet on the outcome. We have to place some chips now because once the trend is clear the cost to transition assets to safety will rise dramatically.
The Answer is in a Painting
I’m an amateur artist and recently read the biography of the impressionist Renoir written by his son Jean in 1958. Its titled Renoir, My Father and a wonderful book. Renoir, Monet, Cezanne were founders of the French Impressionist style of painting that revolutionized art after 1870. Along the course of Renoir’s life we observe the familiar changes common to humanity – that of coming of age, careers, relationships and dying. Financial problems are a constant theme.
The Impressionists revolutionized art because prior to them paintings depicted military scenes or they told a simple story. They were painted with lots of brown and were dark.
The new painting style was filled with light and bright colors. What seems natural now was revolutionary in 1870.
One of Renoir’s most famous paintings is called “The Luncheon of the Boating Party”. I had the opportunity to see this enormous canvas a few years ago in Phoenix. It’s always been a favorite of mine.
Located on the Seine in Chatou France, the outdoor restaurant depicted in this painting opened in 1857 and was a short walk from the train station. It was a favorite haunt of Renoir and his painter friends. Many people would gather, eat and take boat rides on the river. The people in the painting are friends of Renoir. His future wife is holding the dog. The lady in the yellow hat leaning on the railing is Alphonsine Fournaise. She was the daughter of the successful hotelier who owned the restaurant.
Like most popular venues, in time the glow dims and they fade away. This lovely scene no longer exists. The place closed in 1906 and the site eventually became a grimy industrial area. “Beautiful Alphonsine” as they called her inherited a fortune. She was a wealthy woman and placed her money into one of the safest investments of her era – Russian Czarist bonds. Rich in 1900, she died in 1935 at the age of 92 completely penniless. The collapse of the Russian economy and the Bolshevik revolution ruined her. Imagine such a smart, beautiful and fortunate good soul going broke at 65 and scrounging for pennies for 25 years.
I’m sure Alphonsine received excellent financial advice and did what other well-off ladies did. She invested wisely based on the recommendations of the best advisors. From Paris, she probably read the headlines of turmoil in Russia but was convinced by money managers to stay the course and invest for the long term. She had her doubts and knew something was very wrong but didn’t act on her good sense. She lost it all because she wasn’t diversified.
It can be Russian bonds, Bernie Madoff or the American dollar. A rigid method of investing that ignores danger and new trends and places faith in sure things like inflation, deflation, kings, constitutions or “stocks for the long run” always risks ruin. There are times in history when things change.
My financial models and my instincts tell me we are at a turning point in history. We’re each Alphonsine. My models have avoided the two recent stock bear markets. I’ve now exited longer term bonds. Stock and bond markets are at high risk and our place of refuge – cash – can only be a temporary haven. Our success; I should say our financial survival will be determined by our timely exit from cash before it too is devalued. Our assets must be deployed into things that preserve and grow capital. Right now, capital growth opportunities are limited and my focus is on preservation.
I don’t want to sound overly dramatic but if you’re a subscriber to this newsletter then you understand the dangers we face. For that reason, I’ve chosen to shift some money into gold at the risk of being early or perhaps wrong because I don’t want to share the fate of Alphonsine.
I suspect that many subscribers to this newsletter are worried right now. You see the collapsing economy, the unsustainable debt and your common sense screams at you that the future US debt of $15-21 trillion can never be paid off. Your friends act uninterested when you discuss your financial concerns or just change the subject. You hear the talk of nations wanting to dump the dollar as the reserve currency but you perhaps take solace in tax avoider Tim Geithner’s stated confidence of a continuing dollar dominated world. You may really like Obama and believe he wants to do the right thing. That’s probably true – he seems like a good man based on the little I know of him. Still, you know something is wrong but can’t decide what to do.
We continue to experience a deflationary wage and asset price environment. Asset prices are falling. At the same time, central banks and fiat money currencies are losing their credibility. Decades of debt abuse is poised to gradually give way to decades of money printing. There’s no other way out of the debt problem and you know it. We can’t grow our way out of debt because key commodities are growing depleted and, like a hair trigger, will price upward quickly if the economy improves. Any business expansion will be pushed back with increasing costs that the public can’t afford. This is not a good environment for consumer stocks. Yet, I’ll wager that 80% of financial advisors are still preaching buy and hold.
