Saturday, July 26, 2014

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Friday, July 25, 2014

Geopolitics and the Markets

By John Mauldin

Growing geopolitical risk is on everyone’s mind right now, but in today’s Outside the Box, Michael Cembalest of J.P. Morgan Asset Management leads off with a helpful reminder: the only time since WWII that a violent conflict has had a medium term negative effect on markets was in 1973, when the Israeli-Arab war led to a Saudi oil embargo against the US and a quadrupling of oil prices. And he backs up that assertion with an interesting table of facts labeled “War zone countries as a percentage of total world… [population, oil production, GDP, etc.].”

Having gotten that worry out of the way, he takes on the dire warnings that have recently been issued by the BIS, the IMF, and even the Fed, about a disconnect between market enthusiasm and the undertow of global economic developments. (He gives this section the cute title “Prophet warnings.”) Let’s look, he says, at actual measures of profits and how markets are valuing them; and then he goes on to give us a “glass half-full” take on prospects for the U.S. economy for the remainder of the year. He throws in some caveats and cautions, but Cembalest thinks we could finally see another 3% growth quarter this year, which could create room for further profit increases.

There are good sections here on Europe and emerging markets here, too. Cembalest gives us a true Outside the Box, with a more optimistic view than some of our other recent guests have had. But that’s the point of OTB, is it not, to think about what might be on the other side of the walls of the box we find ourselves in? I have shared his work before and find it well thought out. He is one of the true bright lights in the major investment bank research world. That’s my take, at least.

I write this introduction from the air in “flyover country,” heading back home from rural Minnesota. I flew to Minneapolis to look at a private company that is actually well down the road to creating hearts and livers and kidneys and skin and other parts of the body that can be grown and then put into place. It will not be too many years before that rather sci-fi vision becomes reality, if what I saw is any indication. This group is focused and has what it takes in terms of management and science.

When you hold the beating, pumping scaffolding for a heart in your hand and know that it will soon be a true heart – albeit for a test animal at this point, though human trials are not that far off – then you can well and truly feel that we are entering a new era. I declined to pick up a rather huge liver, but the chief scientist handled it like it was just another auto part. Match these “parts” with young IPS cells, and we truly will have replacement organs ready for us when we need them, if we can wait another decade or so (or maybe half that time for some organs!). My friend and editor of Transformational Technology Alert, Patrick Cox, toured the place with me and will write about it in a few weeks. (You will be able to see his complete analysis of this company for free in his monthly letter on new technologies. You can subscribe here.)

Ukraine and Gaza are epic tragedies, but gods, what wonders we humans can create when we pursue life rather than death. It just makes you want to take some people by the back of the neck and shake some sense into them.

And now a brief but enlightening tale from … The Road. It’s about the Code of the Road Warrior. The Road can be a lonely place, soul searing in its weariness, with only brief moments of pleasure. But you have to do it because that is what the job requires. And there are lots of us out there. You see the look, you recognize yourself in the other person. If you can help, you do. It’s the unwritten Code that we all come to realize you must live by. It has nothing to do with race, religion, sexual alignment, or political persuasion. You help fellow Road Warriors on the journey.

As do we all, you seek out your favorite airline club in airports (for me it’s the American Airlines Admirals Club) and know you are “home.” A comfortable chair for your back, a plug for your tools, a drink to quench your thirst, and peace for your soul. But then there are the times when you are in an airport where there is no home for you.

Over the years, I have invited dozens of fellow Road Warriors to be my “guest” in a club. No true cost to me, just a courtesy you give a fellow Roadie. Today, I arrived at the Minneapolis airport, and there Delta and United rule. My companion, Pat Cox, was traveling on Delta back to Florida, so I thought I would see if my platinum card would get us into the Delta lounge. Turns out it would, but only if I was on Delta. I was getting ready to limp away to seek some other place of solace for a few hours when a fellow Road Warrior behind me said, “He is my guest.”

The lady behind the counter said, “That’s fine, but you can only have one guest.” Then the next gentleman looked at Pat in his Hawaiian shirt and flip-flops and said, “He is my guest.” The lady at the counter smiled, knowing she was faced with the Code of the Road Warrior, and let us in.

You have to understand that Pat is nowhere close to being a Road Warrior. He agrees with cyberpunk sci-fi author William Gibson that “Travel is a meat thing.” He indulged me for this trip. I will admit to being meat. I like to meet meat face to face when I can.

So Pat was somewhat puzzled, and he turned to our two benefactors and asked, “Do you know him?” (referring to me). Pat assumed they had recognized me, which sometimes does happen in odd places. But no, they had no idea. I told him I would explain the Code of the Road Warrior to him when we sat down, and everyone grinned at Pat’s astonishment over a random act of kindness. So we said thank you to our Warrior friends, whom we will likely never meet again, and entered into the inner sanctum. With electrical outlets.

The Road can be lonely, but many of us share that space. If you are one of us, then make sure you obey the Code. Someday, it will bring help to you, too. And as I write this, my AA travel companion on the flight back, an exec who runs a large insurance company, who was trying to figure out what the heck today’s court ruling might do to the 70,000 subsidized policies they sold, noticed I did not have the right connection and dug through his bag and found the right plug for me. It’s a Code thing. I knew him only as Ken, and he knew me as John. We then both hunched over our computers and worked.
Have a great week. And maybe commit a random act of kindness, even if you are not on The Road.
Your smiling as he writes analyst,

John Mauldin, Editor
Outside the Box

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Geopolitics and markets; red flags raised by the Fed and the BIS on risk-taking

Michael Cembalest, J.P. Morgan Asset Management

Eye on the Market, July 21, 2014

You can be forgiven for thinking that the world is a pretty terrible place right now: the downing of a Malaysian jetliner in eastern Ukraine and escalating sanctions against Russia, the Israeli invasion of Gaza, renewed fighting in Libya, civil wars in Syria, Afghanistan, Iraq and Somalia, Islamist insurgencies in Nigeria and Mali, ongoing post-election chaos in Kenya, violent conflicts in Pakistan, Sudan and Yemen, assorted mayhem in central Africa, and the situation in North Korea, described in a 2014 United Nations Human Rights report as having no parallel in the contemporary world. Only in Colombia does it look like a multi- decade conflict is finally staggering to its end. For investors, strange as it might seem, such conflicts are not affecting the world’s largest equity markets very much. Perhaps this reflects the small footprint of war zone countries within the global capital markets and global economy, other than through oil production.



The limited market impact of geopolitics is nothing new. This is a broad generalization, but since 1950, with the exception of the Israeli-Arab war of 1973 (which led to a Saudi oil embargo against the U.S. and a quadrupling of oil prices), military confrontations did not have a lasting medium term impact on U.S. equity markets. In the charts below, we look at U.S. equities before and after the inception of each conflict in three different eras since 1950. The business cycle has been an overwhelmingly more important factor for investors to follow than war, which is why we spend so much more time on the former (and which is covered in the latter half of this note).

As for the war zone countries of today, one can only pray that things will eventually improve. Seventy years ago as the invasion of Normandy began, Europe was mired in the most lethal war in human history; the notion of a better day arising out of misery is not outside the realm of possibility.

Soviet invasions of Hungary and Czechoslovakia did not lead to a severe market reaction, nor did the outbreak of the Korean War or the Arab-Israeli Six Day War.

We did not include the U.S.-Vietnam war, since it’s hard to pinpoint when it began. One could argue that Vietnam era deficit spending eventually led to rising inflation (from 3% in 1967 to 5% in 1970), a rise in the Fed Funds rate from 5% in 1968 to 9% in 1969, and a U.S. equity market decline in 1969-1970 (this decline shows up at the tail end of the S&P series showing the impact of the Soviet invasion of Czechoslovakia).



