Tuesday, July 28, 2015

Emerging Market Currencies Destroyed & Hated: Buying Opportunity?

Over the past few years when discussing my personal investment portfolio I have continuously noted I was raising and/or holding cash in U.S. dollars. I do not believe the dollar is a long term fundamentally strong currency, but I felt market forces would push it cyclically higher in the short term. Since mid 2011 the trade weighted US dollar index has risen sharply. The dollar has staged a massive rally against essentially every alternative form of money or currency in the world, including precious metals.

The dollar is now widely considered the bastion of safety, and the euphoria surrounding dollar bullishness has only grown stronger with the U.S. stock market surging simultaneously.

There are certainly still factors in place that can push the dollar higher in the short term, but I am now beginning to diversify some of my cash holdings into foreign currencies. Why? These currencies have stronger long term fundamentals, their prices have recently fallen significantly and sentiment surrounding their future price direction is incredibly bearish. Everyone that "knew" the U.S. dollar would decline a few years ago is now just as sure it will continue to push higher from here.

The following is a chart of emerging market currencies against the U.S. dollar. After steady declines since mid 2011 they have entered free fall.

I am beginning to make purchases in the Brazilian real, South African rand, Russian ruble, Indian rupee, Canadian dollar, and Australian dollar. There are others, such as the New Zealand dollar, I am watching closely but they have not yet fallen enough to warrant a purchase. I like to get exposure to these currencies through the purchase of short term government bonds because they have high interest rates that pay you to wait and help ride through the storm.

Stocks in emerging markets have essentially moved sideways or declined since early 2009 (black line below).

While most emerging market stocks have not fallen enough for me to enter the market, there are already pockets of value in certain stocks and countries. The chart below from Meb Faber provides a snapshot on how expensive or inexpensive some of the world markets are today based on the Shiller price to earnings ratio. You can see that while Brazil and Russia have moved below 10, the U.S. market is above 23.

It is important to note inexpensive currencies, stocks, bonds, commodities and real estate have the ability to become far more very inexpensive before they bottom. I am discussing my personal investment decisions because it is the question I receive most often. This is not investment advice for everyone. I like to buy assets when they are cheap and hated with the full understanding they can become much cheaper and even more hated before they bottom.

My hope is emerging market currencies and stocks continue to fall in the years ahead and their markets move from cheap to extremely cheap. On the opposite end of the spectrum, the bubblicious U.S. stock market is so far removed from reality in terms of price and sentiment that it is not even worth my the time to look at it. That will change some day, but we are a long way away from that day.

For more see: Why I'm Buying Silver & Gold Mining Shares During The Selling Panic

Wednesday, July 22, 2015

Carl Icahn On The Coming Bond Market Crisis

Carl Icahn, in another rare moment of honesty from the billionaire, explains why the high yield (junk) bond market currently rests on a very dangerous precipice. In simple terms; if (when) there is a rush to the exits, there is very little liquidity in the market to stem the panic.

Tuesday, July 21, 2015

Why I'm Buying Silver & Gold Mining Shares During The Panic Selling

In the early 2000's I began reading a lot about financial history and the growth of debt taking place around the world. This reading led me to investing in gold and silver, which I began to accumulate in late 2004. I purchased month in and month out until early 2008 when it felt like the metals were beginning to receive global attention and the prices felt expensive relative to where I began purchasing.

I held the metals through the boom in 2011, and I still own that physical metal today. I began accumulating silver again when prices fell below $30 an ounce and I began accumulating gold mining shares yesterday (more on that below).

Essentially, my purchases in 2004 - 2007 looked great on paper up until 2011, and my holding and buying have looked stupid on paper ever since, while gold and silver have fallen relentlessly over the past four years.

I consider myself someone who still has many working years ahead of them, which I hope means many years of adding to my investment portfolio. With that understanding, if I believe an investment has strong long term fundamentals, lower prices make the investment more attractive to me. If an investment goes up in price (all other factors staying the same) the asset is less attractive to me.

Humans naturally understand and follow this process in every part of their life, except investing. If a TV, car, piece of clothing or food item at the grocery store goes on sale (all other factors staying the same), consumers are more likely to purchase that item. It becomes more appealing. If a stock, bond, commodity or currency goes on sale (all other factors staying the same), people are less likely to purchase that item. The lower a financial asset price falls (all other factors staying the same), the more people want to sell it and become more fearful about purchasing it.

I have covered this topic surrounding investor psychology numerous times in the past, but it is important to review again today as it correlates perfectly to what is currently taking place with precious metals.

