Thursday, October 7, 2010

Gold Accounting

During periods in history when governments move away from gold backed currencies gold will revalue itself in the open market.  Market forces will "re-price" gold to back the supply of currency available.  I like to think of this as an accounting or balance of payments.

This happened in the early 1930's, it happened in the late 1970's, and it is currently happening again today.  For a brief period in 1979 and early 1980, the price of gold was high enough to back every dollar that was printed by central banks.  (Gold rose from $35 an ounce to $850)

The chart below shows that mark being reached in 1980, and it shows where the gold price is today in relation to the new currency that has been created since that point.

As you can clearly see, gold has a long way to go before its price revalues to the level of paper money in existence.  This is before the Federal Reserve and other Central Banks begin their upcoming second round of quantitative easing. (money printing)

Prepare and anticipate massive pull backs along the way, but understand where we are in the big picture.

El-Erian Market Analysis

I keep CNBC on in the morning on mute while I work and read.  Once in a while, depending on the guest, I will unmute to hear their thoughts on the economy.

One of those guests is Muhammad El-Erian the CEO of PIMCO, which is the largest bond fund in the world.

He had a mesmerizing conversation this morning about the state of the economy and where we go from here in terms of market direction.

I felt he said everything that I wrote about earlier in the week, only he said it much better. (His salary is slightly higher than mine)

He feels that the Federal Reserve's QE2 is now baked into the markets.  What is fascinating to me is that the markets have bought up every asset available, not only what they feel the Fed will purchase.  Here is my analysis of each asset class:

Bonds - This is easy.  The Fed's main target has been and will continue to be treasury bonds first, and mortgage bonds second.  Professional investors purchasing now understand bonds are terribly overpriced and this is a short term buy and sell, similar to "flipping" a house.  They are just trying to front run the Fed.

Stocks - This investment in my mind is the most dangerous.  As El-Erian beautifully describes, investors purchasing stocks right now are not only betting on QE2, they are betting it will work and improve the underlying economy significantly.  I am not in this camp, and I feel that stocks are a very dangerous purchase at these prices.

Commodities/Precious Metals -  El-Erian describes the "side effects" of purchasing unlimited assets and the most direct is the devaluation of the dollar and the increase in commodity prices.  Since the inception of this website over two years ago, my focus has been toward this final outcome that we find ourselves in today.  I feel that just as in stocks, QE2 is now priced into commodity prices.  However, opposite to stocks, I feel that commodities are a strong long term investment and even though they are rocketing higher today, their long term movement is in the early stages.

So with this outlook, how would I create an investment plan?

Continue to hold the assets (if they are strong) that you already own.  Keep new incoming cash available as dry powder for pull backs should the Fed disappoint.  This is a dangerous entry point for new investment, even the long term strong assets.

The great discussion with El-Erian is below:

Tuesday, October 5, 2010

The New Foreclosure Problem

I was speaking with my Dad on the phone last night as we were watching the Patriots game.  He was telling me about a segment on The Kudlow Report from last night where they discuss the current title insurance catastrophe.  I pulled it up on my Tivo list and watched the segment during half time.  I was shocked to hear CNBC's excellent reporting on the issue as well as their honesty.

To sum up the problem best:

Title insurance companies are not providing insurance right now because they do not know who has title to the loans.  Mortgages cannot be issued with title insurance.  Home buyers cannot purchase homes without a mortgage.

Look for the government to do something very, very, stupid to resolve this issue.  Here is the segment from last night's show:

Bank Of Japan Fires Back

The Bank of Japan (their version of the Federal Reserve) decided to cut interest rates this morning and announced their plan to keep them at zero essentially, well, forever.

They also announced an additional $419 billion pool of printed dollars that will be used to purchase government bonds, commercial debt, and asset backed securities.

They are doing everything in their power to print money and devalue their currency to keep their export driven economy strong.

The same event is taking place with Central Banks all around the world.  Bernanke watches on closely, and he has plans of his own to attempt to destroy our currency over the next few months with something he likes to call QE2.

In the meantime gold just watches all currencies devalue themselves against each other and has now moved to an all time high over $1330. 

Monday, October 4, 2010

Fourth Quarter Outlook

This week kicks off the fourth quarter of the year after seeing the stock market end the third quarter with an incredible 8% rise in the month of September alone.

The month started off with a bang from Ben Bernanke who in late August hinted at future Federal Reserve support due to the economic data beginning to roll over.

The Federal Reserve then spent the entire month either speaking or writing about how the second round of quantitative easing was on the way.  Quantitative easing is their term for printing money and buying assets.

Since then, speculation has been rampant on what and how much they will purchase.  Estimates are now in the multi-trillions.

My original expectation was for the opposite to occur, as I discussed in my Second Half Outlook.  I expected the markets to begin to roll over and then we would receive confirmation that additional printing would be on the way.  I discussed my thoughts on why the Fed acted early in their announcement in New Second Half Development.

The quantitative easing is now baked into market prices with a new wave of optimism across the board.  This now makes asset purchases even more dangerous than the start of the second half of the year.

Back in May I discussed my favorite assets and the importance of developing a shopping cart and waiting for sales in the marketplace.  All my favorites today are at extremely high sentiment readings, and I do not like to buy investments when the market likes them.

So even for my favorite assets, which have performed very well over the past month, my outlook remains the same as it was when we began the second half of the year:

1.  Do not sell existing positions already in place
2.  Continue to accumulate cash and wait for coming opportunities

Be patient during this process.  It is going to be a very bumpy ride over the next few years.