The commodity price cycle is firming and stock prices are off their lows. Conflicting signals are normal at turning points. But be watchful about what is really going down. We have stopped issuing debt and now are printing money. It would take mega trillions to induce another economic boom and who is going to accept our dollars and give us the raw materials cheap enough to make a boom happen?
The CBO says deficits will run over $1 trillion per year for the next decade. That means by 2018 America will have $21 trillion in national debt. It will cost at least $1 trillion a year just to pay the annual interest on such a debt load. The actual cost will be much more as rates rise. They’ll just print money rather than sell more bonds – what else can they do. And, that’s what they are doing.
It’s happening right before our eyes.
Anyone with retirement savings or a nest egg is wondering if we’ll have inflation or deflation in the years ahead. That’s the big question. I’ve maintained that long term deflation is impossible in a fiat money system if the central bank wishes to break it. Furthermore, it’s my belief that we can have domestic deflation of wages and falling asset prices at home but a weakening dollar making imports more expensive. And, since we import almost all our consumer goods, the cost of living could become unbearable within a few years if the dollar implodes. Even worse, we could see the dollar repudiated by other nations who don’t want to be sucked into our black hole of debt. The progression of currency debasement won’t be linear and won’t be confined just to the dollar. It will move in fits and starts and manifest as trade wars and shortages of basic goods. It’s impossible to predict which currencies will win. I’m inclined to not bet against America but I don’t mind hedging my bet either.
My financial models have been either very lucky or very skillful to avoid the 2001 crash, profit on the 2003 boom and avoid the 2008 crash. I’m not saying to place your trust in me but I am telling you that my model says to stay out of stocks. Long bonds pay us little and can’t be considered safe. My model is in gold and cash.
I believe the safest approach at this time is to hold some cash but also gold and to stay out of debt. This approach would have saved Alphonsine and it will save you too. The decision to hold gold and cash means you will own assets that pay no interest. You’ll receive no income but you’ll preserve capital. Holding long term bonds is very risky as nations print money. Holding stocks is very risky during an economic decline. What percentage should be in gold? I can’t tell you that because I know nothing about your situation and am not a financial advisor.
On March 23rd I posted this note on the subscriber area:
23 March 2009: The market's spectacular rally is a wonderful opportunity to sell any stock swill you're still holding. My stock model shows the S&P500 at 822 to exhibit a large spread between price and fair value. Even the stormiest climate has periods of sunny skies and calm seas. Waves of euphoria and hope within a powerful bear market rally lure investors to a seemingly placid shoreline only to smash them against the rocks. Stay out and preserve your capital. It's not time to buy stocks. I would only change my mind about stocks if the Fed pumped so many dollars into the economy that somehow earnings would soar and inflation would remain low. This would amount to another debt induced stock boom similar to what happened in 2003. My model caught the 2003 boom and rode it until 2008. It will catch a new one also. I doubt though that a new boom is possible.
The US government is now printing money and buying who knows what. What is real and what is contrived? Gold is selling at 7-9% over spot for 1oz coins but is still available at a low markup for large bullion bars. Bullion could become more difficult to obtain if nations increase bullion reserves and drive up the price of gold in anticipation of replacing the dollar as a reserve currency. Whatever happens, do not sell your gold.
On March 27th I read this:
The NYSE-Liffe futures exchange has, it seems, run out of 1 kg bars of gold. Futures markets, like NYSE-Liffe and COMEX, try hard to maintain the fiction that they will deliver physical gold, in completion of executed contracts. Indeed, to prevent fraud, U.S. law requires clearing members to keep a stockpile, of one kind or another, consisting of a minimum of 90% of metal. Up until October, 2008, it didn’t matter. Only about 1% of long buyers of paper gold futures contracts typically took delivery. Now, the situation is very different. Demand has surged and, it appears, one major futures exchange, NYSE-Liffe, and by extension, the COMEX gold warehouses it shares with its larger cousin, are unable to meet the requirements of their contracts, visa vi, delivery of 1 kg. bars. Source
I haven’t verified this story but if true it means that investors are buying futures contracts and taking delivery of the gold rather than pay the large markups on 1oz gold coins. If nations begin to concur on a move away from the dollar they could decide to boost their own reserves.
