Month: February 2009

The House Goes Broke

I spent the weekend in Las Vegas attending a collectable card game tournament. I got to spend some time with my friend, and blog reader, Kevin, who was organizing the tournament. Since I’m a poker player by trade, and since there are plenty of places to play in Los Angeles, I didn’t do any gambling while in Vegas. Instead I took the opportunity to show my girlfriend the town. It was her first time, so I took her to my favorite casino, The Bellagio. As always, it didn’t disappoint. 

Before seeing The Bellagio, her understanding of Vegas was a town that was entirely gaudy and flashy town that was entirely devoid of taste; it’s not that she didn’t like the town, but that she felt that the garish, in-your-face, depictions of the city was what had to be appreciated in and of itself.  In essence, she felt that the nonstop carnival nature of the town permeated everything from the design of the casinos to the behavior of the patrons and that that was its charm. If you could appreciate that, you could have a really fun time, but don’t expect to ever see anything that one could objectively think of as tasteful of beautiful. The town was a carnival. If you wanted taste, you came to the wrong place. 

The Bellagio immediately changed her opinion. She was immediately overtaken not only by the amount of wealth that was on display for all to see. As you can imagine, with a construction price-tag of $1.6 billion dollars, there’s a lot of wealth on display. The celling of the lobby has a display of hand blown glass flowers that, apparently cost over $1 million dollars. There’re really quite beautiful. I always have to pause and just marvel at them. She was speechless, and that was just the beginning of her journey of wonderment. Beauty and taste was everywhere. From the Louis XIV chairs used in the phone room, to the world’s largest chocolate fountain in the desert parlor, everything was simply beautiful. 

I’ve often indicated to people that Las Vegas is my favorite city, and The Bellagio is a big part as to why. Of course, it’s a product of the bubble era. The exorbitant cost of its construction was financed by corporate bond offerings by its owner at the time, Steve Wynn who ran Mirage Resorts Limited. Mirage Resorts was later acquired by MGM to form the corporation MGM Mirage which controlled virtually every high end Vegas casino you could name. Unfortunately, the expense of all of the debt used to make all of those big fancy casinos is now getting hard to finance given that people are cutting back on travel and entertainment.

According to MGM’s latest earnings statement, their earnings are down 66.7% year-over-year. That means, for every $1 they made last year, they made $0.43 this year. Investors have not been very forgiving; the stock has lost over 90% of its value in the last year. The company is currently trading at a price-to-book ratio of .35, which would suggest that the $1.6 Billion dollar Bellagio casino is selling for $560 million today.  

The story of the this stock is the story of both Las Vegas and America: the easy money was flowing and it made both consumers and investors a little crazy; investors poured money into extravagant projects designed to capture more of the consumers money; now that the consumers have gone broke, the investors are in danger of doing the same. Another casino operator, Station Casinos, is defaulting on its bonds and is about to file bankruptcy. Trump Entertainment is also probably a goner this year.  MGM will probably do the same as this recession continues to deepen over the next few years. 

It seems clear that, in light of current events, that The Bellagio was a bad investment, but that does not make it any less beautiful. When deflationary crashes grip an economy, people marvel at how anyone could have spent so much money on such ridiculous projects. In the internet era, it was Pets.com. Today, we are beginning to realize that the Iraq War as a ridiculous way to spend our money. The Bellagio is a child of the era of easy money and poor investments. It stands as a monument to consumer excesses induced by easy money. I doubt another such casino will be built in the United States for decades to come.

It may become increasingly reviled by some as a monument to greed and foolishness, but I will never be among that crowd. Yes, The Bellagio was a poor business investment, but, unlike the Iraq War, it didn’t kill anyone (at least, none that I know of). It may have been built far larger than necessary, but, unlike the “bridge to nowhere”, it wasn’t at taxpayer expense and its far more pleasant place at which to spend time. As this recession drags on, we will need some cheer and value in our lives and I think the Bellagio may be there to provide it for us. Sure, MGM may go bankrupt, but the casino itself is an asset that will emerge from bankrupcy under some new owner and eager to attract customers- which brings me back to my original topic. 