The Arab-Israeli war of 1973 led to an oil embargo and an energy crisis in the US, all of which contributed to inflation, a severe recession and a sharp equity market decline. Pre-existing wage and price controls made the situation worse, but the war/embargo played a large role. Separately, markets were not adversely affected by the Falklands War, martial law in Poland, the Soviet war in Afghanistan, or U.S. invasions of Grenada or Panama. The market decline in 1981 was more closely related to a double dip U.S. recession and the anti inflation policies of the Volcker Fed.



Equity market reactions to US invasions of Kuwait and Iraq, and the Serbian invasion of Kosovo, were mild. There was a sharp market decline after the September 11th attacks, but it reversed within weeks. The subsequent market decline in 2002 was arguably more about the continued unraveling of the technology bust than about aftershocks from the Sept 11th attacks and Afghan War. As for North Korea, in a Nov 2010 EoTM we outlined how after North Korean missile launches, naval clashes and nuclear tests, South Korean equities typically recover within a few weeks.



Prophet warnings. So far, the year is turning out more or less as we expected in January: almost everything has risen in single digits (US, European and Emerging Markets stocks, fixed rate and inflation linked government bonds, high grade and high yield corporate bonds, and commodities). What made last week notable: concerns from the Fed and the Bank for International Settlements (a global central banking organization) regarding market valuations. The BIS hit investors with a 2-by-4, stating that “it is hard to avoid the sense of a puzzling disconnect between the market’s buoyancy and underlying economic developments globally”. The Fed also weighed in, referring to “substantially stretched valuations” of biotech and internet stocks in its Monetary Policy Report submitted to Congress. What should one make of these prophet warnings?

Let’s put aside the irony of Central Banks expressing concern about whether their policies are contributing to aggressive risk-taking. They know they do, and relied on such an outcome when crafting monetary policy post-2008. Instead, let’s look at measures of profits and how markets are valuing them.          

The first chart shows how P/E multiples have risen in recent months, including in the Emerging Markets. The second chart shows valuations on internet and biotech stocks referred to in the Fed’s Congressional submission. The third chart shows forward and median multiples, an important complement to traditional market cap based multiples.





Are these valuations too high? Triangulating the various measures, US valuations are close to their peaks of prior mid-cycle periods (ignoring the collective lapse of judgment during the dot-com era). We see the same general pattern in small cap. On internet and biotech, valuations have begun to creep up again after February’s correction, and I would agree that investors are paying a LOT of money for the presumption that internet/biotech revenue growth is “secular” and less explicitly linked to overall economic growth.

As a result, we believe earnings growth is needed to drive equity markets higher from here. On this point, we see the glass half-full, at least in the US. After a poor Q1 and a partial rebound in Q2, US data are improving such that we expect to see the elusive 3% growth quarter this year (only 6 of 20 quarters since Q2 2009 have exceeded 3%). With new orders rising and inventories down, the stage is set for an improvement.

Other confirming data: vehicle sales, broad-based employment gains, hours worked, manufacturing surveys, homebuilder surveys, a rise in consumer credit, capital spending, etc. If we get a growth rebound, the profits impact could be meaningful. The second chart shows base and incremental profit margins. Incremental margins measure the degree to which additional top-line sales contribute to profits. After mediocre profits growth of 5%-7% in 2012/2013, we could see faster profits growth later this year. With 83 companies reporting so far, Q2 S&P 500 earnings are up 9% vs. 2013.




Accelerated monetary tightening could derail interest-rate sensitive sectors of the economy, so we’re watching the Fed along with everybody else. Perhaps it’s a reflection of today's circumstances, but like Bernanke before her, Yellen appears to see the late 1930s as a huge policy fiasco: when premature monetary and fiscal tightening threw the US back into recession. That’s what Yellen's testimony last week brings to mind: she gave a cautious outlook, cited "mixed signals" and previous "false dawns", and downplayed the decline in unemployment and recent rise in inflation. In other words, she’s prepared to wait until the U.S. expansion is indisputably in place before tightening.

An important sub-plot for the Fed: where are all the discouraged workers? For Fed policy to remain easy, as the economy improves, the pace of unemployment declines will have to slow and wage inflation will have to remain in check. The Fed believes discouraged workers will re-enter the labor force in large numbers, holding down wage inflation. Fed skeptics point out that so far, labor participation rates have not risen, creating the risk of inflation sooner than the Fed thinks. It’s all about the “others” in the chart, since disabled and retired persons rarely return to work. If “others” come back, it would show that there hasn’t been a structural decline in the pool of available workers. The Fed believes they will eventually return, and so do we.


 

Europe

Germany and France are slowing; not catastrophically, but by more than markets were expecting. This has contributed to a decline in European earnings expectations for the year. As shown on page 2, Europe was priced for a return to normalcy, and with inflation across most of the Eurozone converging to 1%, things are decidedly not that normal. Markets are not priced for any negative surprises, which is why an issue with a single Portuguese bank contributed to a sharp decline in banks stocks across the entire region.



 

Emerging Markets

The surprise of the year, if there is one, is how emerging markets equities have rebounded. As we wrote in March 2014, the history of EM equities shows that after substantial currency declines, industrial activity often stabilizes. Around that same time, we often see equity markets stabilize as well, even before visible improvements in growth, inflation and exports. This pattern appears to be playing itself again: the 4 EM Big Debtor countries (Brazil, India, Indonesia and Turkey) have experienced equity market rallies of 20%+ despite modest improvement in economic data (actually, things are still getting worse in Brazil and Turkey).




There’s also some good news on the EM policy front. In Mexico, it appears that the oil and natural gas sector is being opened up after a 25% decline in oil production since 2004. This would effectively end the 75-year monopoly that Pemex has over oil production. Other energy–related positives: Mexico has shifted the bulk of its electricity reliance from oil to cheaper natural gas over the last decade, giving it low electricity costs along with its competitive labor costs. Factoring in new energy investment, new telecommunications and media projects opened to foreign investment and support from both private and public credit, we can envision a 2% boost to Mexico’s GDP growth rate in the years ahead. This can not come soon enough for Mexico: casualties in its drug war rival some of the war zone countries on page 1.

Now for the challenges. Brazil has bigger problems right now than its mauling at the World Cup. With goods exports, manufacturing and industrial confidence slowing and wage/price inflation rising, Brazil is about to experience a modest bout of stagflation. Markets don’t appear to care (yet).




As for China, growth has stabilized (7%-8% in Q2) but we should be under no illusion as to why: credit growth is rising again. China ranks at the top of list of countries in terms of corporate debt/GDP. I don’t know what the breaking point is, but we’re a long way from pre crisis China when GDP growth was organically driven and less reliant on expansion of household and corporate debt1. There’s some good news regarding the composition of growth: investment is slowing in manufacturing and real estate, and increasing in infrastructure; and while capital goods imports are flat, consumer goods imports are rising, suggesting a modest transition to more consumer-led growth. But for investors, the debt overhang of state owned enterprises and its impact on the economy is the dominant story to watch. That explains why Chinese equity valuations are among the lowest of EM countries (only Russia is lower; for more on its re- militarization, economy and natural gas relations with Europe, see “Eye on the Russians”, April 29, 2014).




On a global basis, demand and inventory trends suggest a pick-up in economic activity in the second half of the year. If so, our high single digit forecast for 2014 equity market returns should be able to withstand the onset of (eventually) tighter monetary policy in the US. The ongoing M&A boom probably won’t hurt either.
 