Consider this. If you’re living on a fixed pension or drawing on savings and make enough to get by then the real risk to you is inflation. Hold enough gold so that 8% inflation won’t ruin you. If you have an annual pension of $30k and the buying power depreciates by 8% yearly then you’ll be on the street in short order. Hold at least $30k in gold to offset any possible decline in the value of your pension – that’s the minimum. If we have deflation, then your pension’s purchasing power will rise and everything is fine. You’ll still have a gold reserve in the event of a different disaster.
The cheapest way to own physical gold is to avoid the coins and buy .9999 bars minted by major refiners like Credit-Suisse and Johnson Matthey. They sell at about a 2.5% markup versus over 7% for coins. The best dealer I’ve found is Kitco because the pricing is clear and you can buy online with no sales tax. https://online.kitco.com/bullion/completelist.html
If you’re young or mid-career, save every nickel you can. If you don’t believe in market timing then put half into a broad mix of investments and a good chunk into cash and gold via coins or a bullion ETF like GLD or IAU.
I’m not asking you to take my advice without getting other inputs. I suggest you contact a non-commission financial advisor and see if my ideas makes sense considering your age and situation. You’re not interested in his opinion that you should only have 5% in gold – that’s the standard line. Ask if my idea will protect your purchasing power. If you want stock exposure then ask about a gold-cash-stock strategy that will do well with inflation or a weak dollar. Diversify across nations and stock sectors. Don’t assume America will do worse than the rest of the world. This country has many things going for it if we can get rid of our debt.
I’ve read some commentators who suggest that you should buy a house and hold a huge mortgage because you’ll be able to pay it off with cheap dollars as the government inflates. That would be true if your wages are secure or you had enough cash now and can afford to wait until inflation sets in. This might be a good idea for a young person with a recession-proof job. For older people, it sounds like a risky bet to me because it requires excellent market timing. I prefer a middle path.
I’m certain the government is trying to inflate but can’t predict when their efforts will have the desired effect. The first order of business is to stabilize the financial system. House price declines have hammered bank capital. Soon failing commercial property loans will compound the problem.
Monetization of debt will work wonders for bank capital but it will take a while to percolate through. Next they will work aggressively to shore up employment and household income. I’ve prepared a plan of one way they could transition the economy past debt and it’s presented later in this letter.
One way to monitor inflation in the pipeline is look at indicators of future inflation within the economy.
The chart below shows the year over year rate of change in pricing pressures. The pressure has been down steeply indicating falling prices in the economy overall. The rate of decline moderated in February but it’s too early to say the trend has changed.
Rising commodity prices can also serve to presage inflation and those prices are going sideways. The combination of the indicators and commodity data indicates no systemic inflation threat at this time.
Maintaining Purchasing Power
The real value of a dollar is its purchasing power. US domestic deflation means very little to a foreigner if they don’t have to accept the dollar in exchange for commodities.
Many people have already lost 40% of their savings in the stock market decline. If you rush into the safety of long bond treasuries you could lose another 40% if inflation rates rise. Or maybe you’ll just hold TIPS or cash since inflation and deflation won’t damage them much. But, what if the dollar is devalued? TIPS won’t protect you at first because your dollars will buy less oil at the pump and imported goods at Wal-Mart. Maybe you’ll invest your money in China stocks but China appears to by lying about its economic growth rate.
We have every right to be worried and confused. Accept the fact that the world is at a turning point and no one can predict the future with certainty.
For those who can’t be pulled away from the idea that deflation is here to stay, I’d suggest you trust your intuition and ask yourself this question. If you had to go away on a space journey for five years and couldn’t communicate with anyone, where would you invest your money. You already know reading TGR that the world economy faces a growth roadblock due to depleting oil and essential commodities. You know there’s talk of dumping the dollar as the world’s reserve currency. You know the US government is printing money at an increasing rate. Would you:
Think it over and then create a plan of action. It doesn’t hurt to find a competent and forward thinking non-commission advisor. They can suggest ideas to protect your purchasing power. I’d be very wary of annuity products. Annuities are big profit products for advisors and are only as good as the insurance company backing them.
What TGR Would Do To Get America Out of Debt
In early March before news of “quantitive easing” (money printing) and hand wringing from China about the dollar, I had composed a what-if scenario. What would I do to get America out of debt as soon as possible so we didn’t become a footnote in history. I know debt will destroy us because it’s a 2000lb albatross around our neck. Asia has lower operating costs and we can’t compete in manufacturing unless our wage levels deflate by 50%. The only way out is to dissipate the debt and transform our economy into something greater than ever existed before.
