.jpg)
2009.05.31
Chosing the right asset class.
In my last post, "What is money?" (http://chinookarch.blogspirit.com/archive/2009/05/29/what...) I referenced the work of Paul van Eeden which shows us that inflation of the "Actual Money Supply" (AMS) has been increasing at a rate of approximately 8% per year since 2006 and appears to be maintaining this high growth rate. If this is true, where is all the new money going? We have seen stock prices rise by more than 35% since their recent bottom of March 6, 2009 so some people would argue that this new money is finding its way there but I doubt it. However, this is a very impressive increase over a period of less than 3 months. I believe that most of the new money is being used to pay down existing debt. We have been bombarded with messages in the mainstream media that the "bottom in stock prices is in" as witnessed by "green shoots" popping up all over the economic and financial landscape. Of course the people who are telling us this are the very same people who completely missed predicting the stock market crash that occured from October 2007 to February 2009. Are they right? Can we expect that all this inflation (or printing of money) by the Fed and other world central banks will continue to find its way into the stock market? Don't bet on it.
Once you answer the question, "Do we see inflation or deflation of the money supply over our planning horizon?", the next question to ask is , "How can I protect my wealth?" In order to answer this you must know what your alternatives are. What are the asset classes in which you can invest your money until you need it for consumption purposes at a later date (such as for retirement or the education of a child)? You only have about 6 choices: stocks, bonds, real estate, commodities, money (currencies) or collectibles.
Lets dispose of the easy ones first. Unless you are an expert in some type of collectibles such as rare paintings or antique cars, you should stay away from collectibles. I would argue that even if you do have this specialized knowledge now is not the time to invest in collectibles as they tend to be illiquid (difficult to sell when you need the money).
What about real estate? If you need a place to live and do not want the uncertainties and hassles of having to move every few years associated with renting then this might make sense. As an investment however this is not a good idea. Typically the asset that created the previous bubble is the last one to emerge after the bust. Take the tech bubble for instance. From the peak of the tech bubble early 2000, the NASDAQ fell over 80% to its ultimate bottom in the fall of 2002. In the six and a half years since reaching this bottom the NASDQ has recovered over 40% but the index still remains 70% below its high reached in March 2000. Not a very good investment if you got got in at the high and held until today. I believe that the housing market will see similar results. We may see a bottom sometime in 2011 but barring a hyperinflationary environment we are unlikely to see the high prices of 2006 for a decade or more. High inventories of unsold homes and high interest rates will see to that.
What about stocks and bonds? If I am right, stock prices have not yet hit bottom. The increasing stock prices that we are currently experiencing is reflective of a bear market rally that will be reversed sometime within the next 3 months. In fact, I expect that the Dow will eventually fall below 5000 before we see a true bottom. Valuations are still too high and corporate profits will likely fall even further as the recession deepens. We may even see a double-dip recession where we fall back into recession only a few months after emerging from the current recession. There are many reasons for this prediction but let me just summarize by saying that the problems that caused the financial crisis to occur are still with us and are possibly getting worse. The central banks and financial oligarchs that got us into this mess are trying to reinflate the bubble with even more debt. This very much like a drunk trying to drink himself sober. It is axiomatic that the solution to a problem cannot be to choose the same alternative that caused the problem to occur in the first place. As for bonds, interest rates will have to go considerably higher in order to attract the investment needed by the US Treasury to finance its massive deficits projected over the next decade. Higher interest rates mean a fall in bond prices so bonds are not a reasonable asset choice in the foreseeable future.
That only leaves us with money and commodities. This is where I would suggest you invest over the next several years. Say 40% cash and 60% commodities (or 50/50 if you are more conservative). Money or cash in the form of insured bank deposits or hard currency will be an attractive alternative to the losses otherwise incurred by those investing in stocks and bonds. It will also be good to have cash to invest in some cheap stocks and/or bonds when the true bottom is finally reached. It may be best to hedge your inflation risk by investing in several currencies at the same time. I consider gold bullion to be more like money than a commodity so I would include it in this asset class but even if you see it as a commodity you should carry 10 to 20% of your portfolio in gold bullion as insurance against both inflation and a total collapse of the fiat currencies that you hold.
