Thursday, August 21, 2014

Stop Investing in Leveraged ETFs

By Andrey Dashkov

Bigger, faster, better. That’s the turbocharged investment we all want. Miller’s Money Forever subscribers who pay close attention to our portfolio, though, will notice that we don’t hold leveraged ETFs—those with “2x” or “inverse” or “ultra” in their names, which some investors mistake for “better.”

Exchange-traded funds (ETFs) are a great tool for many portfolios. They allow investors to profit from movements in a huge variety of assets grouped by industry, geography, presence in a certain index, or other criteria. You can find ETFs tracking automobile producers, cotton futures, or cows.

For our purposes, ETFs make it easier to diversify within a certain group of companies—easier because you don’t have to buy them individually. You buy the ETF and leave it to its managers to balance the portfolio when needed.

We have several ETFs in the Money Forever portfolio, and they have served us well so far. They expose us to several universes, such as international stocks, foreign dividend-paying companies, convertible securities, and others.

Why Turbocharged Isn’t Always Better


So, if we think the underlying index or asset class will move in our favor, why wouldn’t we opt for the turbocharged version—the versions that use leverage (credit) to achieve gains two times higher?
First, because we’re very cautious about volatility, and leveraged ETFs are designed to be less stable than the underlying assets. Second, there is a trick to leveraged ETFs that can make your investment in them stink even if the underlying index or asset does well.

Before we get to the details, let me pose two questions:
  • If the S&P 500 goes up by 5% over several days, how much would a 2x leveraged ETF based on the index earn?
  • If the S&P 500 goes up and down, then rises, and after a while ends up flat, will our ETF end up flat too?

If you answer 10% to the first question, you may be correct, and that’s the caveat: you won’t be correct 100% of the time. You can’t just multiply an index’s total gain by the ETF’s factor to gauge how much you’ll earn, because leveraged ETFs track daily gains, not total ones.

To show how that works, here’s a brief example that will also answer question number two.

Day # Index Price Daily Return ETF Price
Index ETF
1,900 $100.00
1 1,800 -5.26% -10.53% $89.47
2 1,870 3.89% 7.78% $96.43
3 2,000 6.95% 13.90% $109.84
4 1,900 -5.00% -10.00% $98.86
Total return 0.0% -1.1%
Source: TheTradeSurfer


What you’re looking at here is a hypothetical index with a value of 1,900 at the beginning of our period. It goes up and down for four days, and then is back to 1,900 by the end of day 4. There is also an ETF that starts with a price of $100 and doubles the daily gains of the index.


On the first day, the index goes down to 1,800 for a daily loss of 5.26%. This forces the daily loss of the ETF to be 10.53% (including rounding error), and the resulting price of the ETF is $89.47. The next day the index is up 3.89%, forcing the ETF to grow by 7.78%, to $96.43, and so on.

We designed this table to show that even though the underlying index is back to 1,900 in five days, returning 0% in total gain, the ETF is down 1.1% by the end of day 4.

It works like this because ETFs are designed to track daily returns, not mirror longer-term performance of the underlying index, and because of how cumulative returns work. If one share of the ETF costs $100 at the beginning of the period and the market dropped 5%, we should expect double the drop. Our share would now be worth $90. If the next day it reverses and goes up 5%, we should expect double the increase. We would be right in doing so, but our share would be worth $99 now, not $100—because it increased 10% above the $90 closing price the day before.

Leveraged ETFs Are for Traders, Not Investors


If a trader is smart and lucky, she or he would buy the ETF at the beginning of day 3 at $96.43, sell at $109.84, and realize a gain of 14%. But if one bought at day 0 and held until the end of our period, one would lose money even though the underlying index ended up flat.

In general, no one can predict where an ETF will end up because it’s impossible to tell in advance what pattern the underlying index will follow. In practice, it means that an ETF only partially tracks the underlying index; its performance also depends on its own past results.

The ideal case for investing in an ETF (we assume it’s long the market) would be to buy it at the beginning of a multi-day, uninterrupted uptrend. In that case, it would come very close to doubling the market’s performance. But such winning streaks are impossible to forecast, and short-term trading like this is not our focus.

We don’t recommend leveraged ETFs in our portfolio because they’re geared for traders, and we take a longer-term perspective. We are investors.

The additional potential reward from a turbocharged ETF doesn’t warrant the additional risk, particularly when you’re investing retirement money. There are safer ways to maximize your retirement income. Learn more about our strategies for doing just that by signing up for Miller’s Money Weekly, our free weekly e-letter that educates conservative investors about timely investment strategies. You’ll receive ahead-of-the-curve financial insight and commentary right in your inbox every Thursday. Start building a rich retirement by signing up today.

The article Stop Investing in Leveraged ETFs was originally published at Millers Money


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Tuesday, August 19, 2014

Bubbles, Bubbles Everywhere

By John Mauldin



The difference between genius and stupidity is that genius has its limits.
– Albert Einstein
Genius is a rising stock market.
– John Kenneth Galbraith
Any plan conceived in moderation must fail when circumstances are set in extremes.
– Prince Metternich
I'm forever blowing bubbles, Pretty bubbles in the air
They fly so high, nearly reach the sky, Then like my dreams they fade and die
Fortune's always hiding, I've looked everywhere
I'm forever blowing bubbles, Pretty bubbles in the air

You can almost feel it in the air. The froth and foam on markets of all shapes and sizes all over the world. It’s exhilarating, and the pundits who populate the media outlets are bubbling over. There’s nothing like a rising market to lift our moods. Unless of course, as Prof. Kindleberger famously cautioned (see below), we are not participating in that rising market. Then we feel like losers. But what if the rising market is … a bubble? Are we smart enough to ride it high and then bail out before it bursts? Research says we all think that we are, yet we rarely demonstrate the actual ability.

My friend Grant Williams thinks the biggest bubble around is in complacency. I agree that is a large one, but I think even larger bubbles, still building, are those of government debt and government promises. When these latter two burst, and probably simultaneously, that will mark the true bottom for this cycle now pushing 90 years old.

So, this week we'll think about bubbles. Specifically, we'll have a look at part of the chapter on bubbles from Code Red, my latest book, coauthored with Jonathan Tepper, which we launched late last year. I was putting this chapter together about this time last year while in Montana, and so in a lazy August it is good to remind ourselves of the problems that will face us when everyone returns to their desks in a few weeks. And note, this is not the whole chapter, but at the end of the letter is a link to the entire chapter, should you desire more.

As I wrote earlier this week, I am NOT calling a top, but I am pointing out that our risk antennae should be up. You should have a well-designed risk program for your investments. I understand you have to be in the markets to get those gains, and I encourage that, but you have to have a discipline in place for cutting your losses and getting back in after a market drop.

There is enough data out there to suggest that the market is toppy and the upside is not evenly balanced. Take a look at these four charts. I offer these updated charts and note that some charts in the letter below are from last year, but the levels have only increased. The direction is the same. What they show is that by many metrics the market is at levels that are highly risky; but as 2000 proved, high-risk markets can go higher. The graphs speak for themselves. Let’s look at the Q-ratio, corporate equities to GDP (the Buffett Indicator), the Shiller CAPE, and margin debt.






We make the case in Code Red that central banks are inflating bubbles everywhere, and that even though bubbles are unpredictable almost by definition, there are ways to benefit from them. So, without further ado, let’s look at what co-author Jonathan Tepper and I have to say about bubbles in Chapter 9.

Easy Money Will Lead to Bubbles and How to Profit from Them

Every year, the Darwin Awards are given out to honor fools who kill themselves accidentally and remove themselves from the human gene pool. The 2009 Award went to two bank robbers. The robbers figured they would use dynamite to get into a bank. They packed large quantities of dynamite by the ATM machine at a bank in Dinant, Belgium. Unhappy with merely putting dynamite in the ATM, they pumped lots of gas through the letterbox to make the explosion bigger. And then they detonated the explosives. Unfortunately for them, they were standing right next to the bank. The entire bank was blown to pieces. When police arrived, they found one robber with severe injuries. They took him to the hospital, but he died quickly. After they searched through the rubble, they found his accomplice. It reminds you a bit of the immortal line from the film The Italian Job where robbers led by Sir Michael Caine, after totally demolishing a van in a spectacular explosion, shouted at them, “You’re only supposed to blow the bloody doors off!”