I’m confident that America will eventually adopt a plan similar to what I propose below. First we’ll go through a period of higher taxes and attempts at fiscal restraint. It will fail. Tax revenues will drop with rising unemployment and less consumer spending. A national sales tax is another brain dead idea. The politicians will come around to the conclusion that our debt is too huge to pay off and we can’t grow our way out.
Eight years ago we had a chance to avoid bank failures and a debt implosion. The 2000 election and the 911 disaster turned the country over to people who sacrificed our economy to pursue a crackpot militaristic solution that bankrupted us. That is how history will see it.
We have to deal with the present reality and the consequences of our mistakes.
Here is the TGR plan: One Generation to a New America
How I would fix America's economy and maintain a leadership role
Assumptions
Objectives
Action Plan
Preparation Phase (One Year - 2009)
Phase Two: Inflation and Transformation (Ten Years 2010-2019):
Phase Three: Reconstruction (Five Years 2020-2024)
Of all the reforms we need in America, none is more important than completely transforming the campaign contribution system. Many of the major leaders in congress are corrupt to the core.
They were paid off to pass the laws that enabled subprime, liar-loans, 40:1 banking leverage, and even Iraq war profiteering. The SEC is corrupted by a leadership anticipating a move into jobs on Wall Street; Congressmen take lobbying jobs after they lose office; our presidents are corrupted by donations to their ego driven presidential libraries.
A successful transition of the American economy is impossible until the motivators for these venal bastards are purged from the political system.
Real Estate as an Income Source
The average price of residential real estate continues to fall as tracked by the Case-Shiller housing index. The index dropped by almost 20% over the last year.
In some areas of the country prices are stable and even rising. Some experts predict that home prices will fall another 20% and that may be true. TGR believes now is the time for adventurous investors to begin educating themselves and consider investment properties for income.
Apartments and multi-unit rental properties are very good long-term income vehicles in an inflation environment. They have to be purchased at the right time, right location, and for good terms.
I don’t consider houses a suitable income property – they’re a place to live. An investor needs multi-unit rentals to generate enough income. For reasons of space, I can’t develop this theme much in this issue but will touch on some key ideas and expand them in a later report. There’s no rush for you to buy buildings right now because the price trend is still down. This is a great time to learn about your local market. Real estate is local – not national.
Market panics occur at turning points and this real estate collapse is one of the greatest in history. It’s not over. The pain has hit mostly in the residential market but we have a very large debacle ahead in commercial real estate loans and that means more pain for the banks.
America will transition away from a consumer society over the next decade. That means we have far too many shopping centers. We have far too much retail space. A contraction in retail and consumer spending means there’s excess office space too. People always need a place to live but they can work out of their home rather than pay rent somewhere.
The price decline in the shares of REITS has been amazing. The S&P500 is off 50% but REITs as measured by VGSIX are down approaching 70% over the last two years. The yield on this fund is over 11%. That sounds great but it’s not a deal if the price keeps falling.
A bloodbath like this can’t help but hide some marvelous gems of value as the properties are auctioned off by the banks. Too many properties means some will languish for a long time. Others, in the path of evolving demographic trends will do very well. There lies the danger and the opportunity.
I worked for quite a few years as a real estate agent and as a property appraiser. Watching my local market, I’ve observed some buildings go up for sale at great prices and quickly sell. Shrewd investors are cherry picking their opportunities.
Summary
There’s no evidence to suggest that we should get back into the stock market. Indicators of the economy are, at best, undecided. My stock model is firmly out of the market.
My bond model is still in the market but it tracks Treasuries. The low yields means there’s no money to be made. In consideration of the forward risks from debt monetization, Treasury rates would move to the upside if not artificially suppressed by government interdiction. Yields on corporate bonds continue to creep upward expanding their historic spread with treasuries. The US bond market is not a place where we want to be.
Commodities are firming but I’ll wait to see how they respond if stocks again slump as my model indicates. There’s no rush to buy. Stocks in the commodity sector may be mimicking the temporary strength in equities. Gold will mark time until inflation enters consumer prices. Until then it will act as a dollar hedge.
A dollar panic could cause a surge into stocks – this can’t be ruled out. Stocks, however, need earnings to support their valuation, and without it, a blind rush into equities will amount to just another bubble.
Sometimes it’s best to do nothing. My personal holdings are in cash and gold.
