Deflation? Only for the Stock Market

I have to take a moment to pat myself on the back.

Around the start of the new year, I said that deflation was not going to be the main concern, and instead, it would be inflation that was going to be making a comeback. As it turns out, the January numbers are in and CPI inflation is up, not down .  Gold closed at $993 an ounce today and is poised to soon break into new all-time highs. In this way, gold is serving its traditional purpose — as the canary in the coal mine warning all of us that things are not well and that danger, (in this case, inflation) is on the way.

Not everything is going up, however. Yesterday, the Dow Jones closed at a 6-year low. Today it went down even more — so now it’s flirting with its 10-year low. The Dow-Gold ratio, which I’ve talked about before, is rapidly reaching new lows. Dividing the Dow’s close of 7365 by gold’s close of $993 gives us a Dow-Gold ratio of 7.4, which is the lowest it’s been in roughly 20 years.

But it’s going to keep heading down even further than that. Soon, we should be seeing a Dow-Gold ratio of three or even two …

Imagine the Dow at 5000 and gold at $2500 an ounce and you get an idea of what the future holds. Continue reading Deflation? Only for the Stock Market

My Investment Scorecard for 2008

I just went through and reviewed how my investments did throughout 2008. I will now reveal my result. Drumroll, please.

In 2008 … my ROI  was …


That’s right. While everyone else went broke, I was makin’ bank. How on earth did I do it? Okay, okay, okay — I’ll tell you. But only ’cause I’m a nice guy; I had three investment accounts: a ROTH IRA, a traditional brokerage account, and a Variable-Universal Life Insurance Policy. At the start of the year, my accounts were invested as follows:

* My VUL Policy had roughly $3500 invested in Gold Mining Stocks through the Rydex Precious Metals Fund. (RYPMX)
* My Roth IRA had roughly $17,000 invested in Water Mining Companies (PHO) and gold bullion (GLD).
* My traditional brokerage account has roughly $1500 invested in the Prudent Global Income Fund (PSAFX)

As you can see from the start, I was invested to profit from a falling dollar. Let’s take a quick step back into the recent past; last fall, to be specific.

It’s October, 2007. The stock markets have recently reached their peak with the Dow Jones closing at 14,100 on the 9th, and I just don’t see how stocks will possibly hold any value with all the bad news now coming out. At the dawn of 2008, I want to try and steer as clear of the main stock market as I can; as February ends, I liquidate both of my Roth positions, basically breaking even.

Springtime, and the market’s begun to heavily swoon; I want to reposition myself to profit from the short side. I put my Roth money into the Prudent Bear Fund, (or BEARX) since it’s 70% short the market, and 30% long on gold mining stocks. Now it’s June; I’m investing another $5,000 into my Roth, (my 2008 contribution), and also continuing to invest in Prudent Bear.

Here comes a September to remember. We see the bankruptcy of Lehman, and the stock market rallying on the news. I’m basically sitting flat in my portfolio for the whole year — quite frustrating. I’d positioned myself well to profit from all of the bad news, and despite the copious amount of it, I’ve yet to show a profit. In fact, the stock market’s flaunting its irrationality by rallying strongly on Lehman’s failure. Over the next couple of days, it’ll proceed to fall, only to rally again as a Keynesian trifecta of Paulson, Bush, and Bernanke totally blow my mind announcing the TARP program.

Now, I’m in totally uncharted territory. I knew the period of history I was living in would show a stock market deflation in comparison to gold, but I wasn’t sure if it would from stocks falling, or gold rising. At the time, it seemed the Powers That Be would be combating the falling market with inflation, and so betting the market would fall, wouldn’t be a winning choice. Going forward, I figured that either: inflation would take hold, raising all boats, (favoring gold particularly), or the market would crash, causing people to then rush to gold in the panic. So, either way, gold was the way to go.

But here is where I made a critical error, choosing to liquidate my short positions just prior to the October crash. I wasn’t sure where to put my money, so half of it went into Barrick gold mining stock (ABX) @ $37, and the other, just sat in cash. A week later, the market’s started crashing, as the credit markets freeze. Barrick’s up to $38, but everything else is uncertain. Volatility has overtaken the market, values bouncing all over the place.