I mentioned I began purchasing gold and silver in 2004 because I was concerned about global debt growth. What has happened since 2007? Global debt has mushroomed in size while incomes and economic growth have been stagnant or in decline. I use the 2007 date because many people believe the world has gone through some sort of deleveraging (reducing debt) since the financial crisis began. The exact opposite has occurred with individual, corporate and government balance sheets swelling in size.

See: A Look Behind The $57 Trillion Increase In Global Debt Since 2007

It was clear to investors following the financial crisis why someone would own gold in their portfolio. Many individuals, corporations, banks and governments would be unable to make good on the money they borrowed if a creditor ever asked them to repay the debt. After witnessing the government response to the financial crisis in 2008 the blueprint became clear for the future. If there was ever trouble, governments would step in with additional debt which would be purchased by central banks with a printing press. Taking the logical next step through this process shows this will ultimately lead to a far greater crisis in the future.

This logical, easy to understand end game has been lost and forgotten with a surging stock market and falling precious metals prices. The charts now "prove" there is no danger ahead. The belief in paper currency, which has been astounding for me to watch over the past 8 years, has only grown. Instead of fearing potential devaluations or defaults in the most bankrupt parts of the world, investors have rushed to those areas to purchase bonds even as interest rates moved negative.

People initially forgot about gold and have now moved to loathing it. The daily sentiment index on gold and silver both reached 10% yesterday, meaning 90% of investors believe gold and silver will fall from here. Mainstream financial writers now confidently predict gold will continue its plunge lower, forever. From yesterday...

Forbes: "How Low Can Gold & Silver Go?"

Market Watch: "Gold's Slump Is Here To Stay"

Fox Business: "Gold Teeters, Headed For More Losses"

Bloomberg: "Investors See No Reason To Buy Gold"

Market Watch: "Gold's Crash Isn't Over"

USA Today: "Gold Loses Luster"

Financial Review: "Gold To Hit $1,000 By December"

Market Watch: "Why Gold Is Falling and Won't Get Up Again"

That sentiment looks bullish, however, when you compare it to what is happening in the mining sector. The Philadelphia Gold and Silver Index below, which tracks a large basket of mining shares, has now moved to prices last seen in 2001 when gold was trading around $300 (gold is at about $1100 as I write this morning).

The GDX, which is the most widely tracked gold mining ETF, fell 11% in trading yesterday alone. I entered the market yesterday to begin buying the GDX when it was down 8% on the day, only to check back after the work day to see it had already dropped another 3%.

As I write this morning gold mining shares are perhaps more depressed than any asset class in history. Does that mean they have to stop falling from here? Of course not. The market believes gold will fall below $500 in the months and years ahead and stay there forever, which will make every mine on the planet unprofitable. That may happen. I do not believe it will, so I am currently purchasing mining shares (along with steady silver buying).

If mining shares and silver continue to plunge in price (and fundamentals behind the metals do not change) then I will accumulate more, at a greater pace and size. Maybe this time global debt and money printing will have a long term positive impact on the global economy, while every previous time in history they they have lead to slowing long term growth and/or a crisis. I am betting this time is not different.

Thursday, July 16, 2015

Governments & Central Banks Do Not Control Market Movement

The following is an excellent chart from Elliott Wave showing the bullish intervention announcements from the U.S. government and Federal Reserve during the 2008 collapse. It is important to reflect back on this chart before the next major crisis begins. Every announcement was immediately followed by a larger relief rally, followed by the market continuing its descent lower. The market continued to fall past where this chart ends to the now famous 666 mark in early March. Click for larger image:

Markets have pushed higher after every major announcement from the U.S. government and Federal Reserve since early 2009. Investors pull up charts and layer these bullish intervention announcements over the charts (think of the QE charts showing how QE "always" moves markets higher). Investors now believe these announcements are the direct cause of the bullish trend over the past 6 years.

With this causation analysis now entered into the history books as fact investors feel 100% confident any market decline will instantly be stopped and reversed by central bank or government intervention. Hopefully the chart above will be a reminder this "fact" is indeed myth, which will be proven again during the next major market decline.

Monday, July 13, 2015

China & Greece: Blueprints For Future Government Crisis Response

Greece and China have dominated the financial news over the past few weeks. What is most interesting to me is not the actual crisis events, which were fairly obvious to see coming in advance, but the response to each crisis from their governments.