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The article Outside the Box: Geopolitics and Markets was originally published at Mauldin Economics


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Tuesday, July 22, 2014

The TRUTH about China’s Massive Gold Hoard

By Jeff Clark, Senior Precious Metals Analyst

I don’t want to say that mainstream analysts are stupid when it comes to China’s gold habits, but I did look up how to say that word in Chinese…..


One report claims, for example, that gold demand in China is down because the yuan has fallen and made the metal more expensive in the country. Sounds reasonable, and it has a grain of truth to it. But as you’ll see below, it completely misses the bigger picture, because it overlooks a major development with how the country now imports precious metals.

I’ve seen so many misleading headlines over the last couple months that I thought it time to correct some of the misconceptions. I’ll let you decide if mainstream North American analysts are stupid or not.

The basis for the misunderstanding starts with the fact that the Chinese think differently about gold. They view gold in the context of its role throughout history and dismiss the Western economist who arrogantly declares it an outdated relic. They buy in preparation for a new monetary order—not as a trade they hope earns them a profit.

Combine gold’s historical role with current events, and we would all do well to view our holdings in a slightly more “Chinese” light, one that will give us a more accurate indication of whether we have enough, of what purpose it will actually serve in our portfolio, and maybe even when we should sell (or not).

The horizon is full of flashing indicators that signal the Chinese view of gold is more prudent for what lies ahead. Gold will be less about “making money” and more about preparing for a new international monetary system that will come with historic consequences to our way of life.

With that context in mind, let’s contrast some recent Western headlines with what’s really happening on the ground in China. Consider the big picture message behind these developments and see how well your portfolio is geared for a “Chinese” future…

Gold Demand in China Is Falling

This headline comes from mainstream claims that China is buying less gold this year than last. The International Business Times cites a 30% drop in demand during the “Golden Week” holiday period in May. Many articles point to lower net imports through Hong Kong in the second quarter of the year. “The buying frenzy, triggered by a price slump last April, has not been repeated this year,” reports Kitco.

However, these articles overlook the fact that the Chinese government now accepts gold imports directly into Beijing.

In other words, some of the gold that normally went through Hong Kong is instead shipped to the capital. Bypassing the normal trade routes means these shipments are essentially done in secret. This makes the Western headline misleading at best, and at worst could lead investors to make incorrect decisions about gold’s future.

China may have made this move specifically so its import figures can’t be tracked. It allows Beijing to continue accumulating physical gold without the rest of us knowing the amounts. This move doesn’t imply demand is falling—just the opposite.

And don’t forget that China is already the largest gold producer in the world. It is now reported to have the second largest in-ground gold resource in the world. China does not export gold in any meaningful amount. So even if it were true that recorded imports are falling, it would not necessarily mean that Chinese demand has fallen, nor that China has stopped accumulating gold.

China Didn’t Announce an Increase in Reserves as Expected

A number of analysts (and gold bugs) expected China to announce an update on their gold reserves in April. That’s because it’s widely believed China reports every five years, and the last report was in April 2009. This is not only inaccurate, it misses a crucial point.

First, Beijing publicly reported their gold reserve amounts in the following years:
  • 500 tonnes at the end of 2001
  • 600 tonnes at the end of 2002
  • 1,054 tonnes in April 2009.
Prior to this, China didn’t report any change for over 20 years; it reported 395 tonnes from 1980 to 2001.
There is no five-year schedule. There is no schedule at all. They’ll report whenever they want, and—this is the crucial point—probably not until it is politically expedient to do so.

Depending on the amount, the news could be a major catalyst for the gold market. Why would the Chinese want to say anything that might drive gold prices upwards, if they are still buying?

Even with All Their Buying, China’s Gold Reserve Ratio Is Still Low

Almost every report you’ll read about gold reserves measures them in relation to their total reserves. The US, for example, has 73% of its reserves in gold, while China officially has just 1.3%. Even the World Gold Council reports it this way.

But this calculation is misleading. The U.S. has minimal foreign currency reserves—and China has over $4 trillion. The denominators are vastly different.

A more practical measure is to compare gold reserves to GDP. This would tell us how much gold would be available to support the economy in the event of a global currency crisis, a major reason for having foreign reserves in the first place and something Chinese leaders are clearly preparing for.

The following table shows the top six holders of gold in GDP terms. (Eurozone countries are combined into one.) Notice what happens to China’s gold to GDP ratio when their holdings move from the last reported 1,054-tonne figure to an estimated 4,500 tonnes (a reasonable figure based on import data).

Country Gold
(Tonnes)
Value US$ B
($1300 gold)
GDP US$ B
(2013)
Gold
Percent
of GDP
Eurozone* 10,786.3 $450.8 12,716.30 3.5%
US 8,133.5 $339.9 16,799.70 2.0%
China** 4,500.0 $188.1 9,181.38 2.0%
Russia 1,068.4 $44.7 2,118.01 2.1%
India 557.7 $23.3 1,870.65 1.2%
Japan 765.2 $32.0 4,901.53 0.7%
China 1,054.1 $44.1 9,181.38 0.5%
*including 503.2 tonnes held by ECB
**Projection
Sources: World Gold Council, IMF, Casey Research proprietary calculations


At 4,500 tonnes, the ratio shows China would be on par with the top gold holders in the world. In fact, they would hold more gold than every country except the U.S. (assuming the U.S. and EU have all the gold they say they have). This is probably a more realistic gauge of how they determine if they’re closing in on their goals.


This line of thinking assumes China’s leaders have a set goal for how much gold they want to accumulate, which may or may not be the case. My estimate of 4,500 tonnes of current gold reserves might be high, but it may also be much less than whatever may ultimately satisfy China’s ambitions. Sooner or later, though, they’ll tell us what they have, but as above, that will be when it works to China’s benefit.

The Gold Price Is Weak Because Chinese GDP Growth Is Slowing

Most mainstream analysts point to the slowing pace of China’s economic growth as one big reason the gold price hasn’t broken out of its trading range. China is the world’s largest gold consumer, so on the surface this would seem to make sense. But is there a direct connection between China’s GDP and the gold price?
Over the last six years, there has been a very slight inverse correlation (-0.07) between Chinese GDP and the gold price, meaning they act differently slightly more often than they act the same. Thus, the Western belief characterized above is inaccurate. The data signal that, if China’s economy were to slow, gold demand won’t necessarily decline.

The fact is that demand is projected to grow for reasons largely unrelated to whether their GDP ticks up or down. The World Gold Council estimates that China’s middle class is expected to grow by 200 million people, to 500 million, within six years. (The entire population of the U.S. is only 316 million.) They thus project that private sector demand for gold will increase 25% by 2017, due to rising incomes, bigger savings accounts, and continued rapid urbanization. (170 cities now have over one million inhabitants.) Throw in China’s deep seated cultural affinity for gold and a supportive government, and the overall trend for gold demand in China is up.

The Gold Price Is Determined at the Comex, Not in China

One lament from gold bugs is that the price of gold—regardless of how much people pay for physical metal around the world—is largely a function of what happens at the Comex in New York.

One reason this is true is that the West trades in gold derivatives, while the Shanghai Gold Exchange (SGE) primarily trades in physical metal. The Comex can thus have an outsized impact on the price, compared to the amount of metal physically changing hands. Further, volume at the SGE is thin, compared to the Comex.
But a shift is underway…..

In May, China approached foreign bullion banks and gold producers to participate in a global gold exchange in Shanghai, because as one analyst put it, “The world’s top producer and importer of the metal seeks greater influence over pricing.”