The now frozen credit market prompts me to look into bonds; and, sure enough, I find some South Trust, rated AAA, maturing six weeks from the day I bought them, yielding an annualized 30%. Having done my homework, I knew South Trust, recently acquired by Wachovia, had now been taken over by Citigroup. Seemed pretty clear from all of the TARP madness that Hank, George, and Ben were peddling that Citi wouldn’t be allowed to go bankrupt. So, I sold most of my Barrick stock (for a small profit) and put the $20,000 into the South Trust bonds.

Turned out, it was a great move. Not only did I make $800 in six weeks when they hit maturity, but I say out the bulk of the decline in Barrick. I’d been actively trading it up and down in my traditional brokerage account, pretty much breaking even once all was said and done. But, as the bonds matured, I was still able to scoop up a ton of Barrick Gold close to the bottom. It was a decision at the time, trying to figure out if I should put the whole $21,000 to work in Barrick, or only half, instead. At this point, Barrick was range-bound between $20 and $25, so I decided to invest $11,000 into Barrick at $20.50, leaving the rest in cash to buy more, should it have fallen any further.

Of course, this was a decision I’d come to regret as Barrick took off — and never looked back.

But, by year’s end, Barrick would be trading in the neighborhood of $36 a share, my $11,000 investment now worth $20,600; had I bought in with everything, knowing I would’ve made even more.

Ah, well. It beats losing money.

As 2008 came to a close, I broke even in my traditional brokerage, (funded up to $9,000), my VUL had fallen to $2,200, or so, with my Roth sitting pretty at $32,000.

Okay, I know my math isn’t exact here, because I’ve not annualized any of these figures to correct for the fact that a lot of the money was added mid-year. If I did, my ROI would be even higher. But why be greedy?

All that being said, my final scorecard was:

Start 2007                    Money Added                     Subtotal                      Year-End
Roth IRA                   $17,000                           $5,000                          $22,000                       $32,000
Traditional                 $1,500                           $7,500                           $9,000                         $9,200
VUL                            $3,500                             $260                           $3,750                          $2,250

Totaling up the subtotal field, I get $34,750 and a year-ending of $43,450. That’s right at 25%. As I mentioned, if I’d have corrected the ROI by factoring in the added money only being used for half the year, that ROI would be even higher.

Furthermore, since the major gains all came in the Roth account (which is TAX FREE, don’t forget) that means that my “tax equivalent yield” is even higher. That’s just a fancy way of saying, that since I don’t have to pay taxes on the gains in the Roth, the return is the same as making a greater amount that I would pay taxes on.

All in all, it was a profitable year.

The Not-So-Efficient Market

There is a theory in stock circles called the “Efficient Market Hypothesis.” It was first proposed by a student of famed mathematician Benoit Mandlebroit (who proposed Chaos Theory) named Eugene Fama. The theory is easy to understand; markets such as the stock market have so many players that it reacts instantaneously to process all known information about a given security. A corollary of this theory is that because all information about the market has already been “priced in”, that it’s impossible to beat the market because any actionable information about a given security is already reflected in its price. This theory was popularized in books such as A Random Walk Down Wall Street. It has been attacked in a number of books including Benoit Madlebroit’s The Misbehavior of Markets as well as my book, What Do You Mean My Money’s Worthless.

I’ve found that some of my biggest investing mistakes are caused by giving any credence to the notion that the market has priced in any information at all. Case in point, for much of this year I was an investor in the Prudent Bear Fund (ticker=BEARX) which is a mutual fund that is short the market, yet, despite many of my predictions of doom and gloom coming true, the stock market continued to hold its value in the face of more and more bad news. Then came October. Paulson and Bush announced that they were going to do a massive bailout of all troubled assets on bank balance sheets after allowing Lehman Brother to fail, and the stock market rallied strongly. 

At that point I lost faith that the stock market was going to decline. It seemed that the Federal Reserve and the US Treasury were simply going to inflate the problem away, and the market was responding in just such a direction. So the logical move to me seemed to be to invest in gold in order to protect from inflation and away from shorting. I figured that, with all the bad news that has come out, if the stock market was going to crash it would have already done so. I closed my short positions just before one of the most violent stock market collapses ever based on the belief that knowledge of the credit freeze and oncoming recession were already “priced into” the market. I’m still up on the year (which few people can say) but I missed out on a great opportunity to profit due to my putting ANY credence in the notion that the market was efficient. 

