The Sane Investor

October 13th, 2008
This week has been a bad week for me.

According to Market Watch, gold futures for December delivery have lost $71.30 this week, or 8.3%, in a time where the Dow essentially didn´t move (from Monday open to Friday close, it ended down -14.79 points, or -0.1%). Even though there wasn´t a strong downward or upward trend by the end of the week, one certainly couldn´t say that things were calm. After Monday´s unprecedented 900+ point gain, equity markets have been in fits of volatility.

So what´s the deal?

Theoretically during extremely volatile times, people should be flocking to safe haven investments like precious metals. Yet, during a week that would be the quintessential example of back breaking volatility, precious metals performed horribly.

The typical argument I´ve heard is that precious metals prices are falling due to deleveraging of hedge funds. Forced either to make margin calls, refund investors, or simply to maintain higher levels of liquidity, the large claim is that these funds are engaging in fire sales, including precious metals that they might otherwise hold on to. This serves to be a decent argument, since leverage reached record levels during the middle of 2007. But this isn´t the first time that I´ve seen the lack of performance in some asset blamed on fire sales by hedge funds.

Physical Demand Remains High, Supposedly

Almost every single article bullish on gold seems to cite unprecedented demand for silver and gold bullion bars and coins from central banks, leading to long wait times. The thing I always bring up is why there isn´t someone using arbitrage in the spot market of gold to serve this physical demand market. I´ve heard totally ludicrous numbers for what the spot price would be if the price of actual gold was reflected in paper markets, and it just doesn´t make sense.

If something was really that cheap in another market, you´d be stupid not to just hop in to that market (hell, if future trades are so out of whack, why don´t you just buy one and hold on till delivery?) and then sell them back to the other.

Others have cited the carry trade that exists between borrowing gold from central banks, selling that in the spot market, and then using that money (the lending rates on gold are relatively low, typically less than 0.5%) to finance other transactions. The thing that doesn´t make sense about this argument is that someone engaging in this carry trade would have to hedge their physical gold short by buying gold futures. In this regard, it´d be really easy to see the impact of the carry trade in the market: there´d be a huge gap between gold spot prices and gold future prices, favoring gold future prices. In this way, it´s kind of hard to argue why things are so out of whack.

What I Think is Going to Happen

I´ve frankly been shocked by how poorly gold and silver have performed lately. The only real reason that I can point to is the strength that the US dollar has maintained. If you´re looking for a safe option right now, you basically have Treasury bills, cash and precious metals.

Treasury Bills are more or less considered to be one of the safest instruments out there, because they´re backed by the United States´ government. A lot of people have used T Bills as the reason that the US dollar has remained so strong, since many investors have fled riskier investments overseas for the greater security of American markets (ironically). However, if you´re a fund looking at where to have your money right now, in the short term you´re likely going to avoid T Bills, since further issuing of debt by the US government will likely only serve to push yields up, thus losing you money in the short term if you buy them now.

Thus, if you´re deciding between cash and gold in the short term, your decision is going to hinge on how much liquidity you´re going to need and where the value of the currency is going. With the direction as of late, it doesn´t seem like the dollar is going to being losing value any time soon.

Because of this, if I was a fund manager, I´d be looking at precious metals and wondering why I should even bother, given that you can´t get more liquid than cash.

Because of this, I really think that as long as the dollar stays strong, gold isn´t really going to go anywhere, especially if it is true that people are unloading just about all types of assets. If we see that unloading continue much longer, and then a coincedental fall in the dollar, that could create a massive ¨gold rush¨ so to speak. Until then, I think I´m going to continue to be frustrated with precious metals.

Disclosure: the author of this article is long GLD, DGP, SLV, SIL, FCX and trying to build a position in EDD

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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October 13th, 2008
If for some reason you decided to go long at the end of last week after the S&P 500 suffered its worst week since 1933, you saw that pay off pretty handsomely today as the market bounced back strongly.  I personally believe it was likely due to an ever increasing amount of bottom calls and signs that the virtually unprecedented steps towards unified worldwide liquidity were finally starting to have an impact.  People were really panicking last week that potentially the only thing that could unfreeze credit markets would be a 0 basis point target by central banks, since the TED spread (the difference between the Libor rate and the Federal Reserve Bank target rate) continued to remain very high.  Now it’s starting to look like things aren’t going to turn apocalyptic in the near term.