When it became clear a few weeks ago the next deal between Greece and the European Union would be postponed at least a few weeks there was a quick and swift response; shut down the banks and shut down the stock market. In essence, your money was locked up and untouchable as a Greek citizen. I discussed the stupidity around having your money in a savings account to begin with last week, but (hopefully?) when the banks re-open after the next bailout is finalized everyone will immediately pull out every dollar they possibly can, right? We'll have to see.

In China the story was different, but the similarities were striking. Their stock market experienced an incredible rise over the past twelve months fueled by speculation from individual citizens within their country. Small retail investors account for 85% of trading in Chinese stocks. There are 90 million of these retail investors and two thirds of them do not have a high school diploma.

A large portion of the spectacular rise from stocks was fueled by margin, meaning money borrowed to purchase shares. The chart below shows the record breaking margin debt in China as a percentage of the value of all their stocks. The total margin borrowing (equivalent to 8.5% of the entire market) is greater than any borrowing binge we have seen in any market in history. Bloomberg estimates there was another 3 trillion yuan borrowed in the shadow lending markets which would push the total to 22% of the entire market!

What happens when 22% of the market is on margin and stocks are purchased by uneducated (mostly new) investors chasing hot money? If stocks reverse course there is panic and liquidation, which is exactly what happened. Stocks fell 35% over 18 trading days, with many of the high flying names falling much further.

Then came the response from the government, which was just as incredible as the waterfall decline in prices:

71% of the shares on the market were halted (meaning trading was shut off - just like in Greece). That is 1,331 companies, $2.6 trillion or 40% of the entire market cap. Their securities regulator then banned any shareholder owning more than 5% of a company from selling for 6 months! Corporate executives and directors were all banned from selling. China ordered government owned institutions to maintain or boost their stock holdings. China restricted short selling in the futures market and then encouraged financial firms to purchase shares.

Think about that last paragraph for just a moment. If you had money in the market you were essentially locked out from selling shares. Your money was trapped in the market like a bank shutting down their ATM machines. Then the government, almost overnight, put together a full blown program designed to halt shares from falling and push prices higher. The government became the stock market. 

The next logical step (if prices do not rise from here) is for the central bank to enter the market and begin printing money to purchase stocks directly. Sounds insane? Japan's central bank currently does it every month.

Where will Chinese stocks go from here? Obviously, I have no idea. Just like almost every action we see by governments during each crisis around the world, the response is unprecedented.

The most important part of each crisis was the initial response; turn off the markets and/or shut the doors and do not allow people to get their moneyThis should be an advance warning for investors around the world.

As an individual living in China, when they turn the markets back on, wouldn't you sell as quickly as possible and stay away from the markets for good? This is the long term problem with government intervention into any market. They may be able to push markets higher in the short term but the unseen long term damage is always far greater.