Las Vegas is really a town of value if you know where to look. My girlfriend and I got a room with a king-size bed for $45 a night, and the casino was advertising rooms as low as $25. We ate steak and eggs breakfasts for $5, and toured a luxurious casino, including art museum and fountain show, for free. For those of you who are looking for a good value vacation spot, I’d encourage you to visit Las Vegas. One of the most helpful guides I’ve found is the book Comp City by former pit boss and fellow Texan, Max Rubin. The stories in the book alone are priceless, and the insiders view of how to work the Las Vegas comp system is fantastic.

I look at the mistakes and excesses of the city of Las Vegas as a microcosm of the mistakes and excesses we have made as Americans. I had to stifle a laugh as I walked past an office in The Bellagio that was selling exclusive condominiums in a project that hadn’t yet been completed. Given how much cheap housing their is in Las Vegas right now, and how far the housing market has to fall, the room probably represented the worst room you could step into in Vegas. After all, in the table games, all you can lose is the money you put up. In Las Vegas real estate, you stand to lose far more. Hey, just ask the house.

Why Diversification is a One-Way Ticket to Poverty

I got another client for my investment advisory services today; an old friend of mine meet me for breakfast. We always had good conversations, and this was no exception. I thought my readers here would benefit from a condensed version of what we discussed. As we were meeting to discuss investment strategies, the specific focus of our conversation was how to position yourself to survive a crash in the dollar- a topic which I know something about.

My friend brought up the topic of the Weimar Republic. He is quite a history buff and I know that he recently completed reading a book on the rise of the Nazis. Today he was wondering how stocks did during that period. The answer was that the broad stock market took quite a hit during that period, but, as a wealth preserving measure, the stock market certainly did far better than say bonds or cash did (although the calculation are a little complicated because of the currency switching). But if we were to place ourselves in that situation, would we place ourselves into the equivalent of a broad based stock mutual fund.

The answer was an obvious no. Not only would we need to survive hyperinflation and the collapse of the Weimar Republic, but also the ensuring World War that saw the devastation of the country. Who would want to own the German stock market over that time? But, if you owned shared in a company that did survive, such as BMW, you would have an investment that would have preserved at least a portion of the wealth you had put into it. If your investment horizon was even longer, BMW would, I’m sure, show quite a return on your investment- even if you had invested on the eve of the hyper-inflationary affair.

Of course, we are acting here with the gift of hindsight. We have knowledge now that BMW is a good car company in 2009, so if we are picking German companies to have owned in 1920, BMW seems a good one. That brings us to the topic that is on everyone’s mind today: where should I put my money in order to best preserve and perhaps grow it in the future. Many people will tell you that the answer to that question is unknowable without the future knowledge that we possessed in our hypothetical Weimar example. They’re wrong. The future really isn’t as hard to predict if you know where to look.

It should have been fairly obvious to anyone who lived in the Weimar Republic that their currency was in trouble. They had lost a war and been saddled with a war debt that they could not possibly pay. Sure, they may have maintained the debt for a time, but how could anyone have thought that such a debt would eventually get paid off? As it turned out, it didn’t survive the first serious post-war economic downturn.

We are not in such a different situation today. It should be obvious to most anyone that the United States is never going to pay off its debt. It would be far too onerous. Instead, there will come a time when the debt will be rendered worthless either because of default of hyperinflation of the currency. We know that day will come eventually, so it’s not as if our own future is so hard to foretell. Given that knowledge of future events, how should we preserve our wealth?

Gold is the obvious choice. Not only does it become more desirable in times of crisis, it can help you bribe officials when you flee the country… if it comes to that. Try doing that with a mutual fund. But if we wanted to step away from the goldbug position for a bit and recommend broker sold securities so we can be respectable at dinner parties, which ones present themselves as tempting targets?