I Disagree Strongly With the Bottom Calls

I think we might see a little bit of a rally, or at the least some more sideways movement coming up here, and if you were in the mood for a bet, you could go long some financials.  If lending rates keep falling and the credit markets start unfreezing, we’ll see some strong rallies in financials.  If you did that, you would have to strongly hedge yourself, because regrettably I think that the downside risk is far too great to ignore.

When up and down 500 point days start to become common place, as they have recently, that to me indicates that there are some significant problems that still exist in the market.  If we were really at a bottom, we would start to recover slowly, not with some giant bounce. 

The direction of the market doesn’t change in a weekend, and we’ve seen bottom calls for the last 14 months.  Frankly, you’re going to get burned if you step in for anything longer than 1-3 weeks.

Consumers Don’t Watch the Stock Market That Closely

It’s important to look at everyday consumers instead of the stock market analysts who are calling a bottom.  I firmly expect spending for this Christmas season to be down pretty significantly. People have lost a lot of money and potentially their homes since this crisis first began in the summer of 2007, and to expect people to just flip on a dime at this point would be extremely foolish.  I think we’re in a short term foolish rally, but as soon as consumer spending data starts getting released (a lot of Christmas shopping happens in November), I think we’ll be in store for another fall.

That’s also not to mention the fact that I believe we’ll likely see at least some sort of bankruptcy or last minute merger agreement in auto companies or airlines.  Things have been relatively quiet in those industries, but the harsh reality still looms.  An all out moratorium on large ticket spending (comparitively to past years) would send auto companies reeling, and an airline industry struggling to turn profits two years ago is going to face even tougher winds as credit becomes more scarce and people get tighter with their lending.  I think this will likely force a few shotgun mergers, but as was discussed in a Bloomberg article today relating to a GM/Chrysler merger, the advantages to that deal are many years off in the distance, and the merger would not represent an overnight fix.

My Calls Remain the Same

I personally would use false rallies like this to try and exit losing long calls and enter in to precious metal calls like gold and silver.  Ironically, precious metal miners tend to rally on days when the market is up, regardless of what gold and silver do. 

I’m guessing this stems from some idea that they’ll better be able to find the credit that they need for daily operations when good news comes out of financials.  In general, I think buying solid miners on market down days and broad precious metal etfs like SPDR Gold Shares (NYSE: GLD) and iShares Silver Trust (AMEX: SLV) on up days are some good bets.  You can also check out my post from last Friday for more suggestions.

What We´re Reading Today (organized by most relevant and interesting going down):

World May Be Lucky to Get Worst Recession Since 1983 - Bloomberg

Why we picked it: if you’re looking for a simple article that gives you a cursory explanation of what all is going on right now, look no further.  It talks about the risks we currently run, and the best case scenario we could be facing.

Treasury to Invest in `Healthy’ Banks, Kashkari Says - Bloomberg

Why we picked it: as the government first talked about making stakes in individual companies, many saw the idea as the only real way to stave off the collapse of financial institutions.  However, there was also speculation that a direction investment from the Federal Government could raise serious doubts about a company’s financial strength, and could in turn result in further problems for the bank.  This statement seems to be aimed at that, hinting that the government would let the good succeed and the bad fail.  This of course raises the big question: if a bank is healthy, why the heck would they need a direct capital investment from the government?

Pelosi Says Congress to Consider Second Economic Stimulus Plan - Bloomberg

Why we picked it: as one of my reasons why today’s rally was a “fool’s rally”, in today’s post I cited my opinion that consumer spending, especially on big ticket items, will likely flat line this holiday season.  A bill like this would be targeted at trying to help raise that negative perception.  For most average Americans, the bailout bill is extremely obtuse as a concept, and they likely won’t receive any sort of direct benefit.  A bill like this would help main street and potentially provide a life line for consumer spending.  Look for consumer discretionary stocks to rally off of this news, however it might very well be possible that Americans will use this check to pay off credit card debts and other obligations, limiting the bills short term impact on the economy.