Now I’m realizing that the key to investing is not to predict the tomorrow’s headlines, but rather to figure out which of yesterday’s headlines will the have staying power to shape market movements in the future. That’s what I’m trying to do today. Call it the “Slow Market Hypothesis”- which significant piece of news will the market take the longest to get through its thick head? A question that is very much on my mind today. 

The headline that’s dominated the last couple of months has been that “Deflation is Coming. Run to Cash!” Call me crazy, but I think that headline’s played out now. The headline of today was that “Dollar slides as Obama vows stimulus.” Gold moved strongly up and Barrick Gold, my personal investment vehicle of choice, closed the day up 8.39%. I think that the headlines going forward are going to become more focused on inflation rather than deflation as markets react to the new ending stream of new dollars being cranked out by the Treasury and the Federal Reserve. Just today, it seems that Congress and Bush are dipping into the bailout goody bag for $15 Billion to loan the auto industry. The hard figures on M2 straight from the Federal Reserve says that our money supply has expanded by 7% over the course of year, which is not nearly as alarming as the “Adjusted Monetary Basis” (a measure which accounts for changes in the reserve requirements as well as changes in foreign exchange market intervention) which the St. Louis Federal Reserve Bank publishes. Here, take a look at it yourself:

That’s a rather astounding rise in the monetary base (1400% annualized), and it’s only going to get worse. The next stimulus package that’s being proposed by Barack Obama is roughly $1 trillion

The rise in the value of the dollar was caused because liquidation was forcing people to sell their assets in order to meet margin calls that were written in terms of US dollars, but that’s going to be a short lived phenomenon. As the full impact of these monetary shenanigans start to sink in, the market will seek a safe haven that isn’t being grossly tampered with, and that’s going to lead them back to gold. That’s my prediction anyway, we’ll see how it turns out.

Liquidation Returns to the Stock Market

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

That statement was reportedly attributed to Andrew W. Mellon, Secretary of the Treasury under Herbert Hoover. October has historically been a horrible month for stocks, but it seems that this November is moving stocks even lower. Today, the Dow and S&P both closed at five-year lows. I was lucky to actually not lose much at all; Barrick Gold (ticker symbol=ABX) closed up .33%. Big relief for me, actually. For the last couple of months, it seemed Barrick has been performing at multiples of the stock market: the market would move one way 5%, and Barrick would move the same way 10%. Today, the Dow closed down 5.1%, but Barrick finished up. I find that very encouraging. To me, it seems like gold and gold miners are starting to divorce themselves from the larger market.

Gold has traditionally been a safe haven in troubled times, and any step back in that direction makes the market seem more sane to me. The month of October saw a lot of good stocks and assets being liquidated with the bad as hedge funds had to meet margin calls. Rumor also has it that banks flooded the COMEX with paper gold sales in an effort to raise money, in the hopes that they wouldn’t have to make physical delivery. Today, the COMEX spot price of gold itself was essentially unchanged on a day of rather pronounced liquidation. Citigroup, by comparison example, declined 23%.

It also makes sense that on a day when stocks are seeing a huge sell-off, just after the Fed hints that it’s about to lower interest rates again to less than 1%, that gold would start to rally. And I’m all for returning to a market that actually makes sense to me as opposed to the month of October, where everything fell but the dollar during a time when the dollar was being printed at the largest quantity in history. If this turns out to be a bottom for COMEX paper gold and Barrick stock, then it will make for a very happy holiday season for me.

The above reasons to rally in gold are not even counting the amount of new Socialist policies that have the potential to be introduced in the next two years under the Obama administration. And speaking of Socialist policies — whatever happened to the TARP bailout? You remember — that bailout Bush, Bernanke, and Paulson were telling us were necessary to buy up all the troubled assets on bank balance sheets? Except, it turns out that none of the money apportioned to do so actually went to buying up troubled assets. Which was … y’know … the whole justification for the program to begin with.

Why, I remember way back in the far-off days of last month when the whole justification for the bailout was that the taxpayers would show a profit by buying these troubled assets. Oh, well. You can’t trust the government to actually use the money they raised for the program on which they claimed the money was to be spent.

You heard it here first folks.