Tuesday, December 1, 2009

Investors Guru Small Cap Stock Observer

Is Silver Set to Rocket Higher - much more than gold prices, in percentage terms?

The Intrinsic Value of Gold - it all boils down to confidence and trust

Firstly, I should point out that Investors Guru, and I expect most of our members, tend to be on the bullish side of gold, silver and precious metals. This is as true now as it was in 1995 when we started this site, and even during our investment hibernation for most of the Bush years - that was mainly just a sidelining stance until that administration's fiscal, debt, housing, currency and economy smash-up derby concluded.
I should also clarify that when I refer to those lost years, for investment purposes that is, this is not just political opinion but rather a reference to look at any stock index chart from the end of Clinton to the end of Bush - the point is they are all down, as we expected! If there was a Bush upside, it's for gold - again as we expected.
Many now believe, us included, these lost years have set the stage for the greatest gold and precious metals markets in history. However, finding a rational consensus for a short, mid and long-term $X dollar gold target can be daunting. After a few hours of web browsing the topic, you will start to wonder which sources you can trust. Various gold bugs and gold conspiracy sites post volumes in support of their gold targets that can range from $2000 and up, to even tens or hundreds of thousands $USD per ounce. On the other hand, you wonder how much you can trust various governments and financial industry sources on the topic, such as central banks and the Fed, the IMF, gold councils and various brokerage metals analysts' reports etc.
If you decide government and financial industry pages are to be trusted, you might also remember who got us into this mess - the debt crisis, currency crisis, housing crisis etc. And I don't remember any Wall Street analyst predicting any of these bubbles, at least not before they popped. There are some sources that claim a good gold price prediction track record, but then fall short of providing any tangible gold information until some amount of your paper or plastic money is paid.
Further, it seems that some of these sites base their conclusions on not much more than psychic or astrological readings, while others are basically a rear-view history or math lesson on where gold prices have been, as the only real support for where prices are heading. I guess the point is that everyone seems conflicted, so tread carefully.

Golden Millennium - since Y2K, gold has been the only money worth trusting

We continue to believe that as gold was putting in its price bottoms in 2001 that a perfect storm was already forming, which continues and has accelerated today on many fronts, in support of higher gold and precious metals prices. Our members are well aware of the many reasons for this, most notably the current devaluation of the $USD and possibly other fiat paper currencies, to the probable re-emergence of high inflation to possible hyperinflation at some point forward.
This report focuses on the gold/silver ratio and how it may be useful to identify a silver opportunity in particular, if gold prices continue to go higher. In other words if you understand which factors and trends affect gold prices, and you believe a bullish case can be made, then perhaps there is an even better case for comparables such as silver.
To stay on the gold/silver ratio topic, we won't go into the various gold price-influencing factors in too much detail. However, I just mentioned that gold usually does well when paper currencies are weak or when high inflation is expected. My main observation on these points are that the $USD is historically low and expected by many to go even lower - which only makes sense with all the fundamental dilution represented by the many trillions of dollars issued or borrowed recently, with only the US governments' tarnished good faith promise as collateral.
As for inflation, all we read or hear in the mainstream media says that it is low and expected to remain low, as will interest rates, for the foreseeable future as a result of the financial crisis. So if there's no inflation, why did oil and gasoline, flour and bread, to even vegetables such as tomatoes, cucumbers, potatoes and corn prices all double to quadruple or more over the past few years? No wonder they quote inflation "excluding food and transportation", but what about similar increases in the cost of drugs and education etc., to even your property taxes?
My question is when they quote inflation as less than 1% or even negative, what the heck are they referring to as their basket of items that make up our inflation rate? Can you think of a single staple item that has gone up by only 1% over that time? More importantly, why doesn't mainstream media ask these questions? My point is that we should consider common sense financial indicators, like our grocery or gas receipt, or our financial statements - at least as much as a media sound bite.
Lately it seems a reporter will say that inflation and interest rates are low and will stay that way because of the global recession that won't end until 2010, but in the next breath that Australia and Israel are already raising interest rates and others may have to do the same - because of higher inflation. They say the dollar remains strong and that China, India and the Middle East are eager to accept more, and in the next breath that over the past few years the purchasing power of the dollar versus the Euro and other currencies has fallen 40% - do you really believe they are happy losing 40%?
With all the booms and busts, or bubbles and pops if you prefer, this leads us then to ask when will there be an overall paper money loss-of-confidence? I mean how many economic bubbles will the average American tolerate, before simply giving up and hiding what little money or credit remains - into gold or the mattress? Keep in mind that 70% of the US economy depends on these average citizens continuing to keep up with the Jones and spend. Housing prices have traditionally only gone up, so the housing bubble pop may prove to be the real eye opener for millions of Americans - the catalyst as a spending behaviour game changer.
Even those who were lucky enough to avoid or recover from the housing bubble, might see the writing on the wall this time in regards to the ever building debt bubble formed at every level of government, and start asking when it all might finally pop. Sceptics will argue that the markets always climb a wall of worry, and they are right, but when does that wall become insurmountable? At the average Joe level, so many have suffered from losing their investments or retirement savings, higher credit costs or loss of availability, mortgages now underwater or in foreclosure, and the loss of a job or risk of it disappearing - all over a very short period of time.
Those who think that systemic debt contagion is limited to just the US or UK may point to emerging markets that are booming as a safe haven. Ask anyone who bought Dubai stocks or bonds lately how that's worked out. My point is not just that the average Joe is starting to question who they can trust - governments and banks don't trust each other!