Central banks are trying to make stock prices and house prices go up, but much like the winners of the 2009 Darwin Awards, they will likely get a lot more bang for their buck than they bargained for. All Code Red tools are intended to generate spillovers to other financial markets. For example, quantitative easing (QE) and large-scale asset purchases (LSAPs) are meant to boost stock prices and weaken the dollar, lower bonds yields, and chase investors into higher-risk assets. Central bankers hope they can find the right amount of dynamite to blow open the bank doors, but it is highly unlikely that they’ll be able to find just the right amount of money printing, interest rate manipulation, and currency debasement to not damage anything but the doors. We’ll likely see more booms and busts in all sorts of markets because of the Code Red policies of central banks, just as we have in the past. They don’t seem to learn the right lessons.

Targeting stock prices is par for the course in a Code Red world. Officially, the Fed receives its marching orders from Congress and has a dual mandate: stable prices and high employment. But in the past few years, by embarking on Code Red policies, Bernanke and his colleagues have unilaterally added a third mandate: higher stock prices. The chairman himself pointed out that stock markets had risen strongly since he signaled the Fed would likely do more QE during a speech in Jackson Hole, Wyoming, in 2010. “I do think that our policies have contributed to a stronger stock market, just as they did in March of 2009, when we did the last iteration [of QE]. The S&P 500 is up about 20 percent plus and the Russell 2000 is up 30 percent plus.” It is not hard to see why stock markets rally when investors believe the most powerful central banker in the world wants to print money and see stock markets go up.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – Please Click Here.

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Monday, August 18, 2014

Casey Research "Our Highest Rated Speech of All Time"

By Olivier Garret, Chief Executive Officer

Never in my life have I seen a round of applause like this one… and at an event normally composed of conservative, introspective investors to boot. But most surprising of all - and I must admit in my bias here  they were applauding a lawyer. A defense lawyer at that.

The usual fare at our conferences has much more to do with how to keep your money safe (and invest it to grow, of course). But we always prefer to mix in a few speakers to give us a real, on the ground reality check of what’s happening to our freedoms. Thus, when we invited constitutional law and criminal defense attorney Marc J. Victor to speak, we expected he'd share his insights into a slowly eroding respect for individual rights. He did not. Instead, he showed us just how bad things are getting and at a breakneck pace just beyond the public eye.

His talk was downright chilling. And now, for the first time, I'm excited to share his Casey Summit presentation in its entirety with all of you. He's the highest reviewed outside speaker we've ever gotten feedback on. This is a must watch.

But first, I'm sharing it with you now because Mr. Victor has agreed to appear once again at next month's Summit with a complete update on his talk. I just checked with our events team, and they say that, per usual, the Summit will likely end up selling out the hotel. There are just over a dozen rooms left for next month's conference.

So, you must register now if you want one of the few remaining rooms on site.

And now, Marc's full presentation:


Marc's shiver inducing talk is exactly the kind of amazing speeches our regular summit attendees have come to expect of our always sold out events. If you've never been to a Casey Summit before, now is the perfect chance to try one.

Click here for complete details on the upcoming conference September 19-21 in the beautiful San Antonio hill country.

Sincerely,

Olivier Garret, CEO
Casey Research



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Friday, August 15, 2014

The Biggest Lesson from Microsoft’s Recent Battle with the US Government

By Nick Giambruno, Senior Editor, InternationalMan.com

A court ruling involving Microsoft’s offshore data storage offers an instructive lesson on the long reach of the US government—and what you can do to mitigate this political risk.

A federal judge recently agreed with the US government that Microsoft must turn over its customer data that it holds offshore if requested in a search warrant. Microsoft had refused because the digital content being requested physically was located on servers in Ireland.

Microsoft said in a statement that “a US prosecutor cannot obtain a US warrant to search someone’s home located in another country, just as another country’s prosecutor cannot obtain a court order in her home country to conduct a search in the United States.”

The judge disagreed. She ruled that it’s a matter of where the control of that data is being exercised, not of where the data is physically located.

This ruling is not at all surprising. It’s long been crystal clear that the US will aggressively claim jurisdiction if the situation in question has even the slightest, vaguest, or most indirect connection. Worse yet, as we’ve seen with the extraterritorial FATCA law, the US is not afraid to impose its own laws on foreign countries.
One of the favorite pretexts for a US connection is the use of the US dollar. The US government claims that just using the US dollar—which nearly every bank in the world does—gives it jurisdiction, even if there were no other connections to the US. It’s quite obviously a flimsy pretext, but it works.

Recently the US government fined (i.e., extorted) over $8 billion from BNP Paribas for doing business with countries it doesn’t like. The transactions were totally legal under EU and French law, but illegal under US law. The US successfully claimed jurisdiction because the transactions were denominated in US dollars—there was no other US connection.

This is not typical of how most governments conduct themselves. Not because they don’t want to, but because they couldn’t get away with it. The US, on the other hand—as the world’s sole financial and military superpower (for now at least)—can get away with it.

This of course translates into a uniquely acute amount of political risk for anyone who might fall under US jurisdiction somehow, especially American citizens. A prudent person will look to mitigate this risk through international diversification.

So let’s see what kinds of lessons this recent court ruling offers for those formulating their diversification strategies.

The Biggest Lesson


The most important lesson of the Microsoft case is that any connection to the US government —no matter how small—exposes you to big risks.

If there’s anything connected to the US, you can count on the US government using that vulnerability as a pressure point. Microsoft, being a US company with a huge US presence, is of course exposed to having its arms easily twisted by the US government—regardless if the data it stores is physically offshore.

Now let’s assume the company in question was a non-US company, with no US presence whatsoever (not incorporated in the US, no employees in the US, no servers or computer infrastructure in the US, no bank accounts in the US): then the US government would have a much more difficult time accessing the data and putting pressure on the company to comply with its demands.

It’s important to remember that even if a company or person is more immune to traditional pressures, there are plenty of unconventional ways the US can respond.

The US government could always resort to hacking, blackmail, or other acts of subterfuge to access foreign data that is seemingly out of its reach. This is where encryption comes in. We know from the Edward Snowden revelations that when properly executed, encryption works. For all practical purposes as things are today, strong and proper encryption places data beyond the reach of any government or anyone without the encryption keys.

Of course, there is no such thing as 100% protection, and there never will be. But using encryption in combination with a company that—unlike Microsoft—is 100% offshore is the best protection you can currently get for your digital assets.

Once you get the hang of it, encryption is actually easy to use. Be sure to check out the Easy Email Encryption guide; it’s free and located in the Guides and Resources section of the IM site.

How easily the US can access your offshore digital data will also come down to the politics and relationship between the US and the country in question. You can count on the UK, Canada, Australia, and others to easily roll over for anything the US wants. On the other hand, you can bet that a country with frosty relations with the US—like China or Russia—will toss most US requests in the garbage. This political arbitrage is what international diversification is all about.

The lessons of the Microsoft case extend to offshore banking.

It’s much better to do your offshore banking with a bank that has no branch in the US. For example, if you open an HSBC account in Hong Kong, the US government can simply pressure HSBC’s large presence in the US to get at your Hong Kong account—much like how the US government pressured Microsoft’s US presence to get at its data physically stored in Ireland.

Obtaining the Most Diversification Benefits


Most of us know about the benefits of holding uncorrelated assets in an investment portfolio to reduce overall risk. In a similar fashion, you can reduce your political risk—the risk that comes from governments. You do this by spreading various aspects of your life—banking, citizenship, residency, business, digital presence, and tax domicile—across politically uncorrelated countries to obtain the most diversification benefits. The optimal outcome is to totally eliminate your dependence on any one country.