The invited bullion banks include HSBC, Standard Bank, Standard Chartered, Bank of Nova Scotia, and the Australia and New Zealand Banking Group (ANZ). They’ve also asked producing companies, foreign institutions, and private investors to participate.

The global trading platform was launched in the city’s “pilot free-trade zone,” which could eventually challenge the dominance of New York and London.

This is not a proposal; it is already underway.

Further, the enormous amount of bullion China continues to buy reduces trading volume in North America. The Chinese don’t sell, so that metal won’t come back into the market anytime soon, if ever. This concern has already been publicly voiced by some on Wall Street, which gives you an idea of how real this trend is.
There are other related events, but the point is that going forward, China will have increasing sway over the gold price (as will other countries: the Dubai Gold and Commodities Exchange is to begin a spot gold contract within three months).

And that’s a good thing, in our view.

Don’t Be Ridiculous; the US Dollar Isn’t Going to Collapse

In spite of all the warning signs, the US dollar is still the backbone of global trading. “It’s the go-to currency everywhere in the world,” say government economists. When a gold bug (or anyone else) claims the dollar is doomed, they laugh.

But who will get the last laugh?

You may have read about the historic energy deal recently made between Chinese President Xi Jinping and Russian President Vladimir Putin. Over the next 30 years, about $400 billion of natural gas from Siberia will be exported to China. Roughly 25% of China’s energy needs will be met by 2018 from this one deal. The construction project will be one of the largest in the world. The contract allows for further increases, and it opens Russian access to other Asian countries as well. This is big.

The twist is that transactions will not be in US dollars, but in yuan and rubles. This is a serious blow to the petrodollar.

While this is a major geopolitical shift, it is part of a larger trend already in motion:
  • President Jinping proposed a brand-new security system at the recent Asian Cooperation Conference that is to include all of Asia, along with Russia and Iran, and exclude the US and EU.
  • Gazprom has signed agreements with consumers to switch from dollars to euros for payments. The head of the company said that nine of ten consumers have agreed to switch to euros.
  • Putin told foreign journalists at the St. Petersburg International Economic Forum that “China and Russia will consider further steps to shift to the use of national currencies in bilateral transactions.” In fact,a yuan-ruble swap facility that excludes the greenback has already been set up.
  • Beijing and Moscow have created a joint ratings agency and are now “ready for transactions… in rubles and yuan,” said the Russian Finance Minister Anton Siluanov. Many Russian companies have already switched contracts to yuan, partly to escape Western sanctions.
  • Beijing already has in place numerous agreements with major trading partners, such as Brazil and the Eurozone, that bypass the dollar.
  • Brazil, Russia, India, China, and South Africa (the BRICS countries) announced last week that they are “seeking alternatives to the existing world order.” The five countries unveiled a $100 billion fund to fight financial crises, their version of the IMF. They will also launch a World Bank alternative, a new bank that will make loans for infrastructure projects across the developing world.
You don’t need a crystal ball to see the future for the US dollar; the trend is clearly moving against it. An increasing amount of global trade will be done in other currencies, including the yuan, which will steadily weaken the demand for dollars.

The shift will be chaotic at times. Transitions this big come with complications, and not one of them will be good for the dollar. And there will be consequences for every dollar based investment. U.S. dollar holders can only hope this process will be gradual. If it happens suddenly, all U.S. dollar based assets will suffer catastrophic consequences. In his new book, The Death of Money, Jim Rickards says he believes this is exactly what will happen.

The clearest result for all U.S. citizens will be high inflation, perhaps at runaway levels—and much higher gold prices.

Gold Is More Important than a Profit Statement

Only a deflationary bust could keep the gold price from going higher at some point. That is still entirely possible, yet even in that scenario, gold could “win” as most other assets crash. Otherwise, I’m convinced a mid-four-figure price of gold is in the cards.

But remember: It’s not about the price. It’s about the role gold will serve protecting wealth during a major currency upheaval that will severely impact everyone’s finances, investments, and standard of living.
Most advisors who look out to the horizon and see the same future China sees believe you should hold 20% of your investable assets in physical gold bullion. I agree. Anything less will probably not provide the kind of asset and lifestyle protection you’ll need.

In the meantime, don’t worry about the gold price. China’s got your back.

You don’t have to worry about silver, either, which we think holds even greater potential for investors. In the July issue of my newsletter, BIG GOLD, we show why we’re so bullish on gold’s little cousin.

And we provide two silver bullion discounts exclusively for subscribers, and name our top silver pick of the year.

Of course, we also have all our best buys in the gold mining sector as well.

Click here to get it all with a 90 day risk free trial to our inexpensive BIG GOLD newsletter

The article The TRUTH about China’s Massive Gold Hoard was originally published at Casey Research


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Sunday, July 20, 2014

Beware of Flashy Stock Repurchases When The Market Is on The Rise

By Andrey Dashkov

Retail giant Bed Bath & Beyond just announced plans to buy back another $2 billion in shares, which the company will start doing after it completes its current share repurchase program. You’ve seen it before: Press releases emphasize that buybacks return value to shareholders, analysts sometimes rely on repurchases to spot a stock to write up next, and management likes to tout their focus on shareholder returns. But what’s the real story? Why would a company buy its own shares?


There are but a few situations when returning cash to shareholders instead of paying dividends or investing in new projects is prudent:
  • The company has largely exhausted investment opportunities that would generate a positive net present value (NPV).
  • The stock is trading below its intrinsic value; or
  • The tax on dividends is so high compared to the capital gains tax that it makes sense to boost the share price and let shareholders enjoy the extra return instead of receiving heavily taxed dividends.
When these situations happen we support repurchases. In the reality, however, managers often have their own reasons to buy back shares; let’s look at the more popular ones.

First, management’s compensation is often based on share price performance or earnings based metrics like earnings per share (EPS), which buybacks are designed to boost.

Second, higher share price increases the value of a company’s options. Managers are often shareholders, too, but unlike you and me, they have direct access to the Treasury. When managers own a lot of their own company’s stock, they may have too much skin in the game. This may skew their preferences toward increasing the share price at the expense of long term business growth.

Third, share buybacks became a standard (and often abused) signal to the market that: a) the company’s stock is undervalued, and b) that management takes care of the shareholders. Both of these statements may be correct in isolation, based on the company’s fundamentals and management practices. Nonetheless, a buyback should not convince you that either is true.

One additional reason is often overlooked. Many a CEO has been fired for an acquisition that did not work out. When the decision is made to dump the acquisition, it is accompanied by a write off against earnings, sometimes worth billions of dollars. Wall Street armchair quarterbacks are quick to point out how much better off shareholders would have been if they had just paid out what they lost in dividends. Buying back company shares, with all the accompanied hoopla, is less likely to be a career threatening move.

Linking the two subjects together makes for nice copy; however, keep it in perspective. For example, a technology company that realizes their product line is becoming obsolete will often make acquisitions to increase their product line market share, or move them into a new business with long term potential. Buying back company stock, then having to go into the market and borrow at high interest rates, might be the exact wrong move. The key is making the right acquisitions for the company to continue to grow and pay dividends for the next generation.

In fact, managers have proven to be pretty bad stock pickers even when they have only one stock to pick. As my colleague Chris Wood showed in A Look at Stock Buybacks, managements have bought shares of their own companies at pretty bad times in the past. Moreover, the expectations of higher valuation based on higher EPS did not always materialize. Even though a lot of investors use P/E as their main gauge of value (which they shouldn’t), there is no convincing evidence that buybacks can support high valuation multiples in the long term.