What commodities should you invest in? I would choose those commodities that are considered essential needs. I include energy and food in this category. Oil, natural gas, grains, uranium as well as beef and pork should do well over the next several years. Luckily there are numerous ETFs (exchange traded funds that are basically like mutual funds but trade like stocks) that you can use as investment vehicles. You can get the name of some of these from your broker or just search the internet for the commodity ETF that you wish to invest in. Also silver bullion (in the form of bullion bars and coins) can be held in your safe deposit box as a good hedge against inflation. I treat silver bullion as a commodity since it is more like an industrial commodity than a monetary metal. I would not recommend investing in the ETFs of base metals or stocks of base metal producers. It is likely that world trade will be depressed for several years so these commodities will not see the increases that are likely to be seen in oil and gas for example.
Bottom line is that it is time to get very defensive in your investment portfolio if you have not already done so. Start by paying down debt and reducing your consumption in order to increase savings. I have been preaching this to my family and friends for several years now and it is not yet time to let down your guard. Do not chase higher returns ... they will be elusive and short lived. Such a strategy will more often than not result in losses as gains. Be very patient and be satisfied with protecting the wealth you have already accumulated. Remember that over the next several years return "of" investment will be more important than return "on" investment.
20:28 Posted in Finance | Permalink | Comments (0) | Email this | Tags: investment class, money, stocks bonds, real estate, commodities, collectibles, financial crisis
2009.05.28
What is money?
What is money and what is meant by inflation of the money supply? How can we measure inflation? You will get many different answers from different economists as to how to measure money: M0; M1; M2; M3; MZM; and TMS. I believe that the last one mentioned (TMS or True Money Supply) is the correct measure. It was proposed by the late Murray Rothbard, an economist of the Austrian school of economic thought. Unfortunately no government agency measures TMS but Paul van Eeden has developed an approximation of TMS for the US which he refers to as Actual Money Supply (AMS). You can find out what real money is by reading his article on the subject which is short and easy to understand at http://www.paulvaneeden.com/The.Actual.Money.Supply. He has updated the graph of monetary inflation to April 2009 at http://www.paulvaneeden.com/Actual.Money.Supply.
This is all well and good and it helps us to understand what money really is but how can we use this information to make sensible investment decisions? I will address this question in my next post.
Gerry
21:23 Posted in Finance | Permalink | Comments (0) | Email this | Tags: m0, m1, m2, m3.tms, ams, murray rothbard, paul van eeden
Is the worst yet to come?
14:46 Posted in Finance | Permalink | Comments (0) | Email this
2009.05.27
More debt!
Individuals and corporations are still either defaulting on their debt or doing their best to repair their mismanaged balance sheets by attempting to pay down their debt. The governments of the world however do not want to let this happen. They have taken it upon themselves to replace private debt that is disappearing with public debt. The Canadian government has had government surpluses for several years and have actually paid down total government debt ... until this year that is. Just a few months ago Jim Flaherty, the Canadian finance minister, announced that Canada could expect to incur a deficit of $30 billion in 2009 in a worst case scenario. Today he announced that the estimate of the Canadian deficit for 2009 has risen to $50 billion. I am predicting that it will likely be closer to $65 billion. Why? Because revenues are falling, unemployment is rising and the government will likely be increasing the balance sheet of the Bank of Canada by $40 billion in order to buy bank assets from the Canadian chartered banks in an attempt to help them bring down their still high leverage ratios. The government has smugly proclaimed that Canadian banks are in much better shape than any other western banks and yet they feel compelled to bail them out with these cash infusions. The Bank of Montreal today announced that their profits dropped in 2Q09 by 44% over the same quarter last year and guess what happened? The markets rewarded BMO by increasing the share price by 5.17% in one day (to close at C$43.71). The reason for this share price increase is that the markets deemed that the reduction in profits were not as bad as had been expected. This "improvement" over expectations occurred as a result of a lower than expected charge for probable loan defaults. Of course expectations can change in the future as well.
BMO today also announced a layoff of 1100 management positions across Canada which the market also applauded. Speaking of layoffs and unemployment we also heard today that Canadian unemployment claims jumped by 10.6% in March from the previous month, the biggest increase since the labour market started to weaken last October. The province of Alberta was hit hardest with regular unemployment beneficiaries increasing by 32.1% in March from the prior month and more than doubling since October 2008. The Certified General Accountants of Canada (CGA) also released their debt report that said that the total debt held by individual households has reached an all-time high of C$1.3 Trillion which is roughly equal to the Canadian GDP. Anthony Ariganello, President and CEO of CGA-Canada states: "Many Canadians are not aware of how the economic downturn has impacted their financial situation and continue to load up their credit cards and lines of credit, while committing few, or in some cases, no resources to savings."