The Golden Uptrend - and Its Silver Lining

Over Any 10-Year Period, Stocks Always Outperform Gold - don't they?

In condolence to all these real losses, and a major loss of confidence, the same political and financial pundits now point to the V-shaped bounce off the March 2009 lows of any stock market's chart as proof that its ok to invest and spend again. And of course they claim the growth rate of inflation, deficits and the debt, and the fundamental values of the economy and the dollar are all sound and manageable.
This might not matter for those already wiped out, but if you were smart and lucky enough to survive each bubble and financial crisis of the last decade, then you might already be thinking gold's uptrend has stayed the course and continues to look solid. Compare any US stock index chart of the last decade to the following gold chart.

January 2000 to November 2009 - London Gold Price Chart
Not surprisingly, mining and exploration stock indexes tend to follow the overall expected trend of the underlying metal being explored for or mined. However, shares in individual mining and exploration companies may perform significantly better, or worse, due to a wide range of factors. This includes managements abilities to efficiently raise capital, control marketing and operating costs, discovery success, to even political risks depending on where mining activities occur. Many other factors may come into play.
For those that do succeed, everything seems to be positioned in gold's favor. For years many central banks were selling gold in favor of US dollars, but now appear to be buyers of gold again. For example, recently the Reserve Bank of India bought half of the gold sold by the IMF, and the Central Bank of China is reportedly buying. And don't forget the sudden wildcards that can spike the price of gold overnight - such as political uncertainty, corruption, war or any destabilizing situation.
Not only is demand up, gold production and supply has been falling since 2000. In addition to central bank sellers now becoming buyers, for years there was a perceived overhang supply of gold in the market from gold miners selling gold not yet produced into the futures markets. One key signal for us that the secular gold trend was finally turning higher again, after 20 years in the doldrums, was after NEM Newmont Mining announced early this decade that they had ended all gold production hedging.
This fall we got one of the bullish gold signals you can get, when T.ABX Barrick Gold announced they were paying billions to close out all forward gold sales. Barrick has been one of the largest, if not the largest, forward seller of gold. They would sell almost all of their production forward, which worked well for years - until a few years ago. Why all the sudden urgency, worth paying billions? Just stop writing new contracts and let your existing hedge-book expire, or deliver the gold - unless of course you expect gold prices to move considerably higher in the short or near term.
Further, new gold discoveries are not keeping up with demand, and even the ability to put proven resources into production may be difficult. Future input costs such as volatile oil prices and credit availability need to be factored into business models, before a production decision can even be made. My point is the gold tap cannot be turned on quickly in response to a spike in gold prices, as it takes years to put a proven gold resource into production - on top of the years it takes to find it.
I'm not saying gold will outperform most US stock indexes. I'm just pointing out that contrary to what many financial planners are taught to say, that gold can and did outperform stocks by a wide margin over the past decade. However, other than a new punitive gold law, or the discovery, acceptance and implementation of an inexpensive, abundant and environmentally friendly new energy source to replace oil, I don't see any sustainable scenarios that can derail this secular gold market.