This means you’ll want to diversify into countries that won’t necessarily roll over easily for other countries. This is of course just one consideration, and it needs to be balanced with other factors. For example, Russia isn’t going to be easily pressured by the US government. But that doesn’t mean it’s a good idea to bank there.

Personally, I’m a fan of jurisdictions that are friendly with China—which helps insulate them from US pressure—but have a degree of independence and are competently run, like Hong Kong and Singapore.
Naturally, things can change quickly. New options emerge, while others disappear. This is why it’s so important to have the most up-to-date and accurate information possible. That’s where International Man comes in. Be sure to check out our Going Global publication, where we discuss the latest and best international diversification strategies in great, actionable detail.



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Wednesday, August 13, 2014

Low and Expanding Risk Premiums Are the Root of Abrupt Market Losses

By John Mauldin


Risk premiums. I don’t know anyone who seriously maintains that risk premiums are anywhere close to normal. They more closely resemble what we see just before a major bear market kicks in. Which doesn’t mean that they can’t become further compressed. My good friend John Hussman certainly wouldn’t argue for such a state of affairs, and this week for our Outside the Box we let John talk about risk premiums.

Hussman is the founder and manager of the eponymous Hussman Funds, at www.Hussmanfunds.com. Let me offer a few cautionary paragraphs from his letter as a way to set the stage. I particularly want to highlight a quote from Raghuram Rajan, who impressed me with his work and his insights when we spent three days speaking together in Scandinavia a few years ago. At the time he was a professor at the University of Chicago, before he moved on to see if he could help ignite a fire in India.

Raghuram Rajan, the governor of the Reserve Bank of India and among the few economists who foresaw the last financial crisis, warned last week that “some of our macroeconomists are not recognizing the overall build-up of risks. We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost. Investors say ‘we will stay with the trade because central banks are willing to provide easy money and I can see that easy money continuing into the foreseeable future.’ It’s the same old story. They add ‘I will get out before everyone else gets out.’ They put the trades on even though they know what will happen as everyone attempts to exit positions at the same time.”

As a market cycle completes and a bull market gives way to a bear market, you’ll notice an increasing tendency for negative day-to-day news stories to be associated with market “reactions” that seem completely out of proportion. The key to understanding these reactions, as I observed at the 2007 peak, is to recognize that abrupt market weakness is generally the result of low risk premiums being pressed higher. Low and expanding risk premiums are at the root of nearly every abrupt market loss. Day-to-day news stories are merely opportunities for depressed risk premiums to shift up toward more normal levels, but the normalization itself is inevitable, and the spike in risk premiums (decline in prices) need not be proportional or “justifiable” by the news at all. Remember this, because when investors see the market plunging on news items that seem like “nothing,” they’re often tempted to buy into what clearly seems to be an overreaction. We saw this throughout the 2000-2002 plunge as well as the 2007-2009 plunge.

Yesterday evening, another astute market observer in the form of my good friend Steve Cucchiaro, founder of Windhaven, joined a few other friends for an entertaining steak dinner; and then we talked long into the night about life and markets. It is difficult to be “running money” at a time like this. The market is clearly getting stretched, but there is also a serious risk that it will run away for another 10 or 15%. If you are a manager, you need to be gut-checking your discipline and risk strategies. If you’re a client, you need to be asking your manager what his or her risk strategy is. It’s not a matter of risk or no risk but how you handle it.

What is your discipline? What non-emotional strategy instructs you to enter markets and to exit markets? Is it all or nothing, or is it by sector? Are you global? If so, do you have appropriate and different risk premiums embedded in your strategies? Just asking…. John’s piece today should at least get you thinking. That’s what Outside the Box is supposed to do.

It’s an interesting week around the Mauldin house. All the kids were over Sunday, and we grilled steaks and later ended up in the pool, shouting and horsing around, all of us knowing that three of the seven would be off to different parts of the country the next day. I know that’s what adult children do, and as responsible parents we all want our children to be independent, but the occasion did offer a few moments for reflection. Sunday night we just told stories of days past and laughed and tried not to think too much about the future.

A friend of mine just came back from California and Oregon complaining about the heat. Dallas has been rather cool, at least for August. If this weather pattern somehow keeps up (and it won’t), I can see lots of tax refugees streaming into Texas from California.

Tomorrow (Thursday) my mother turns 97, and we will have an ambulance bring her to the apartment, where she wants to have her birthday party. She is bedridden but is absolutely insisting on this party, so my brother and I decided to let her have her way. Which isn’t any different from the way it’s always been. Have a great week.

You’re rich in family and friends analyst,
John Mauldin, Editor
Outside the Box

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Low and Expanding Risk Premiums Are the Root of Abrupt Market Losses

By John P. Hussman, Ph.D.
Through the recurrent bubbles and collapses of recent decades, I’ve often discussed what I call the Iron Law of Finance: Every long-term security is nothing more than a claim on some expected future stream of cash that will be delivered into the hands of investors over time. For a given stream of expected future cash payments, the higher the price investors pay today for that stream of cash, the lower the long-term return they will achieve on their investment over time.

The past several years of quantitative easing and zero interest rate policy have not bent that Iron Law at all. As prices have advanced, prospective future returns have declined, and the “risk premiums” priced into risky securities have become compressed. Based on the valuation measures most strongly correlated with actual subsequent total returns (and those correlations are near or above 90%), we continue to estimate that the S&P 500 will achieve zero or negative nominal total returns over horizons of 8 years or less, and only about 2% annually over the coming decade. See Ockham’s Razor and The Market Cycle to review some of these measures and the associated arithmetic.

What quantitative easing has done is to exploit the discomfort that investors have with earning nothing on safe investments, making them feel forced to extend their risk profile in search of positive expected returns. The problem is that there is little arithmetic involved in that decision. For example, if a “normal” level of short-term interest rates is 4% and investors expect 3-4 more years of zero interest rate policy, it’s reasonable for stock prices to be valued today at levels that are about 12-16% above historically normal valuations (3-4 years x 4%). The higher prices would in turn be associated with equity returns also being about 4% lower than “normal” over that 3-4 year period. This would be a justified response. One can demonstrate the arithmetic quite simply using any discounted cash flow approach, and it holds for stocks, bonds, and other long-term securities. [Geek's Note: The Dornbusch exchange rate model reflects the same considerations.]

However, if investors are so uncomfortable with zero interest rates on safe investments that they drive security prices far higher than 12-16% above historical valuation norms (and at present, stocks are more than double those norms on the most reliable measures), they’re doing something beyond what’s justified by interest rates. Instead, what happens is that the risk premium – the compensation for bearing uncertainty, volatility, and risk of extreme loss – also becomes compressed. We can quantify the impact that zero interest rates should have on stock valuations, and it would take decades of zero interest rate policy to justify current stock valuations on the basis of low interest rates. What we’re seeing here – make no mistake about it – is not a rational, justified, quantifiable response to lower interest rates, but rather a historic compression of risk premiums across every risky asset class, particularly equities, leveraged loans, and junk bonds.

My impression is that today’s near-absence of risk premiums is both unintentional and poorly appreciated. That is, investors have pushed up prices, but they still expect future returns on risky assets to be positive. Indeed, because all of this yield seeking has driven a persistent uptrend in speculative assets in recent years, investors seem to believe that “QE just makes prices go up” in a way that ensures a permanent future of diagonally escalating prices. Meanwhile, though QE has fostered an enormous speculative misallocation of capital, a recent Fed survey finds that the majority of Americans feel no better off compared with 5 years ago.