Can the governments succeed in selling the massive amounts of new debt needed to stimulate the economy, bail out banks and maintain (or increase) spending in the face of declining revenues? Please read the article by Ambrose Evans-Pritchard in today's Telegraph and decide for yourself.
Gerry
19:20 Posted in Finance | Permalink | Comments (0) | Email this | Tags: debt, bank of montreal, canadian deficit, bmo
2009.05.25
The Crisis and How to Deal with It
I have an interesting and thought provoking
article to recommend to you today. It is actually a few excerpts from a
symposium on the economic crisis presented by The New York Review of Books and
PEN World Voices at the Metropolitan Museum of Art on April 30. The participants
were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini,
George Soros, and Robin Wells, with Jeff Madrick as moderator. These are
some very heavy thinkers in economics and include some of the people that were
concerned about a financial crisis even before it occurred. Niall
Ferguson, Nouriel Roubini and George Soros actually predicted the crisis before
the fact. The article can be found at http://www.nybooks.com/articles/22756.
I agree with most of the discussion but I object to
the recurring mention of a "savings glut" that some participants seem to believe
led us into this crisis. I do not believe that a savings glut ever
existed or that it even can exist. Talk of a savings glut only makes sense
if you believe that we had reached the ideal level of debt in the world and that
this ideal level of debt must be maintained at all costs. I believe that
the problem is that we had excessive levels of debt. There can be no such
thing as a savings glut since savings = investment. The problem is
that the market made bad investments (actually malinvestments)
due to the erroneous signals given to decision makers through manipulated
interest rates. Interest rates have been manipulated by the central banks
for almost a century in the false belief that a few powerful people can do a
better job at setting the price of money (i.e.. interest rates) than the market
can. I would suggest that most people believe that it is impossible for
the government to set the price for consumer goods in the economy (like shoes
for example) without causing massive disruptions in supply and demand. The
failed experiment of central planning attempted by the USSR and Communist China
as well as other command economies is testament to this. So why is it that
almost nobody questions the ability of central planners to set the most
important price in the economy, the price of money (interest rates). The
errors made by these central banks in the past century (but especially since
1970) have caused us to take on much more debt than we as a society are able to
repay. We built too many large residential dwellings (McMansions) and
created too many toxic financial assets (such as credit default swaps or
CDS). There is no demand for these products, or at least the demand
greatly exceeds supply so their prices are falling. There is no knowable
ideal level of debt. It is up to the market to decide how much debt to
take on and how much to save and invest. These decisions can only be made
in a rational way if the price of money is not manipulated by some academics and
self interested politicians and bank managers but instead left to the market to
determine.
Gerry
18:16 Permalink | Comments (0) | Email this
2009.05.22
The future of pension funds.
Today the CAW (Canadian Auto Workers) announced its
latest agreement with GM Canada. The union bargained hard to protect the
pensions of its retired workers but they had to agree to a freeze in cost
of living allowance increases until at least 2015. This bargaining was
looked upon by many as a test of the sanctity of Canadian private pension
plans. I don't think that we have seen the last of this
battle.
Pension plans and government entitlement programs
are under attack worldwide. This will ultimately lead to increased savings
(and a reduction of debt loads) by consumers everywhere. The share of GDP
contributed by consumer spending is bound to fall especially in the US. To
get an idea of how bleak the future of pensions (both public and private) looks
in the US please read Michael Pento's article: Who Will TARP
America?
Gerry
13:41 Permalink | Comments (0) | Email this
2009.05.20
Is fractional banking fraudulent?
Fractional lending gone awry is what led us into
the current financial crisis and which could still lead to what some refer to as
"the Greater Depression". Is fractional lending in and of itself
fraudulent? Certainly our bank charges and other fees would skyrocket
upwards if fractional lending was made illegal. It is hard to imagine how
or if our society could even function without it. Karl Denninger argues
convincingly that fractional banking could and should be allowed to
continue. He argues that it is not so much the banks who are at fault as
the regulators who allowed the banks to circumvent the safeguards put in place
following the Great Depression of the 1930s. Please read his recent
article entitled: Making Sure "It" Never Happens Here (Again).
Gerry
12:02 Permalink | Comments (1) | Email this
2009.05.16
The most important video you'll ever see.