I talked about two different investment options that I found attractive: foreign Real Estate Investment Trusts (aka REITs) and, my personal favorite, Barrick Gold. Each presents an attractive option; foreign REITs are yielding in the neighborhood of 15% in foreign currencies and Barrick gives you exposure to gold while being a dividend paying stock. Ultimately, it seems he seems to be favoring Barrick. That took me by surprise a bit given that he works closely with real estate projects. I though the foreign REITs would have been a natural choice, but it seems he’s taking the political upheaval possibilities pretty seriously. 

We also reviewed his tax situation. I told him about a maneuver he could use to make his kids private school tuition tax deductible. It’s perfectly legal and it should save him a fair amount of money. I took real pride in knowing the difference I can make in people’s lives. When the whole world’s going down the tubes, the smallest victories have meanings. I vaguely remember the closing lines of the movie City of Joy with Patrick Swayze. The movie was brutal in its depiction of life in India, and, at the end, Om Puri says something like “The odds are stacked against being human.”

Swayze’s character replied, “That’s why it feels so good to beat the odds.”

In the Eye of the Hurricane

Gold sold off a bit today; the Comex spot price was down $25 or so to $880, which is close to where it started the year. The talking heads are see this kind of action and come up with the headline that “Gold falls on speculation rally went too far.” Of course, I wonder how they came up with that conclusion. It’s not much over where it opened this year or the last. So what rally are they really talking about?

Sure, gold has come back a lot from when the central banks where elephant stomping it with paper gold claims back in October, but when you see headlines such as “Treasury needs to borrow $493B in current quarter” (which is two trillion dollars annualized) I’d expect to see gold going a lot higher than that. But I can’t say I’m surprised. In fact, I was hoping for it.

Since I’m actively trading a portion of my shares of Barrick Gold (ticker symbol ABX), the volatility helps me to make money. It just becomes basic at that point: buy low, sell high. If you buy and it dips lower, just hold it. You can’t keep gold down in an economy that is running trillion dollar deficits; it’ll come back up, just be patient. But in terms of exploding off the charts like we saw in the late 1970s through early 1980s, the central banks are doing their level best to keep that from happening. That means you have gold going ever higher, only to be pushed down in a flurry of Comex future contract selling. I mean hey, if you know the powers that be are doing all they can to play hell with your favorite commodity, you might as well try to profit from it- right?

I spent some time looking over the blogs I wrote back in October. When I read them I almost question who wrote them. I know it was me, but the day to day events I’m describing is almost too fantastic to be believed. The Dow Jones Industrial Average having one days swings in excess of 10%. Gold falling down to $745 only to make it all the way up to $920 soon thereafter, only to give most of it back up… only to rise again. The volatility of that period seems to have given way to the complacency of this one. People seem to have accepted the idea that deflation is upon us, but that the magnitude of the inflationary policies of the US Government and the Federal Reserve will ameliorate what’s going on. Furthermore, many people seem to also believe that the Federal Reserve will then be able to mop up all of that liquidity once inflation rears its ugly head and that we’ll somehow end up alright.

In that way, I suppose we see ourselves as a being in the eye of the hurricane. We know that we just went through a bad storm. It’s pretty clear that it’s still raging, but we feel safe in this weird pressure pocket between the forces of high pressure and low pressure. We know that eventually we’re going to have to endure the other end of the storm, complete with its ferocious eye-wall, but things are OK for now. For that matter, people believe, they will eventually be OK again. I suppose they are right in that way, but the long term eventuality they are thinking of is much father away than they’re thinking.

The truth is, we’re not talking about things go back to normal in a year or two. That’s just not going to happen. Instead, this crisis is only going to get worse, and we will have episodes of volatility just as we did last year. It’s not going to get better next year, or the year after. This crisis is going to drag on year after year after year until, eventually, the whole system crashes. It’s just like I told the church congregation on Saturday, we aren’t witnessing a recession. We are witnessing the death of our financial system. You see, we one had productive industries in this country, but we decided to replace them with a printing press. It defied common sense, but the Keynesians told us it would work out… but it’s not working out… and here we are.