This period of pause in the economy won’t last through the end of the year. The situation becomes more dangerous the longer the problems fester and there seems to be no cure for the infection of debt. The US leadership needs to present a plan to eradicate debt and give the nation hope and a goal with a real solution.
The government’s money printing and obsession with propping up the failed mega banks indicates the system is trying to save itself and prevent a needed cleansing, contraction and reformation. The solution is always more taxes, control and rules. That’s all a politician knows.
The deflationists tell you to hold dollars and to ignore the far greater danger of the decline of empire. Others simply won’t accept that things are changing. Guys like Warren Buffett have spent 50 years doing well playing by the old rules but have stumbled badly. I suspect many super rich guys are like the old aristocracy of France whose belief in the system and privilege was so unshakeable that they ended up executed rather than consider a Plan B. Or the aristocrats of old Spain with their treasure galleons looting the gold of primitive nations. What a business model they thought. They spent themselves broke on a worldwide empire trying to protect their lines of trade. How was it any different in 2003 America with hundreds of overseas bases and a phony war on terror to keep the home population fearful while the generals pillaged for energy? It's crazy but empires never let go gracefully until forced by crisis. Well, it’s here and someone needs to speak the truth to the American people.
Q&A:
Q. We have a nice lakeside home with no balance, and 40% of liquid assets in 1 Oz gold coins. We agree with your 1-5 year outlook on the dollar. The dilemma is what to do with the other 60% of assets that are in several reputable brokerage money markets. We don’t like the way the financial winds are blowing again and feel some major devaluation or a new currency might take our cash accounts down 25 to 75% on the dollar on some dark, foggy, Friday the 13th! If you are only 10% in gold, are you not faced with the same dilemma? This Pandora’s Box I think would be of interest to most of your readers.
A. Many people are waiting for rising inflation before buying precious metals. You clearly have a broader perspective. Much of the talk right now about dumping the dollar is chatter. I don’t expect the dollar to lose its reserve status until the world’s banking systems are more stable. The US could actually want this to happen because it would provide much more freedom to inflate the currency.
Inflation would follow after a dollar devaluation due to the rising price of imports. The history of devalued currencies shows that devaluations occur in spasms and not all at once. I recommend a core gold position of 10% as a minimum. A person with a large mortgage and big monthly cash expenditures should have a much smaller gold percentage than a person with a large cash position, living on a fixed income and with no monthly payments. The percent in gold depends on one’s circumstances and it would be irresponsible of me to suggest an amount that could be reckless. If inflation does strike, there will be assets in addition to gold that we can invest in. Your 40% in gold will go a long way if the dollar hits the skids. I wouldn’t put all my money in gold but for some people perhaps 30-50% is reasonable if they can handle a big bet.
Q. Your latest report continued stressing that stocks are heading down and your model was out of stocks. Would you recommend to quit stocks altogether now or it is too late as I've already lived through the 2008 decline and might realize the losses permanently if I quit now? In order words, what would be the correct interpretation of your model status - does "out of stocks" mean one should have moved out WHEN the alert came out or the recommendation to move out remains correct AT ANY TIME as soon as your Web site shows "out of stocks"? My time horizon is 25 years. I completely understand that you don't give personal investment advice and that's not what I'm asking for. I rather want to understand how to comprehend your model recommendations correctly.
A. Historically, my stock model has given a buy signal very close to market bottoms – within about 5%. Riding the market down because of previous losses probably isn’t a good idea. What has happened in the past is irrelevant. At the time of your email on 2 March 2009 the S&P500 was at 700 and today it’s close to 800. That’s a 14% rise. If it falls back down like my model suggests, then that’s a real 14% paper loss. Bear markets go far lower than people can imagine. The real decision is how much do you trust my timing methods and honesty and ability to continue past successes. These are all uncertainties. Perhaps it’s best to use timing for a portion of your portfolio and compare the results after a year. With a 25 year investing horizon you can afford a lot more mistakes than someone age 60.
Q. On February 11, Bloomberg Business News reported that China was seeking "guarantees" for its US Government debt and it now appears they got it. Well placed senior sources at the US Embassy in Beijing CONFIRM the formal written agreement was delivered by Secretary of State Hillary Clinton during her recent trip to China. This means that in the event the US Government defaults on its financial obligations to China, the Communist Government of China would be permitted to physically take -- inside the USA – (via Eminent Domain) land, buildings, factories, perhaps even entire cities - to satisfy the financial obligations of the US government.