Across the Country, Fear About Savings, the Job Market and Retirement - New York Times

Why we picked it: continuing on the theme discussed in today’s post that you should be watching consumer confidence and not market analysts, this article does a great job of summing up the fears present right now.  These are the things that a one day rally doesn’t fix, and as long as this negative perception persists, we will not see a bottom soon.

Bullion Shortage and Spot Prices Tell Two Different Gold Stories - Seeking Alpha

Why we picked it: if you’re someone like me long on gold and silver, stories like this provide an interesting dilemna, since according to most sources worldwide gold and silver have ballooned in demand, in many instances leading to physical scarcity.  Ironically, the spot price for gold hase fallen today and Friday, leading many to think that there are some problems with the way that paper markets for commodities work, some claiming it’s an all out conspiracy.  Although I don’t believe that it’s that complex, I do think that if there is a sudden correction in spot prices that this might lead to a bull market for precious metals.

GM-Chrysler Merger Won’t Fix Problems, May Add More - Bloomberg

Why we picked it: I talked about this article in today’s post, but I think points to the general problems of so called “shotgun wedding” mergers.  The term essentially applies to failing companies that either quickly sell themselves to bigger or healthier institutions or when two failing companies mash themselves together.  The article raising questions about whether the merger could actually allow the two to realize any sort of short term benefit.

Spanish Bank Said to Be Close to Buying Sovereign Bancorp - New York Times

Why we picked it: I’ve been thinking about Santander Rio a lot lately, mostly stemming from the fact that they more or less avoided most of the problems with the subprime mess in the United States.  This article talks about their proposed buyout of American Soverign Bancorp, which would give them a larger presence in the United States.  I frankly see them becoming one of the mega-banks coming out of their crisis if they play their cards right.

Disclosure: the author of this article is long GLD, DGP, SLV, SIL, FCX and trying to build a position in EDD

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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October 10th, 2008
So throughout these rattling times, I always try and take a step back and think how things aren´t actually that bad, at least in my life. I mean, things could of course be better, but applying that type of metric in terms of trying to find happiness really results in nothing good. I can for the least say that I have a roof over my head, food, and really great friends and family. Although I´m a total optimist, and I really do think that the innovative American spirit can save our economy from the current crisis (my hope is currently invested in alternative energy), the world of investing to me contains nothing of the same free-floating optimism.

I talked yesterday about the disadvantages of liquidating your assets in favor of cash, however including that it might make sense to stop automatic contributions to your retirement account. I´m still heavily in favor of gold and silver, and after both of those assets got pummeled today, I think the outlook is still pretty bright.

I think what´s keeping those markets relatively quiet is the strength that the dollar has maintained against the usual suspects (i.e. the Euro and the Pound, but it has however fallen prey to the Yen). If you remember back a few months ago, when gold was ripping up above $1,000 an ounce, there was some really bearish concerns with the dollar.

I think what´s happening right now is most institutional investors feel pretty safe with cash right now, and unless they start feeling like the value of the dollar is starting to come under attack, I can understand why they wouldn´t want to move in to gold. I think right now everyone is defaulting to the typical trade, which is in times of crisis buy the dollar. People are really scared, and until we start to see some actual safe havens in terms of countries, the dollar is going to continue to be the reserve currency. Once you see that fall start happening (I think the unprecedented level of debt we´re loading up is going to add some serious concerns to major dollar holders) there is going to be a very swift buying spree in gold and silver.

The Title of the Post

Since the Dow is hovering in the 8,000 region (wow, just…wow), I think more and more people are going to start pulling the ¨not that bad argument¨. It doesn´t seem real to be reading all of this, and you start to wonder whether it´s a mistake. With things dropping so far in price and companies hitting historic lows, some of the full on bears are starting to feel like things are basically at their lows. I still feel like we have a long ways to go, and because of this, I think if you´re going to be buying anything other than gold, silver and treasury bills/TIPS, you have to implement what I call cold steel investing.