We increasingly see carry being confused with expected return. Carry is the difference between the annual yield of a security and money market interest rates. For example, in a world where short-term interest rates are zero, Wall Street acts as if a 2% dividend yield on equities, or a 5% junk bond yield is enough to make these securities appropriate even for investors with short horizons, not factoring in any compensation for risk or likely capital losses. This is the same thinking that contributed to the housing bubble and subsequent collapse. Banks, hedge funds, and other financial players borrowed massively to accumulate subprime mortgage-backed securities, attempting to “leverage the spread” between the higher yielding and increasingly risky mortgage debt and the lower yield that they paid to depositors and other funding sources.

We shudder at how much risk is being delivered – knowingly or not – to investors who plan to retire even a year from now. Barron’s published an article on target-term funds last month with this gem (italics mine): “JPMorgan's 2015 target-term fund has a 42% equity allocation, below that of its peers. Its fund holds emerging-market equity and debt, junk bonds, and commodities.”

On the subject of junk debt, in the first two quarters of 2014, European high yield bond issuance outstripped U.S. issuance for the first time in history, with 77% of the total represented by Greece, Ireland, Italy, Portugal, and Spain. This issuance has been enabled by the “reach for yield” provoked by zero interest rate policy. The discomfort of investors with zero interest rates allows weak borrowers – in the words of the Financial Times – “to harness strong investor demand.” Meanwhile, Bloomberg reports that pension funds, squeezed for sources of safe return, have been abandoning their investment grade policies to invest in higher yielding junk bonds. Rather than thinking in terms of valuation and risk, they are focused on the carry they hope to earn because the default environment seems "benign" at the moment. This is just the housing bubble replicated in a different class of securities. It will end badly.




Raghuram Rajan, the governor of the Reserve Bank of India and among the few economists who foresaw the last financial crisis, warned last week that "some of our macroeconomists are not recognizing the overall build-up of risks. We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost. Investors say 'we will stay with the trade because central banks are willing to provide easy money and I can see that easy money continuing into the foreseeable future.' It's the same old story. They add 'I will get out before everyone else gets out.' They put the trades on even though they know what will happen as everyone attempts to exit positions at the same time."

While we’re already observing cracks in market internals in the form of breakdowns in small cap stocks, high yield bond prices, market breadth, and other areas, it’s not clear yet whether the risk preferences of investors have shifted durably. As we saw in multiple early sell offs and recoveries near the 2007, 2000, and 1929 bull market peaks (the only peaks that rival the present one), the “buy the dip” mentality can introduce periodic recovery attempts even in markets that are quite precarious from a full cycle perspective. Still, it's helpful to be aware of how compressed risk premiums unwind. They rarely do so in one fell swoop, but they also rarely do so gradually and diagonally. Compressed risk premiums normalize in spikes.

As a market cycle completes and a bull market gives way to a bear market, you’ll notice an increasing tendency for negative day-to-day news stories to be associated with market “reactions” that seem completely out of proportion. The key to understanding these reactions, as I observed at the 2007 peak, is to recognize that abrupt market weakness is generally the result of low risk premiums being pressed higher. Low and expanding risk premiums are at the root of nearly every abrupt market loss. Day-to-day news stories are merely opportunities for depressed risk premiums to shift up toward more normal levels, but the normalization itself is inevitable, and the spike in risk premiums (decline in prices) need not be proportional or “justifiable” by the news at all. Remember this because when investors see the market plunging on news items that seem like “nothing,” they’re often tempted to buy into what clearly seems to be an overreaction. We saw this throughout the 2000-2002 plunge as well as the 2007-2009 plunge.

As I’ve frequently observed, the strongest expected market return/risk profile is associated with a material retreat in valuations that is then joined by an early improvement across a wide range of market internals. These opportunities occur in every market cycle, and we have no doubt that we will observe them over the completion of the present cycle and in those that follow. In contrast, when risk premiums are historically compressed and showing early signs of normalizing even moderately, a great deal of downside damage is likely to follow. Some of it will be on virtually no news at all, because that normalization is baked in the cake, and is independent of interest rates. All that’s required is for investors to begin to remember that risky securities actually involve risk. In that environment, selling begets selling.

Remember: this outcome is baked in the cake because prices are already elevated and risk premiums are already compressed. Every episode of compressed risk premiums in history has been followed by a series of spikes that restore them to normal levels. It may be possible for monetary policy to drag the process out by helping to punctuate the sell offs with renewed speculation, but there’s no way to defer this process permanently. Nor would the effort be constructive, because the only thing that compressed risk premiums do is to misallocate scarce savings to unproductive uses, allowing weak borrowers to harness strong demand. We don’t believe that risk has been permanently removed from risky assets. The belief that it has is itself the greatest risk that investors face here.

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Monday, August 11, 2014

Top 7 Reasons I’m Buying Silver Now

By Jeff Clark, Senior Precious Metals Analyst

I remember my first drug high.

No, it wasn’t from a shady deal made with a seedy character in a bad part of town. I was in the hospital, recovering from surgery, and while I wasn’t in a lot of pain, the nurse suggested something to help me sleep better. I didn’t really think I needed it—but within seconds of that needle puncturing my skin, I WAS IN HEAVEN.

The euphoria that struck my brain was indescribable. The fluid coursing through my veins was so powerful I’ve never forgotten it. I can easily see why people get hooked on drugs.

And that’s why I think silver, purchased at current prices, could be a life-changing investment.

The connection? Well, it’s not the metal’s ever-increasing number of industrial uses… or exploding photovoltaic (solar) demand… nor even that the 2014 supply is projected to be stagnant and only reach 2010’s level. No, the connection is….

Financial Heroin

The drugs of choice for governments—money printing, deficit spending, and nonstop debt increases—have proved too addictive for world leaders to break their habits. At this point, the US and other governments around the world have toked, snorted, and mainlined their way into an addictive corner; they are completely hooked. The Fed and their international central-bank peers are the drug pushers, providing the easy money to keep the high going. And despite the Fed’s latest taper of bond purchases, past actions will not be consequence-free.

At first, drug-induced highs feel euphoric, but eventually the body breaks down from the abuse. Similarly, artificial stimuli and sub-rosa manipulations by central banks have delivered their special effects—but addiction always leads to a systemic breakdown.

When government financial heroin addicts are finally forced into cold-turkey withdrawal, the ensuing crisis will spark a rush into precious metals. The situation will be exacerbated when assets perceived as “safe” today—like bonds and the almighty greenback—enter bear markets or crash entirely.

As a result, the rise in silver prices from current levels won’t be 10% or 20%—but a double, triple, or more.

If inflation picks up steam, $100 silver is not a fantasy but a distinct possibility. Gold will benefit, too, of course, but due to silver’s higher volatility, we expect it will hand us a higher percentage return, just as it has many times in the past.

Eventually, all markets correct excesses. The global economy is near a tipping point, and we must prepare our portfolios now, ahead of that chaos, which includes owning a meaningful amount of physical silver along with our gold.

It’s time to build for a big payday.

Why I’m Excited About Silver

When considering the catalysts for silver, let’s first ignore short-term factors such as net short/long positions, fluctuations in weekly ETF holdings, or the latest open interest. Data like these fluctuate regularly and rarely have long-term bearing on the price of silver.

I’m more interested in the big-picture forces that could impact silver over the next several years. The most significant force, of course, is what I stated above: governments’ abuse of “financial heroin” that will inevitably lead to a currency crisis in many countries around the world, pushing silver and gold to record levels.

At no time in history have governments printed this much money.

And not one currency in the world is anchored to gold or any other tangible standard. This unprecedented setup means that whatever fallout results, it will be of historic proportions and affect each of us personally.
Specific to silver itself, here are the data that tell me “something big this way comes”….

1. Inflation-Adjusted Price Has a Long Way to Go

One hint of silver’s potential is its inflation-adjusted price. I asked John Williams of Shadow Stats to calculate the silver price in June 2014 dollars (July data is not yet available).

