Showing posts with label investments. Show all posts
Showing posts with label investments. Show all posts

Sunday, March 25, 2018

This Week's Stock Market Analysis & Warning in Layman's Terms

As you likely know, the stock market, trading, and even long term investing are not easy. That’s why in this post we want to make the complex simple for you. We will do this in a way that will give you that “Eureka!” moment regarding knowing what the stock market is doing now, and where it is headed over the next 12-36 months.

Last August we spotted trends in the underlying financial system that are very early warning signs that the bull market in stocks will be coming to an end, along with this growing economy. There is a ton of data taken into account for this information, but we have broken it down into simple bite size points that simply make logical sense, from a technical analysts perspective.

First Warning

Back in April 2017, we posted an article showing the first set of data that most traders and investors do not see or follow, mortgage delinquency rates. Delinquency rates in Single Family Residential Mortgages and other Consumer Loans began to climb through the second half of 2016 and continue to rise today. We shared with readers a way to take advantage of this using the Real Estate Bear Fund (DRV). This fund is now up over 20% and climbing as it rises when real estate falls. The rise and timing of this delinquency rate increase coincide almost identically with the Fed when they raise rates. And the problem is not just mortgages defaulting, the same is happening with commercial loans, and credit card debt.

Just look at what has the fed being doing like a mad-man of late? Ya, jacking up rates like they are going out of style!

The graph below shows a red line which is the fed rate, and as that rises so do loan delinquency rates (blue line). You will also see the grey shaded areas on the graph, and these are bear markets (falling stock prices). It’s obvious that we are headed towards financial issues once again with debt and the stock market.

Mortgage Rates and Delinquency Rates on the Rise



On March 18th 2018 we post an update showing how real estate foreclosures are starting to rise dramatically! Subscribers to our Wealth Building Trading Newsletter took advantage of this as we got long SRS inverse real estate fund which jumped over 5% in the first two days of owning it.



Second Warning – Asset and Business Cycles

Because we are traders and investors our focus is on making money, so we are only looking at the blue wave/cycle on the diagram below. The blue cycle is the stock market, and the numbers posted along that cycle indicate which stocks/assets should be the most in favor, rising.

As you can see the numbers 9 and 11 at the top are both commodity based (precious metals and energy). And knowing that commodities typically perform well just before a bear market in stocks unfolds, we are on the cusp of a new trade that could last a few months and post significant gains.



COMMODITY PRICE INDEX

Take a look at the commodity index chart below. Without getting to deep in to stage analysis I will just say commodities have formed a very strong “Stage 1” and are primed and ready for a multi-month rally.



Third Warning – Psychology of the Market

This market appears to be in a EUPHORIC “wonderland” moment driven by the fact that the global central banks have created a waterfall event of cheap money that is driving all of this asset valuation recovery. And, as capital is continually searching for the best environment for ROI, it is moving into the best areas of the global economy for survival purposes which we feel should soon be commodity-related assets, then eventually cash once the bear market takes hold.



Stock Market Conclusion

In short, as long as the capital continues to flow into the securities (stocks) and commodities in search for the best return on investment, we will continue to see markets hold up. But, stay cautious because when the markets turn and money is no longer looking for the next top performing sector or commodity, but rather just wants to exit investments as a whole and convert to cash (cash is king), that is when the bear market starts, and it could be very quick and violent.

Additionally, as we’ve shown with these charts and graphs today, we are entering a frothy period in the markets, and we would urge all investors to be critically aware of the risks involved in being blind to these facets of the current stock market and housing bubbles.

With 53 years experience in researching and trading makes analyzing the complex and ever-changing financial markets a natural process. We have a simple and highly effective way to provide our customers with the most convenient, accurate, and timely market forecasts available today. Our stock and ETF trading alerts are readily available through our exclusive membership service via email and SMS text. Our newsletter, Technical Trading Mastery book, and 3 Hour Trading Video Course are designed for both traders and investors. Also, some of our strategies have been fully automated for the ultimate trading experience.

Chris Vermeulen
Technical Traders Ltd.



Stock & ETF Trading Signals

Thursday, December 22, 2016

Five Easy Ways to Make Your Finances Less Fragile

By Justin Spittler

A few days ago, we sat down with E.B. Tucker, editor of The Casey Report, to talk shop. The conversation was so good, we just had to share it with you. In the following interview, E.B. talks about how he manages his own money. As you’ll see, he has a unique, yet intuitive approach to investing, especially when it comes to asset allocation. We hope you find this conversation as useful as we did. Also, make sure you read until the end to learn about one of E.B.’s top speculations.

Justin Spittler: I want to talk investment strategy. Could you tell us how you manage your own money?

E.B. Tucker: I like to break up my investments into buckets. I have about five of them. I have one for gold, one for permanent life insurance, one for real estate, and two for stocks. I don’t limit myself to a certain number of buckets. But I’ve had very good results looking at asset allocation this way.

J.S.: Can you tell us a little more about your “buckets”? Why do you break them up this way? What kind of assets go into each?

E.B.: First of all, the buckets change with life and market conditions. For example, I put most of my capital into a real estate bucket in 2009–2010. As you know, the U.S. housing market had just crashed. If you had the capital, you could buy some houses for next to nothing. And that’s exactly what I did.…

During that period, I bought six single-family homes. I bought one of them for just $10 per square foot. I spent another $10 per square foot fixing the place up, so I put about $20 per square foot all in. The guy before me paid $160 per square foot and ended up in foreclosure. He bought near the peak of the housing bubble. My timing was much better. Today, I’m not adding to my real estate bucket. There just aren’t that many great deals out there. This is key to how I invest. Rather than fight the market, I let it determine how I allocate my money.

J.S.: Can you tell us about some of your other buckets?

E.B.: Well, I have a bucket for gold. But I don’t view gold as an investment designed to make money. I see it as a key long term asset. When gold is cheap, I pour money into this asset. I don’t think about this bucket often. I just get the gold, vault it, and move on.

I also have a permanent life insurance bucket. This bucket is important because I have a few people that depend on me. If I die, they’re out of luck. So, I need to have life insurance. Specifically, I own a couple dividend-paying life insurance policies. A lot of people consider these terrible investments, but that’s because they don’t understand them.

You see, any extra money that I put in this bucket on top of the minimum annual premium grows 6% to 7% per year, tax free. If I don’t use the policy, over time I’ll have a fairly large amount of cash in that bucket that I spend, borrow from, or use to buy more life insurance. And, of course, if the worst does happen, my dependents receive a large death benefit. This money will help them get by in my absence.

J.S.: Interesting, it sounds like this bucket protects you and gives you flexibility.

E.B.: Exactly. The reason I invest this way is because it makes me less “fragile." Now, I still have plenty of exposure to rising asset prices in other buckets. But, if you’re smart about when and how much you add to each bucket, your “boring” buckets will eventually balance out your more speculative buckets. The result is a more stable financial situation without giving up the quest for profits. I like investing this way because I no longer worry about trying to maximize my profit on every trade or every time the market changes course.

J.S.: Let’s talk about your stock buckets next. I’m sure our readers would love to know what’s in your portfolio. 

E.B.: Sure. As I said earlier, I have two of them. One is for stocks I plan to hold for the long haul. I don’t trade these stocks often. I’m only a seller if something happens that changes the business landscape for one of the companies. I typically own between six and eight of these companies at any given time. One of my favorite long term holdings is a company that make crackers you buy at the gas station and pretzels that go well with beer. Last year, the company acquired a business that sells almonds and other nuts. It’s a great company. And it now pays me a decent yield of 3%, since I’ve owned the stock for a few years.