To me, cold steel investing bascially means you divorce yourself from your emotions and your perceptions of companies. I think to really do well in this market, and to do well in the short term in any market, you have to divorce yourself from the idea of what the company stands for. My example of this would be a company like Google. I think Google is one of the best companies in America in terms of innovation, and if I were to have to pick five companies to invest in for the next twenty years, they would be one of them. However, we´re not doing ¨20 year¨ picks. We´re doing survival picks, which are picks that will make you money in the short term as you try to navigate your portfolio towards safety. For this type of market, if you want to see any types of gains, you´re going to have to invest for the next 1-3 months tops. We´re facing some serious bearish pressure right now, and no matter how good the technical analysis looks on a company, it is very likely that credit problems will cause those technicals to deteriorate or just general fear and panic will push that stock down.

My Example of What A Cold Steel Pick Would Be

So to give you an idea of what I´m talking about, I´d like to bring to the table a company like Phillip Morris International (NYSE: PM). This is a company that was trading at $50 a share a month ago, and today fell as low as $33.30. Now although I think this will be a great stock for the next 3-5 years, I´m not comfortable throwing my money in to the wind and hoping I landed right with this one. Instead, I´m banking on the idea that PM will beat their third quarter results. The reason I think they´re set to do this stems from the fact that they sell a low ticket item with a basically built in audience. I don´t expect that demand for cigarettes will be hit anywhere except countries like the United States, whose ¨sin¨ taxes have pushed the cost up much higher and made a smoking habit there a much bigger chunk of your pay check.

However, internationally the cigarette market is expanding, and cigarettes are still pretty cheap. If you were to pick up PM in the sub $35 region prior to their October 22nd earnings announcement, I wouldn´t be surprised if you saw them rally back up to a price in the mid 40s as their results confirm that type of valuation. The plus with a pick like this is if you see some really stellar results, you can turn it in to a long opportunity as well. I think you should take your gain, however, and stick to it.

If You´re Looking for Safer Debt with a Higher Return, Look to Emerging Markets

After the news that Iceland was likely going to have to default on their debt, I´m guessing the siren went off around the world to watch for other countries that might do the same thing. Because of this, funds like Morgan Stanley Emerging Markets Domestic Debt Fund (NYSE: EDD) are trading at a +40% discount to their Net Asset Value (NAV), resulting in yearly dividends that at some points today got up to 30% as the share price fluctuated.

Now when you hear the word ¨emerging markets¨ and ¨government debt¨ in the same sentence, your immediate reaction is likely to cringe. Indeed, throughout the nineties it was the problems that emerging markets were having with repaying their debt that brought in the IMF and caused a huge flight of capital and solvency concerns. After that debacle, most countries have essentially removed themselves from the practice of pegging their currencies (one of the practices that caused them the problems), and with most running twin surpluses (budget and commercial/current), the threat of them defaulting on their debt really isn´t as big as everything thinks it is.

It should be mentioned that Government debt funds like EDD should be strongly separated from ones that combine commercial debt and government debt. Although countries will likely continue to nationalize and/or bailout banks as problems occur, I do strongly believe that after Argentina´s legendary government default in 2001, most developing countries know that they cannot sacrifice the government´s credit rating to save the private banking arena. Because of this, I feel like emerging market government bonds are actually very safe, and I´ll continue to snap these up in the current future as negative price dips put them in to good territory.

In General Though, I´m All Government Debt, Gold and Silver

I´m essentially using government debt in emerging markets to hedge myself in case things actually end up not being that bad. The hedge for me comes from the idea that a less than apocalyptic credit crunch would result in an upward valuation of the emerging market debt that I´d be holding. In terms of stores of value, I see these types of assets as the only ones that I trust, since to me a ¨AAA¨ corporate bond rating doesn´t really mean that much anymore.

Disclosure: the author of this article is long GLD, DGP, SLV, SIL, FCX and trying to build a position in EDD

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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