Shown below is the silver price adjusted for both the CPI-U, as calculated by the Bureau of Labor Statistics, and the price adjusted using ShadowStats data based on the CPI-U formula from 1980 (the formula has since been adjusted multiple times to keep the inflation number as low as possible).


The $48 peak in April 2011 was less than half the inflation-adjusted price of January 1980, based on the current CPI-U calculation. If we use the 1980 formula to measure inflation, silver would need to top $470 to beat that peak.

I’m not counting on silver going that high (at least I hope not, because I think there will be literal blood in the streets if it does), but clearly, the odds are skewed to the upside—and there’s a lot of room to run.

2. Silver Price vs. Production Costs

Producers have been forced to reduce costs in light of last year’s crash in the silver price. Some have done a better job at this than others, but check out how margins have narrowed.


Relative to the cost of production, the silver price is at its lowest level since 2005. Keep in mind that cash costs are only a portion of all-in expenses, and the silver price has historically traded well above this figure (all-in costs are just now being widely reported). That margins have tightened so dramatically is not sustainable on a long-term basis without affecting the industry. It also makes it likely that prices have bottomed, since producers can only cut expenses so much.

Although roughly 75% of silver is produced as a by-product, prices are determined at the margin; if a mine can’t operate profitably or a new project won’t earn a profit at low prices, the resulting drop in output would serve as a catalyst for higher prices. Further, much of the current costcutting has come from reduced exploration budgets, which will curtail future supply.

3. Low Inventories

Various entities hold inventories of silver bullion, and these levels were high when U.S. coinage contained silver. As all U.S. coins intended for circulation have been minted from base metals for decades, the need for high inventories is thus lower today. But this chart shows how little is available.


You can see how low current inventories are on a historical basis, most of which are held in exchange-traded products. This is important because these investors have been net buyers since 2005 and thus have kept that metal off the market. The remaining amount of inventory is 241 million ounces, only 25% of one year’s supply—whereas in 1990 it represented roughly eight times supply. If demand were to suddenly surge, those needs could not be met by existing inventories. In fact, ETP investors would likely take more metal off the market. (The “implied unreported stocks” refers to private and other unreported depositories around the world, another strikingly smaller number.)

If investment demand were to repeat the surge it saw from 2005 to 2009, this would leave little room for error on the supply side.

4. Conclusion of the Bear Market

This updated snapshot of six decades of bear markets signals that ours is near exhaustion. The black line represents silver’s decline from April 2011 through August 8, 2014.


The historical record suggests that buying silver now is a low-risk investment.

5. Cheap Compared to Other Commodities

Here’s how the silver price compares to other precious metals, along with the most common base metals.

Percent Change From…
1 Year Ago 5 Years Ago 10 Years
Ago
All-Time
High
Gold -2% 38% 234% -31%
Silver -6% 35% 239% -60%
Platinum 3% 20% 83% -35%
Palladium 14% 252% 238% -21%
Copper -4% 37% 146% -32%
Nickel 32% 26% 17% -64%
Zinc 26% 49% 128% -47%


Only nickel is further away from its all-time high than silver.

6. Low Mainstream Participation

Another indicator of silver’s potential is how much it represents of global financial wealth, compared to its percentage when silver hit $50 in 1980.


In spite of ongoing strong demand for physical metal, silver currently represents only 0.01% of the world’s financial wealth. This is one-twenty-fifth its 1980 level. Even that big price spike we saw in 2011 pales in comparison.

There’s an enormous amount of room for silver to become a greater part of mainstream investment portfolios.

7. Watch Out for China!

It’s not just gold that is moving from West to East….


Don’t look now, but the SHFE has overtaken the Comex and become the world’s largest futures silver exchange. In fact, the SHFE accounted for 48.6% of all volume last year. The Comex, meanwhile, is in sharp decline, falling from 93.4% market share as recently as 2001 to less than half that amount today.
And all that trading has led to a sharp decrease in silver inventories at the exchange. While most silver (and gold) contracts are settled in cash at the COMEX, the majority of contracts on the Shanghai exchanges are settled in physical metal. Which has led to a huge drain of silver stocks….


Since January 2013, silver inventories at the Shanghai Futures Exchange have fallen a remarkable 84% to a record low 148 tonnes. If this trend continues, the Chinese exchanges will experience a serious supply crunch in the not-too-distant future.

There’s more….
  • Domestic silver supply in China is expected to hit an all-time high and exceed 250 million ounces this year (between mine production, imports, and scrap). By comparison, it was less than 70 million ounces in 2000. However, virtually none of this is exported and is thus unavailable to the world market.
  • Chinese investors are estimated to have purchased 22 million ounces of silver in 2013, the second-largest amount behind India. It was zero in 1999.
  • The biggest percentage growth in silver applications comes from China. Photography, jewelry, silverware, electronics, batteries, solar panels, brazing alloys, and biocides uses are all growing at a faster clip in China than any other country in the world.
These are my top reasons for buying silver now.

Based on this review of big-picture data, what conclusion would you draw? If you’re like me, you’re forced to acknowledge that the next few years could be a very exciting time for silver investors.

Just like gold, our stash of silver will help us maintain our standard of living—but may be even more practical to use for small purchases. And in a high-inflation/decaying dollar scenario, the silver price is likely to exceed consumer price inflation, giving us further purchasing power protection.

The bottom line is that the current silver price should be seen as a long-term buying opportunity. This may or may not be our last chance to buy at these levels for this cycle, but if you like bargains, silver’s neon “Sale!” sign is flashing like a disco ball.

What am I buying? The silver bullion that’s offered at a discount in the current issue of BIG GOLD. You can even earn a free ounce of silver at another recommended dealer by signing up for their auto accumulation program, an easy way to build your portfolio while prices are low.

Check out the low-cost, no-risk BIG GOLD to capitalize on this opportune time in silver

The article Top 7 Reasons I’m Buying Silver Now was originally published at Casey Research


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Saturday, August 9, 2014

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Thursday, August 7, 2014

How the Destruction of the Dollar Threatens the Global Economy

By John Mauldin


Forbes Editor-in-Chief and longtime friend Steve Forbes leads off this week’s Outside the Box with a sweeping historical summary – and damning indictment – of the “cheap money” policies of the US executive branch and Federal Reserve. Four decades of fiat money (since Richard Nixon and his Treasury Secretary, John Connally, axed the gold standard in 1971) and six years of Fed funny business have led us, in Steve’s words, to an era of “declining mobility, great inequality, and the destruction of personal wealth.”

And of course the damage has not been limited to the US; it is global. Steve reminds us that “The bursting of the subprime bubble put in motion a collapse of dominoes that started with the U.S. financial sector and European banks and led to the sovereign debt crisis in Europe, the Greek bankruptcy crisis, and the banking disasters in Iceland and Cyprus.” To make matters worse, the fundamentally weak dollar (and fiat currencies worldwide) have contributed a great deal to record-high food and energy prices that are spurring serious social instability.

As I showed in Code Red and as Steve notes here, we now face the looming specter of a global currency war. Steve reminds us that the real bottom line is that....

Money is simply a tool that measures value, like a ruler measures length and a clock measures time. Just as changing the number of inches in a foot will not increase the building of houses or anything else, lowering the value of money will not create more wealth. The only way we will ever get a real recovery is through a return to trustworthy, sound money.  And the best way to achieve that is with a gold standard:  a dollar linked to gold.

Today’s Outside the Box is from Steve’s latest book, which is simply called Money.
I think it’s Steve’s best book in years. Get it for your summer reading. While there is more than one solution to reining in the current abuses by the major global central banks, Steve highlights the problems as well as anyone. This situation really has the potential to end badly. Just this morning the Wall Street Journal noted that “Reserve Bank of India Governor Raghuram Rajan warned Wednesday that the global economy bears an increasing resemblance to its condition in the 1930s, with advanced economies trying to pull out of the Great Recession at each other’s expense.” Rajan is one of the more highly respected economists in the world.