J.S.: What are some of your other long term stock holdings?

E.B.: I also have shares of one of the country’s best regional banks. And I own shares of one of America’s most iconic companies. This company is basically a drug dealer, peddling sugar and caffeine from small rented stores. You get the picture. Now, these aren’t the most exciting investments in the world but, over time, you see the value of owning rock solid American businesses.

You end up with companies that slowly capture market share from their competitors, invest money back into their businesses, and pay dividends. I don’t see how you can get hurt having this bucket represent 20% of your net worth. It’s also worth mentioning that I like to own these stocks in company sponsored dividend reinvestment plans.

Since these are long-term investments, I don’t want to log into a brokerage account and see them next to my trading positions every day. Holding them directly on the company’s books means all my dividends get reinvested into additional shares, usually at no cost. The final benefit is I don’t have to worry about my broker going bust. Holding shares directly registered with a company means there’s nobody standing between you and your investment.

J.S.: That leaves us with your speculation bucket. Can you tell us a little bit about this one?

E.B.: Ah, my favorite. I’ve done fairly well speculating. The key here is separating good speculations from bad ones. As a professional investor, a lot of opportunities come across my desk. Most of them aren’t worth my time. You have to pass on a lot of bad speculations before you find a great one.

J.S.: Can you tell us about one of your better speculations?

E.B.: At a lunch meeting with my banker in 2009, he told me about a company in town that invented a hurricane simulation machine. They placed a few in malls, shopping centers, arcades, and museums and charged $2 per customer. The test machines took in $4,000 to $5,000 per month. The company built each machine for around $12,000. The company had trouble getting a bank to lend it money. It was right after the financial crisis, after all.

I met with the company, saw the machine, and looked at their business plan. A few other investors and I funded the company. We bought preferred shares that paid a 20% dividend. We also received a portion of the company’s profits for the first two years, which boosted our initial returns. Seven and a half years later, I’m still collecting monthly checks from the company. I’ve more than doubled my money, and I could sell the shares anytime I want.

J.S.: Have you done any other speculations like this recently?

E.B.: Yes. Before I got into this business, I ran a gold fund for a few years. My former business partner from that fund just took his gold streaming and royalty company public. Our company policy does not allow me to share the name of the stock, since I own shares. I’m involved in that deal to the tune of about 1% of the company. I think there’s a realistic shot that I’ll make 5–10 times my money.

J.S.: Most people would kill to make that much on a single investment. Why are you so optimistic?

E.B.: I think it’s a good time to speculate on small gold and silver stocks. I especially like royalty and streaming companies like this one. They avoid the tremendous financial burdens that mining companies face.
I also look for companies that have a winning strategy but that are overlooked by the market. If these companies execute, my odds of success go up.

But you need to have cash on hand, or what some people call dry powder, to take advantage of these opportunities. That’s because great deals usually require quick action. When one of my speculations is a winner, I’ll take profits and put them into other buckets, depending on what looks good at the time. I almost never leave the entire profit in the bucket it came from.

J.S.: Got it. So, do you like to keep a certain percentage in each bucket at any given time? What rules, if any, do you follow?

E.B.: I don’t really follow a set of rules when it comes to asset allocation. That makes it hard to take advantage of huge opportunities when they appear. For example, I wouldn’t have invested in the Florida rental real estate market in 2009 and 2010 if I stuck to strict rules. When in doubt, you can divide new money equally between buckets. You can also sit on cash and wait for buying opportunities to present themselves.

J.S.: What kind of investments do you focus on in The Casey Report?

E.B.: That’s your most valuable question so far. In The Casey Report, we fill the long-term stock and speculative stock buckets. We try to predict what the investing world will be like one to two years down the road. We then buy stocks that will benefit most as the world changes. In stock investing, that’s the sweet spot where you find the most value in the shortest period of time.

Our goal is to beat the S&P 500 every year. We want our readers to have enough success to irritate their wealth manager. Hopefully, they can use that success and the lessons learned in The Casey Report to beat the market in their asset buckets.

J.S.: Thank you for your time, E.B.

E.B.: You’re welcome.

In August, E.B. told his readers to buy a small North American mining company. At the time, few investors knew about the company. Its stock traded for less than $1. But E.B. said the stock wouldn’t fly under the radar for much longer…and he was exactly right.

In just four months, this stock has soared 115%. Normally, we wouldn’t encourage you to buy a stock after an explosive run like this. But E.B. recently went on record and said, “the stock doubled, it will double again.” To see why, watch this brand-new presentation. It talks about an event that E.B. says will take place exactly one month from today. If the event goes as expected, this stock should skyrocket again.

You can learn more about this event, including how to take advantage of it, by watching this FREE video.

The article Five Easy Ways to Make Your Finances Less Fragile was originally published at caseyresearch.com.



Stock & ETF Trading Signals

Saturday, November 15, 2014

So....Your nervous about trading overnight options trades? Don't be, and here's how!

You've seen us talking about a new Options strategy that John Carter was working on recently...and he is finally sharing it with us.

Video: My Favorite Way to Trade Options on ETFs

This strategy is the "sleep at night as you trade options" strategy. And we ALL need that!

Here's just a taste of what John shows you in this video:

*  Why trading options on ETFs cuts your risk so you can sleep at night

*  How you can profit with ETFs from the unexpected move in the dollar

*  Why you avoid the games high frequency traders play by trading ETFs

*  Why most analysts have the next move in the dollar wrong and how to protect your investments

*  What are some of the markets that will be impacted by the dollars next move

Here's the link to watch the video again

Enjoy the video,
Ray C. Parrish
aka the Crude Oil Trader


Reserve your seat now for John's next FREE webinar "Why You Should Trade Options on ETF's"....Just Click Here!


Friday, September 5, 2014

What does a “good” Chinese adjustment look like?

By John Mauldin


People of privilege will always risk their complete destruction rather than surrender any material part of their advantage. Intellectual myopia, often called stupidity, is no doubt a reason. But the privileged also feel that their privileges, however egregious they may seem to others, are a solemn, basic, God-given right. The sensitivity of the poor to injustice is a trivial thing compared with that of the rich.
– John Galbraith, The Age of Uncertainty

Malinvestment occurs when people do stupid things with free money. One of the characteristics of malinvestment is its dominance; i.e., other investments have little chance of competing. Malinvestments always bust and end in liquidation.
–  Joan McCullough, writing yesterday in her daily commentary

Worth Wray and I have been writing for some time now about the problems that are developing in China. Worth is somewhat more pessimistic about the outcomes than I am, but we agree that China is problematic. China is the number one risk, in my opinion, to global financial economic stability, more so than Europe or Japan, which are also ticking time bombs.

I contend that Xi and Li are the most radical leaders of the Chinese nation since Deng Xiaoping, with the emphasis being on Xi. He is shaking up the current power structure by going after some of the entrenched leaders for corruption. He has earned rebukes from a former president for his actions in op-eds in the Financial Times. This is extraordinary pushback and clearly shows that what is happening is beyond the normal regime-change shakeups we have seen in China.