Your Bottom Line

 

History has shown that the only value-creating buybacks were the ones carried out when stocks were deeply undervalued. In those instances, the repurchases helped companies outperform the market. But overall the optimism and confidence inducing press releases that accompany buybacks should be taken with a huge grain of salt.

As a rule of thumb, beware of increased buybacks when the market is on the rise (everybody is an investment guru when everything is going up) or when management compensation is closely tied to the share price performance or earnings based metrics. Companies with better corporate governance may fare better when it comes to managing conflicts of interest, but there is a significant vested interest there that investors should be aware of. Don’t mistake noise for a sign is all.

When it comes to returning value to shareholders, we appreciate companies that invest in long term projects—or pay dividends. Despite the potential tax implications, the yield strapped investors may be better served with a special dividend these days than with a promise of a better price in the future.

Learn more ways to cut through press rhetoric by signing up for our free weekly e-letter, Miller’s Money Weekly, where my colleagues and I share timely financial insight tailored for seniors and conservative investors alike.

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Wednesday, July 16, 2014

Hoisington Investment Management: Quarterly Review and Outlook, Second Quarter 2014

By John Mauldin

This week’s Outside the Box is from an old friend to regular readers. It’s time for our Quarterly Review & Outlook from Lacy Hunt of Hoisington Investment Management, who leads off this month with a helpful explanation of the relationship between the U.S. GDP growth rate and 30 year treasury yields. That’s an important relationship, because long term interest rates above nominal GDP growth (as they are now) tend to retard economic activity and vice versa.

The author adds that the average four quarter growth rate of real GDP during the present recovery is 1.8%, well below the 4.2% average in all of the previous post war expansions; and despite six years of federal deficits totaling $6.27 trillion and another $3.63 trillion in quantitative easing by the Fed, the growth rate of the economy continues to erode.

So what gives? We’re simply too indebted, says Lacy; and too much of the debt is nonproductive. (Total U.S. public and private debt rose to 349.3% of GDP in the first quarter, up from 343.7% in the third quarter of 2013.) And as Hyman Minsky and Charles Kindleberger showed us, higher levels of debt slow economic growth when the debt is unbalanced toward the type of borrowing that doesn’t create an income stream sufficient to repay principal and interest.

And it’s not just the US. Lacy notes that the world’s largest economies have a higher total debt to GDP ratio today than at the onset of the Great Recession in 2008, and foreign households are living farther above their means than they were six years ago.

Simply put, the developed (and much of the developing) world is fast approaching the end of a 60-year-long debt supercycle, as I (hope I) conclusively demonstrated in Endgame and reaffirmed in Code Red.
Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub adviser of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX).

Some readers may have noticed that there was no Thoughts from the Frontline in their inboxes this weekend. As has happened only once or twice in the last 14 years, I found myself in an intellectual cul-de-sac, and there was not enough time to back out. Knowing that I was going to be involved in a fascinating conference over the weekend, I had planned to do a rather simple analysis of a new book on how GDP is constructed. But as I got deeper into thinking about the topic and doing more research, I remembered something I read 20 years ago about the misleading nature of GDP, and I realized that a simple analysis just wouldn’t cut it.

Rather than write something that would’ve been inadequate and unsatisfying, I decided to just put it off till next week. Your time and attention are quite valuable, and I try not to waste them. But there will be no excuses this weekend.

The conference I attended was organized by Great Point Partners, a hedge fund and private equity firm focusing on medical and biotechnology. I really had not seen the program until I arrived and did not realize what a powerful lineup of industry leaders would be presenting on some of the latest technologies and research. The opportunity was too good to pass up, as it is so rare that any of us get to sit down with people who are responsible for the science we all read about.

I had breakfast with a small group of 11 readers/investors one morning and learned a lot by asking them what their favorite investing passion was. Although everyone had concerns, they all had areas in which they were quite bullish. I find that everywhere I go. It was interesting, in that they all expected me to be far more negative about things than I am. I guess when you write about macroeconomics as much as I do, and there’s as much wrong with it as there is, you kind of end up being labeled as a Gloomy Gus. I am actually quite optimistic about the long-term future of humanity, but I’ll admit there will be a few bumps along the way. Given how many bumps there have already been, just in my own lifetime, and given that we seem to have gotten through them, I can’t help but be optimistic that we’ll get through the next round.

It was a fascinating weekend, made all the more so by my very gracious hosts, Jeff Jay and David Kroin, Managing Directors of Great Point. They and their staff made sure I could enjoy my time on Nantucket Island. It was my first visit to the area, and I hope it won’t be the last.

Last night I had dinner with Art Cashin, Barry Ritholtz, Jack Rivkin, and Dan Greenhaus. It was a raucous, intellectually enlivening evening, and our conversation ranged from macroeconomics to our favorite new technologies. Jack Rivkin is involved with Idealab, and one of his favorites is that he sees the eventual end of Amazon as 3-D printing becomes more available. Given how Bezos has adapted over the years, I’m not so sure. Jack and Barry will join me in Maine in a few weeks, where we will again join the debate about bull and bear markets.

Now let’s go to Lacy and think about the intersection of velocity and money supply and what it says about future growth potential. I have two full days of meetings with my partners and others here in New York before I return to Dallas, and then I get to stay home for a few weeks. There are lots of new plans in the works. And lots of reading to do between meetings. Have a great week!

Your hoping to be able to stay optimistic analyst,
John Mauldin, Editor
Outside the Box
subscribers@mauldineconomics.com



Hoisington Investment Management – Quarterly Review and Outlook, Second Quarter 2014

Treasury Bonds Undervalued

Thirty year treasury bonds appear to be undervalued based on the tepid growth rate of the U.S. economy. The past four quarters have recorded a nominal “top line” GDP expansion of only 2.9%, while the bond yield remains close to 3.4%. Knut Wicksell (1851-1926) noted that the natural rate of interest, a level that does not tend to slow or accelerate economic activity, should approximate the growth rate of nominal GDP. Interest rates higher than the top line growth rate of the economy, which is the case today, would mean that resources from the income stream of the economy would be required to pay for the higher rate of interest, thus slowing the economy. Wicksell preferred to use, not a risk free rate of interest such as thirty year treasury bonds, but a business rate of interest such as BAA corporates.



As chart one attests, interest rates below nominal GDP growth helps to accelerate economic activity and vice versa. Currently the higher interest rates are retarding economic growth, suggesting the next move in interest rates is lower.

To put the 2.9% change in nominal GDP over the past four quarters in perspective, it is below the entry point of any post-war recession. Even adjusting for inflation the average four-quarter growth rate in real GDP for this recovery is 1.8%, well below the 4.2% average in all of the previous post war expansions.

Fisher's Equation of Exchange

 

Slow nominal growth is not surprising to those who recall the American economist Irving Fisher’s (1867-1947) equation of exchange that was formulated in 1911. Fisher stated that nominal GDP is equal to money (M) times its turnover or velocity (V), i.e., GDP=M*V. Twelve months ago money (M) was expanding about 7%, and velocity (V) was declining at about a 4% annual rate. If you assume that those trends would remain in place then nominal GDP should have expanded at about 3% over the ensuing twelve months, which is exactly what occurred. Projecting further into 2014, the evidence of a continual lackluster expansion is clear. At the end of June money was expanding at slightly above a 6% annual rate, while velocity has been declining around 3%. Thus, Fisher’s formula suggests that another twelve months of a 3% nominal growth rate is more likely than not. With inflation widely expected to rise in the 1.5% to 2.0% range, arithmetic suggests that real GDP in 2014 will expand between 1.0% and 1.5% versus the average output level of 2013. This rate of expansion will translate into a year over year growth rate of around 1% by the fourth quarter of 2014. This is akin to pre-recessionary conditions.

