Golden wall of worry

http://www.marketwatch.com/story/contrarian-reaction-to-golds-big-plunge-2010-07-02

Gold's huge drop on Thursday is not the beginning of a new major leg down for the yellow metal.

That at least is the conclusion reached by a contrarian analysis of gold market sentiment. There does not currently exist the kind of stubborn optimism among gold timers that is the hallmark of major market tops.

Jim Cramer jumping on the gold bandwagon

Jim Cramer of CNBC's Mad Money was praising gold's all-time new highs today, as well as a couple gold mining ETF's. Which caused me to pause, as he's been bashing the shiny metal for a while. To his credit, I believe his trust fund owns Agnico, a gold miner.

Could this about-face be the death knell for gold's ascent? Perhaps a correction is in order, and I did take a little profit off the table yesterday. Cramer has been a good contrarian indicator, as I believe most of his calls are wrong-way bets (sorry, Jim, but your track record is questionable), but that doesn't mean gold will stop climbing in price. A correction is expected after recent surges, but the secular bull market for gold since 2001 is still intact, in my opinion. In which case, I'm with Cramer on this one. Booyah!

As long as central bankers worldwide are accomodative with low interest rates and stimulative monetary policies, gold has nowhere to go but up.

I started buying gold and silver coins and mining shares last November, gradually adding to my holdings ever since on dips. With the exception of one, all the mining shares have appreciated triple digits since then, yet Cramer is only now touting the yellow metal. Curious, but predictable.

Does this mean I will exit all my precious metals holdings? After all, as a contrarian, you want to bet against the extreme majority. When sentiment gets too exuberant, you sell. Likewise, when there's blood in the streets, you buy. In other words, has the trade become too crowded? Absolutely not. Because even though some people are now understanding the logic behind holding precious metals as an inflation hedge and as a reliable store of value, very few have acted on this knowledge. I would argue most people don't understand the value of gold--or just have a distaste for the yellow metal. Most won't jump aboard until the mania phase kicks in at much higher prices, when everyone and their brother will be recommending gold as a speculative bet, without understanding its intrinsic role as a means of preserving purchasing power.

The prudent strategy is to sell into that mania--not buy into it. The parabolic rise in gold and silver prices probably won't occur for a few more years, the normal lag time behind an increase in the money supply. Inflation usually doesn't kick in until these massive liquidity injections eventually flow through the economy via bank lending. But then again, we are in uncharted territory. This is a monetary experiment run by mad scientists at the Fed and US Treasury. No country has ever printed so many trillions of dollars so quickly.

An orderly decline of the dollar will cause a steady climb in gold and silver. But should there be a run on the dollar in a currency crisis, the mania phase in hard assets will go into high gear almost overnight.

See disclaimers on the sidebar.

Disclosure: long gold and silver, and long gold mining shares.

CNBC--the Ultimate Contrarian Indicator

The Business Week contrarian indicator is fairly well-known among savvy investors. The theory goes like this: whatever investment is touted on the cover of Business Week, sell it, because by the time the mainstream audience gets wind of it, it is too late, and expectations have reached a manic peak. Likewise, when the cover story of Business Week declares disaster for a certain asset, a bottom is near and it may be time to buy it. In other words, Business Week is a "Wrong-Way Corrigan" indicator--doing the exact opposite of what Business Week urges investors to do is usually enormously profitable, as it sends signals for inflection points.

I believe CNBC has replaced Business Week as the ultimate contrarian indicator, because following the economy and finances has become America's past time. More Americans are becoming literate in financial matters--even when they are learning the wrong things. And CNBC is the flagship business network.

Predictably, CNBC is on permanent bull market mode. From Kudlow to Cramer, and other pundits and journalists in between, they tend to be overly bullish. And their content couldn't have predicted the stock market peak any better. Right before markets worldwide cratered last fall, CNBC was running special programs investigating how hedge fund managers were becoming super wealthy. They also had specials running on Warren Buffett, the world's best long-term investor. Both hedgies and Buffett's Berkshire Hathaway shares have cratered since.

I even saw a business show declaring how Iceland was now one of the wealthiest countries in the nation last year. Today, they are completely bankrupt.

Shorting hedge fund returns, Berkshire Hathaway's shares, and Iceland's currency would have made you a mint last year.