Make sure you catch this weeks video "What Market Makers Don't Want You to Know".....Just Click Here

For today’s Outside the Box, we turn to my friend professor Michael Pettis to get his latest take on China. Michael’s biography describes him as a “Wall Street veteran, merchant banker, equities trader, economist, finance professor, entrepreneur – iconoclast – Michael Pettis is a unique individual living and working in China, at the heart of the world’s most exciting and vibrant economy.” He is certainly all that and more and just an all-around fun guy to hang out with. I mean, where else do you get a professor who also helps found an indie rock club in Beijing? I should note that he is a professor at Peking University’s Guanghua School of Management. He is published everywhere and gets to talk to “everyone” in China. So I pay attention to what Michael Pettis says when it comes to China. Michael writes a free blog but also has a subscription service that you can get to on his website.

He posted a blog on Monday asking the question, “What does a ‘good’ Chinese adjustment look like?” Which of course assumes there might be a bad Chinese adjustment.

And while the consequences of a smooth transition would be important for those who live in China, the consequences if Xi and Li get it wrong would be significant for the world. We need to be paying attention. This piece is a good overview of what “we” would like to see happen. But as Michael points out, there are some in China who very much don’t want our favored scenario to play out.

For most of the Western world, summer is officially over with the beginning of September, although technically the equinox will not arrive for another 20 days. For the most part, I enjoyed a lazy Labor Day (apart from the obligatory workout), ending with a cookout by the pool with family and friends, joined by David Tice (formerly of the Prudent Bear and my neighbor in the building) and his crew.

My kids gave me a lot of grief because I mentioned Henry’s birthday last week as being his 31st. It is his 33rd. In my defense I at least got the birthday part right. I cannot believe how fast my kids are growing up / have grown up. To see them interacting as adults is both pleasurable and unsettling. I don’t feel any older than they look, although my body complains every now and then and more than it used to. But I know that technically speaking I am anywhere from 29 to 45 years older.

But for the nonce I think I will ignore the technical part and go with my feelings. At least until reality issues a true wake-up call.

Your not ready to give up the game analyst,
John Mauldin, Editor
Outside the Box

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Each day, you get the three tech news stories with the biggest potential impact.

What does a “good” Chinese adjustment look like?

By Michael Pettis
Michael Pettis’ China Financial Markets

I have always thought that the soft landing/hard landing debate wholly misses the point when it comes to China’s economic prospects. It confuses the kinds of market-based adjustments we are likely to see in the U.S. or Europe with the much more controlled process we see in China. Instead of a hard landing or a soft landing, the Chinese economy faces two very different options, and these will be largely determined by the policies Beijing chooses over the next two years.

Beijing can manage a rapidly declining pace of credit creation, which must inevitably result in much slower although healthier GDP growth. Or Beijing can allow enough credit growth to prevent a further slowdown but, once the perpetual rolling-over of bad loans absorbs most of the country’s loan creation capacity, it will lose control of growth altogether and growth will collapse.

The choice, in other words, is not between hard landing and soft landing. China will either choose a “long landing”, in which growth rates drop sharply but in a controlled way such that unemployment remains reasonable even as GDP growth drops to 3% or less, or it will choose what analysts will at first hail as a soft landing – a few years of continued growth of 6-7% – followed by a collapse in growth and soaring unemployment.

A “soft landing” would, in this case, simply be a prelude to a very serious and destabilizing contraction in growth. Rather than hail the soft landing as a signal that Beijing is succeeding in managing the economic adjustment, it should be seen as an indication that Beijing has not been able to implement the reforms that it knows it must implement. A “soft landing” should increase our fear of a subsequent “hard landing”. It is not an alternative.

Surprisingly enough, until the announcement last month that Zhou Yonkang was under investigation, Premier Li has been pretty insistent that China will make its 7.5% growth targets, even as many analysts have lowered their expectations (Moody’s and the IMF are now saying that 6.5% is a possibility), and it is clear that President Xi is taking far more responsibility for and control of the economy than any recent president. My guess is that as the problems of the real estate sector kick in, with lower prices causing a drop in real estate development, which matters for employment, we are likely to see additional stimulus spending aimed at managing the threat of unemployment and, perhaps more importantly, at managing the possibility of rising anger among provincial elites as the glorious prospect of easy money continues to retreat.

This, to me, is the explanation for the rather surprising insistence by Premier Li in June that 7.5% GDP growth was a hard target. GDP targets are part of domestic signaling about the expected pain of adjustment. I suspect that lower growth targets are likely to generate greater opposition.

Certainly it does seem that growth has temporarily bottomed out. According to this June’s Financial Times, “Expenditure by local and central governments in China jumped nearly 25 per cent from the same month a year earlier, a sharp acceleration from the 9.6 per cent growth registered in the first four months of the year, according to figures released by the finance ministry,” and HSBC’s Flash PMI index suggests for the first time in six months that there has been an expansion in manufacturing, although the flash index is, of course, preliminary and may be revised.

Can Beijing rein in credit?


There should be nothing surprising about the improvement in some of the numbers. The “soft landing” that we are seeing is a consequence of credit growth. It means that it is proving politically hard to implement reforms as quickly as some in the administration would like, and it also means that we are getting closer to debt capacity constraints. We would be better off with the long landing scenario, in which GDP growth rates drop sharply but manageably by 1-2 percentage points every year.

I have written many times before that what will largely determine the path China follows is the political struggle the Xi administration will have in imposing the needed reforms on an elite that will strongly resist these reforms – mainly of course because these reforms must necessarily come at their expense. As an aside my friend, Ken Miller, with whom I was having a very different discussion last week, just sent me one of his favorite John Galbraith quotes (from The Age of Uncertainty) that seemed apropos.

People of privilege will always risk their complete destruction rather than surrender any material part of their advantage. Intellectual myopia, often called stupidity, is no doubt a reason. But the privileged also feel that their privileges, however egregious they may seem to others, are a solemn, basic, God-given right. The sensitivity of the poor to injustice is a trivial thing compared with that of the rich.

Although I don’t think China’s economy is adjusting quickly enough, especially credit growth, I remain cautiously optimistic that Beijing knows what it must do and will be able to pull it off. In an older issue of my blog, I tried to place the last 3-4 decades of Chinese growth in a historical context that recognizes four different stages of this growth process. By doing so I try to show how China’s own recent history can help us understand how to consider the policies President Xi must implement.

The first stage of China’s growth story, which occurred mainly during the 1980s, consisted of liberalizing reforms that undermined the Communist elite and which were strongly opposed by them. Because power was highly centralized under Deng Xiaoping, however, including a loyal PLA, he and the reform faction were nonetheless able to force through the reforms.

The next two stages of growth, I argued, required policies that had a very different relationship to the interests of the Chinese elite. Because they involved the accumulation and distribution of resources to favored groups whose role was to achieve specific economic targets, they helped to reinforce the wealth and power of a new elite, many of whose members were, or were related to, the old elite. Not surprisingly this new elite strongly supported the growth model imposed by Beijing during these stages.

The fourth stage, I argued, is the stage upon which we are currently trying to embark. In an important sense it involves liberalizing reforms similar politically to those that Deng imposed during the 1980s, making it vitally important to their success that the current administration is able to centralize power and create support to overcome the inevitable opposition, which it seems to be doing.

This is why, even though Beijing doesn’t seem to have yet gotten its arms around the problem of excess credit creation, I nonetheless think it is moving in the right direction. For now I would give two chances out of three that Beijing will manage an orderly “long landing”, in which growth rates continue to drop sharply but without major social disruption or a collapse in the economy. In this issue of the newsletter I want to write out a little more explicitly what such an orderly adjustment might look like.

