The great conundrum…answered. Sort of.
Oct 312011
What recession, I dare ask?
{Caveat Emptor: earnings expectations may have been revised down prior to earnings season, making expectations easier to beat. Also, forward earnings expectations may be revised down to reflect current uncertainty. Nevertheless, Q3 ‘adjusted’ and ‘as reported’ earnings have risen year-over-year by 14.27% and 20.02% respectively. Sort of makes ECRI’s “you haven’t seen anything yet” recession call sound like a flop, doesn’t it?}
If you ask the common man in the street about investing in gold (GLD) most will give you a funny look. After all, mainstream investing is about stocks, bonds and term deposits.
If you ask someone with a bit more investing knowledge they will tell you to buy gold during inflationary periods.
If you ask someone with a relatively sophisticated investing knowledge they will tell you to buy gold during deflationary and inflationary periods. Some may even say to buy gold during periods of uncertainty and instability, or when real interest rates are low/negative.
If you ask the world’s wealthy elite about gold they will give you a very different answer. At Plan B Economics, we’ve found that most of the world’s wealthy elite don’t view gold as an investment at all. I would argue these folks have it right. Simply put, they consider gold to be a store of wealth and believe that anytime is a good time to own some gold.
The rich are less concerned with fluctuations in gold prices than most investors. They aren’t trying to profit from gold ownership – they are trying to maintain their overall purchasing power. Since the wealthy have a large asset base, losses in purchasing power add up to big dollar figures. Therefore the protective characteristics of gold are critically important.
Gold can protect real wealth because it tends to move in a different direction than other types of assets. When gold prices are falling, other forms of wealth are usually rising in real terms. When gold is rising, other assets are usually falling in real terms. Gold has an offsetting effect when it is part of an overall asset base.
However, there are other, more important reasons the wealthy use gold as a way to preserve wealth, regardless of its correlation with other assets. As the world sinks into greater financial and political uncertainty, the wealthy want to protect their families if the unthinkable happens. Physical gold can store substantial wealth in a compact, universally-accepted form that can be hidden from the prying eyes of governments. So if/when collapse truly occurs, as it has consistently throughout history, the wealthy can escape with a big portion of their assets.
At this point, many of you reading this may be rolling your eyes, thinking such asset positioning is reserved for conspiracy theorists, but history and current anecdotal evidence suggest this is how many wealthy people think. In fact, through Plan B Economics I have encountered many wealthy people who have caches of food, precious metals and weapons (but rarely admit it). They are acutely aware that if society broke down, they’d be the first scape-goats the masses, and any government filling a power vacuum, would seek.
Ask the rich people who escaped Hitler’s Germany (or many other similar situations throughout history) about gold. These are the people who left behind houses, businesses and paper assets to escape their home country. They may have even left behind assets in savings and securities accounts, the withdrawal of which would have created a paper trail. (Moreover, German currency and securities may not have been accepted by non-German institutions.) They did, however, take as much gold as was physically possible. To these people, gold wasn’t an investment but a way to smuggle a lifestyle across borders in a suitcase.
Today, I believe gold can provide the same utility to rich and middle-class alike. Everyone should have a portion of their wealth stored in a fungible, highly-concentrated, portable form. The goal here is to prepare, not to predict. After-all, you buy house insurance but never expect your house to burn down.
So next time you consider gold as an investment, ask yourself why you are buying it. If you’re worried about 20% up and down moves then you are simply speculating on the price of gold. If you’re looking for a portfolio diversifier then you will be willing to accept gold’s counter relationship to other asset classes. But if you are truly looking for a store of wealth, like the world’s wealthy elite, you may want to hold physical gold in a hidden yet easily accessible location.
More:
Is Gold Overvalued?
How to Buy Gold for Under $300
How Gold Performs During a Financial Crash
You’ve probably seen the video of a 2 year old girl in China run over by a van. About 17 bystanders walked past the girl ignoring her as she lay on the road dying. The video is gut-wrenching to watch, but cases like these are far too common in China.
The first reaction is that Chinese people are heartless. But how can this be so when so many Chinese are just as moved by this incident as non-Chinese? The truth behind this behavior lies in the messed up Chinese legal system.
In 2006, an elderly woman fell to the ground and was helped by a bystander named Peng Yu. At the request of the elderly woman, Peng took her to the hospital. He also gave her 200 yuan to help her out. After the incident, the woman accused Peng of knocking her down and sued him to pay for medical expenses totaling 40,000 yuan (about $6200; Chinese GDP per capita is about $4400). The judge sided with the old woman stating that, according to societal norms, only the person that caused the accident would have helped her out. The judge went on to state that if Peng was indeed doing a good deed he could have let the old woman’s family send her to the hospital after they arrived. Since Peng went out of his way to help the elderly woman, it was decided that he must have caused the accident and was obligated to pay her medical bills.
