Putting the debt ceiling in perspective

Today, the US government hit the ceiling of the "official" or on "the books" debt.

This milestone, I believe, is quite immaterial. First and foremost, this is the on balance sheet debt that people are talking about. The US government has lot more liabilities than this $14.3 trillion represents.

If the government did their accounting as US corporations, using US General Accepted Accounting Principles (US GAAP), the unfunded liabilities would be greater than $100 trillion.

In other words, the US government would have to have today, saved away more than $100 trillion in order to fulfill its financial obligations to creditors, current and future social security retirees, medicare and medicaid recipient, among others.

We can clearly say that the government is bankrupt. But what will the government do? What other governments have done throughout history, that is, debase their currency to pay off their creditors, whether foreign (central banks mostly) or domestic (every worker and retiree in the US).

Outright default is never politically correct, but kicking the can and devaluing the currency is. At the end, when the effects of money printing are felt, governments can always blame goods producers for "creating inflation by raising prices". As the old saying by Ortega & Gasset "When the price of bread rises, the first thing people do is burn down the bakery"

David Walker, the former Comptroller of the US government (The nation's top accountant) clearly explains the unmanageable fiscal outlook. Take a look at this video from 2007:

The fallacy of the “Efficient Market Hypothesis”

The fallacy of the “Efficient Market Hypothesis”

The efficient market hypothesis (EMH) basically says that markets are objective and fully reflect all available information. In other words, whatever a share price is selling for, is a good value and moreover, investors are not going to be able to outperform the market by timing their purchase. This theory also negates the existence of asset cycles and investors do not have to mind when to buy or to sell since “most” investors will get the average market return. The EMH cannot simply explain how you can have “outliers” like Jim Rogers, Jim Puplava, Marc Faber and Peter Schiff.

A good example of why the theory of Efficient Market Hypothesis doesn’t work is Cisco stock.

Back in March 2000, when the Dow Jones stock bubble was deflation, Cisco’s stock was the most valuable company in the planet. It had a market capitalization greater than $550 billion dollars. Its share price was close to $80 and the new economy was going to overtake the “old economy” As we have mentioned before, because of market interference by the Federal Reserve through money and credit creation, asset markets have become increasingly volatile.  

Back then they had revenues of $18.9 billion and net income of $2.7billion and operating cash flow of $6.1 billion, today, they have revenues of $40 billion and net income of $7.7 billion and operating cash flow of $10billion. Today their market capitalization is $97 billion and a share price of $18. The market cap has gone down by a factor of 6, yet earnings have gone up by a factor of 2.85.

The point that we are trying to make is that the market was valuing Cisco at that a very high price (203 times earnings in March 2000) versus its current price/earnings ratio of 12.60. And we are just using Cisco as an example since it was “the stock” to own back then, there are numerous companies which has had happened the same. In our opinion, this is still overvalued, but you get the point that we are trying to make. Capital markets in a Fed-induced credit bubble are not by any way “efficient”. As an investor, you should be weary of using traditional investment valuation tools such as financial statement analysis and take into account investment cycles that we have spoken before. A secondary risk of using financial statements is the fact that accounting standards today change so much, and can vary by industry (Subscription accounting, etc…). 

Lastly, what this example tells us is that the “buy and hold” strategy (more akin to “buy and pray strategy” though) doesn’t work. The astute investor should highly consider actively managing their money by factoring in asset cycles. By doing this, investors should come ahead far more than 99% of other people.

Marc Faber on interest rates, gold and silver

JIm Rogers on CNBC

The Trend is your friend

Alfonso Colombano

While technical analysis is a great tool to time the markets, trying to get market timing right is no easy task.

In my opinion, the best way for most investors to make sustainable gains is to simply invest with the bigger cycle. As we have spoke before about cycles, basically the most important cycle is the long-term bull or short market for whatever asset class you are evaluating. By studying cycles, most investors that do not want to divert their time away from their main profession or business, can comfortably and safely invest in several asset classes.

We know that equities cycle tend to run from anywhere to 18-24 years. The last US bull market we had lasted from 1982-2000. Commodities cycles also last about the same range of time, but their performance is opposite of that of stocks.