A. Eminent Domain has nothing to do with China debt. You’re right - I'm sure China wants guarantees. It also wants to buy US assets at low prices and pick up technology. I don't think the US needs China to buy more debt since there isn't enough free cash remaining in the Milky Way to pay for our future deficits. England today announced, obliquely, that it will monetize debt and that's where we'll go too (a week later the US announced monetization – tg). China wants protection from future inflation but probably won't get it. The US won’t default on its debt - it will be monetized and that means inflation and that’s what China is worried about. This ties in to another question below about deflation.
Q. I am a new subscriber (Feb), awaiting opportunities to invest according to your smart portfolios. I have a few questions. (paraphrased to the key details – tg) When your model is in a buy mode, is there any reason not to put up to 30% of my cash into the asset right way even if I missed the initial signal? In general, when investing do you generally suggest to reinvest or pay dividends and capital gains?
A. If you miss the initial buy signal I would not buy the asset if the price has moved up significantly. I will normally give an opinion if I believe a buy is a trade opportunity or a major cyclical change. The decision to reinvest dividends depends on if you need monthly cash flow or can afford to let the gains ride.
Q. When the US stock model indicates IN, do you also recommend going in on REIT, commodities, and international stock indices?
A. US and major foreign stock indices are often tightly correlated. I’d buy both and I’d buy US small and large cap for diversification. I don’t have a timing model for REITs and commodities and they don’t correlate with my stock model. For REITs I look at yield and the price trend. For commodities, I look at the components and see if the whole class is moving together.
Q. Your latest issue says nothing about inflation protected securities (TIPS), which you earlier thought had merit. Has your view changed? How about GNMA? Do either of these provide any stable security?
A. I like TIPS (VIPSX +5.5% ytd) and short term bonds (VBISX +.4 ytd) better than other bonds classes because they’re fairly immune to inflation. GNMA has little credit risk. Vanguard’s VFIIX (GNMA) has only a 2.3 year duration – that shows the Vanguard people are playing it careful. GNMA is up 2%. These are good assets if part of a broad portfolio. VFIIX is safe credit-wise and I owned it for years. I don’t hold any bonds right now but I might consider VFIIX with such a short duration.
Q. You’re a few hours behind us with you being out west and all, so I just wanted to give you an early “heads-up” from the east coast; Our “Dear Leader” has announced (3/13/09) there is no financial/stock/mortgage/economic/banking crisis. It’s all good now. And stocks are up. Champaign corks are a popping. As you were…crisis cancelled.
A. Obama’s job is to build confidence while trying to fix the mess. Your portfolio could be a casualty believing any politician.
Q. Are the alerts to subscribers sent out via email? I noticed in the subscriber section that you posted one on 3/16 but I didn't receive an email. Just making sure my email address is in your alert database.
A. The comments posted in the subscriber area of the web site aren't alerts but just observations made that day. Alerts are buy and sell recommendations and subscribers are notified by email. I rarely send out emails to subscribers because I don’t like to annoy people with small talk that doesn’t put money in their pocket.
Q. I would like to hear your thoughts on the deflation argument for the future. It seems too many people are assuming we will have a lot of inflation in the coming years and I'm wondering if a contrarian view might be more likely. What about the argument that we won't have all the billions in home equity or gains from the stock market to spend on consumption like we did the last 20 years, especially as wages begin to fall as desperate people take jobs making less money than they made before. Gary Shilling makes a pretty good case for deflation based on waning demand for goods. Thank you.
A. This Inflation/Deflation argument has become a religion for many. It's not either-or. It's both but when. I read Shillings book 'Deflation' back in 2000. It’s excellent and he’s a very smart guy and I respect his opinion. However, the book was written in 1999 and pastor Shilling wasn’t right until 2008. We had a commodities boom and soaring gold prices after his book was published – the opposite of what he predicted. Some notable people now warn of inflation from money printing. They'll also be right at some point. When/If inflation comes it will show up in commodity prices. It's not here yet. We have falling asset prices and maybe some deflation. Consumer prices are not falling like the deflationists would have you believe. Inflation is much more common than deflation over time. How we get prolonged deflation in a fiat money world is beyond me. I don't belong to either church. I've not committed to commodities yet and won't until I see some upticks in inflation. I own gold as insurance because of dollar risk and not because of current inflation though it serves both roles and I believe it’s coming. Inflation is most likely after the dollar loses reserve status because there will be no more restraints on the Fed/Treasury. I can’t predict when it will happen.