The Gold / Silver Ratio - silver may rocket higher if history repeats

Like any investment, gold alternatives should also be evaluated - for some risk diversification within the investment class, or to possibly enhance overall performance. Silver especially, and to some extent platinum, palladium and other precious metals are the obvious comparables, but the case can even be made for base metals, diamonds and other gemstones, or even commodities such as oil - to provide some correlation within very large portfolios.
The gold/silver ratio is simply the price of gold divided by the price of silver, or how many ounces of silver are equivalent in US dollars to one ounce of gold. Gold and silver prices generally trend up and down together, but there are times when the gold/silver ratio gets way out of sync. In other words, once you recognize the overall long-term gold trend, significant further upside may be found by also identifying how the gold/silver ratio will react to this gold trend.
As you see in the table below, the gold/silver ratio was set at 15 until the mid 1800's, but has steadily moved up from there. Not only has gold and silver increased in dollar terms, but gold has also increased relative to silver. This in itself is not favorable to silver over gold, until you understand why and when the ratio has swung to one extreme or the other.
There have been times when the gold/silver ratio was close to 100 and other times when it was lower than 15. For demonstration purposes only, if gold prices stayed the same and you had bought silver when the ratio was 100, and sold when the ratio contracted to 15, you could have theoretically made (100 / 15) * 100 = 666.67%. However gold prices do change, these ratio changes are extreme, and losses are just as severe if the ratio expands instead of contracting.
I believe there is support for the gold/silver ratio contracting during secular bull gold markets and expanding during bear gold markets. In other words, when gold is in a major bull market, silver can outperform. The table below loosely correlates this, although the top half of this table is from when gold prices and the gold/silver ratio were fixed by government and not fully deregulated until 1972.
I also believe the best secular bull gold market to look at is the late 1970's to 1980. The comparisons to today are uncanny, with record oil prices and the US auto industry again in shambles. Then it was the Iran Hostage Crisis, and Chrysler at risk; today it's the Iran Nuclear Crisis, and GM in bankruptcy. Again we have trade and fiscal deficits, debt at all levels of government, job losses and unemployment, a falling currency and a deep recession - all at record levels or the worst since WWII.
The main difference then is that inflation hit over 14%, with an even higher bank rate and mortgage rates over 20%. Today they say inflation and interest rates are 0% - unless of course you have a credit card, eat groceries, or drive a car. The real question is how long will it be before all those cheap trillions sloshing around today, again cause 1980-style inflation and interest rates?
Ignoring 14% inflation and 20% mortgage rates for now, shouldn't gold prices today have appreciated by at least the average inflation rate since 1980? If the government's normal target inflation rate is around 3%, and then applying this rate to the 1980 gold high of $850, this suggests that an equivalent inflation adjusted high today might be approximately $2,003. For silver starting at $52 this works out to $123 per ounce.
I'm not suggesting $2,003 as a gold target or $123 for silver. All I'm saying is that if $850 was the previous gold high in 1980, and if you believe like we do that the forces behind this bull gold market will be at least as powerful as during the 1980 bull gold market, then it only reasons that the current bull gold market might put gold at an equivalent high in today's dollars, adjusted for the affects of inflation over the past 29 years. In other words, if you believe that $850 dollars in 1980 is equivalent to $2,003 dollars in 2009, then it's not much of a stretch to believe that $850 gold in 1980 might be equivalent to $2,003 gold today.
If you see this as purely coincidental or conjecture, you surely must agree that a direct relationship exists between the value of the $USD and gold priced in US dollars. An inverse correlation can be shown that when the dollar persistently goes down versus other major currencies, then the price of gold usually goes up, and vice versa.
An indirect correlation can also be shown for major commodities like oil, still priced in US dollars - at least for the time being. Historically oil has traded at about 15 barrels per ounce of gold, however there are times when the ratio falls out of sync and one commodity appears expensive compared to the other. For example, in 1980 gold topped out at $850 and oil topped out at $40, which is 21 barrels of oil per ounce of gold. Oil was at all time highs but seemed cheap compared to gold. However, when gold first hit $1,000 an ounce in 2008 at about the same time oil made new highs at over $140 a barrel, gold seemed cheap versus oil this time, at only 7 barrels of oil per ounce of gold.
These ratios are not perfect indicators, but today we can see that the gold/oil ratio has normalized again at 15, with gold at $1175 and oil at $75 ( 1175 / 75 = 15.66 ). So why can't this work for the gold/silver ratio to indicate if gold or silver is undervalued compared to the other, and what is the normal gold/silver ratio? Again this is tricky because gold prices and the gold/silver ratio were fixed at one time. Here are some notable gold/silver ratio highs and lows since 1980:
Gold/Silver Ratio - Lows: 1980 = 14.9, 1998 = 40, 2006 = 43
Gold/Silver Ratio - Highs: 1991 = 99.8, 2003 = 80, 2008 = 84.
The table below explains how the gold/silver ratio was once fixed by law at 15, and for the 20th century it averaged 47.1. It also says that at the peak of the Nelson and Bunker Hunt silver crisis in 1980 that silver was as high as $49.45 and the gold/silver ratio was as low as 17. If memory serves, I believe the high was actually $52, and the gold/silver ratio as low as 14.9.
The point is that silver is a small enough market that just two Texas billionaire brothers and a few Arab oil buddy's could corner it, at least until anti-trust lawyers became involved. This also shows how the price of silver can skyrocket even beyond gold (in percentage terms), and that it is possible for the gold/silver ratio to fall as low as 15 again during a bull gold/silver market.
The next notable gold/silver ratio low was 40 in 1998. Correct me if I'm wrong, is that when Warren Buffett and Bill Gates each started buying around 130 million ounces of silver? I'd love to know what/who made them sell out by 2006, as the fundamental reasons for holding gold and silver were never better. Everyone makes mistakes and in any event, based only on the above sketchy scenarios, a first guess at a low gold/silver ratio might be argued somewhere between 15 and the 20th century average of 47.
Gold currently is $1,175 and silver is $18.30, a ratio of 64.20. It seems strange that the ratio is 17 higher than the 47 average, at a time when gold is making new highs almost daily. Last year when gold made new highs at $1,030, silver traded as high as $20.86, a gold/silver ratio of 49. I would argue the ratio should have contracted to around 40 at least by now - or $1,175 / 40 = $29 silver. Even a ratio of 47 would put silver to at least $25 by now, instead of $18.
In other words, I believe silver should be somewhere between $25 and $30 right now, at $1,200 gold. But I also believe gold could go to at least $2,003 if this bull gold market plays out like in 1980. If it does, I can only guess if/when the gold/silver ratio may finally contract, which I would place my best guess right now at a ratio of around 30, or around $67 an ounce. Some may think that's crazy, but this is only $15 or 29% higher than the 1980 silver high - not even adjusted for inflation!
If 1980-style inflation rates of 14% are mixed into the equation, I can only speculate where prices may eventually top out. Historically, hard assets like gold, silver and other precious metals have been one of the few asset classes that protects capital and actually benefits, while the value of other investments get ravaged, during periods of high inflation.
But I also believe the case can be made for an even stronger bull gold market this time, because all the same old crisis' seem worse this time, and there are several new crisis'. In other words, is there more or less oil used and available today than in 1980 (with no real solution for either close at hand); are the debt, fiscal and trade deficits better or worse now than in 1980 (inflation adjusted, as a percentage of GDP, GNP, per capita, or expressed in whatever terms you prefer); are there more or less dangers and fear today than in 1980 (war, disease, pollution and global warming); are families better or worse off today than in 1980 (crime, divorce, education, health care, life expectancy, savings, net worth, weekly hours worked, incomes needed per household, years to retirement etc.); and is the US dollar stronger or weaker than it was in 1980 (and where is it headed). And I don't believe a banking crisis or housing crisis existed back in 1980 anywhere close to today.
In closing, I believe we are in the mid to early innings of a secular gold trend. More importantly, if I'm right silver could do even better. Instead of poor mans gold, I prefer to call silver "Wise mans gold".
Signup Now, It's Free! - to become a member, and then Login to post your thoughts about this report at our Special Topics Bulletin Board: Is Silver Set to Rocket Higher - much more than gold prices, in percentage terms?
Please note that nothing in this report should be taken as a recommendation in any way, and that everything from InvestorsGuru.com is subject to the terms of our Privacy Policy and Disclaimer.
The following information about silver is from Wikipedia.org.