Shouldn't CNBC have run specials on Wall Street fraud, Ponzi schemes, bank insolvency, billion-dollar bonuses when banks were bleeding billions, the auto industry burning cash by the billions, unscrupulous mortgage lenders, over-extended and irresponsible consumers and home borrowers, the impending subprime mortgage crisis, countries defaulting on loan obligations, currencies collapsing, or any number of indicators revealing a wave of cracks which would give way to an avalanche of financial meltdown? Where was the investigative journalism?

The investing public needed these stories before the crisis, not ex post facto. However, to investors with a shrewd eye, the writing should have been on the wall. A modest 2 bedroom, 1 bathroom home is NOT worth $2 million, no matter which neighborhood it resides. And when home prices reached ten times average incomes, something didn't smell right.

But that's spilled milk, the proverbial "looking in the rearview mirror". Let's look forward through the windshield, in order to be constructive.

What should one notice? Government central banks worldwide are printing money ad nauseum, raising fiscal Cain in the process, in an effort to prop up their local economies. This can only debase all foreign currencies in lock step. The only reason why the USDollar remains stronger relative to other foreign currencies is because as bad as our economy is (the US consumer drives over 70% of gross domestic product), other developed and emerging countries are in even deeper water. Many are export-driven, and they are not exporting goods, because the American consumer is tapped out and no longer has any credit. And many foreign banks are more leveraged than their already overly-levered US counterparts.

The biggest reason why the USDollar is stronger than the others (with the exception of the Japanese yen, which has a reserve surplus, i.e., they are savers) is because we still possess the world's reserve currency. However, our USDollar's reserve currency status is slowly eroding, as the Fed continues to print trillions of excess dollars to fund the huge bailouts.

Other sovereign banks and funds are slowly migrating to the realizing that the reign of the USDollar as the dominant currency is coming to an end. They need to hold USDollars in a flight to safety in these shaky markets, but they also realize this is a losing trade as the USDollar is being devalued.

This is one of the reasons why gold is now considered the currency of last resort. Gold has held its value to mankind for centuries, beyond hundreds of empires, nations, wars, economic expansions, economic contractions. Meanwhile, every currency over that span has been devalued--into oblivion eventually.

So when CNBC "pundits" were bashing gold last week, I had to laugh. They claimed owning gold was "unpatriotic"--literally a bet against America. Don't believe them--they are categorically and emphatically wrong.

Owning gold protects citizens from bubbles caused by reckless governments, runaway deficit spending and crippling busts. It's a vote for sound money policy that retains its value from generation to generation. It preserves your purchasing power--and your children's. It enables true economic growth--not false prosperity built on debt quicksand. It rewards successful businesses and ideas, not broken business models subsidized by bureaucracy and favoritism.

If anything, gold is the ONLY patriotic currency available to an increasingly skeptical citizenry.

Assets

I don't think real estate and raw land would have been a safe hedge if you purchased 2, 3, 4 years ago. In fact, in some regions, you'd be grossly upside down.

Having said that, I called the real estate top 2 years ago, and called the severity of the subprime mortgage crisis last July as well as the second leg down on banks last month (ironically enough, in sports message boards). The take away message is the commodities listed (oil, gold, futures, etc.) are just assets, altho a different category of assets. Some were dormant for 20 years, and have recently come back with a vengeance. But you would have lost your ass several times over going long on them for all those years. They are just another class of assets, just like biotech stocks or mortgage-backed securities are financial assets. Some shine during certain periods of economic cycles, while others have their own value trajectories.

You're better off being a contrarian, buying assets that are beaten down and hence, grossly undervalued. Call me dumb, and that's okay, but I've never made any money following the crowd--in fact, I've always lost money going against my instincts. I will be a net buyer of certain downtrodden assets in the next couple years, as this downturn is going to last longer than most predict. We have time in this buyer's market to be choosy. But the bottom will be well-formed before the economic indicators pick up. That's my next call: when there's blood on the streets for the next 2 years, there will be huge buying opportunities. Just when the last bulls throw in the towel is when expectations will be lowest for even the most optimistic. That's when the secular low will be reached. The economy will eventually crawl up again, much like other recoveries, but entirely unique because inflationary pressures won't be dormant this time. In fact, that alone will temper the upside a bit.

I really do think future boom/bust cycles will be more pronounced, but that's not the worse part. What's worse is that the US is on its downslope in terms of being the top dog on the world stage. The 20th century experienced major dislocations as well, but America came back stronger than ever each time. These next recoveries won't be as crisp. We will have to accept that while we will still be one of the two biggest consumers of the world's goods, the adult table will now be more crowded. We will fall back into the pack along with China and a handful of powers.