Will financial repression abate?


The key economic policy for China over the past two decades has been financial repression. There have been three components to financial repressive policies. First, by constraining the growth of household income and subsidizing production, China forced up its savings rates to astonishingly high levels. Second, by limiting the ways in which Chinese households could save, mostly in the form of bank deposits, Beijing was able to control the direction in which these savings flowed. Finally, Beijing controlled the lending and deposit rates and set them far below any “natural” level.

Very low interest rates had several important impacts. First, because they represented a transfer from net savers to net borrowers, they helped to exacerbate the split between the growth in household income (households are net savers) and the growth in GDP (which is generated by net borrowers), and so led directly to the extraordinary imbalance in the Chinese economy in which consumption, as a share of GDP, has declined to perhaps the lowest level ever recorded in history.

Second, by making credit extremely cheap for approved borrowers, it created among them an almost infinite demand for credit. Financial repression helped foster tremendous growth in economic activity as privileged borrowers took advantage to borrow and invest in almost any project for which they could get approval.
Third, when China desperately needed investment early in its growth period, this growth in economic activity represented real growth in wealth. But low interest rates, along with the moral hazard created by implicit guarantee of nearly all approved lending, led almost inevitably to a collapse in investment discipline. Financial repression has been the main explanation for the enormous misallocation of capital spending we have seen in China during the past decade.

This is why understanding financial repression is so important to understanding the way in which China will adjust. There are two ways to think about the “cost” of financial repression to net savers. The least sophisticated but easiest to explain is simply to look at the real return on loans and deposits. In this case you would subtract the appropriate deflator from the lending or deposit rate.

In the US we usually use CPI inflation as the deflator, but for many reasons this won’t do in China. Consumption is a much lower share of GDP in China than in the US or anywhere else, so that it is less “representative” of economic activity, and there is anyway a great deal of dispute about the rate at which the consumption basket is actually deflating (Chinese households seem to think it seriously understates inflation). I prefer to use the GDP deflator, which until about 3-4 years ago was in the 8-10% region and currently runs around 1-2% or even less, depending on the period you are looking at.

Using the GDP deflator suggests that the real rate for savers has been very negative for most of this century until the past three years – with savers implicitly losing perhaps as much as 5-8% of their real savings every year. It also suggests that the real rate for borrowers has also been negative, perhaps by 1-3% for most of this century. Clearly these interest rates are too low, especially for a very volatile, poor, and rapidly growing economy.

The more appropriate measure of financial repression is not the deflator, whichever one we choose to use, but rather very roughly the gap between the nominal lending rate and the nominal GDP growth rate, the latter of which broadly represents the return on investment within the economy. Until a few years ago nominal GDP grew at around 18-21% while the lending rate was around 7%.

This is a huge gap. In this case the “cost” of financial repression to households was the gap between nominal GDP growth and nominal lending rates, plus an additional 1-1.5% to account for the larger than normal gap between the lending rate and the deposit rate. This is because in China the gap between lending and deposit rates during this century has been much higher than in other developing countries, probably as part of the process of recapitalizing the banks after the last banking crisis at the turn of the century.

If you multiply the sum of these two gaps by the total amount of household and farm deposits (very roughly around 80-100% of GDP a few years ago, when I last checked), you get an estimate of the total transfer from the household sector to banks and borrowers. Because I think China’s nominal GDP growth has been overstated by a substantial amount because of its systematic failure to write down bad loans, I usually have subtracted 2-4 percentage points from the nominal GDP growth rate before I did my very rough calculation. This was how I got my 5-8% of GDP estimate for the amount of the annual transfer from households to savers. This of course is a huge transfer, and can easily explain most of the decline in the household share of GDP over this period.

It is worth noting by the way that a recent widely-discussed study by Harry Wu of the Conference Board claims the China’s average GDP growth from 1978 to the present was not 9.8% but rather 7.2%. The main reason for the revision, according to Wu, is that the GDP deflator had been significantly underestimated which, if even partially true, means real interest rates were even lower (more negative) than I have assumed.
There is some controversy about whether it is true that the nominal lending rate should be broadly equal to the nominal GDP growth rate. In fact most studies of developed countries suggest that over the medium and long term this is indeed the case. UBS tried to show that this was not applicable to China and did a study several years ago showing that among developing countries this relationship didn’t hold. Their studies suggested that among developing countries nominal lending rates had on average been around two-thirds on nominal GDP growth rates (although China, at around one-third, was still well below anyone else’s at the time).

I had a real problem with their sample of countries however. Their sample included a lot of small OPEC countries, who necessarily had high growth and low interest rates when oil prices were high, as well as a lot of Asian countries that followed the Japanese development model and themselves practiced financial repression, which of course made them pretty useless as points of comparison. Neither group of countries, in other words, could help us determine what a “normal” interest rate is compared to nominal GDP.

But regardless of the debate, the point to remember is that when the nominal lending rate is much below the nominal GDP growth rate, two very important things happen. First, it helps eliminate capital allocation discipline. If GDP is growing nominally at 20%, for example, and you can borrow at 7% (which was the case in China for much of this century), you should rationally borrow as much as you can and invest it into anything that moves, no matter how poorly thought out the investment. Imagine a totally ineffective investor, or one whose incentives do not include earning a reasonable return on capital, who manages to earn on his investment only half of nominal GDP. This would be a pretty poor use of capital.

Adjusting the repression gap


But with nominal GDP is growing at 20%, this extremely incapable investor still makes a substantial profit by borrowing at 7% and earning 10%, even though his investment creates no value for the economy. His “profit”, in this case, is simply transferred from the pockets of saving households.

Under these conditions it should be no surprise that borrowers with access to bank credit overuse capital, and use it very inefficiently. They would be irrational if they didn’t, especially if their objective was not profit but rather to maximize employment, revenues, market share, or opportunities for rent capture (as economists politely call it).

The second point to remember is that in a severely financially repressed system the benefits of growth are distributed in ways that are not only unfair but must create imbalances. Because low-risk investments return roughly 20% on average in a country with 20% nominal GDP growth, financial repression means that the benefits of growth are unfairly distributed between savers (who get just the deposit rate, say 3%), banks, who get the spread between the lending and the deposit rate (say 3.5%) and the borrower, who gets everything else (13.5% in this case, assuming he takes little risk – even more if he takes risk).

This “unfair” distribution of returns is the main reason why the household share of income has collapsed from the 1990s until recently. I calculate that for most of this century as much as 5-8% of GDP was transferred from households to borrowers. The IMF calculated a transfer amount equal to 4% of GDP, but said it might be double that number, so we are in the same ballpark. This is a very large number, and explains most of why the growth in household income so sharply lagged the growth in GDP.

This was why financial repression, although useful in the early stages of China’s growth period because it turbocharged investment, ultimately became one of the county’s biggest problems once investment no longer needed turbocharging. For many years nominal GDP growth in China was 18-21% and the official lending rate was around 7%. This, combined with widespread moral hazard, had inevitably to result in both tremendous misuse of capital and a sharp decline in the consumption share of GDP (as the household income share declined) – both of which of course happened to a remarkable degree in China.