An Alternative View of Debt

 

The perplexing fact is that the growth rate of the economy continues to erode despite six years of cumulative deficits totaling $6.27 trillion and the Federal Reserve’s quantitative easing policy which added net $3.63 trillion of treasury and agency securities to their portfolio. Many would assume that such stimulus would be associated with a booming economic environment, not a slowing one.

Readers of our letters are familiar with our long-standing assessment that the cause of slower growth is the overly indebted economy with too much non productive debt. Rather than repairing its balance sheet by reducing debt, the U.S. economy is starting to increase its leverage. Total debt rose to 349.3% of GDP in the first quarter, up from 343.7% in the third quarter of 2013.

It is possible to cast an increase in debt in positive terms since it suggests that banks and other financial intermediaries are now confident and are lowering credit standards for automobiles, home equity, credit cards and other types of loans. Indeed, the economy gets a temporary boost when participants become more indebted. This conclusion was the essence of the pioneering work by Eugen von Böhm-Bawerk (1851-1914) and Irving Fisher which stated that debt is an increase in current spending (economic expansion) followed by a decline in future spending (economic contraction).

In concert with this view, but pinpointing the negative aspect of debt, contemporary economic research has corroborated the views of Hyman Minsky (1919-1996) and Charles Kindleberger (1910-2003) that debt slows economic growth at higher levels when it is skewed toward the type of borrowing that will not create an income stream sufficient to repay principal and interest.

Scholarly studies using very sophisticated analytical procedures conducted in the U.S. and abroad document the deleterious effects of high debt ratios. However, the use of a balance sheet measure can be criticized in two ways. First, income plays a secondary role, and second, debt ratios are not an integral part of Keynesian economic theory.

We address these two objections by connecting the personal saving rate (PSR) which is at the core of Keynesian economic analysis, and the private debt to GDP ratio that emerges from non-Keynesian approaches. Our research indicates that both the “Non Keynesian” private debt to GDP ratios, as well as the “Keynesian” PSR, yield equivalent analytical conclusions.

The Personal Saving Rate (PSR) and the Private Debt Linkage

 

The PSR and the private debt to GDP ratio should be negatively correlated over time. When the PSR rises, consumer income exceeds outlays and taxes. This means that the consumer has the funds to either acquire assets or pay down debt, thus closely linking the balance sheet and income statement. When the PSR (income statement measure) rises, savings (balance sheet measure) increases unless debt (also a balance sheet measure) declines, thus the gap between the Keynesian income statement focus and the non-Keynesian debt ratio focus is bridged.



The PSR and private debt to GDP ratio are, indeed, negatively correlated (Chart 2). The correlation should not, however, be perfect since the corporate sector is included in the private debt to GDP ratio while the PSR measures just the household sector. We used the total private sector debt ratio because the household data was not available in the years leading up to the Great Depression.

The most important conceptual point concerning the divergence of these two series relates to the matter of the forgiveness of debt by the financial sector, which will lower the private debt to GDP ratio but will not raise the PSR. The private debt to GDP ratio fell sharply from the end of the recession in mid-2009 until the fourth quarter of 2013, temporarily converging with a decline in the saving rate. As such, much of the perceived improvement in the consumer sector’s financial condition occurred from the efforts of others. The private debt to GDP ratio in the first quarter of 2014 stood at 275.4%, a drop of 52.5 percentage points below the peak during the recession. The PSR in the latest month was only 1.7 percentage points higher than in the worst month of the recession. Importantly, both measures now point in the direction of higher leverage, with the PSR showing a more significant deterioration. From the recession high of 8.1%, the PSR dropped to 4.8% in April 2014.

Historical Record

 

The most recently available PSR is at low levels relative to the past 114 years and well below the long-term historical average of 8.5% (Chart 3). The PSR averaged 9.4% during the first year of all 22 recessions from 1900 to the present. However this latest reading of 4.8% is about the same as in the first year of the Great Depression and slightly below the 5% reading in the first year of the Great Recession.



In Dr. Martha Olney’s (University of California, Berkeley and author of Buy Now, Pay Later) terminology, when the PSR falls households are buying now but will need to pay later. Contrarily, if the PSR rises households are improving their future purchasing power. A review of the historical record leads to two additional empirical conclusions. First, the trend in the PSR matters. A decline in the PSR when it has been falling for a prolonged period of time is more significant than a decline after it has risen. Second, the significance of any quarterly or annual PSR should be judged in terms of its long term average.

For example, multi-year declines occurred as the economy approached both the Great Recession of 2008 and the Great Depression of 1929. In 1925 the PSR was 9.2%, but by 1929 it had declined by almost half to 4.7%. The PSR offered an equal, and possibly even better, signal as to the excesses of the 1920s than did the private debt to GDP ratio. Both the level of PSR and the trend of its direction are significant meaningful inputs.

John Maynard Keynes (1883-1946) correctly argued that the severity of the Great Depression was due to under-consumption or over saving. What Keynes failed to note was that the under consumption of the 1930s was due to over spending in the second half of the 1920s. In other words, once circumstances have allowed the under saving event to occur, the net result will be a long period of economic under performance.
Keynes, along with his most famous American supporter, Alvin Hansen (1887-1975), argued that the U.S. economy would face something he termed “an under-employment equilibrium.” They believed the U.S. economy would return to the Great Depression after World War II ended unless the federal government ran large budget deficits to offset weakness in consumer spending. The PSR averaged 23% from 1942 through 1946, and the excessive indebtedness of the 1920s was reversed. Consumers had accumulated savings and were in a position to fuel the post WWII boom. The economy enjoyed great prosperity even though the budget deficit was virtually eliminated. The concerns about the under employment equilibrium were entirely wrong. In Keynes’ defense, the PSR statistics cited above were not known at the time but have been painstakingly created by archival scholars since then.

Implications for 2014-2015

 

In previous letters we have shown that the largest economies in the world have a higher total debt to GDP today than at the time of the Great Recession in 2008. PSRs also indicate that foreign households are living further above their means than six years ago. According to the OECD, Japan’s PSR for 2014 will be 0.6%, virtually unchanged from 2008. The OECD figure is likely to turn out to be very optimistic as the full effects of the April 2014 VAT increase takes effect, and a negative PSR for the year should not be ruled out. In addition, Japan’s PSR is considerably below that of the U.S. The Eurozone PSR as a whole is estimated at 7.9%, down 1.5 percentage points from 2008. Thus, in aggregate, the U.S., Japan and Europe are all trying to solve an under-saving problem by creating more under-saving. History indicates this is not a viable path to recovery. [reference: Atif Mian and Amir Sufi,. House of Debt, University of Chicago Press 2014]
Japan confirms the experience in the United States because their PSR has declined from over 20% in the financial meltdown year of 1989 to today’s near zero level. Japan, unlike the U.S. in the 1940s, has moved further away from financial stability. Despite numerous monetary and fiscal policy maneuvers that were described as extremely powerful, the end result was that they have not been successful.

U.S. Yields Versus Global Bond Yields

 

Table one compares ten-year and thirty year government bond yields in the U.S. and ten major foreign economies. Higher U.S. government bond yields reflect that domestic economic growth has been considerably better than in Europe and Japan, which in turn, mirrors that the U.S. is less indebted. However, the U.S. is now taking on more leverage, indicating that our growth prospects are likely to follow the path of Europe and Japan.