Saturday, July 11, 2015

The Importance Of Thinking Globally With Your Portfolio

Peter Schiff of Euro Pacific Capital

The past four years or so have been extremely frustrating for investors like me who have structured their portfolios around the belief that the current experiments in central bank stimulus, the anti-business drift in Washington, and America's  mediocre economy and unresolved debt issues would push down the value of the dollar, push up commodity prices, and favor assets in economies with relatively low debt levels and higher GDP growth. But since the beginning of 2011, the Dow Jones Industrial Average has rallied 67% while the rest of the world has been largely stuck in the mud. This dominance is reminiscent of the four years from the end of 1996 to the end of 2000, when the Dow rallied 54% while overseas markets languished. Although past performance is no guarantee of future results, a casual look back at how the U.S. out-performance trend played out the last time it had occurred should give investors much to think about.
The late 1990's was the original "Goldilocks" era of U.S. economic history, one in which all the inputs seemed to offer investors the best of all possible worlds. The Clinton Administration and the first Republican-controlled Congress in a generation had implemented policies that lowered taxes, eased business conditions, and encouraged business investment. But, more importantly, the Federal Reserve was led by Alan Greenspan, whose efforts to orchestrate smooth sailing on Wall Street led many to dub Mr. Greenspan "The Maestro."
Towards the end of the 1990's, Greenspan worked hard to insulate the markets from some of the more negative developments in global finance. These included the Asian Debt Crisis of 1997 and the Russian debt default of 1998. But the most telling policy move of the Greenspan Fed in the late 1990's was its response to the rapid demise of hedge fund Long term Capital Management (LTCM), whose strategy of heavily leveraged arbitrage backfired spectacularly in 1998. Greenspan engineered a $3.6 billion bailout and forced sale of LTCM to a consortium of Wall Street firms. The intervention was an enormous relief to LTCM shareholders but, more importantly, it provided a precedent that the Fed had Wall Street's back.
Not surprisingly, the 1990's became one of the longest sustained bull markets on record. But in the latter part of the decade the markets really started to climb in an unprecedented trajectory.  As the bubble began inflating in earnest Greenspan was reluctant to follow the dictum that the Fed's job was to remove the punch bowl before the party got out of hand. Instead he argued that the Fed shouldn't prevent bubbles from forming, but simply to clean up the mess after they burst.
But while U.S. markets were taking off, the rest of the world was languishing, or worse:
Created by EPC using data from Bloomberg
All returns are currency-adjusted
But then a very funny thing happened. In March 2000, the music stopped and the dotcom bubble finally burst, sending the Nasdaq down nearly 50% by the end of the year, and a staggering 70% by September 2001.  When investors got back into the market their values had changed. They now favored low valuations, real revenue growth, understandable business models, high dividends, and low debt. They came to find those features in the non-dollar investments that they had been avoiding.
Over the seven years that began at the end of 2000 and lasted until the end of 2007 the S&P 500 inched upwards by just 11%, for an average annual return of only 1.6%. But over that time frame the world index (which includes everything except the U.S.) was up 72%. The emerging markets, which had suffered the most during the four prior years, were up a staggering 273%. See table below:
Created by EPC using data from Bloomberg
All returns are currency-adjusted
Not surprisingly, the markets and asset classes that had been decimated by the Asian debt and currency crises, delivered stunning results. South Korea, which was only up 10% in the four years prior, was up 312% from 2001-2007. Brazil, which had fallen by 4%, notched a 407% return, and Indonesia, which had fallen by 50%, skyrocketed by 745%.
The period was also a great time for gold and gold stocks. The earlier four years had offered nothing but misery for investors like me who had been convinced that the Greenspan policies would undermine the dollar, shake confidence in fiat currency, and drive investors into gold. Instead, gold fell 26% (to a 20-year low), and shares of gold mining companies fell a stunning 65%.
But when the gold market turned in 2001, it turned hard. From 2001 - 2007, the dollar retreated by nearly 18% (FRED, FRB St. Louis), while gold shot up by 206%, and shares of gold miners surged 512%. As it turned out, we weren't wrong about the impact of the Fed's easy money, just too early.
2010 - 2014
In recent years, investors who have looked to avoid the dollar and the high-debt developed economies have encountered many of the same frustrations that they encountered in the late 1990's. Foreign markets, energy, commodities and gold have gone nowhere while the dollar and U.S. markets have surged as they did in 1997-2000.
Created by EPC using data from Bloomberg
All returns are currency-adjusted
It is said history may not repeat, but it often rhymes. If so, there may be a financial sonnet brewing. There are reasons to believe that relative returns globally will turn around now much as they did back in 2000. Perhaps even more decisively.
Just as they had back in the late 1990's, investors appear to be ignoring flashing red flags. In its Business and Finance Outlook 2015, the Organization for Economic Cooperation and Development (OECD), a body that could not be characterized as a harbinger of doom, highlighted some of the issues that should be concerning the markets. Reuters provides this summary of the report's conclusions:
  • Encouraged by years of central bank easing, investors are plowing too much cash into unproductive and increasingly speculative investments while shunning businesses building economic growth.
  • There is a growing divergence between investors rushing into ever riskier assets while companies remain too risk-averse to make investments.
  • Investors are rewarding corporate managers focused on share-buybacks, dividends, mergers and acquisitions rather than those CEOS betting on long-term investment in research and development.
While these trends have been occurring around the world, they have become most pronounced in the U.S., making valuations disproportionately high relative to other markets. As we mentioned in a prior newsletter, looking at current valuations through a long term lens provides needed perspective. One of the best ways to do that is with the Cyclically-Adjusted-Price-to-Earnings (CAPE) ratio, which is also known as the Shiller Ratio (named after its developer, the Nobel prize-winning economist Robert Shiller).Using 2014 year-end CAPE ratios that average earnings over a trailing 10-year period, the global valuation imbalances become evident:
As of the end of 2014, the S&P 500 had a CAPE ratio of well over 27, at least 75% higher than the MSCI World Index of around 15. (High valuations are also on evidence in Japan, where similar monetary stimulus programs are underway). On a country by country basis, the U.S. has a CAPE that is at least 40% higher than Canada, 58% higher than Germany, 68% higher than Australia, 90% higher than New Zealand, Finland and Singapore, and well over 100% higher than South Korea and Norway. Yet these markets, despite the strong domestic economic fundamentals that we feel exist, are rarely mentioned as priority investment targets by the mainstream asset management firms. 
In addition, U.S. stocks currently offer some of the lowest dividend yields to compensate investors for the higher valuations (see chart above). The current estimated 1.87% annual dividend yield for the S&P 500 is far below the current annual dividend yields of Australia, New Zealand, Finland and Norway.
If a dramatic shock occurs as it did in 2000, will investors again turn away from high leverage and high valuations to seek more modestly valued investments? Then, as now, we believe those types of assets can more readily be found in non-dollar markets.
Another similarity between then and now is the propensity to confuse an asset bubble for genuine economic growth. The dotcom craze of the 1990's painted a false picture of prosperity that was doomed to end badly once market forces corrected for the mal-investments. When that did occur, and stock prices fell sharply, the Fed responded by blowing up an even bigger bubble in real estate. When that larger bubble burst in 2008, the result was not just recession, but the largest financial crisis since the Great Depression.
But once again investors have mistaken a bubble for a recovery, only this time the bubble is much larger and the "recovery" much smaller. The middling 2% GDP growth we are currently experiencing is approximately half of what we saw in the late 1990's. In reality, the Fed has prevented market forces from solving acute structural problems while producing the mother of all bubbles in stocks, bonds, and real estate. A return to monetary normalcy is impossible without pricking those bubbles. Soon the markets will be faced with the unpleasant reality that the U.S. economy may now be so addicted to monetary heroine that another round of quantitative easing will be necessary to keep the bubble from deflating.
The current rally in U.S. stocks has gone on for nearly four full years without a 10% correction. Given that high asset prices are one of the pillars that support this weak economy, it is likely that the Fed will unleash another round of QE as soon as the market starts to fall in earnest. The realization that the markets are dependent on Fed life support should seal the dollar's fate. Once the dollar turns, a process that in my opinion began in April of this year, so too should the fortunes of U.S. markets relative to foreign markets. If I am right, we may be about to embark on what could become the single most substantial period of out-performance of foreign verses domestic markets.
While the party in the 1990's ended badly, the festivities currently underway may end in outright disaster. The party-goers may not just awaken with hangovers, but with missing teeth, no memories, and Mike Tyson's tiger in their hotel room.