In the last year or so, however, the official lending rate has risen to 7.5% and nominal GDP has dropped to 8-9% (and just under 8% in the first quarter of 2014). This changes everything in China. First, it is now much harder for borrowers to justify investment in non-productive projects because they can no longer count on the huge gap between nominal GDP growth and the lending rate to bail them out of bad investments. Of course this also means a dramatic slowdown in economic activity, but because this slowdown is occurring by the elimination of non-productive investment, the slowdown in Chinese growth actually represents higher wealth creation and greater real productivity growth. China is getting richer faster now than it did before, even though it looks like wealth creation is slowing (the difference is in the slower required accumulation of bad debt).

Second, the huge transfer from net savers to net borrowers has collapsed, so that growth in the future must be far more balanced. Over time this means that households will retain a growing share of China’s total production of goods and services (at the expense of the elite, of course, who benefitted from subsidized borrowing costs) and so not only will they not be hurt by a sharp fall in GDP growth, but their consumption will increasingly drive growth and innovation in China.

Interest rates are still too low, but not by nearly as much as in the past, and over the next two years as nominal GDP growth continues to drop, the financial repression “tax” will be effectively eliminated. When this happens solvent Chinese businesses will be forced to use capital much more productively, and slowly they will learn to do so. In that case the PBoC will be able to liberalize interest rates (although not without tremendous political opposition from those that have depended on having great access to very cheap capital for their wealth) without worrying about either the deposit rate of the lending rate surging.

There is, however, one group of wasteful borrowers for whom higher interest rates will not represent a more careful approach to borrowing and investing and these, of course, are borrowers that are already effectively insolvent or otherwise unable to repay loans coming due. In that case as long as they can borrow they will do so, no matter the interest rate. It is not clear to me how many such borrowers exist, but I’d be surprised if there weren’t an awful lot of them. These borrowers can only really be disciplined by constraining credit growth and eliminating government support, including implicit guarantees, but this might not be happening.
One of the ways Beijing seems to be reducing the pain of more expensive borrowing (relative to nominal GDP growth) is to loosen credit in a targeted way. We have heard talk of targeted bond purchases although it is not yet clear what exactly Beijing plans to do.

An article in Caixin suggests that regulators may also be trying to relax the loan to deposit constraint:
The China Banking Regulatory Commission (CBRC) will change the rules for figuring the loan-to-deposit ratio so banks can have more money to lend to businesses, an official with the regulator says. The requirement that the ratio not exceed 75 percent – meaning banks cannot lend more than 75 percent of their deposits out – would remain the same, but the way ratio is calculated would be adjusted, Wang Zhaoxing, deputy chairman of the CBRC, said June 6.
The regulator would consider broadening the scope of deposits to include “relatively stable” funds that are not now used to calculate the ratio, he said. He did not say what the funds could be, and added that a precondition for doing this was keeping the money market stable.

I suspect that over the next few months we are going to get very inconsistent signals about credit control. But as long as the PBoC can continue to withstand pressure to lower interest rates – and it seems that the traditional poor relations between the PBoC and the CBRC have gotten worse in recent months, perhaps in part because the PBoC seems more determined to reduce financial risk and more willing to accept lower growth as the cost – China will move towards a system that uses capital much more efficiently and productively, and much of the tremendous waste that now occurs will gradually disappear. Just as importantly, lower growth will not create social disturbance because Chinese households, especially the poor and middle classes, will keep a larger share of that growth.

So what does “good” rebalancing look like?


It seems pretty clear to me that the great distortions in the Chinese economy that led both to rapid but unhealthy growth and to the consumption imbalance (by forcing down the household income share of GDP) are gradually being squeezed out of the system. One distortion has been the excessively low exchange rate, but after seven years of 30-40% net appreciation against the dollar, the RMB is far less undervalued today than it has been in the past. I still do not agree, however, with analysts who say the currency is actually overvalued and call for a depreciation, nor, more importantly, does the PBoC seem to agree.

Another one of the great distortions that led to China’s current imbalances was the very low growth in wages relative to productivity. This too has improved. The surge in wages in 2010-11, and their continued relatively rapid pace of growth, has reduced this distortion significantly, especially as it is becoming increasingly clear that productivity growth has been overstated in recent years.

Most importantly, with nominal GDP growth rates having dropped from 20% to 8-9%, the greatest of all the distortions, the interest rate distortion, has been the one most dramatically to adjust in the past three years. This is why even though many people I respect are still insisting that China has not really rebalanced, I am moderately optimistic that in fact China is adjusting as quickly as could be expected. Credit growth remains a serious problem, but the forces that put China in the position of relying on excess credit growth have genuinely abated.

And it is this abatement of the great distortions that have caused growth to slow so rapidly, and although we haven’t seen much evidence of significant rebalancing yet, it should take a few years for the effects fully to be worked out. Chinese growth is less dependent than ever on the hidden transfers from the household sector, and these transfers both encouraged massive waste and created the imbalances that required this massive waste to continue.

China is still vulnerable to a debt crisis, but if President Xi can continue to restrain and frighten the vested interests that will inevitably oppose the necessary Chinese economic adjustment, he may in the next one or two years be able even to get credit growth under control, before debt levels make an orderly adjustment impossible.

It won’t be easy, and already there are many worried about the politically destabilizing impact his measures may have. The Financial Times, for example, had the following article:

Mr Xi came of age in that turbulent time and watched as his elite revolutionary family and everything he knew were torn to pieces. Now it seems it is his turn to wreak havoc on the cozy networks of power and wealth that have established themselves in the era of “socialism with Chinese characteristics”. In recent weeks, the president’s signature campaign against official corruption appears to have spilled into something more significant and potentially destabilising for the increasingly autocratic regime.

Clearly there are many risks to Xi’s political campaign, and unfortunately I have no special insight into how these are likely to play out, but if Xi is able to consolidate power enough to impose the reforms proposed during the Third Plenum, Chinese growth rates will continue to decline sharply but in an orderly way. Average growth during the decade of his administration will drop to below 3-4%, but an orderly adjustment means that not only will the hidden transfers from the household sector be eliminated, they will also be reversed.

If China can reform land ownership, reform the hukou system, enforce a fairer and more predictable legal system on businesses, reduce rent-capturing by oligopolistic elites, reform the financial system (both liberalizing interest rates and improving the allocation of capital), and even privatize assets, 3-4% GDP growth can be accompanied by growth in household income of 5-7%. Remember that by definition rebalancing means that household income must grow faster than GDP (as happened in Japan during the 1990-2010 period).

This has important implications. First, the idea that slower GDP growth will cause social disturbance or even chaos because of angry, unemployed mobs is not true. If Chinese households can continue to see their income growth maintained at 5% or higher, they will be pretty indifferent to the seeming collapse in GDP growth (as indeed Japanese households were during the 1990-2010 period). Second, because consumption creates a more labor-intensive demand than investment, much lower GDP growth does not necessarily equate to much higher unemployment.

A “good” and orderly adjustment, in other words, might look a little like this:

1.  GDP growth must drop every year for the next five or six years by at least 1 percentage point a year. If it drops faster, the period of low growth will be shorter. If it drops more slowly, the period of low growth will be stretched out. On average, GDP growth during President Xi’s administration will not exceed 3-4%.