Many similar well-known cases have occurred in China. Unfortunately, the system is built to discourage good Samaritans.
So I ask you this: how prepared would you be to help someone out if it could cost you more than a year’s income (in a highly competitive country with a weak social safety net)?
If China wishes to change the behavior of those that simply walk past accident victims, the authorities must make it clear that good Samaritans won’t be punished for helping.
There is an old saying that a penny saved is a penny earned. The premise of this saying is that an individual can create as much wealth by saving money as by earning money. Let me add a modern twist.
This saying originated in the days when income taxes and sales taxes were immaterial. Believe it or not, income tax in the US did not become a permanent fixture until it was introduced in a sixteenth amendment to the constitution made in 1913. Prior to that income taxes existed periodically, but usually only during times of war. Also, income taxes were relatively small proportions of total income. Broad-based sales taxes were introduced across different states between 1930 and 1969 (some states still do not have a sales tax).
Prior to the introduction of income and sales tax a penny saved truly was a penny earned. Today, however, savings is even more important to generating personal wealth.
While the calculation varies, let’s imagine a person has a 25% average tax rate and lives in a region with a 13% sales tax. For this person to buy $1 worth of goods he would have to earn $1.50 in income. Clearly, spending money is an expensive hobby – more expensive than most realize.
If one were to consider money as units of effort, it turns out this person needs to work 1.5 units for each unit spent. So a penny saved is more than a penny earned. I think if more people thought of spending this way they’d save more.
via chartsbin.com
Germany and France have agreed in principle to a 2 trillion euro bailout. What does this mean to investors?
Oct 142011
For some major categories, retail sales have gone nowhere over the last decade:
Oct 132011
I must say that anyone who denies Q3 earnings are coming in well is being too rigid. I see negative economic data pointing to recession, but these earnings are looking relatively good.
Unfortunately I don’t have the data to see if estimates were revised down before actual numbers were released. Also, we’re early in the schedule so let’s see what the remaining issuers report.
Click to see what % of announcements are beating expectations.
Most people think gold and deflation are like water and oil, and cannot coexist. Nothing can be further from the truth…if you’re a gold investor you better understand this.
Click to see the myth get busted
Oct 032011
The industrial revolution introduced the world to a new prosperity never seen before. New sources of energy enabled mechanized and automated industrial processes to increase per capita output and free up labor to participate in value-added activities. Energy from coal and oil substituted manual labor many times over, leading to faster transportation, faster construction, greater agricultural production, cheaper materials (i.e. plastics), and more. With a barrel of oil reportedly replacing 25,000 man hours of work effort and costing very little to obtain (prior to 2005), the ROI on energy created a world of plenty.
A world of plenty can suddenly afford kitchen appliances, cars, bigger houses, post secondary education, entertainment, health care, social security, and more. Furthermore, a world of plenty can afford to structure it’s consumption economy using a credit-based model, because economic surpluses from future ROI on energy can be used to repay or service consumer loans made today.
I don’t think a higher being sat back and designed the economy to take advantage of the high returns on energy. The economic relationship between energy and economic growth was more likely an organic evolution led by consumers and innovative businesses that found ways to take advantage of an inexpensive resource. As the innovations became more pervasive, so too did economic dependence on the resource. After a couple centuries of high energy ROI (first from coal, then from oil) most people today don’t think twice about how much of our societal success is dependance on cheap energy. The truth is, we may owe much of what we’ve accomplished in bridging the gap between the bourgeoisie and proletariat, namely the growth of the middle class, to the surpluses generated by a high return on energy.
To clarify, return on energy, not the availability of energy, determines how energy use impacts an economy. If it costs less than a barrel of oil to extract a barrel of oil, energy is a net contributor to our lives. The less energy it takes to extract energy, the greater the economic influence – the world economy has benefited greatly because, for a long time, it took very little energy to obtain more energy. However, as the difficulty of extraction rises, it takes more energy to extract a barrel of oil and the economic benefits shrink. Eventually, when it takes 1+ units of energy to extract 1 unit of energy, the energy form is a sink and is no longer a viable source of economic or societal benefit.
Over the past decade energy prices have been rising as the difficulty to extract new sources rose. The days of sticking a straw in the ground and watching the oil gush out have been replaced by deep water drilling, shale oil and arctic exploration. Not coincidentally, the economies of the western world appear to have reached their limits. Real economic life has been replaced by the last gasps of a credit-based system. What little growth we’ve seen over the past 10 years was fueled easy money rather than real economic growth and the middle class today appears to be falling apart.
I believe the middle class may unfortunately be a fleeting phenomenon in the economic history of the world. With the availability of cheap energy, mankind stumbled upon a windfall gain that lasted a couple-hundred years, and democratic societies chose to spread the new wealth across all its members, creating a moderate, well-off majority that strengthened domestic stability. As this windfall gain begins to dwindle (because energy is harder to obtain), societies are caught between paying the over-promises of the past and watching domestic stability disintegrate.