With U.S. rates higher than those of major foreign markets, investors are provided with an additional reason to look favorably on increased investments in the long end of the U.S. treasury market. Additionally, with nominal growth slowing in response to low saving and higher debt we expect that over the next several years U.S. thirty year bond yields could decline into the range of 1.7% to 2.3%, which is where the thirty year yields in the Japanese and German economies, respectively, currently stand.

Van R. Hoisington
Lacy H. Hunt, Ph.D.
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Saturday, July 12, 2014

Weekly Crude Oil Market Recap with Mike Seery

Our trading partner Mike Seery is giving us his weekly crude oil futures market recap.....go shorty, go shorty!

Crude oil futures in the August contract are down $1.00 at 101.93 a barrel and I am currently recommending a short position as prices have hit a 4 week low while placing your stop at the 2 week high of 106.10 risking around $4,000 from today’s price levels as the commodity markets in general have turned extremely bearish as deflation is a short term concern as prices are trading below their 20 day but still above their 100 day moving average telling you the trend is mixed as the chart structure will improve on a daily basis so I remain bearish.

Problems in Iraq have basically gone on the back burner and not talked about as much as it was a couple weeks back when prices hit new highs at 107 as prices are down over $2 for the trading week with the next major support around 101 and if that level is broken I think you could trade between 96 – 98 here in the short term. Crude oil prices have rallied from $90 in January all the way up to 107 as many of the commodity markets rallied early in 2014 but that has changed in recent weeks as many of the agricultural markets have absolutely plunged as I think that will start to pressure crude oil prices also due to the fact that the Federal Reserve is cutting back on the quantitative easing which is bearish commodities.

TREND: LOWER
CHART STRUCTURE: IMPROVING

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Wednesday, July 9, 2014

Using Supply and Demand to Beat the Market: An Interview with Fund Manager Charles Biderman

By Dan Steinhart, Managing Editor, The Casey Report

It’s an investing strategy so simple, you’ll wonder why you didn’t think of it. Like any other market, the stock market obeys the laws of supply and demand. Reduce supply, and prices should rise. Therefore, companies that reduce their outstanding shares by buying back their own stock should outperform the market.

That’s the basic theory that Charles Biderman, who was recently featured in Forbes and is chairman and founder of TrimTabs Investment Research, follows to manage his ETF, TrimTabs Float Shrink (TTFS).
And it works. Since its inception in October 2011, TTFS has beaten the S&P 500 by 15 percentage points. That’s no small feat, especially during a bull market. Most hedge fund managers would sacrifice their firstborns for such stellar performance.

There are, of course, nuances to the strategy, which Charles explains in an interview with Casey Research’s managing editor Dan Steinhart below. For example, companies must use their own money to buy back shares. Borrowing for buybacks is a no no.

It’s also worth mentioning, you can meet and learn all about Charles’ strategy in person. He’ll be available at  Casey Research’s Summit: Thriving in a Crisis Economy in San Antonio, TX from September 19-21 where he’ll be working with attendees to teach them how to beat the market using supply and demand analysis.

And Charles is just one of many all stars on the faculty for this summit—click here to browse the others, which include Alex Jones, Jim Rickards, and, of course, Doug Casey.

Also, you can still sign up for this Summit and meet some of the world’s brightest financial minds and receive a special early bird discount. You’ll save $400 if you sign up by July 15th. Click here to register now.
Now for the complete Charles Biderman interview. Enjoy!


Using Supply and Demand to Beat the Market: An Interview with Fund Manager Charles Biderman

Dan: Thanks for joining us today, Charles. Could you start by telling us a little bit about your unique approach to stock market research?

Charles: Sure. I’ve been following the markets for 40 years. Everybody talks about earnings and interest rates and growth rates and what the government is doing. But here’s the thing: the stock market is made up of shares of stock. That’s it. There is nothing else in the stock market.

So my firm tracks the supply and demand of the stock market. The number of shares outstanding is the supply. Money is the demand. We discovered when more money chases fewer shares, the market goes up. Isn’t that shocking?

Dan: [Laughs] Not very, when you put it that way.

Charles: Whenever I talk with individual investors, I tell them that there’s only one reason for them to listen to me: that they think I can help them beat the market. I’ve spent 40 some years looking at markets in a different way than other people. I’ve found that the market is like a casino: it has a house and players. You know the house has an edge, because if it didn’t, the stock market wouldn’t exist.

Who is the house in the stock market? Not brokers, or even high frequency traders. Companies are the house. As investors, we’re playing with their shares, and the companies know more about them than we do.
I’ve discovered that companies buy back their own shares because they think the price is heading higher. So when a company buys back its own shares using its own money, you should buy that stock too. But only if the company uses its own money. Borrowing money to buy shares is a no-no.

Conversely, when companies are growing their shares outstanding by selling stock to raise money, they don’t like where their stock price is headed. If they don’t want to own their own stock, you shouldn’t either.
My basic philosophy is to follow supply and demand of stocks and money, and you can’t go wrong.

Dan: Your theory has worked very well in practice. Your TrimTabs Float Shrink ETF (TTFS) beat the S&P 500 by an impressive 12 percentage points in 2013. And that’s really saying something, considering how well the S&P 500 performed.

Charles: Yes, and we’ve outperformed the S&P 500 over the past year as well.

Dan: What specific investment strategies did you use to generate that return?

Charles: Our fund invests in 100 companies that are growing free cash flow—which is the money left over after taxes, R & D, capital expenditures, and dividends—and using it to buy back their own shares.
We modify our holdings every month because we’ve discovered that the positive effects of buybacks only last for a short time. So when a company stops shrinking its float, we kick it out. Our turnover is about 20 stocks per month.

Dan: The supply side of the equation seems pretty straightforward. What do you use to approximate demand? Money supply numbers?

Charles: Sort of. Institutions own around 80% of the shares of the Russell 1000, so we track the money that flows through them into and out of the stock market.

We also track wage and salary growth. We’re not interested in income generated by government actions, but rather by the wages of the 137 million Americans who have jobs subject to withholding. Money for investment comes from income. People can only invest the money they have left over after they cover expenses.

Income in the U.S. is currently around $7.5 trillion per year. That’s an increase of around $300 million over last year, or a little under 3% after inflation. That’s not sufficient to generate money for investment.

However, the Fed’s zero interest rate policy has showered companies with plenty of cash to improve their operations. As a result, many industries have record high profit margins. But at the same time, most management teams are still afraid to reinvest their profits into expanding their businesses because they don’t see final consumption demand growing. So these companies have been buying back their shares instead. The total number of shares in the market has declined pretty much consistently since 2010.

An investment institution typically targets a specific percentage of cash to hold, say 5%. So when a company buys back its own stock from these institutions, the institutions now have more money and fewer shares. To meet their cash allocation target, they have to go out and buy more shares. So the end result is more money chasing fewer shares.

This is why we’ve been experiencing a “melt-up” in the market. It has nothing to do with the economy—it’s solely due to supply and demand. And as buybacks continue, stock prices will continue to rise.

The caveat is that unless the economy recovers in earnest, the gap between stock prices and the real-world economy will continue to grow. At some point, it will get too wide, and we’ll get a bang moment similar to the housing crisis, when everyone realized that housing prices were too far above their underlying value in 2007.

Dan: Do you monitor macroeconomic issues as well?

Charles: Yes, but as I like to say, all macro issues manifest as supply and demand eventually. Supply and demand is what’s happening right now. All of those other inputs get us to “now.”