Silver as an investment

Silver, like other precious metals, may be used as an investment. For more than four thousand years, silver has been regarded as a form of money and store of value. However, since the end of the silver standard, silver has lost its role as legal tender in the United States. (It continued to be used in coinage until 1964, when the intrinsic value of the silver overtook the coins' face values.)

Silver price

The price of silver has been notoriously volatile as it can fluctuate between industrial and store of value demands. At times this can cause wide ranging valuations in the market, creating volatility.
Silver often tracks the gold price due to store of value demands, although the ratio can vary. The gold/silver ratio is often analyzed by traders and investors and buyers. In 1792, the gold/silver ratio was fixed by law in the United States at 1:15, which meant that one troy ounce of gold would buy 15 troy ounces of silver; a ratio of 1:15.5 was enacted in France in 1803. The average gold/silver ratio during the 20th century, however, was 1:47.
YearSilver price
(avg. US$/ozt)
Gold price
(avg. US$/ozt)
2009 (as of Nov 3)16.441059.5664.45
From September 2005 onwards, the price of silver has risen fairly steeply, being initially around $7 per troy ounce but reaching $14 per ozt. for the first time by late April 2006. The monthly average price of silver was $12.61 per troy ounce during April 2006, and the spot price was around $15.78 per troy ounce on November 6, 2007. As of March 2008, it hovered around $20 per troy ounce. However, the price of silver plummeted 58% in October 2008, along with other metals and commodities, due to the effects of the credit crunch.

Factors influencing the silver price

Private and institutional investors

* From 1973 the Hunt brothers began cornering the market in silver, helping to cause a spike in 1980 of $49.45 per troy ounce and a reduction of the gold/silver ratio down to 1:17.0 (gold also peaked in 1980, at $850 per troy ounce). However, a combination of changed trading rules on the New York Mercantile Exchange (NYMEX) and the intervention of the Federal Reserve put an end to the game.
* In 1997, Warren Buffett purchased 130 million troy ounces (4,000 metric tons) of silver at $4.41 per troy ounce (total value $572 million). Similar to gold, the silver price has more than doubled in value against the United States dollar since December 2001. On May 6, 2006, Buffett announced to shareholders that his company no longer held any silver.
* In April 2006 iShares launched a silver exchange-traded fund, called the iShares Silver Trust (NYSE: SLV), which as of April 2008 held 180 million troy ounces of silver as reserves.

The large concentrated short position

The CFTC publishes a weekly Commitments of Traders Report which shows that the four or fewer largest traders are holding 90% of all short silver contracts. Furthermore, these four or fewer traders were short a total of 245 million troy ounces (as of April 2007), which is equivalent to 140 days of production. According to Ted Butler, one of these banks with large silver shorts, JP Morgan Chase, is also the custodian of the SLV silver ETF. Some silver analysis have pointed to a potential conflict of interest, as close scrutiny of Comex documents reveals that ETF shares may be used to 'cover' Comex physical metal deliveries. This leads analysts to speculate that some stores of silver have multiple claims upon them.
On 2008-09-25 The CFTC finally relented and probed the Silver Market after persistent complaints of foul play draw the still-skeptical Agency to investigate.