So gold is down a bit today. Fine. I hope it goes a bit lower, because that’s where I have my next buy order in for Barrick Gold stock. Gold and gold mining stocks are experiencing constant upward pressure, but they keep getting knocked about by a financial system that won’t accept its own demise. The bankers sell gold short in an effort to keep its price down while those of us who know better, keep buying more. The strain between the two has resulted in larger premiums between the price for physical gold and the Comex spot price. Right now the premiums seem to be around $100 or so. Not as high as they were in October and November, but still high enough to show the strain between the demand for physical gold and the forces at work in the market for paper gold.

Then there are the bystanders just sitting around and hoping that everything works out OK, that they will get to keep their job, and that they might someday be able to pay off those credit cards. They don’t know what the future holds, but they hope. Unfortunately, when gold breaks lose and the system collapses, these are the people who are going to be absolutely devastated. In the song lyrics of Aimee Mann, “It’s not going to stop, ’til you wise up.”

Investing, According to The Bible

I gave a talk at Bethel Temple in Longview, Texas today. It was a largely black, Protestant church; as you can imagine, there was a lot of very vocal Jesus-praising going on. Maybe it was my years of parochial school, but I feel worship services should be more reserved. Of course, I’ve also had a crisis of faith since then, so I’m sure all religious services make me slightly uncomfortable. Still, I believe that the message I have for them — that an economic crisis is unfolding and these people need to make themselves ready — is one that transcends religion. At no time do I hold, or have I ever, held myself out to anyone as an authority on spiritual matters. I’m here to talk about the economy, and I’ve found that Christian audiences are very receptive.

A touchstone I return to is one borrowed from Bill Bonner: capitalism, at its core, rewards virtue and that to prosper in a such a system, we need to be industrious and thrifty. I then point to fact that we, as a nation, have been gluttonous and foolish in terms of how we’ve conducted ourselves, and the economic crisis we’re facing is merely a consequence of that conduct. When speaking to a Christian audience, I term it as we’ve violated Biblical principles, since the following can be found in the Bible:

  • Proverbs 23:21: “for drunkards and gluttons become poor, and drowsiness clothes then in rags.”
  • Proverbs 22:7: “the rich rule over the poor and the borrower is servant to the lender.”

So, just going off of these verses from the book of Proverbs, the Bible seems to pretty clearly state that being thrifty and industrious will lead to prosperity, whereas the reverse will lead to ruin. Add to that the parable of the talents from the book of Matthew, the Bible is telling us that, were we to want to acquire wealth, we need to work hard, save money, and invest it well.

It’s hard to find verses in the Bible that relate to investing much at all, because a lot of the Bible — the New Testament in particular — are about giving up worldly goods and embracing eternal life. Still, Bible verses make the rest of the message more receptive.

Coincidentally, in doing Internet searches for silver, I found Jason Hommel’s website. He has a section dedicated to “Biblical Capitalism” because “it’s what Jesus would do.” In reading the website, he seems to firmly have this conviction with the appropriate uses of “The Lord Jesus Christ” in his speech. In comparison, I feel my discussion of the Bible verses in favor of working and saving far more genuine.

I always get a strong reaction from Christian audiences. This time I talked about the structure of the US economy in terms of four major players:

  • the government that taxes and borrows money and spends it
  • the consumers who earn and borrow money and spend it
  • the bankers who creates the money for the other two
  • and foreign lenders who keep the whole system from collapsing by continuing to lend us money and honor the US Dollar

I told the congregation that the United States transformed itself from a production-based economy to a consumption-based one; that we tried to replace the real wealth acquired by producing and exporting goods with the fake semblance of wealth provided by the printing press. Furthermore, I told them, that what we were now witnessing was not a recession that would subside, but rather a death. We were witnessing the death of the financial system that we had set into motion decades ago.

All in all, I found it a receptive audience. I have been asked back and now have a line on speaking at another church. I am realizing that I need to branch out to speak to other communities, so that’s my next step. As I recently passed the Series 65 exam, and will soon pass the Series 63, I’ll be allowed to call myself a Financial Adviser, and start taking on clients seeking investment advice. I figure, this is one of the better (and cheaper) ways to start building a client base.