As they are over-levered to consumption growth in a world where consumption growth is shrinking, developed market economies are highly vulnerable to a shrinking energy ROI. This vulnerability is bubbling to the surface, as the middle class in the western world has struggled over the past decade and real economic activity in developed energy consuming nations has disappointed. Crash after crash, recession after recession, we could be witnessing the beginning of the slow demise of the middle class. The devolution of the middle class could take generations to play out, just as it took generations for a meaningful middle class population to form. Nevertheless, unless we discover a way to raise energy ROI to previous levels, the middle class might vanish.
Sep 272011
Is it possible? Is it a scam? What do the ads that promise cheap gold really offer?
Sep 252011
This is a re-post from an article I wrote December 2010. I think it’s appropriate give that Europe is now putting all its chips on the EFSF and IMF:
Earlier in 2010, when it appeared like Greece was close to defaulting on its debts, members of the European Union created an emergency bailout fund called the European Financial Stability Facility.
This fund was put together in order to supply emergency liquidity to EU members that could no longer access the bond market under favorable terms (I.e. affordable interest rates). So far, the facility has been accessed by Ireland, which suffered a ‘near economic death’ experience. Greece also received a bailout earlier in 2010, but this pre-dated the facility. In both cases, it was deemed that a coordinated bailout would be more palatable than an outright default.
The lesson taken from the Lehman Brothers collapse illustrates why authorities wish to avoid the default of another highly interlinked entity. The default of a major nation could lead to another global run on the banks, which are highly exposed to sovereign debt. Also, as government bonds are historically viewed as low-risk, conservative public and private pension funds also have large sovereign debt exposures. A government bond default would simply shift the bail-out decision to the financial system and pension system. As the financial and pension systems include thousands of entities, a bail-out would, at this point, be a far more decentralized and complicated undertaking.
Bail-outs are the preferred route for most Treasury and central bank officials. However, bail-outs are becoming increasingly unpopular among the masses, as they watch the elite flourish by dipping into already depleted tax coffers. At some point, the political climate of democratic nations could either tip towards authoritarian control or democratic popularism. For now, crony capitalism and the bail-outs continue.
The European Financial Stability Facility ‘allocated’ €750 billion for future funding crises. This money, however, does not exist and will not appear out of thin air. The facility raises funds on an ‘as needed basis’ by selling bonds to large investors (e.g. foreign governments, pension plans, etc.). The funds are then pooled to provide bail-outs to members in trouble – a one-for-all and all-for-one approach. The bulk of the facility is ‘covered’ a €440 billion guarantee made by EU member states.
The value of these guarantees depends on the strength of the state providing the guarantee. When member states have to contribute to a bailout, they collectively tap into their own fiscal reserves and/or borrowing capacity via the facility. If the guarantor country has insufficient reserves they must issue bonds. Alternatively, funding nations can take (steal?) from long-term assets. For example, to fund part of its own bailout Ireland plundered the pension assets of its children and grandchildren, under the assumption that future growth will cover the re-payment. This is a giant logical leap for a country experiencing a devastating real estate collapse and massive unemployment. Asset-liability matching be damned…Ireland is swinging for the fences.
Frankly, Germany (and maybe France) is the only country holding the EU economy together so the EU guarantee (which encompasses many countries with economies far weaker than Germany’s) is tantamount to taking from the poor to give to the poor – most other EU members are themselves sub-prime borrowers of the sovereign kind.
So far we’ve only seen the relatively isolated, and manageable, cases of Greece and Ireland hitting the fan. What happens if/when the bond vigilantes hit Portugal, Italy or Spain? Each member that falls simply concentrates the obligations of remaining EU members, intensifying their own funding requirements and fiscal stress. The ‘all-for-one’ side of the equation weakens substantially as members drop into fiscal oblivion. The pro-cyclicality of the weakening process has the potential to quickly send the EU economy spiraling out of control.
In what amounts to a massive bluff, the entire fiscal condition of the EU is on the table. If the bluff is called, Germany could be left holding the bail-out bag. By this point, the market for EU bonds would have seized, the ECB could be running the printing presses at full speed and Germany would be on the verge of succession. If Europe burns, don’t expect the rest of the global economy not to feel the heat.
So what rating is a rating agency to give such a gamble? (This is where things get ridiculous.) The rating agencies see the European Financial Stability Facility as a triple-A investment. This view is similar to that used when analyzing the credit worthiness of CDOs and residential MBS that re-packaged sub-prime real estate loans of days past. The bail-out fund, which essentially re-packages the debts of fiscally-stretched, sub triple-A countries that could fall like dominos if the fund actually gets used to a significant extent, has been granted a rating that makes it eligible for even the most conservative widows and orphans pension fund.