I am back in Dallas for an extended period of time (at least extended by my standards), where my new apartment is paying off in a less hectic lifestyle – people seem to be coming to me for the next few weeks. Tomorrow my good friend Bill Dunkelberg, the Chief Economist of the National Federation of Independent Business, will drop by for a day. We’re going to talk about the future of work, what kind of jobs will be there for our kids (and increasingly our fellow Boomers), what policies should be developed to encourage more jobs, and a host of other issues.

I’m still trying to absorb what I learned in Maine. We enjoyed the most beautiful weather we’ve had in the last eight years, and the conversations seemed to take it up a notch. I fished more than usual, too, which gave me more time to think. On Sunday, however, my thought process was not disturbed by so much as a nibble on my hook. That was after the previous two days, when the fish were practically jumping into the boat.

We had a discussion on complexity theory and why complexity actually had a hand in bringing down more than 20 civilizations. I understand the argument but think there is more to it than that. Something can be complex but continue to work smoothly if information is allowed to run “noise-free.” I began to ponder whether our government has become so complex that it has begun to stifle the flow of information. Dodd–Frank. The Affordable Care Act. Energy policy. The list goes on and on and on. Are we taking all of the profit out of the system in order to comply with complex rules and regulations? Not for large companies, necessarily, but for small ones? When we are losing companies faster than new ones are being created, that should be a huge warning flag that something is wrong in the system. The data in this chart ends in 2011, but the pictures is not getting better.


It will be good to see my old friend Dunk, and perhaps he can shed some light on my continually confused state. Enjoy your August.

John Mauldin, Editor
Outside the Box
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The following book excerpt is adapted from Chapter One of Money: How The Destruction of the Dollar Threatens The Global Economy – and What We Can Do About It, by Steve Forbes and Elizabeth Ames

The failure to understand money is shared by all nations and transcends politics and parties. The destructive monetary expansion undertaken during the Democratic administration of Barack Obama by then Federal Reserve chairman Ben Bernanke began in a Republican administration under Bernanke’s predecessor, Alan Greenspan. Republican Richard Nixon’s historic ending of the gold standard was a response to forces set in motion by the weak dollar policy of Democrat Lyndon Johnson.

For more than 40 years, one policy mistake has followed the next.  Each one has made things worse. The most glaring recent example is the early 2000s, when the Fed’s loose money policies led to the momentous worldwide panic and global recession that began in 2008. The remedy for that disaster? Quantitative easing—the large monetary expansion in history.

One of the reasons that QE has been such a failure was a distortionary bond-buying strategy that was part of QE known as “Operation Twist.” The Fed traditionally expands the monetary base by buying short-term Treasuries from financial institutions.  Banks then turn around and make short-term loans to those businesses that are the economy’s main job creators. But QE’s Operation Twist focused on buying long-term Treasuries and mortgage-backed securities. This meant that instead of going to the entrepreneurial job creators, loans went primarily to large corporations and to the government itself.

Supporters insisted that Operation Twist’s lowering of long-term rates would stimulate the economy by encouraging people to buy homes and make business investments. In reality this credit allocating is cronyism, an all-too-frequent consequence of fiat money.  Fed-created inflation results in underserved windfalls to some while others struggle.

Unstable Money:  Odorless and Colorless

Unstable money is a little bit like carbon monoxide:  it’s odorless and colorless.  Most people don’t realize the damage it’s doing until it’s very nearly too late.  A fundamental principle is that when money is weakened, people seek to preserve their wealth by investing in commodities and hard assets. Prices of things like housing, food, and fuel start to rise, and we are often slow to realize what’s happening. For example, few connected the housing bubble of the mid-2000s with the Fed’s weak dollar.  All they knew was that loans were cheap. Many rushed to buy homes in a housing market in which it seemed prices could only go up. When the Fed finally raised rates, the market collapsed.

The weak dollar was not the only factor, but there would have been no bubble without the Fed’s flooding of the subprime mortgage market with cheap dollars.  Yet to this day the housing meltdown and the events that followed are misconstrued as the products of regulatory failure and of greed. Or they are blamed on affordable housing laws and the role of government-created mortgage enterprises Fannie Mae and Freddie Mac. The latter two factors definitely played a role.  Yet the push for affordable housing existed in the 1990s, and we didn’t get such a housing mania. Why did it happen in the 2000s and not in the previous decade?

The answer is that the 1990s was not a period of loose money. The housing bubble inflated after Alan Greenspan lowered interest rates to stimulate the economy after the 2001 – 2002 recession. Greenspan kept rates too low for too long. The bursting of the subprime bubble put in motion a collapse of dominoes that started with the U.S. financial sector and European banks and led to the sovereign debt crisis in Europe, the Greek bankruptcy crisis, and the banking disasters in Iceland and Cyprus.

Other Problems Caused by the Weak Dollar

Many may not realize it, but the weakening of the dollar is at the heart of many other problems today:

High Food and Fuel Prices

As with the subprime bubble, the oil price rises of the mid-2000s (as well as the 1970s) were widely blamed on greed.  Yet here, too, no one bothers to ask why oil companies suddenly became greedier starting in the 2000s.  Oil prices averaged a little over $21 a barrel from the mid-1980s until the early part of the last decade when there was a stronger dollar, compared with around $95 a barrel these days.  Rising commodity prices spurred by the declining dollar have also driven up the cost of food. Many shoppers have noticed that the prices of beef and chicken have reached record highs. This is especially devastating to developing countries where food takes up a greater portion of people’s incomes.  Since the Fed and other central banks began their monetary expansion in the mid-2000s, high food prices wrongly blamed on climate shocks and rising demand have caused riots in countries from Haiti to Bangladesh to Egypt.

Declining Mobility, Great Inequality, and the Destruction of Personal Wealth

The destruction of the dollar is a key reason that two incomes are now necessary for a middle-class family that lived on one income in the 1950s and 1960s. To see why, one need only look at the numbers from the U.S. Bureau of Labor Statistics. What a dollar could buy in 1971 costs $5.78 in 2014.  In other words, you need almost six times more money today than you did 40 years ago to buy the equivalent goods and services. Say you had a 2014 dollar and traveled back in time to 1971. That dollar would be worth, according to the CPI calculator, a mere 17 cents. What has this meant for salaries?  According to statistics from the U.S. Census Bureau, a man in his thirties or forties who earned $54,163 in 1972 today earns around $45,224 in inflation adjusted dollars –a 17% cut in pay. Women have entered the workforce in much larger numbers since then, and women’s incomes have made up the difference for families. As Mark Gimein of Bloomberg.com points out, “The bottom line is that as two-income families have replaced single-earner ones, the median family has barely moved forward. And the single-earner family has fallen behind.”

Increased Volatility and Currency Crises

The 2014 currency turmoil in emerging countries is just the latest in a succession of needless crises that have occurred over the past several decades as a consequence of unstable money. Today’s huge and often-violent global markets, in which a nation’s currency can come under attack, did not exist before the dollar was taken off the gold standard. They are a direct response to the risks created by floating exchange rates. The crises for most of the Bretton Woods era were mild and infrequent. It was the refusal of the United States to abide by the restrictions of the system that brought it down.

The weak dollar has also been the cause of banking crises that have been blamed on the U.S. system of fractional reserve banking. Traditionally, banks have made their money by lending out deposits while keeping reserves to cover normal withdrawals and loan losses. 
The rule of thumb is that banks have $1 of reserves for every $10 of deposits.  In the past, fractional reserve banking has been criticized for making these institutions unnecessarily fragile and jeopardizing the entire economy. Indeed, history is replete with examples of banks that made bad loans and went bust.  Historically, the real problems have been bad banking regulations.  In the post-Bretton Woods era, however, the cause has most often been unstable money. Misdirected lending is characteristic of the asset bubbles that result when prices are distorted by inflation. This has been true of past booms in oil, housing, agriculture, and other traditional havens for weak money.