Why do I claim that all fiat currencies are doomed? This is a mathematical certainty and not merely a prediction. All fiat currencies are debt based. This means that the amount of debt must increase exponentially into perpetuity in order to feed the debt (and interest) monster. This is flat out impossible.
Do yourself a favor and watch the following series of videos (8 in all) that will open your eyes to the problems of debt, oil usage, population growth, water usage, water quality, pollution and most other problems faced by humankind. I know ... this is a tall order ... but see for yourself.
15:44 Posted in Finance | Permalink | Comments (0) | Email this | Tags: important video
The new protectionism
It is generally accepted that trade wars and
protectionism made the depression of the 1930's deeper and longer. In a
misguided attempt to "save jobs" and "buy local" politicians destroyed the
efficiencies produced by the natural division of labour and world trade.
Although the intended goal of maintaining local employment is laudable, the
unintended consequences of political meddling resulted in a net loss of
jobs. This process is being repeated again in this current crisis.
Protectionism is on the rise throughout the world and especially in the
US. Will this new protectionism push us over the edge into a full blown
depression? Please read the following Washington Post article, "A New Form
of Trade War Brews".
Gerry
10:52 Permalink | Comments (0) | Email this
2009.05.12
Credit Default Swaps ... useful insurance contracts or systemic time bombs?
I suspect that many of you are aware that the
exponential growth of financial derivatives over the past 2 decades had
something to do with the financial crisis that began in mid 2007 and is
continuing today but perhaps you are not sure exactly how the global financial
markets were negatively affected by these instruments. These opaque
financial instruments were (and still are) held by many to be nothing more than
insurance contracts taken to protect against the risk of financial loss due to
the bankruptcy or default of corporate bond issuers. This position was
even put forward by Greenspan, Rubin, Sumners and others over the past 2 decades
to justify their reluctance to see CDS and other over-the-counter (OTC)
derivatives regulated in any meaningful way. We were told that these
instruments were a good thing for society; that they would reduce systemic
financial risk by spreading this risk widely so that no one loss could trigger a
crisis similar to the Long Term Capital Management (LTCM) failure in 1998
following the Russian financial crisis. In fact the failure of Lehman
Brothers in September 2008 had much to do with the crisis we now find ourselves
in. The Lehman failure led directly (within days) to the takeover by
the US government of AIG, one of the world's largest insurance companies.
Today AIG is an insolvent entity save for the cash infusions of its new owner
... the US taxpayer.
So what went wrong? Why didn't the CDS
insurance contracts save us from this calamity? The reason is that these
contracts were not really insurance policies at all. As many of you know I
used to teach insurance theory some time ago. These CDS instruments were
anything but insurance. In fact they were more like gambling in a casino
than taking out fire insurance on your house. First of all insurance law
requires that the insured have an insurable risk on the property or life that he
is attempting to insure. Otherwise someone could take out a policy against
my house then intentionally burn it down in order to collect the insurance
payment. Secondly the insurer is required by law (supervised by a public
regulator) to hold sufficient asset reserves to enable the insurer to pay any
losses that may occur. Both of these basic insurance principles were
violated by the CDS OTC market. Since they were traded OTC they were
considered private contracts and there were no specific regulations in
force. It was assumed that each counterparty would "do the right thing"
and set up sufficient reserves. Greenspan and others certainly did not
want any government regulator slowing the growth of this new financial product
that was making so much money for the large US banks, brokers and insurance
companies (as well as massive bonuses for their traders and managers).
Also no insurable interest was required ... even by the insurance company
counterparties such as AIG that should have known better. Any legal
person could take out a CDS contract on any other legal entity as long as a
willing counterparty could be found. As predicted by insurance theory the
lack of such controls has led to the spread of a dangerous new form of
instrument with all sorts of unintended consequences. A recent example is
the partial default of BTA, Kazakhstan's largest bank caused in part by Morgan
Stanley, a major creditor of the bank. Why would Morgan Stanley push a
client who was servicing its loans into default? Perhaps to collect on its
CDS? Read the Financial Times article here: http://www.ft.com/cms/s/0/fa0428ee-35a7-11de-a997-00144fe...
If you would like to know more about CDS and other
financial derivatives Wikipedia has a lot of useful information here: http://en.wikipedia.org/wiki/Credit_default_swap
Gerry
15:06 Permalink | Comments (0) | Email this