2.  But this does not mean that household income growth will drop by nearly that amount. Rebalancing means, remember, that household consumption growth must outpace GDP growth, and the only sustainable way for this to happen is for household income growth also to outpace GDP growth. If consumption grows by four percentage points more than GDP, Chinese household consumption will be 50-55% of GDP in a decade – still low, but no longer exceptionally low and quite manageable for the Chinese economy. This suggests that if investment growth is zero and the trade surplus does not vary much, 3-4% GDP growth is consistent with 6-7% household income growth. It might be in principle possible to pull this off if Beijing is able to transfer 2-4% of GDP from the state or elite sector to the household sector by reforming the hukou system, land reform, privatizations, and other transfers, but of course we shouldn’t assume that this level of household income growth will be easy to maintain once investment growth, and with it GDP growth, drops sharply.

3.  What about employment? If investment growth falls sharply, especially investment in the real estate sector, it should cause unemployment to surge, which of course puts downward pressure on household income growth as well as on consumption growth, potentially pushing China into a self-reinforcing downward spiral. This, I think, is one of the biggest risks to an orderly adjustment. The good news is that if large initial wealth transfers to households can kick start a rise in consumption, growth driven by household consumption, especially growth in services, tends to be much more labor intensive than the capital-intensive investment growth that too-low interest rates have forced onto China. A transfer of domestic demand from investment to consumption implies, in other words, that employment growth can be maintained at much lower levels of GDP growth.

4.  What about the debt, which is the other great risk to an orderly and successful Chinese adjustment? There are two things China can do to address its substantial debt problem. First, it can simply transfer debt directly onto the government balance sheet so as to clean up banks, SOEs and local governments, thus preventing financial distress costs from causing Chinese growth to collapse. As long as this government debt is rolled over continuously at non-repressed interest rates, which will be low as nominal GDP growth drops, China can rebalance the economy without a collapse in growth. This, essentially, is what Japan did in the 1990s.

The problem with this solution is that it is politically attractive (no wealth transfers from the elite to ordinary households) but it does not fundamentally address China’s debt problem, but rather simply rolls it forward. In that case the burgeoning government debt will itself prevent China, once the economy is rebalanced, from ever regaining rapid growth. I have previously explained why the debt burden can prevent growth in my discussions of why I do not think Abenomics can succeed, if by success we mean raising inflation and real GDP growth. What’s more, if a relatively poor, volatile economy like that of China cannot bear the debt levels that a country lie Japan can bear, it is not clear that this solution will work even during the rebalancing period.

A real solution to the debt problem, in other words, may involve initially a transfer of debt onto the government balance sheet, but ultimately Beijing must then take real steps to lower debt relative to debt capacity. This may involve using privatization proceeds to pay down debt, higher corporate taxes, and even higher income taxes if other forms of wealth transfer are robust enough to support them, but one way or another total government debt must be reduced, or at least its growth must be contained to less than real GDP growth.

5.  Although it may be hard to see it in the economic ratios, or in any real restraint in credit expansion, in fact Beijing has already taken serious steps towards rebalancing, although it may take a few more years to see this in the consumption share of GDP. The three most important of the transfers that created the imbalance have all reversed. The currency may still be undervalued, but not by nearly the extent it has been in the past, wages have risen quickly in recent years, and, most importantly by far, the financial repression tax has collapsed, and even nearly disappeared, which it will do fully in the next two years as nominal GDP growth continues to fall (as long as the PBoC does not reduce rates by much more than one or two percentage points over the next two years). Even the much-ballyhooed decision to improve the environment represents a partial reversal of one of the sources of the household share imbalance.

All of these mean that the hidden transfers that both generated spectacular growth in economic activity (if not always in economic value creation) and the unprecedented drop in the household income share of GDP no longer exist, or do so to a significantly reduced extent. It will take time for the elimination of these transfers to work themselves fully though the economy, but we are already seeing their very obvious initial impacts in the much lower GDP growth numbers, even as credit creation remains high.

Credit creation remains the great risk to the economy. It is still growing much too quickly. I think there are few people in Beijing who do not understand the risk, so my guess is that political constraints are the main reason that credit has not been more sharply reduced. I believe that the president cannot allow too sharp a contraction in credit growth until he feels fully secure politically, and for me the pace at which credit is brought under control is, to a large extent, an indication of the pace of the process of power consolidation.

The best-case scenario


Although I am still cautiously optimistic that Beijing will pull off an orderly rebalancing, I want to stress that the scenario described above is not my predicted scenario. It is, instead, an examination of the best case of an orderly transition towards a more balanced economy.

As regular readers know I am not very comfortable making predictions, preferring instead to try to understand the structure of an economic system and work out logically the various ways in which that system can evolve. The description above is one of the ways in which it can evolve, and because I think this is probably the best-case scenario, I thought it might prove useful as a way of framing thinking about the adjustment process for China.

One caveat: This is not necessarily the best-case assumption. I can make certain assumptions, which I haven’t made because I believe them to be implausible, although not impossible, that lead to a better outcome. If the global economy were to recover much more quickly than most of us expect, and, much more importantly, if Beijing were to initiate a far more aggressive program of privatization and wealth transfer than I think politically possible, perhaps transferring in the first few years the equivalent of as much as 2-5% of GDP, the surge in household income could unleash much stronger consumption growth than we have seen in the past. This could cause GDP growth over the Xi administration period to be higher than my 3-4% best-case scenario.

The amount of the direct or indirect wealth transfer from the state sector to ordinary households is, I think, the most important variable in understanding China’s adjustment. The pace of growth will be driven largely by the pace of household income growth, which will itself be driven largely by the pace of direct or indirect wealth transfers to ordinary Chinese households. If we could guess this right, much else would almost automatically follow.

Academics, journalists, and government and NGO officials who want to subscribe to my newsletter, which sometimes includes potions of this blog and sometimes does not, should write to me at chinfinpettis@yahoo.com, stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.

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Tuesday, July 29, 2014

We’re Ready to Profit in the Coming Correction....Are You?

By Laurynas Vegys, Research Analyst

Sometimes I see an important economic or geopolitical event in screaming headlines and think: “That’s bullish for gold.” Or: “That’s bad news for copper.” But then metals prices move in the opposite direction from the one I was expecting. Doug Casey always tells us not to worry about the short term fluctuations, but it’s still frustrating, and I find myself wondering why the price moved the way it did.


As investors we’re all affected by surges and sell offs in the investments that we own, so I want to understand. Take gold, for example. Oftentimes we find that it seems to tease us with a nice run up, only to give a big chunk of the gains back the next week. And so it goes, up and down…..

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The truth is, and it really is this simple, but so obvious that people forget, that there are always rallies and corrections. The timing is rarely predictable, but big market swings within the longer term megatrends we’re speculating on are normal in our sector.

Since 2001, the gold price had 20 surges of 12% or greater, including the one that kick-started 2014. Even with last year’s seemingly endless “devil’s decline,” we got one surge. If we were to lower the threshold to 8%, there’d be a dozen more and an average of three per year, including two this year.


Here at Casey Research, we actually look forward to corrections. Why? We know we’ll pay less for our purchases—they’re great for new subscribers who missed the ground floor opportunities years ago.

This confidence, of course, is the product of decades of cumulative experience and due diligence. We’re as certain as any investor can ever be that today’s data and the facts of history back our speculations on the likely outcomes of government actions, including the future direction of the gold price.

When you keep your eye firmly on the ball of the major trends that guide us, you can see rallies and corrections for what they are: roller-coaster rides that give us opportunities to buy and take profits. This volatility is the engine of “buy low, sell high.” Understanding this empowers the contrarian psychology necessary to buy when prices on valuable assets tank, and to sell when they soar.