My main point is that for the vast majority of investors, rather than trying to time the market, the best solution is to do what’s called dollar cost averaging in the current bull market, which is mainly commodities. Dollar cost averaging, as defined by Wikipedia, is simply  “form of investing equal monetary amounts regularly and periodically over specific time periods (such as $100 monthly) in a particular investment or portfolio.”

For example, an investor that had accumulated precious metals and resource stocks in the past 10 years, would have probably outperformed all of the of the major “diversified” funds. Another advantage of investing in commodities directly is that there’s a lot less evaluation to be done. Even though we recommend investing in commodities producers, there are always extra risks such as management, financial reporting and others that you do not get with the physical commodity. Oil has gone from roughly $10 in 1999 to $107 currently, an increase of roughly 10 times. In about the same time, ExxonMobil, the largest private integrated Oil & Gas Company in the world (before 1999, Exxon), has increased from $33 to $84 currently, (an increase of 2.5-3 times).  The same holds for many other resource producers. Of course, it is always advisable to own these stocks in a commodity cycle since they have outperformed other sectors’ stocks.

Political Prisoner Bernard von Nothaus

Bernard von Nothaus, creator of the Liberty Dollar medallion, has been found guilty of numerous counts including counterfeit and now potentially faces 15 years in prison (he hasn't been sentenced yet) because his company minted one ounce silver and gold medallions. The US government now considers him a domestic terrorist. Von Nothaus created a product that is currently in high demand. His product competed directly with US fiat currency that has lost 96% of its value since its inception and is losing value at an exponentially faster rate. The issue is simply that Von Nothaus has threatened the government’s monopoly on counterfeiting.

While the dollar, according to the Bureau of Labor Statistics, has declined in value by over 20% in the last decade, one of von Nothaus’ Liberty gold and silver one ounce medallions have increased in value by over 425% and 585%, respectively. Why would anyone ever prefer use of dollars when comparing them to medallions? There is no wonder why the feds shut down von Nothaus’ operation. The government has set an example of what they will do to those who challenge them. Mr. Nothaus will become another of the many political prisoners in the US.

Von Nothaus is accused of counterfeit but counterfeiting, as von Nothaus has said, is “using something of no value to get something for value.” His company was doing the opposite of what the government is doing. The fact that the government is targeting those who choose to protect themselves from a devaluing fiat currency is Orwellian. Unfortunately, this is a trend that I fear will escalate.

Marc Faber on Inflation

Jim Rogers and Oil Prices

Price Inflation

As we discussed in podcast a couple of weeks ago, the common definition of inflation is incorrect and obfuscates the real cause. Inflation, until recently, has always been defined as an increase in the money supply. Increasing the money supply, or inflating, has the consequence of increasing prices throughout the economy, whether these are consumer goods or capital goods.

Most mainstream economists wrongly define inflation as being an increase in the price level. First of all, defining a “price level” is quite an impossible and futile task. Measuring consumers’ subjective valuations and aggregating those in an average cannot be done.  For example, as people get older, they tend to consumer more medical services, which in the US, have been going in prices at a very fast level. In other words, the “price level” for somebody in their 70’s-80’s is quite different from the “price level” of somebody in their 20 or 30’s.

Many people dismiss that having a proper definition of inflation is important at all. What they don’t see is that by wrongly defining inflation they are concealing the source of these price increases, which is always the central bank increasing the money supply. The mainstream media always blames price inflation on some other cause, rather than blaming the monetary authority. Whether it’s the “evil speculators”, “greedy OPEC” or other boogiemen of the day, the media hides the true source of these price increases. The CNNMoney article below is a clear example of this:

On a monthly basis, CPI rose 0.5% in December, from 0.1% growth the previous month -- the largest monthly move since June 2009. Economists surveyed by Briefing.com had expected a 0.4% rise in December.

Most of that increase was due to gasoline prices, which surged 8.5% in December alone, as commodities rallied.

The U.S. Consumer Price Index, a key measure of inflation, increased 1.5% over the past 12 months ending in December, up from 1.1% in November, the Bureau of Labor Statistics said.

Core CPI, which strips out volatile food and energy prices, is still at a historic low, after rising a mere 0.8% for the entire year, and only 0.1% for the month.