Dan: I understand. So you’re more concerned with the effects of supply and demand than the causes.

Charles: Right. Price is a function of the world as it exists right now. If you don’t have cash, it doesn’t matter how fantastic stock market fundamentals look. Without cash, you can’t buy, no matter how compelling the value.

Dan: Could you share a preview of what you’ll be talking about at the Casey Research Summit in San Antonio?

Charles: I’ll be giving specific advice to individual investors on how to beat the market. Outperforming the overall market is very difficult to do, and earnings analysis and graphic analysis has never been proven to do it over a long period. Supply and demand analysis has. So I will work with attendees and show them how to apply those strategies to beat the market going forward.

Dan: Great; I look forward to that. Is there anything else you’d like to add?

Charles: The phrase “disruptive technology” is popular today. I think investing on the basis of supply and demand is a disruptive technology compared with other investing strategies, most of which have never really worked. Cheap, broad-based index funds are so popular because very few investing strategies offer any real edge. I believe supply and demand investing gives me an edge.

Dan: Thanks very much for sharing your insights today. I’m excited to hear what else you’ll have to say at our Thriving in a Crisis Economy Summit in San Antonio.

Charles: I’m looking forward to the Summit as well. I hope the aura of the San Antonio Spurs’ victory will rub off on all of us.

Dan: Me too. Thanks again.




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Monday, July 7, 2014

Gold Option Trade – Will Gold Continue to Consolidate?

Until recently, the world has forgotten about gold and gold futures prices it would seem. A few years ago, all we heard about was gold and silver futures making new highs on the back of the Federal Reserve’s constant money printing schemes.

However, after a dramatic sell off the world of precious metals it became very quiet.


Gold prices have been in a giant basing or consolidation pattern for more than one year. As can clearly be seen below, gold futures prices have traded in a range between roughly 1,175 and 1,430 since June of 2013.


Chart1


The past few weeks we have heard more about gold prices as we have seen a five week rally since late May. I would also draw your attention to the fact that gold futures also made a slightly higher low which is typically a bullish signal.


At this point in time, it appears quite likely that a possible test of the upper end of the channel is possible in the next few weeks / months. If price can push above 1,430 on the spot gold futures price a breakout could transpire that could see $150 or more added to the spot gold price.


Clearly there are a variety of ways that a trader could consider higher prices in gold futures. However, a basic option strategy can pay handsome rewards that will profit from a continued consolidation. The trade strategy is profitable as long as price stays within a range for a specified period of time. Ultimately this type of trade strategy involves the use of options and capitalizes on the passage of time.


The strategy is called an Iron Condor Strategy, however in order to make this trade worth while we would consider widening out the strikes to increase our profitability while simultaneously increasing our overall risk per spread. Consider the chart of GLD below which has highlighted the price range that would be profitable to the August monthly option expiration on August 15th.


Chart2


As long as price stays in the range shown above, the GLD August Iron Condor Spread would be profitable. Clearly this strategy involves patience and the expectation that gold prices will continue to consolidate. This trade has the profit potential of $37 per spread, or a total potential return based on maximum possible risk of 13.62%. The probability based on today's implied volatility in GLD options for this spread to be profitable at expiration (August 15) is roughly 80%.


Our new option service specializes in identifying these types of consolidation setups and helps investors capitalize on consolidating chart patterns, volatility collapse, and profiting from the passage of time. And if you Advanced options trades are not your thing, we also provide Simple options where we buy either a call or put option based on the SP500 and VIX. The nice thing about buying calls and puts is that you can trade with an account as little as $2,500.


If You Want Daily Options Trades, Join the Technical Traders Options Alerts

See you in the markets!

Chris Vermeulen

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Friday, July 4, 2014

Low VIX and What It Means to Your Trading....Our Next Free Webinar

You are invited to attend our next free webinar, presented by former CBOE floor trader Dan Passarelli on Tuesday July 15th at 4:30 EDT. Dan's focus for this webinar will be "Low VIX and What It Means to Your Trading".

Many traders are having a tough time making money in this market. Why? Low VIX. Professional traders use the VIX as a guide to gauge potential option profits. Attend this webinar with Dan and learn what the VIX is telling us about your trading this summer.

Don't miss this special webinar.

Just click here to reserve your seat now

See you Tuesday July 15th!

Ray @ The Crude Oil Trader

Our next free webinar "Low VIX and What It Means to Your Trading"....Just Click Here!


Tuesday, July 1, 2014

5 Simple Rules to Evolve Past the Hot Stock List

By Andrey Dashkov

If you’re a typical small time investor, chances are you prefer to let a team of analysts fuss about such irksome things as correlation and beta. Maybe you’ve bought a stock because your brother in law gave you a hot tip, maybe you heard something about it on a financial news show, or maybe you just loved the company’s product.


Friends often ask me for “hot stock tips”—which is like walking up to someone at the craps table and asking what number to bet on. An accomplished craps player will have position limits, stop losses, income targets, and an overall strategy that does not hinge on one roll of the dice. You need an overall strategy long before you put money down.

So, what do I tell those friends asking for hot stock tips? Well, that they can retire rich with a 50-20-30 portfolio:
  • Stocks. 50% in solid, diversified stocks providing healthy dividends and appreciation.
  • High Yield. 20% in high yield, dividend paying investments coupled with appropriate safety measures. These holdings are bought for yield; any appreciation is a nice bonus.
  • Stable Income. 30% in conservative, stable income vehicles.
Unless you’re starting entirely from scratch, you should review your current portfolio allocations, identify where you’re over or underallocated, and then look for investments to fill those holes. In our portfolio here at Miller's Money Forever, we separate our recommendations into StocksHigh Yield, and Stable Income to help you do just that.

The Art of the Pick

 

By the time an investment lands in our portfolio, we’ve already run it through our Five Point Balancing Test. When your boasting brother in law tempts you with a “can’t-miss opportunity” or some pundit touts a hot tech company on television, you can come back to these five points, again and again.
  1. Is it a solid company or investment vehicle? Investing your retirement money safely is a must. How do you know if a company is solid? Take the time to validate essential company information, particularly when the recommendation comes from a source with questionable motivation.
  2. Does it provide good income? A good stock combines a robust dividend and appreciation potential.
  3. Is there a good chance for appreciation? There are two types of appreciating stocks: those that rise because of general market conditions and those that rise further because of the way management runs the business. We want both.
  4. Does it protect against inflation? High inflation is one of the biggest enemies of a retirement portfolio.
  5. Is it easily reversible? Ask yourself, “Can I quickly and easily reverse this investment if something unexpected occurs?” The ability to liquidate inexpensively is critical to correcting errors.

Marking the Bull’s Eye So You Can Hit It

 

It’s worthwhile to write down your goal—including an income target and the price at which you’ll sell if things head south—with every investment. After all, if you can’t see the bull’s eye, how will you know if you’ve hit it? Buying any investment because a trusted adviser, newsletter, or pundit recommended it is not a good enough reason. Buying because your portfolio has a hole, you understand the company, the investment vehicle, the risks, and the potential is.

Remember, retiring rich means having enough money to enjoy your lifestyle without money worries. Do your homework on every investment and you’ll make that pleasant thought your life’s reality. Every week, the Miller’s Money team provides no nonsense, practical advice about the best ways to invest for your retirement in  Miller’s Money Weekly Sign up here to receive it every Thursday.

The article 5 Simple Rules to Evolve Past the Hot-Stock List was originally published at Millers Money


Get your seat for our next free webinar "Low VIX and What It Means to Your Trading"....Just Click Here!



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