There have been plenty of opportunities to buy during the corrections in the current secular gold bull market. The following chart shows every correction of 6% or more since 2001.


As you can see, there have been 28 such corrections over the past 13 years—two per year, on average. Note that the corrections only outnumber surges because we used a lower threshold (6%). At the 12% threshold we used for surges, there wouldn’t be enough to show the somewhat periodic pattern we can see above. It’s also worth noting that our recent corrections fall well short of the sharp sell off in the crash of 2008.

Of course, there are periods when the gold price is flat, but the point is that these kinds of surges and corrections are common.

Now the question becomes: what exactly drives these fluctuations (and the price of gold in general)?
In tackling this, we need to recognize the fact that not all “drivers” are created equal. Some transient events, such as military conflicts, political crises, quarterly GDP reports, etc., trigger short-lived upswings or downturns (like some of those illustrated in the charts above). Others relate to the underlying trends that determine the direction of prices long term. Hint: the latter are much more predictable and reliable. Major financial, economic, and political trends don’t occur in a vacuum, so when they seem to become apparent overnight, it’s the people watching the fundamentals who tend to be least surprised.

Here are some of the essential trends we are tracking…...

The Demise of the US Dollar

Gold is priced around the world in United States dollars, so a stronger US dollar tends to push gold lower and a weaker US dollar usually drives gold higher. With the Fed’s money-printing machine (“quantitative easing”) having been left on full throttle for years, a weaker dollar ahead is a virtual certainty.

At the same time, the U.S. dollar’s status as reserve currency of the world is being pushed ever closer to the brink by the likes of Russia and China. Both have been making moves that threaten to dethrone the already precarious USD. In fact, a yuan-ruble swap facility that excludes the greenback as well as a joint ratings agency have already been set up between China and Russia.

The end of the USD’s reign as reserve currency of the world won’t end overnight, but the process has been set in motion. Its days are all but numbered.

The consequences are not favorable for the US and those living there, but they can be mitigated, or even turned into opportunities to profit, for those who see what’s coming. Specifically, this big league trend is extremely bullish for real, tangible assets, especially gold.

Out-of-Control Government Debt and Deficits

Readers who’ve been with us for a while know that another major trend destined for some sort of cataclysmic endgame can be seen in government fiscal policy: profligate spending, debt crises, currency crises, and ultimately currency regime change. This covers more than the demise of the USD as reserve currency of the world (as mentioned above); it also covers a loss of viability of the euro, and hyperinflationary outcomes for smaller currencies around the world as well.

It’s worth noting that government debt was practically nonexistent, by modern standards, halfway through the 20th century. It has seen a dramatic increase with the expansion of government spending, worldwide. The U.S. government has never been as deep in debt as it is today, with the exception of the periods of World War II and its immediate aftermath, having recently surpassed a 100% debt to GDP ratio.

Such an unmanageable debt load has made deficits even worse. Interest payments on debt compound, so in time, interest rates will come to dominate government spending. Neither the dollar nor the economy can survive such a massive imbalance so something is bound to break long before the government gets to the point where interest gobbles up 80%+ of the budget.

Gold Flowing from West to East

The most powerful trend specifically in gold during the past few years has been the tidal shift in the flow of gold from West to East. China and India are the names of the game with the former having officially overtaken the latter as the world’s largest buyer of gold in 2013. Last year alone, China imported over 1,000 tonnes of gold through Hong Kong and mined some 430 tonnes more.

China hasn’t updated its government holdings of gold since it announced it had 1,054 tonnes in 2009, but it’s plain to see that by now there is far more gold than that, whether in central bank vaults or private hands. Just adding together the known sources, China should have over 4,000 tonnes of monetary gold, and that’s a very conservative estimate. That would put China in second place in the world rankings of official gold holdings, trailing only the United States. The Chinese government supports this accumulation of gold, so this can be seen as a step toward making the Chinese renminbi a world currency, which would have a lot more behind it than U.S. T-bills.

India presents just as strong a bullish case, if only slightly tainted with Indian government’s relentless crusade to rein in the country’s current account deficit by maintaining the outrageously high (i.e., 10%) import duty on gold and silver. Of course, this just means more gold smuggling, which casts official Indian stats into question, as more and more of the industry moves into the black and grey markets. World Gold Council research estimates that 75% of Indian households would either continue or increase their gold buying in 2014. Even without gold-friendly policies in place, this figure is extremely bullish for gold and in line with the big picture we’re betting on.

So What?

Nobody can predict when the next rally will occur nor the depth of the next sell-off. I can promise you this: as an investor you’ll be much happier about those surges if you stick to buying during the corrections. But it has to be for the right reasons, i.e., buying when prices drop below reasonable (if not objective) valuation, and selling when they rise above it. Focusing on the above fundamental trends and not worrying about short-term triggers can help.

Profiting from these trends is what we dedicate ourselves to here. Under current market conditions, that means speculating on the best mining stocks that offer leverage to the price of gold.

Here’s what I suggest: test drive the International Speculator for 3 months with a full money back guarantee, and if it’s not everything you expected, just cancel for a prompt, courteous refund of every penny you paid. Click Here to get Started Now.



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Thursday, April 3, 2014

What Is Worse Than Being at Risk?

By Dennis Miller

You may have heard the old adage: “What is worse than being lost? Not knowing you are lost.” In that same vein: What is worse than being at risk? You guessed it! Not knowing you’re at risk. For many investors, portfolio diversification is just that. They think they are protected, only to find out later just how at risk they were.

Diversification is the holy grail of portfolio safety.

Many investors think they are diversified in every which way. They believe they are as protected as is reasonably possible. You may even count yourself among that group. If, however, you answer “yes” to any of the following questions, or if you are just getting started, I urge you to read on.
  • Did your portfolio take a huge hit in the 2008 downturn?
  • Was your portfolio streaking to new highs until the metals prices came down a couple years ago?
  • Do oil price fluctuations have a major impact on your portfolio?
  • When interest rates tanked in the fall of 2008, did a major portion of your bonds and CDs get called in?
  • Are you nervous before each meeting of the Federal Reserve, wondering how much your portfolio will fluctuate depending on what they say?
  • Has your portfolio grown but your buying power been reduced by inflation?
  • Do you still have a tax loss carry forward from a stock you sold more than three years ago?
There are certain lessons most of us learn the hard way—through trial and error. But that can be very expensive. Ask anyone who has a loss carry forward and they will tell you that the government is your business partner when you are winning. When you are losing, you are on your own.

The old saying rings true here: “When the student is ready to learn, the teacher shall appear.” Sad to say, for many investors that happens after they have taken a huge hit and are trying to figure out how to prevent another one.

Alas, there is an easier way. Anyone who has tried to build and manage a nest egg will agree it is a long and tedious learning experience. The key is to get educated without losing too much money in the meantime.

Avoid Catastrophic Losses

The goal of diversification is to avoid catastrophic losses. In the past, we’ve mentioned correlation and shared an index related to our portfolio addition. The scale ranges from +1 to -1. If two things move in lockstep, their correlation rates a +1. If the price of oil goes up, as a general rule the price of oil stocks will also rise.