Industrial demand

The use of silver in items such as electrical appliances and medical products has increased since 2001. New applications for silver are being explored in batteries, superconductors and microcircuits, which may further increase non-investment demand. The expansion of the middle classes in emerging economies aspiring to Western lifestyles and products may also contribute to a long-term rise in industrial usage. Even so, due to the advent of digital cameras the enormous reduction in the use of silver halide-based photographic film has tended to offset this.

Methods of investing in silver

Silver Bars, Coins, Rounds, Certificates, Accounts, Spread Betting, Derivatives, ETF's and investing in Mining Companies, are the most common ways to invest in silver. Within each of these categories of silver investments there are several choices, for example:
Exchange-traded funds (or ETFs) represent a quick and easy way for an investor to gain exposure to the silver price, without the inconvenience of storing physical bars. The silver ETFs are:
* iShares Silver Trust (NYSE: SLV), launched in April 2006 by iShares.
* ETFS Silver Trust (NYSE: SIVR), launched in July 2009 by ETF Securities.
* Central Fund of Canada (TSX: CEF.NV.A, NYSE: CEF), which has 45% of its reserves held in silver with the remainder invested in gold.
* In September 2006 ETF Securities launched ETFS Silver (LSE: SLVR), which tracks the DJ-UBS Silver Sub-Index, and later in April 2007 ETFS Physical Silver (LSE: PHAG), which is backed by allocated silver bullion.
* PowerShares DB Silver (AMEX: DBS), holds its worth in futures contracts for physical delivery, which are later sold to silver consumers in order to roll over expiring contracts to contracts further from expiration.
* ProShares Ultra Silver (NYSE: AGQ), seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of silver bullion as measured by the U.S. Dollar fixing price for delivery in London.

Wednesday, November 11, 2009

InvestorsGuru.com Site Tour Video - Part 1 of 2 - The Ultimate Stock Research Site, Empowering Investors Since 1995. Watch us prove it!

Free Membership provides Investors Guru Small Cap Stock Observer monthly e-newsletter, plus new Featured Stocks Profiles. Login anytime to post on our Featured Stocks & Special Topics Bulletin Boards and to view/update/save your My Preferences: your My Portfolio, My Watchlist & Alerts and if/when they should be emailed.

Comprehensive stock quotes, charts and news, plus company & insider info, financials, analyst ratings, earnings estimates, historical data and much more. Fast, Free and No more endless clicking through ad-filled pages for just tidbits of info.

Visit InvestorsGuru.com to Join Our Stock Community - Signup Now, It's Free!

InvestorsGuru.com Site Tour Video - Part 2 of 2 - The Ultimate Stock Research Site, Empowering Investors Since 1995. Watch us prove it!

Free Membership provides Investors Guru Small Cap Stock Observer monthly e-newsletter, plus new Featured Stocks Profiles. Login anytime to post on our Featured Stocks & Special Topics Bulletin Boards and to view/update/save your My Preferences: your My Portfolio, My Watchlist & Alerts and if/when they should be emailed.

Comprehensive stock quotes, charts and news, plus company & insider info, financials, analyst ratings, earnings estimates, historical data and much more. Fast, Free and No more endless clicking through ad-filled pages for just tidbits of info.

Visit InvestorsGuru.com to Join Our Stock Community - Signup Now, It's Free!

Monday, March 30, 2009

Investors Guru Small Cap Stock Observer

Dr. Jekyll and Mr. Hyde - a tale of two US economies. The best buying opportunity of our lifetime, or the start of the next great depression?