Have Investment Returns Become An Entitlement?

Tuesday, July 7, 2015

Why CEOs Authorize Heavy Buybacks At Market Tops

Why do companies buy back their own shares even when they know the shares are overpriced? The following graphic from Bloomberg should help explain the reason. It shows how the compensation for IBM's CEO, Ginni Rommetty, is broken down.

When a company buys back their shares they are removing the number of total outstanding shares. Reducing the supply of shares raises the earnings for each share that is remaining.

Think of it like this; a company goes public and issues 10 shares of stock to investors. The company is earning $10 per year, meaning they are earning $1 per share. If the company decides they would like to buy back 5 shares there are only 5 remaining shares outstanding. The $10 in annual earnings now equals $2 per share with no improvement in earnings. The portion of the CEO's pay tied to earnings per share has now doubled. Everybody wins, until the market goes down, but fortunately that will never happen again.

For more see U.S. Stocks: Something Wicked This Way Comes

Monday, July 6, 2015

The Trojan Finger

The people of Greece sent a nice little gift to Germany and the rest of the European leadership Sunday night with their "No" vote for additional bailouts (additional debt they can never repay in return for immediate spending cuts).

This does not mean Greece will ultimately say no to a bailout package, but it gives them political courage to go back to the negotiating table with a country behind them. To be honest, I was surprised by the vote results. By voting no, it could impact pension payments and the ability for banks to open their doors. Defaulting on the debt owed would create a much tougher short term road for the country as a whole, but it would create a much stronger country with a foundation for growth in the future.

As an American I wish our leaders gave us the opportunity to vote back in 2008 if we wanted to nationalize the banking system, the housing market (Fannie & Freddie), the automobile industry (General Motors) and the student loan market.

We have lived in a perverse world in America since early 2009 where the banking system keeps the profits during booms and receives taxpayer aid during the busts. No one pays attention during the boom (2009 to present) as long as 401k's and home prices are rising in value, but I assure you they will pay attention during the next collapse (coming soon).

For more see: Greece Is Only A Preview Of The Real Crisis