One thing is for sure: we are in for a rough ride. I just find it counterproductive that the pundits and experts always want to look back retrospectively for a cure to prevent the next boom/bust cycle. But in doing so, they will introduce more legislation that merely adds to the cost of doing business. The laws to prevent fraud are in place--it's the enforcement that is lacking. Adding more legislation after the FSLIC S & L fiasco didn't prevent the current mortgage crisis. It just created more complexity and increased business costs. Just like Sarbanes/Oxley won't prevent the next stock market bubble. All S/O did was drive smaller companies out of business. They ended up too busy with compliance in lieu of concentrating on their core competence of running their businesses.

Bottom-line: we need to just accept that greed and fear have always, and will always drive market fluctuations. Irrational exuberance (coined by former Fed Chairman Greenspan) exists in every market boom, just like panic selling occurs with every market meltdown. Now, can measures be put in place to attenuate volatility? Perhaps, but the cure shouldn't be worse than the illness.

Investments and taxes

To be honest, it's more an academic discussion for me, as I don't play the markets like I used to, and when I do, I follow astute managers who happen to have similar philosophies on markets--and life. When my philosophies are congruent, I don't allow myself to second guess my decisions, and to me, second guessing has been my achilles heel when it comes to investing. I've lost far too much money when I let emotions, politics, and other people influence me unduly. That's one of the reasons I disdain politics: like the talking heads on CNBC, I follow it with mild interest, but only to get a beat on the general consensus, and I use it as a contrarian indicator. Because let's face it, when it comes to investing, most people get it wrong. The average 35 year old American has a net worth of $15,000. We are taught from day one to go to school and how to get a job, but we have had zero training on personal financial management. And the mortgage crisis just happens to be one big symptom of that mentality.

My whole investment methodology turns conventional wisdom upside down, but in reality, I am merely a good plagiarizer--I just follow unpopular strategies that the majority of the population is not exposed to, but are readily adopted by the wealthy. Even some of the brightest and best investment managers aren't privy to these strategies--or their emotional makeup doesn't allow them patience to implement them. They're great at picking stocks, and a few are even good at market timing, but they don't understand asset optimization--the optimization of ALL assets.

Dawgbytes is 100% correct--Wall St. money managers like to brag that the long-term returns of equities is between 8-12% historically (depending on the time window), but that's only if dividends are reinvested. Without that boost, the Dow and S & P's returns are closer to 2-3% or less, underperforming inflation. And since divies are taxed as earned, it ends up being a losing game.

And because we are humans, with emotions, the average investor thinks they can time the markets, when in reality, they are terrible at it. Owning stocks between 1983 to 2000 was the best time to own equities in the history of mankind--the annual rate of return for the S & P was over 12%. Guess what the average investor earned? 2.3%. They suffer from the casino delusion--that somehow they can beat the house.

So what does that mean? You better pick the right stocks for long-term appreciation and income--or pick the right money manager. Which means you eliminate 96% of the mutual funds out there, as they underperform the Lipper averages and indices. That's mainly due to exorbitant trading transaction costs, as well as the more unscrupulous window dressing. The gentler explanation is that the funds are "actively managed", and yet clients have to pay a 3% load to have it actively managed. It's unbelievable what many of these managers get away with. So cheat with my wife, and stick me with the hotel bill while you're at it.

Then there's the indexed method of investing which I espouse, as the loads are lower, but even in that case, there are hidden transaction costs as indexed funds get re-balanced as companies exit/enter the index and market caps vary. But at least clients get a semblance of earning the averages, which 80% of active money managers can't even meet. And then there's the taxation.

People have no idea how taxes hurt investment portfolios. They think they do, but they have no idea of the magnitude.

An individual earns an income, and gets taxed on that income. After paying expenses, and he/she is disciplined enough to save enough money to invest, and lucky enough to earn a positive rate of return on that money, they are taxed again (hopefully at the lower capital gains rate). Dividends are taxed as earned. Tax what I make, tax that same money short-term, and long-term. That sounds like a triple tax to me.

That's why tax-free accumulation and income is so crucial. $1 doubled 20 times ends up being over $1 million. $1 doubled 20 times, but taxed as earned at 27%, nets a little over $50,000. I'd rather have the million.