I'm not going to answer this question - you are! Hopefully you will be kind enough to share your thoughts at our Special Topics Bulletin Board of the same title as this article.
As a backdrop, I'll start the discussion by stirring up the current macroeconomic mess we find ourselves in, and how we got here. Then I'll leave it to you to pick apart these facts, opinions and ideas, and provide your insight into where this all might be heading. I'm interested to see where the pulse of this debate goes, and if a consensus forms over time.
I'm a believer that when analysts start saying, "it's different this time", this is a serious signal to start questioning if the current trend is about to change. When they all seem to agree, I become even more nervous.
With the benefit of 20/20 hindsight, it is obvious that tech stocks were overvalued in the late 1990's and due to correct. But at that time most analysts kept telling us there wasn't a bubble and that earnings didn't really matter in the new dot-com economy.
This time, starting in August 2007, stock cheerleading TV networks continued to deny that even a recession was at hand until the end of 2008. Not even the failures or near failures of household names like Bear Sterns, Lehman, Wachovia, Washington Mutual or Merrill Lynch could shake their confidence. Even the front running GOP presidential candidate last summer insisted US economic fundamentals remained strong.
Coincidentally, or not, August 2007 was also when the down tick rule was removed. Very little coverage was given to the short-selling push down effect this could have on already spooked markets. Then after the markets had fallen over 50%, the ostrich pundits finally pulled their heads up for a breath of fresh air and started recognizing that perhaps a mild recession was a possibility. How astute and timely!
As this turned into panic in early 2009, with the DJIA up or down 700 points on any given day, with the VIX volatility index regularly making new highs, the pom-poms were finally tucked away. Instead of the usual buy criers, gloom and doomers were cast to debate if this recession most resembled that of Y2K, the 1990's, 1980's, 1970's, or some other decade. Some even suggested this was the start of the next great depression, and to sell all stocks and buy gold before the dollar becomes totally worthless.
Brokers used to tell us to look at quality stocks as shares of businesses to buy-low, hold long-term, and eventually sell-high. Panic selling was supposed to be a buy opportunity. Now that everyone is down 50%, and wondering whether to take advantage of low prices by averaging into the markets, as we were previously told to do, many so-called experts are instead saying, "it's different this time".
Do you ever get the feeling that analysts and brokers are always wrong - saying one thing like buy-low and sell-high, but doing the opposite? They say buy if the fundamentals indicate a stock is cheap, and don't follow the herd. But their buy-charts say something else, making you wonder why the stock wasn't a buy before it already doubled or tripled.
Who really is the first to panic sell or panic buy - you or your broker? Why are simple investing concepts made to seem complex? Why don't analysts, brokers and stock TV commentators provide more balanced advice, and why is it that the vast majority of overpaid investment managers never beat the markets?
These types of observations are why our investing style tends to be fundamentals first, tempered by contrarian technical's. In other words we look for fundamental values of how much a quality stock may be worth - compared to its price, its peers and the market. If the chart shows it is technically beaten-up and out of favour by the street - even better!
In January 2000 we emailed our members to look closely at a long-term NASDAQ chart. The slope of its ascent was straight up from the end of 1998, from around 1500 to 5000. We believed the dot-com bubble was signalling a major selloff by May, and that most stock markets and the overall economy would go into a prolonged recession. The NASDAQ actually started crashing in March, at a time when most analysts were still trying to outdo each other's price targets, for dot-com stocks with stratospheric P/E's.
Later that year we wrote that our site was closing, as the markets most likely were not going anywhere for at least 4-years, and that it would be higher commodity prices like oil, gold and base metals that would lead the markets out of recession. At that time oil was about $12 a barrel, gold $260 an ounce and copper .80 a pound.
Fast forward four years and the economy and stock markets had changed materially. After 911 interest rates were slashed to historic lows to keep the economy from going further into recession. Cheap money and deregulated debt markets fuelled an artificial housing boom and today's subprime/ABCP crisis. Oil, gold and base metals prices soared as we predicted, but it was a bit of a shocker when the Bush administration was re-elected in 2004. With the US sinking from fiscal surpluses into major deficits and debt, with trade deficits still at $60+ billion per month, we decided to keep the site closed until a majority of Americans finally realized that Republican hillbilly economics had to change.
In January 2000 North American stock markets were approximately: NASDAQ 5,000, DJIA 12,000, S&P500 1,500 and TSX 9,500. Now it's March 2009, so let's see what we missed: NASDAQ 1,400 -72%, DJIA 7,000 -42%, S&P500 700 -53% and TSX 8,000 -16%. US stock markets are down 50% from 2007 highs and many companies have disappeared, both large and small alike. For credibility sake, rather than try and fight a long-term losing dead horse trend, we made our market expectations clear back in Y2K by simply closing down until valuations made sense again.
Our charts tell us that March 9 signalled a major technical bottom, with the DJIA holding the 6,350 levels and bouncing +15% since. Value and risk now appear to be discounted in today's much lower prices, but there remain major cracks in the world's economic foundation. On one hand, government money floodgates have been opened full tilt in the name of all things stimulus. On the other, how will much higher debt, inflation, taxes, and currency devaluation be managed, to prevent the whole house of cards from collapsing?
If you believe the latter, perhaps you should look into gold and silver bullion, or a farm for value. But if you believe the value of paper money and the current economy will survive, you need to read, research and consult with your advisors to put money to work somewhere in the markets.
Historic charts show that equity market values generally behave like a pendulum on any given day, month or year, but in the long-term prices tend to gradually increase over time. Blue-chip stocks seem to trend this way, at least for as long as their products, services and execution remain relevant. Real-estate prices follow this tendency as well.