If the two things move in the opposite direction (a correlation of -1), we can also predict the results. If interest rates rise, long term bond prices will fall and generally so will the stocks of homebuilders. At the same time, a correlation of zero means there is no determinable relationship. If the price of high grade uranium goes up, more than likely it will not affect the market price of Coca Cola, ticker $KO, stock. So, your goal should be to minimize the net correlation of your portfolio so no single event can negatively impact it catastrophically.

General Market Trends

An investor with mutual funds invested in Large Cap, Mid Cap, and Small Cap stocks may think he is well diversified with investments in over 1,000 different companies. Ask anyone who owned a stable of stock mutual funds when the market tumbled in 2008 and they will tell you they learned a lesson.

Mr. Market is not known to be totally rational and many have lost money due to “guilt by association.” When the overall stock or bond market starts to fall, even the best managed businesses are not immune to some fallout. While the Federal Reserve has pumped trillions of dollars into the system, there is no guarantee the market will rebound as quickly as it has in the last five years. The market tanked during the Great Depression and it took 25 years to return to its previous high.

If you listen to champions of the Austrian business cycle theory, they will tell you the longer the artificial boom, the longer and more painful the eventual bust. Mr. Market can dish out some cruel punishment.
Diversification is indeed the holy grail, but there are some risks which diversification cannot mitigate entirely. No matter how hard you try to fortify your bunker, sooner or later we will learn of a bunker buster. There are times when minimizing the damage and avoiding the catastrophic loss is all anyone can do.

Sectors

Allocating too much of your portfolio to one sector can be dangerous. This is particularly true if a single event can happen that could give you little time to react. While no one predicted the events of September 11, people who held a lot of airline stocks took some tough losses. Guilt by association also applied here. After September 11, the stocks of the best-managed airlines, hotels, and theme parks took a downturn.

When the tech bubble and real estate bubble burst, the stock prices of the best-run companies dropped along with the rest of the sector, leaving investors to hope their prices would rebound quickly.

Geography

One of the major factors to consider when investing in mining and oil stocks is where they are located. It is impossible to move a gold mine or an oil well that has been drilled. Many governments are now imposing draconian taxes on these companies, which negatively impacts shareholders. In some cases, this can be a correlation of -1. If an aggressive government is affecting a particular oil company, other companies in different locations may have to pick up the slack and their stock may rise in anticipation of increased sales.

Many governments around the world have become very aggressive with environmental regulation, costing the industry billions of dollars to comply. If you want to invest in companies that burn or sell anything to do with fossil fuels, you would do well to understand the political climate where their production takes place.
Investors who prefer municipal bonds must make their own geographical rating on top of the ratings provided for the various services. States like Michigan and Illinois are headed for some rough times. I wouldn’t be lending any of them my money in the current environment no matter what the interest rate might be.

Currency Issues

Inflation is public enemy number one for seniors and savers. One of the advantages of currencies is they always trade in pairs. If one currency goes up, another goes down. If the majority of your portfolio is in one currency, you are well served to have investments in metals and other vehicles good for mitigating inflation.

Tim Price sums it up this way in an article posted on Sovereign Man:

“Why do we continue to keep the faith with gold (and silver)? We can encapsulate the argument in one statistic.
“Last year, the US Federal Reserve enjoyed its 100th anniversary. … By 2007, the Fed’s balance sheet had grown to $800 billion. Under its current QE program (which may or may not get tapered according to the Fed’s current intentions), the Fed is printing $1 trillion a year. To put it another way, the Fed is printing roughly 100 years’ worth of money every 12 months. (Now that’s inflation.)”
It is difficult to determine when the rest of the world will lose faith in the U.S. dollar. Once one major country starts aggressively unloading our dollars, the direction and speed of the tide could turn quickly.


Interest-Rate Risk

The Federal Reserve plays a major role in determining interest rates. Basically they have instituted their version of price controls and artificially held interest rates down for over five years. Interest-rate movement affects many markets: housing, capital goods, and some aspects of the bond markets. While it also makes it easier for businesses to borrow money, they are not likely to make major capital expenditures when they are uncertain about the direction of the economy.

While holders of long term, high interest bonds had an unexpected gain when the government dropped rates, their run will eventually come to an end as rates rise. Duration is an excellent tool for evaluating changes in interest rates and their effect on bond resale prices and bond funds. (See our free special report Bond Basics, for more on duration.)

While interest rates have been rising, when you factor in duration there is significant risk, even with the higher interest offered for 10- to 30-year maturities. Again, having a diversified portfolio with much shorter term bonds helps to mitigate some of the risk.


Risk Categories of Individual Investments

While investors have been looking for better yield, there has been a major shift toward lower-rated (junk) bonds. Many pundits have pointed out that their default rate is “not that bad.”

At the same time, the lure of highly speculative investments in mining, metals, and start-up companies with good write-ups can be very appealing. There is merit to having small positions in both lower-rated bonds and speculative stocks because they offer terrific potential for nice gains.

So What Can Income Investors Do?

There are a number of solid investments out there that offer good return, with a minimal amount of risk exposure and that won’t move because of an arbitrary statement by the Fed. It’s not always easy to find them, but there is hope for people wondering what to do now that all of the old adages about retirement investing are no longer true.

There are three important facets of a strong portfolio: income, opportunities and safety measures. Miller's Money Forever helps guide you through the better points of finance, and helps replace that income lost in our zero-interest-rate world—with minimal risk.

This is where the value of one of the best analyst teams in the world comes into focus. We focus on our subscribers’ income-investing needs, and I challenge our analysts to find safe, decent-yielding, fixed-income products that will not trade in tandem with the steroid-induced stock market—or alternatively, ones that will come back to life quickly if they do get knocked down with the market. They recently showed me seven different types of investments that met my criteria and still withstood our Five Point Balancing Test.

My peers are of having holes blown in their retirement plans. While nuclear bomb shelter safe may be impossible, we still want a bulletproof plan. This is what we’ve done at Money Forever: built a bulletproof, income generating portfolio that will stand up to almost anything the market can throw at it.

It is time to evolve and learn about the vast market of income investments safe enough for even the most risk-wary retirees. Some investors may want to shoot for the moon, but we spent the bulk of our adult lives building our nest eggs; it’s time to let them work for us and enjoy retirement stress free. Learn how to get in, now.

The article What Is Worse Than Being at Risk? was originally published at Millers Money


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Friday, March 28, 2014

U.S. Government Is Unaffordable and Unsustainable, Says David Walker

By David Walker

Former Comptroller General of the United States David Walker talks about the trouble with Obamacare and the sky high national debt. 

Just for starters he covers  how much to spend on national defense and outlines his top 3 reforms to fix the U.S. government.


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Here are a few highlights:

“America can definitely be made great again. It’s not too late, but what we need is a wakeup call, a call to action and a specific course correction to try to be able to make sure that we don’t repeat history.”

“President Obama promised … that he was going to be a uniter rather than a divider, and unfortunately, he hasn’t done that. Our financial condition today is much worse than when President Obama took office.

Frankly, from George Washington, who was our first president, to William Jefferson Clinton, who was our 42nd president, we only accumulated $5.5 trillion in debt—and now we’re up to $17.5 trillion.”

“The government is going to always do more for the poor, for the disabled, and for the military, but … promises way too much and it subsidizes way too many people, and the result of that is that it creates a system that is unaffordable and unsustainable.”

“What a lot of people don’t realize is built into the Affordable Care Act, is a bailout provision for insurance companies. So that taxpayers are probably going to be on the hook for, you know, some large payments due to meet those guarantees.”



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