To be clear, I’m not necessarily forecasting anything (positive or negative) for Europe. I am, however, attempting to illustrate the systemic risk introduced by such a shell game. Because of the bigger numbers involved, this is a farce of a much grander scale than the sub-prime CDO mess that unraveled and nearly destroyed the global banking system in 2008. In fact, we’ve manufactured a ponzified, securitized gamble of such massive proportions that the downside risk could make October 2008 seem like a fairy tale.
Random thoughts as I sit and watch my kids in the playground:
1. Politicians and businesses lie and get away with it.
2. The risks are bigger than anyone ever thinks.
3. Individuals, institutions and governments are gravely unprepared for any above-average risks.
4. Buy and hold investing needs a whole lotta things to work befor it does.
5. No matter how confident they may be, economists and politicians really don’t know what they’re doing.
6. At the end of every economic ‘solution’ to a crisis is a central banker with his finger on the ‘print’ button.
7. We would rather be lied to and live in denial until a crisis blows up in our faces.
8. The majority will always have to clean up the mistakes of the few.
8a. The middle class will always have to clean up the mistakes of the elite.
Sep 202011
Over the past decade investors have quietly made a big change in the way they buy companies.
Just over a decade ago people clamored for companies with light speed growth, justifying valuations for unprofitable companies with new metrics like clicks and eyeballs.
Nobody knew how these businesses would ever make money, never mind repay shareholders, but somehow everyone “knew” dot-com companies were the way of the future. This was a time when nobody (except classic investors like Warren Buffett) talked about earnings or dividends.
One dot-com crash later the world is a different place. Maybe it’s the need to pay for retirement, maybe it’s the want for something tangible, but, unlike during the tech bubble, investors today seek yield. And the current market decline has produced some juicy dividend yields for some DJIA components:
• AT&T, Inc (T): 6.02%
• Verizon Communications Inc. (VZ): 5.51%
• Merck & Co. Inc (MRK): 4.71%
• Pfizer Inc (PFE): 4.43%
• Intel Corporation (INTC): 3.83%
• General Electric Co. (GE): 3.71%
Many of my readers have asked why investing strategists such as
Don Coxe and David Rosenberg believe in dividend yields. If you’re wondering too, here are just 5 of the many reasons to love dividends:
1. Bird in the Hand Theory
Finance theory (Modigliani – Miller) states that before taxes and transaction costs, investors should be indifferent to whether a company pays a dividend or not. In theory the total returns for two equivalent companies, one that pays dividends and one that does not, should be equal. In reality, even if tax rates and transaction costs make no difference, many investors prefer a known, cash-in-hand (after all, a capital gain isn’t real until a stock is sold) return to something less tangible.
2. Management “Discipline”
Like interest on debt, dividend payments on equity capital enforce a degree of discipline on company management. While dividends are theoretically discretionary, managers are extremely reluctant to cut them because a dividend cut, barring widespread economic chaos, broadcasts management failure. Because of this attitude towards dividend cuts, managers work hard to ensure that cash-flow exists to cover dividends. This means that management must pay particular attention to profitability and return on business investment.
In my opinion, this is the most debatable reason to invest in dividend paying companies. Corporate executives have any number of tricks to cook the books and shuffle money to cover dividends (over the short term at least). Moreover, as we’ve seen with many dividend paying financial companies during the market crash, the longevity of dividend policy is only as good as the longevity of the company’s business model. In other words, a business model that may provide profit and a good return on business investment today may actually do so to the detriment of profitability and return on investment in the future.
3. Signals from Insiders
Given the amount of discipline needed to maintain dividends, corporate management will only raise dividends when they are very confident about the future. In many respects, a dividend increase signals to the world positive news that corporate insiders may not be able to divulge.
The reverse is also true. If a company’s management hasn’t raised dividends for a while, why not? What do they know that isn’t being disclosed to the public?
4. Raw Outperformance
There are a number of research studies that show dividend paying stocks outperform non-dividend paying stocks (Ned Davis Research). Research also suggests that, despite conventional wisdom, companies with high payout ratios grow earnings faster than companies with low payout ratios (Rob Arnott, Research Affiliates LLC). While these studies don’t necessarily forecast the future, they do provide some comfort for the dividend investor by providing quantitative validation of the strategy.
5. Get Paid to Wait
Let’s face it, investors can get eager and buy a stock too early. If someone buys a dividend paying stock and it declines in price, a regular dividend helps ease the pain while the investor waits for the price to recover. In fact, many investors buy dividend stocks with the mentality that they are buying a long-term cash flow stream, and don’t necessarily ever intend to take back their original capital investment.
For more dividend ideas, take a look at this: 3 Cheap, High Yield Big Oil Stocks
Sep 192011