Any Keynesian economics or intro to business course will teach you that supply and demand determine prices. From the price of a paperclip, to a barrel of oil, to how much your house is worth, it's a simple matter of S&D. But here's my question: Is supply just another way of saying scarcity, and demand just another way of saying inflation?
Was the 2000-2007 housing boom based on sound fundamentals, or was this demand simply synthesized by creative financing? We believe the latter and that the lows these events created will return higher stock prices nearer to their long-term ROI values, at least for a few good years.
Our new logo puts this on the line, showing the NASDAQ chart from its 1971 inception. The first green dot indicates when we started our website in 1995. The red dot indicates when we emailed our members the site was closing in 2000. The second green dot indicates when we decided to re-launch InvestorsGuru.com in March 2009.
I believe normal long-term housing prices compound annually at about 3%, because the normal long-term inflation rate is around 3%. In other words a house will go up in value at about the same pace as overall construction costs.
I have read credible reports suggesting long-term real-estate returns of 1% to 6%, and of course it can perform significantly better or worse for short periods of time. But I can't find another time like 2000-2007, with continual +15% yearly returns, and prices doubling in just 4 years. Much of this red-hot demand for housing was based on pure speculation, a result of cheap financing with practically no government oversight.
Cheap money is another way of saying inflation - with too many dollars chasing too few houses, or so it seemed. As cheap financing dried up, not only did demand dry up, we found out supply was actually far more than ever needed. Almost overnight, millions of multiple home speculators were stuck levered into mortgages, now owing more than their investment's value. These underwater mortgages turned into foreclosures as the artificial demand created by no-money-down, no-doc and teaser-rate mortgages collapsed.
What does this have to do with stock markets? Stocks, bonds and real-estate compete for investment capital, which flows to the best-perceived return. As the dot-com bubble burst, the stock market became a bad bet. Investment capital needed a new home... literally! And why upsize to just one McMansion when you could have 2 or even 5?
Some anticipate these trends early and understand that short-term deviations from the normal long-term rate of return, if extended, usually create bubbles that eventually crash. The pendulum then tends to swing the other way, with overly depressed prices, until the normal long-term rate of return and S&D comes back into equilibrium. This is usually true for stocks, bonds, real-estate or any type of quality long-term investment.
Just like it seemed obvious in 1999 and early 2000 to get out of tech stocks, it should have been obvious by 2004 to start exiting real-estate. Maybe you could have waited another year, reasonably speculating the government would make sure the applecart wasn't upset during an election year. But you should have realized that property values were extended compared to long-term trends, and that it was only greed that kept mainly other flippers overbidding homes. Don't be the last one holding the hot potato!
Easy credit actually continued to flow until summer 2007, expanding the magnitude of the housing bubble's inevitable pop into a near financial industry collapse. And the worst of it may be yet to come!
Deregulated debt markets with cheap and easy money created the housing bubble. Government policy made this mess as their short-term recession-preventing lack of focus failed to realize the long-term implications. In the buy-now pay-later society we live in today, short-term pain for long-term gain is almost always reversed. The result, just print more money to ease the pain, and we'll deal with curing the disease later.
Government continues to choose more and more debt, without a plan to avoid its inevitable future wealth consequences of catastrophic inflation, high taxes and interest rates, plummeting currency and asset values, and economic depression, some say. Most people believe that inflation simply means higher prices, but this is only one symptom.
I'm worried about hyperinflation if the world loses confidence in the value of the dollar, produced by decades of out of control debt growth. Money is manufactured out of thin air and is no longer backed by hard assets. The last 8-years may have caused this new money bubble to stretch beyond the point of no return. If foreign lenders simply threaten to turn off the debt taps, or price commodities such as oil in another currency, or replace dollars as their reserve currency, any one of these dollar S&D factors, or others, could pop this $ bubble overnight. Watch gold prices if the US ever loses its AAA sovereign credit rating!
Has long-term real-return value been enhanced, or lost; and has the inflation effect simply made it seem that values always go up over time? Yes, I agree prices tend to go higher over time, but does this usually translate into more, the same, or even less buying power than when you started?
Are we really better off today than our parents? Not that long ago, a typical family had one breadwinner. Today the norm is both parents working, just to keep up. But we have bigger homes, two cars, multiple TV's, i-everythings and we eat out more. True, but we also have 10 credit cards charged up to more than we earn in a year, and we can only pay our loan shark, err I mean banker, the minimum balance each month. We borrow or lease to buy everything, and hope that we can pay it off before it rusts or falls apart.
Back then our home was our castle and paying it off within 20 years was a reasonable goal. Today, for a $300,000 5% mortgage, many prefer a 40-year amortization instead of 30-years; because the lower payment represents an extra $164 per month in extra spending now, even though you have to pay $1,447 per month for an extra 120 months, including an extra $115,000 in interest. Reverse mortgages didn't exist back then, as they would have begged the question "what's the difference with renting?"
Over 70% of the US economy is consumer spending, and is it any surprise that personal savings rates remain at historic lows, while debt continues to build from the individual, the family and to every level of government. Most of what we buy is imported, as we prefer to do finance and marketing over old-fashioned work like industrial production or manufacturing. My point is that all this stuff we buy doesn't build wealth.
So we borrow like drunken sailors to buy depreciating consumer products, mostly made and imported from somewhere else, and we believe we are entitled to this standard of living beyond our means, and that it can go on forever. We are deaf to the piper and don't worry about nor intend to pay him, as this is a problem for our children to figure out.