“Core CPI” applies to you if you don’t drive and don’t eat. I guess there isn’t that many people who can live without transportation or food. This measure of price inflation is completely bogus and tries to obfuscate the real cause as mentioned earlier.

When all prices rise, it is not a matter of the supply of goods, or another good, like gasoline rising in price, cause price increases. When all prices rise, it simply means that the currency is depreciating (in other words, the supply of money is increasing).

More importantly, people have adjusted to the fallacy that price inflation is a “fact of life”. Quite the contrary, in a growing economy, price decreases every year are a result of higher productivity in the economy and should be welcomed. The 19^th century in the US was a period of unprecedented economic growth accompanied by appreciation of the currency. In fact, a dollar in 1900 bought as much as double the amount of goods that it did in 1800.

http://research.stlouisfed.org/fred2/graph/?s[1][id]=BASE

As the money supply keeps increasing, the dollar will continue to depreciate vis-à-vis goods, in particular commodities. As a hedge for the next couple of months, it is indeed a very good idea to invest in agricultural commodities. And don’t forget, the mainstream 90% of the time misses the point and outright lies to the public, so don’t believe most of the news out of the media.

Marc Faber on Treasury Bonds and Stocks

Energy Podcast

2011 Themes

2011 Themes

Municipal Bond Market is due for a correction

State and local governments, unlike the federal government, cannot print their way out of the financial troubles. With an estimated unfunded pension liability of $1-$3 trillion, declining revenues from lower property valuations, higher unemployment and thus lower income taxes, state and local governments are going to be in a lot of trouble in 2011.

Gold will definitely reach new highs

Although in the short term gold will have a meaningful correction, gold will reach a record high, probably in the $1700-$1900 range. Also, if due diligence is performed, many gold mining stocks will outperform the underlying resource itself.

Silver will also have a good year

If you like gold, silver is also a good buy. The most attractive thing about silver is that it hasn’t hit its nominal peak of $40 in 1982. As an industrial metal, it is used from electronics to special metallurgy to window panning. Moreover, the silver/gold ratio, although still not as cheap as before, it still makes silver a bargain.

Natural gas will likely outperform crude oil this year

Everywhere in the news media we hear about shale gas driving prices lower than before. For the past 2 years, natural gas has been one of the worst performing commodities. Many analysts are bearish on natural gas, which as contrarians encourages us. Lastly, the oil/gas price ratio is sitting at a 24-year high, making natural gas very attractive.

2011 will be a bad year for US treasury bonds

On November 2nd, when Ben Bernanke announced, “Quantitative Easing part II” (euphemism for money printing), he claimed that long-term interest rates would go down, but they have actually risen. More and more investors are catching up to the fact that investing in a market that has been in a bull market for 29 years is not a good idea. For the first time in a long time, corporate bonds from AAA companies are paying less than treasuries. More over, even foreign central banks are slowly reducing their holdings (either by outright selling or not buying at the same pace as before). A good example is China, which had a peak ownership of Treasuries in October 2009. Add to this fact the fiscal position of the US government with unfunded liabilities of anywhere from $40 trillion to $80 trillion, an overtaxed population and demographics problems with baby boomers retiring, and it’s certainly not the best market to be in.

Agricultural commodities

If you are a value investor, look no further than agricultural commodities, specifically rice, coffee, sugar. Even though they’ve hit recent intermediate highs, they are still the biggest bargain out there. Sugar hit at an all time high in 1975 of 55-56 cents per pound , and that’s in nominal dollars ( in today’s dollars, that would be $2.17/lb), sugar is currently selling for 33 cents. Coffee had its all time high in 1977 at $3/lb ($11.82/lb in today’s dollars) and now is selling at $2.40/lb. And rice is only 40% higher from its all-time low of $.10/lb. With weather conditions more unpredictable (droughts and floods more common) and inventories running very small, agricultural commodities and land look more appealing than ever.

Conclusion

From a value perspective, except for agriculture, nothing looks inexpensive, especially with the Federal Reserve printing money and depreciating the dollar. With the current market cycle favoring commodities for the next 5-10 years, and with a better price inflation hedge than stocks, commodities should certainly be in investors' holdings for the coming year. To sum up our thoughts for the new year, the best investments are agriculture and precious metals while the worst will be bonds.