Q. In your March letter you wrote that gold prices "above $800 are anticipatory." Do recent events ratchet that number up a bit? I'm only asking what you think for yourself - I know you can't give personal advice - but I'm curious. I also remember reading a few letters ago that you think eventually multi-unit real estate investments will make sense. I've been digging through foreclosure properties on-line, hoping to find an interesting investment opportunity. Do you think today's events make real estate more interesting and worth starting the research process?
A. I’ve calculated the fair value price of gold at about $800. This is based on 40 years of gold pricing and applying an inflation calculator to the various price points. If there’s interest I can show the logic but essentially it shows that inflation since 1971 would price gold at about $730 to $800. I picked the higher number because I think gold was underpriced early in the 1970s. The reason to own gold is my fear of a dollar collapse from debt and future inflation. The trigger will be the loss of reserve currency status for the dollar which will unleash the forces of chaos. Until that happens a price of gold over $800 is anticipatory. Notice, that I didn’t say gold-bug crazy. The fear of inflation is real – just ask China.
I think real estate will offer tremendous opportunity in the years ahead once (and if) inflation kicks in. I spoke with a guy today who has a total income of $45,000 and is building an $800,000 house. He lost his big job and was worried about foreclosure. The bank is now begging to make him a 30 year fixed loan at under 5% to get money out the door. The government wants money lent out to anyone with a pulse. They don’t intend to foreclose so how will he pay off the loan? I don’t get it.
Q. Have you seen the videos at http://www.chrismartenson.com/?
His conclusions are right in line with yours, Shadow Statistics, etc., but he really brought everything together and explained why in a way that makes a lot of sense. He contends that our fiat money system, by its very design, requires exponential (x% per year) economic growth, inflation, and debt, which makes our current state of affairs a natural outcome of the system. Do you see any holes in his argument?
And as I understand it, every major country in the world uses a fiat money system, so there wouldn't appear to be a safe haven in anything other than physical assets like precious metals and commodities. What is your rationale for investing in foreign currencies as an inflation hedge if that is the case -- that the US debt is so much larger than everyone else's that the dollar will end up being the biggest loser?
Also, if he and the Shadowstats people are right, the government understates inflation quite a bit (on the order of 4 to 8 percent so far), making TIPS a questionable inflation hedge. Would you agree?
A. I viewed the info and highly recommend the Chris Martenson site to all subscribers. His analysis is logical. Our financial system required ever increasing debt and leverage and it just collapsed. I have no problem with foreign currencies in a portfolio but can’t guarantee they’ll do better or worse than the dollar. The currencies of commodity countries like Canada or Australia might seem like better bets – my guess. I don’t agree with Shadowstats.com that the inflation is really 4-8% higher than the government reports – at least looking at consumer prices – maybe Mr. Williams is measuring something else like money supply.
Q. It is very hard not to add some exposure to the market (comment made during the recent stock run up –tg) especially when one sits on the sideline with cash
A. It’s even harder to have patience and preserve precious capital until the time is right. A person can work their whole life to earn their savings and lose half of it in six months as we’ve seen.
Q. I've been paying attention to Peter Schiff for a while, and he seems to be pretty accurate. I was hoping you might oblige me and suggest any regular reading or anymore relevant books.
A. Crash Proof by Peter Schiff is an excellent book. Schiff takes a lot of heat but the guy is consistent and he’s been right. This video says it all. (Note: I didn’t agree with Schiff about buying foreign stocks). Another good book is “Buy Gold Now” by Shayne McGuire. He’s a Texas pension fund advisor and not a gold bug or a fanatic. Stephen Leeb just came out with a book, “Game Over” and it matches my forecast that rising commodity prices will choke off any economic recovery. None of this is wild-eyed stuff – these are analytical and thoughtful books.
Best Regards,
Southwest Ranch Financial, LLC (www.gleasonreport.com)
Tom Gleason, Manager & Researcher
Author of: How To Invest If You Can't Afford To Lose (Free download on the website)
Tom Gleason has degrees in finance and information systems. He's worked as a bullion dealer, fraud investigator, real estate appraiser and financial analyst.
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