The US economy has been ravaged by over 3 million foreclosures and many believe the worst is now over. Some reply to the severe selloff in stocks with a shrug, because we can magically pull a rabbit from the hat again to save our economy from its current doldrums.
So what say you about the 9,000,000 US option ARM mortgages that get very little airplay, that are supposed to reset or recast starting in 2010? These aren't the same toxic mortgages for those who could never afford a mortgage in the first place, but rather middle class mortgages for those who probably never missed a debt payment before now.
Keep in mind the unemployment rate has gone from near full employment at the end of the 1990's, to now 8% that some predict may eclipse 10% this year. The estimate for both unemployed and underemployed is over 15%. Many have simply lost their job and can no longer afford to own a house under any scenario.
For the vast majority of these mortgages it is the unknown that is most daunting. Many are liar loans now subject to an income test that will not pass go next time. Interest rates are as low as they can get, with the Fed funds rate at 0.0% to 0.25% and people still can't pay. What happens to property values and defaults if rates go up just 1%? The Fed doesn't control this - watch the yield on long-term bonds!
Home values have plummeted and over half of these mortgages are now underwater. Some predict housing prices in 20 major US cities to decline 20-25% further this year. Even if you can get a mortgage, how many will choose to, or will they just walk away?
I could draw similar horrific debt bomb scenarios for commercial loans, auto loans, credit cards, social security, Medicare, and all levels of government debt. But what's the point when even our leaders have a hard time keeping track of whether they meant to say millions, billions or trillions!
Any one of these scenarios could be the perfect storm that may make our current mortgage tidal wave seem like a fart in the bathtub. The interest on all this debt comes from taxes and goes to the privately owned Federal Reserve. Tricky debt and the wiping out of Middle American equity is the real problem, and the Fed is now being held out as the obvious systemic risk protector. Talk about conflict of interest!
One thing seems absolutely clear. If we are to get out of this mess, prices must somehow go higher, for a long enough period to absorb the bad debt on everyone's balance sheets, to build equity again and discover new growth industries. I believe higher prices will come, but for only the short-term as the long-term fundamentals will not have changed.
The long-term fundamentals I believe we need to embrace are higher savings and lower debt levels, and new technologies. We don't want to do real labour and there's a limit to how many cokes a person can drink, so we will need to start discovering the medical, robotics, and energy breakthroughs the world needs - to have something to sell again.
The US has always fostered an entrepreneurial spirit, but the will to succeed today is not enough unless supported by the highest educational standards. Outsourcing engineers and scientists is not an option in building real wealth at home, from the future's newest technologies, quality products, innovations and efficiencies.
Maintaining the lead is what protects market share and gross profit margins, and attracts experienced management, liquidity, access to capital and healthy balance sheets. Done right the results are more long-term sales, earnings and dividends. Done wrong the results are losses, more debt and financial ruin. Only time will tell!
Many more terms are applicable, but no matter how they are expressed they all boil down to one word - Growth! But what happens to stock prices if there is no more growth? Absurd you say; there will always be growth.
But hasn't our growth always been based on two continuing assumptions - population expansion and low cost energy? More population has simply meant more consumers. Low cost energy has meant prices could remain low, and profit margins high, because the cost of energy to produce, manufacture and ship remained low.
Perhaps we can have the best of both worlds, again supplying and servicing growing demand in China, India and other emerging economies. At the same time we can rationalize and return our legacy costs of social security, health care and debt costs to a low percentage of GDP/GNP without relying on domestic consumption. It's ironic how these statements compare to GM's current troubles - I wonder how that will turn out?
However, these hurdles are not even close to within our sights and I believe there will be significant inflation in any event. I believe this to be true whether the dollar, stock markets and oil prices, debt and savings levels, go up or even down. Since we left the gold standard the puppet masters parade has always led to more inflation, and I see no reason why it should be different this time. Start asking why they don't publish the M3 money supply anymore?
But one thing that has changed is the magnitude and velocity of change itself. Debt and stock markets move faster than ever and can pull the rug from under any stock, currency or commodity in minutes on just a rumour - thanks to global markets and round the clock computer trading. Did you notice last year how some banks that were proclaimed safe on a Thursday, were gone that weekend?
If you believe things will get much worse, you may need to position quickly. For most this means to pay off high cost debt and lock-in low mortgage rates while you still can. For investors this may mean gold related assets, as a hedge at least. You can even argue certain quality stocks with high-cash and low-debt levels may benefit, even if interest rates take off to dampen high inflation and to support the dollar's value. Simple buy and hold does seem to need to be replaced by more nimble trading, for at least the near term.
In conclusion, I do believe the markets are due for a nice run higher for at least the next year, to possibly the next four years. The past eight years has reinforced my belief that the presidential cycle and government policies can have a major impact on investment values. In this regard I'm really just saying that government should stay out of the way of businesses - that are best at creating sustainable long-term jobs, and private citizens - who are best at allocating their own wealth.
My point is that government usually doesn't have to help in this regard, but they can surely mess things up. Significant fixes are now needed, as the Bush administration left several gargantuan flaming bags of poop on Obama's doorstep.
Please note that nothing in this report should be taken as a recommendation in any way, and that everything from InvestorsGuru.com is subject to the terms of our Privacy Policy and Disclaimer.