The Weak Recovery

This bears repeating:  the Federal Reserve’s quantitative easing, the biggest monetary stimulus ever, has produced the weakest recovery from a major downturn in American history.  QE’s Operation Twist has not been the only constraint on loans to small and new businesses.  Regulators have also compounded the problem by pressuring banks to reduce lending to riskier customers, which by definition are smaller enterprises.

In 2014 the Wall Street Journal reported that this credit drought had caused many small businesses, from restaurants to nail salons, to turn in desperation to nonbank lenders—from short-term capital firms to hedge funds—that provide loans at breathtakingly high rates of interest. Interest rates for short-term loans can exceed 50%.  Little wonder there are still so many empty storefronts during this period of supposed recovery.  Monetary instability encourages a vicious cycle of stagnation: the damage it causes is usually blamed on financial sector greed. The scapegoating and finger-pointing bring regulatory constraints that strangle growth and capital creation.  That has long been the case in countries with chronic monetary instability, such as Argentina.  Increased regulation is now hobbling capital creation in the United States as well as in Europe, where there is growing regulatory emphasis on preventing “systemic risk.”  Regulators, the Wall Street Journal noted, “are increasingly telling banks which lines of business they can operate in and cautioning them to steer clear of certain areas or face potential supervisory or enforcement action.”

In Europe, this disturbing trend toward “macroprudential regulation” is turning central banks into financial regulators with sweeping arbitrary powers. The problem is that entrepreneurial success stories like Apple, Google, and Home Depot—fast-growing companies that provide the lion’s share of growth and job creation—all began as “risky” investments. Not surprisingly, we’re now seeing growing public discomfort with this increasing control by central banks. A 2013 Rasmussen poll found that an astounding 74% of American adults are in favor of auditing the Federal Reserve, and a substantial number think the chairman of the Fed has too much power.

Slower Long-Term Growth and Higher Unemployment

Even taking into account the economic boom during the relatively stable money years of the mid-1980s to late 1990s, overall the U.S. economy has grown more slowly during the last 40 years than in previous decades. From the end of World War II to the late 1960s, when the U.S. dollar had a fixed standard of value, the economy grew at an average annual rate of nearly 4%.  Since that time it has grown at an average rate of around 3%. 
Forbes.com contributor Louis Woodhill explains that this 1% drop means a lot. Had the economy continued to grow at pre-1971 levels, gross domestic product (GDP) in the late 2000s would have been 56% higher than it actually was.  What does that mean?  Woodhill writes: “Our economy would have been more than three times as big as China’s, rather than just over twice as large. And, at the same level of spending, the federal government would have run a $0.5 trillion budget surplus, instead of a $1.3 trillion deficit.”  And what if the United States had never had a stable dollar? If America had grown for all of its history at the lowest post-Bretton Woods rate, its economy would be about one-quarter of the size of China’s.  The United States would have ended up much smaller, less affluent, and less powerful.

Unemployment has also been higher as a consequence of the declining dollar. During the World War II gold standard era, from 1947 to 1970, unemployment averaged less than 5%. Even with the economy’s ups and downs, it never rose above 7%.  Since Nixon gave us the fiat dollar it has averaged over 6%:  it averaged 8.5% in 1975, almost 10% in 1982, and around 8% since 2008. The rate would have been higher had millions not left the workforce. The rest of the world has also suffered from slower growth, in addition to higher inflation, since the end of the Bretton Woods system. After the 1970s, world economic growth has been a full percentage point lower; inflation, 1.5% higher.

Larger Government with Higher Debt

By enabling endless monetary expansion, the post-Bretton Woods system of fiat money has helped propel the unchecked growth of government. In 1971 the total U.S. federal debt stood at $436 billion.  Today it is more than $17 trillion. It’s no coincidence that the federal debt has doubled since 2008, the same year that the Fed started implementing QE.

The Keynesian and monetarist bureaucrats who today set the monetary policies of the Fed and other central banks are like pre-Copernican astronomers who subscribed to the notion that the sun revolved around the earth. They are convinced that government can successfully direct the economy by raising and lowering the value of money. Yet, over and over again, history, and recent events, has shown that they are wrong.

What they don’t understand is that money does not “create” economic activity. Money is simply a tool that measures value, like a ruler measures length and a clock measures time. Just as changing the number of inches in a foot will not increase the building of houses or anything else, lowering the value of money will not create more wealth. The only way we will ever get a real recovery is through a return to trustworthy, sound money.  And the best way to achieve that is with a gold standard:  a dollar linked to gold.

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Wednesday, August 6, 2014

The Single Most Important Strategy Most Investors Ignore

Jeff Clark, senior precious metals analyst for Casey Research, explains to skeptics why international diversification is so important.

The Single Most Important Strategy Most Investors Ignore

“If I scare you this morning, and as a result you take action, then I will have accomplished my goal.” That’s what I told the audience at the Sprott Natural Resource Symposium in Vancouver two weeks ago.

But the reality is that I didn’t need to try to scare anyone. The evidence is overwhelming and has already alarmed most investors; our greatest risk is not a bad investment but our political exposure.

And yet most of these same investors do not see any need to stash bullion outside their home countries. They view international diversification as an extreme move. Many don’t even care if capital controls are instituted.

I’m convinced that this is the most common—and important—strategic investment error made today. So let me share a few key points from my Sprott presentation and let you decide for yourself if you need to reconsider your own strategy. (Bolding for emphasis is mine.)

1: IMF Endorses Capital Controls

Bloomberg reported in December 2012 that the “IMF has endorsed the use of capital controls in certain circumstances.“

This is particularly important because the IMF, arguably an even more prominent institution since the global financial crisis started, has always had an official stance against capital controls. “In a reversal of its historic support for unrestricted flows of money across borders, the IMF said controls can be useful...”

Will individual governments jump on this bandwagon? “It will be tacitly endorsed by a lot of central banks,” says Boston University professor Kevin Gallagher. If so, it could be more than just your home government that will clamp down on storing assets elsewhere.

2: There Is Academic Support for Capital Controls

Many mainstream economists support capital controls. For example, famed Harvard Economists Carmen Reinhart and Ken Rogoff wrote the following earlier this year:

Governments should consider taking a more eclectic range of economic measures than have been the norm over the past generation or two. The policies put in place so far, such as budgetary austerity, are little match for the size of the problem, and may make things worse. Instead, governments should take stronger action, much as rich economies did in past crises.

Aside from the dangerously foolish idea that reining in excessive government spending is a bad thing, Reinhart and Rogoff are saying that even more massive government intervention should be pursued. This opens the door to all kinds of dubious actions on the part of politicians, including—to my point today—capital controls.

“Ms. Reinhart and Mr. Rogoff suggest debt write-downs and ‘financial repression’, meaning the use of a combination of moderate inflation and constraints on the flow of capital to reduce debt burdens.”

The Reinhart and Rogoff report basically signals to politicians that it’s not only acceptable but desirable to reduce their debts by restricting the flow of capital across borders. Such action would keep funds locked inside countries where said politicians can plunder them as they see fit.

3: Confiscation of Savings on the Rise

“So, what’s the big deal?” Some might think. “I live here, work here, shop here, spend here, and invest here. I don’t really need funds outside my country anyway!”

Well, it’s self-evident that putting all of one’s eggs in any single basket, no matter how safe and sound that basket may seem, is risky—extremely risky in today’s financial climate.

In addition, when it comes to capital controls, storing a little gold outside one’s home jurisdiction can help avoid one major calamity, a danger that is growing virtually everywhere in the world: the outright confiscation of people’s savings.

The IMF, in a report entitled “Taxing Times,” published in October of 2013, on page 49, states:

“The sharp deterioration of the public finances in many countries has revived interest in a capital levy—a one-off tax on private wealth—as an exceptional measure to restore debt sustainability.”

The problem is debt. And now countries with higher debt levels are seeking to justify a tax on the wealth of private citizens.

So, to skeptics regarding the value of international diversification, I would ask: Does the country you live in have a lot of debt? Is it unsustainable?

If debt levels are dangerously high, the IMF says your politicians could repay it by taking some of your wealth.

The following quote sent shivers down my spine…

The appeal is that such a task, if implemented before avoidance is possible and there is a belief that is will never be repeated, does not distort behavior, and may be seen by some as fair. The conditions for success are strong, but also need to be weighed against the risks of the alternatives, which include repudiating public debt or inflating it away.

The IMF has made it clear that invoking a levy on your assets would have to be done before you have time to make other arrangements. There will be no advance notice. It will be fast, cold, and cruel.

Notice also that one option is to simply inflate debt away. Given the amount of indebtedness in much of the world, inflation will certainly be part of the “solution,” with or without outright confiscation of your savings. (So make sure you own enough gold, and avoid government bonds like the plague.)

Further, the IMF has already studied how much the tax would have to be:

The tax rates needed to bring down public debt to pre-crisis levels are sizable: reducing debt ratios to 2007 levels would require, for a sample of 15 euro area countries, a tax rate of about 10% on households with a positive net worth.

Note that the criterion is not billionaire status, nor millionaire, nor even “comfortably well off.” The tax would apply to anyone with a positive net worth. And the 10% wealth-grab would, of course, be on top of regular income taxes, sales taxes, property taxes, etc.
4: We Like Pension Funds

Unfortunately, it’s not just savings. Carmen Reinhart (again) and M. BelĂ©n Sbrancia made the following suggestions in a 2011 paper:

Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of ‘financial repression.’ Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.

Yes, your retirement account is now a “captive domestic audience.” Are you ready to “lend” it to the government? “Directed” means “compulsory” in the above statement, and you may not have a choice if “regulation of cross-border capital movements”—capital controls—are instituted.

5: The Eurozone Sanctions Money-Grabs

Germany’s Bundesbank weighed in on this subject last January:

“Countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.”

The context here is that of Germans not wanting to have to pay for the mistakes of Italians, Greeks, Cypriots, or whatnot. Fair enough, but the “capital levy” prescription is still a confiscation of funds from individuals’ banks or brokerage accounts.

Here’s another statement that sent shivers down my spine:

A capital levy corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required.

The central bank of the strongest economy in the European Union has explicitly stated that you are responsible for your country’s fiscal obligations—and would be even if you voted against them! No matter how financially reckless politicians have been, it is your duty to meet your country’s financial needs.

This view effectively nullifies all objections. It’s a clear warning.

And it’s not just the Germans. On February 12, 2014, Reuters reported on an EU commission document that states:
The savings of the European Union’s 500 million citizens could be used to fund long-term investments to boost the economy and help plug the gap left by banks since the financial crisis.

Reuters reported that the Commission plans to request a draft law, “to mobilize more personal pension savings for long-term financing.”

EU officials are explicitly telling us that the pensions and savings of its citizens are fair game to meet the union’s financial needs. If you live in Europe, the writing is on the wall.
Actually, it’s already under wayReuters recently reported that Spain has

…introduced a blanket taxation rate of .03% on all bank account deposits, in a move aimed at… generating revenues for the country’s cash-strapped autonomous communities.

The regulation, which could bring around 400 million euros ($546 million) to the state coffers based on total deposits worth 1.4 trillion euros, had been tipped as a possible sweetener for the regions days after tough deficit limits for this year and next were set by the central government.

Some may counter that since Spain has relatively low tax rates and the bail-in rate is small, this development is no big deal. I disagree: it establishes the principle, sets the precedent, and opens the door for other countries to pursue similar policies.

6: Canada Jumps on the Confiscation Bandwagon

You may recall this text from last year’s budget in Canada:

“The Government proposes to implement a bail-in regime for systemically important banks.”

A bail-in is what they call it when a government takes depositors’ money to plug a bank’s financial holes—just as was done in Cyprus last year.

This regime will be designed to ensure that, in the unlikely event a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital.

What’s a “bank liability”? Your deposits. How quickly could they do such a thing? They just told us: fast enough that you won’t have time to react.

By the way, the Canadian bail-in was approved on a national level just one week after the final decision was made for the Cyprus bail-in.

7: FATCA

Have you considered why the Foreign Account Tax Compliance Act was passed into law? It was supposed to crack down on tax evaders and collect unpaid tax revenue. However, it’s estimated that it will only generate $8.7 billion over 10 years, which equates to 0.18% of the current budget deficit. And that’s based on rosy government projections.

FATCA was snuck into the HIRE Act of 2010, with little notice or discussion. Since the law will raise negligible revenue, I think something else must be going on here. If you ask me, it’s about control.

In my opinion, the goal of FATCA is to keep US savers trapped in US banks and in the US dollar, in case the US wants to implement a Cyprus-like bail-in. Given the debt load in the US and given statements made by government officials, this seems like a reasonable conclusion to draw.

This is why I think that the institution of capital controls is a “when” question, not an “if” one. The momentum is clearly gaining steam for some form of capital controls being instituted in the near future. If you don’t internationalize, you must accept the risk that your assets will be confiscated, taxed, regulated, and/or inflated away.

What to Expect Going Forward

  • First, any announcement will probably not use the words “capital controls.” It will be couched positively, for the “greater good,” and words like “patriotic duty” will likely feature prominently in mainstream press and government press releases. If you try to transfer assets outside your country, you could be branded as a traitor or an enemy of the state, even among some in your own social circles.
  • Controls will likely occur suddenly and with no warning. When did Cyprus implement their bail-in scheme? On a Friday night after banks were closed. By the way, prior to the bail-in, citizens were told the Cypriot banks had “government guarantees” and were “well-regulated.” Those assurances were nothing but a cruel joke when lightning-fast confiscation was enacted.
  • Restrictions could last a long time. While many capital controls have been lifted in Cyprus, money transfers outside the country still require approval from the Central Bank—over a year after the bail-in.
  • They’ll probably be retroactive. Actually, remove the word “probably.” Plenty of laws in response to prior financial crises have been enacted retroactively. Any new fiscal or monetary emergency would provide easy justification to do so again. If capital controls or savings confiscations were instituted later this year, for example, they would likely be retroactive to January 1. For those who have not yet taken action, it could already be too late.
  • Social environment will be chaotic. If capital controls are instituted, it will be because we’re in some kind of economic crisis, which implies the social atmosphere will be rocky and perhaps even dangerous. We shouldn’t be surprised to see riots, as there would be great uncertainty and fear. That’s dangerous in its own right, but it’s also not the kind of environment in which to begin making arrangements.
  • Ban vs. levy. Imposing capital controls is a risky move for a government to make; even the most reckless politicians understand this. That won’t stop them, but it could make them act more subtly. For instance, they might not impose actual bans on moving money across borders, but instead place a levy on doing so. Say, a 50% levy? That would “encourage” funds to remain inside a given country. Why not 100%? You could be permitted to transfer $10,000 outside the country—but if the fee for doing so is $10,000, few will do it. Such verbal games allow politicians to claim they have not enacted capital controls and yet achieve the same effect. There are plenty of historical examples of countries doing this very thing.
Keep in mind: Who will you complain to? If the government takes a portion of your assets, legally, who will you sue? You will have no recourse. And don’t expect anyone below your tax bracket to feel sorry for you.

No, once the door is closed, your wealth is trapped inside your country. It cannot move, escape, or flee. Capital controls allow politicians to do anything to your wealth they deem necessary.

Fortunately, you don’t have to be a target. Our Going Global report provides all the vital information you need to build a personal financial base outside your home country. It covers gold ownership and storage options, foreign bank accounts, currency diversification, foreign annuities, reporting requirements, and much more. It’s a complete A to Z guide on how to diversify internationally.

Discover what solutions are right for you—whether you’re a big investor or small, novice or veteran, many options are available. I encourage you to pursue what steps are most appropriate for you now, before the door is closed.Learn more here…



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