Monday, October 1, 2012

Reader Question: Should I Purchase Hard Assets On Credit?

A reader left this comment and question on an article from over the weekend. As I was typing out my response, I realized it might be easier to post it here.

First and foremost I want to mention that I've been reading your blog for about a year and very much enjoy your insights.


Let me ask you a question, I followed your advise and read James Rickards "Currency Wars". The book was great and led me to make a few conclusions about the current crisis and where we will end up.


As you noted on multiple occasions the FED's response is to print and print ad infinitum.
The end game of this being a global repudiation of a dollar not just as a reserve currency but the end of fiat systems worldwide. According to conclusion of the book (which I agree with) the FED is daring the world to give up on the dollar - hence unlimited printing. Plan B is already in place with the establishment of a new dollar which will be fully backed by gold. This will be possible due to the fact that approximately 57% of all the gold in the world is housed in US.
With the above being the case it seems that the rates will never go down in our current dollars until the system itself is repudiated. If that is so, wouldn't it make sense to borrow as much as possible from the banks to purchase hard assets (real estate, agriculture, commodities)?



Glad you read and enjoyed the book. Rickards sees two possible outcomes: 

1. Global leaders put a plan in place to create a slow and orderly process of returning to the gold standard. He felt an analysis could be done to come up with a gold price that could reflect the amount of printed currency that has entered the system since 1971 (when we left the gold standard globally). This outcome is very unlikely in my opinion. Why? Because it would put limits on the amount of money governments can borrow and spend as well as put restrictions on the banking sector. 


2. The gold price will revalue itself in a chaotic and violent fashion upward to reflect the destruction taking place in all fiat currencies around the world. Governments and central banks will act in a reactionary manner (as they always do). You will see gold move upward in a way that seems truly impossible today. This is the most likely outcome I see occurring. It just seems that they will do every thing possible to push back the ultimate day of reckoning to the last possible moment. 


It is important to understand, based on what you mentioned above, that in either case the United States is in an excellent position due to their gold holdings. It will ultimately be a very sad ending for the foreign countries that have spent the last 40 years working hard to send America goods that we have consumed only to take worthless paper I.O.U.'s. It is almost possible to imagine that with the amount of information available today that this ridiculous process is still taking place. The US, since they took the world off the gold standard in 1971, has kept the gold stored in the vaults on US soil. They have essentially conned the world for over forty years running.


It is no different for investors holding their savings in paper assets such as stocks and bonds in a 401k and counting on government support through social security, medicare, or a pension. They have been conned as well believing that governments will always be able to borrow and print worthless paper dollars in the future in order to provide everyone the lifestyle they have been promised forever.


To answer your question I want to tread VERY carefully. Let me remind you that I am not a financial advisor and you need to talk to one before making any investment decision, ESPECIALLY one that involves debt.


Your question was "should you borrow money to purchase hard assets?" Let me answer that question first using myself as an example.


I started a business over the last year. I had the personal capital to fund the entire start up cost of the business. In order to do that, however, I would have had to sell precious metals.


Instead, I approached three different credit card companies who offered me a total of $25,000 in credit with 0% interest for 18 months


So I had a decision to make. If I decided to fund the creation of my business through credit, I was essentially betting that the value of gold and silver would be higher in 18 months than it was today. The banks allowed me to make this bet with their money at 0% interest.


I chose to borrow the money at 0% interest. My business is now up and running strong and I am  paying down this debt with the income generated through the business. What else did this allow me to do?


During the summer months when precious metals fell and pessimism was extremely strong throughout the market, I had the opportunity to purchase metals - not  sell. The banks were essentially providing me a loan to purchase distressed assets.


This type of thinking is the exact opposite of the way most people think. However, it is the way all business owners and large scale investors view debt - as a tool, not something to be afraid of. While I think real estate is still over valued, I plan on using a tremendous amount of borrowed money (leverage) to purchase commercial real estate in the coming years. The debt does not make me afraid, but at the same time I have respect for it.


I AM NOT RECOMMENDING THAT SOMEONE ELSE DO WHAT I JUST DESCRIBED. Please re-read the last sentence again.


Here is another example, which I think is a more direct answer to your question. What if I was not starting a business and I borrowed $25,000 at 0% interest for 18 months and I used this money to directly purchase precious metals or commodities. 


This for me is a more dangerous option. In the first example I was investing in a cash flowing asset with the debt (something that every major business owner or real estate investor does across the country). Why is it dangerous? Because silver and gold (or other commodities) can fall in price and take a long time to come back to their previous high level. If someone bought silver at $22 in March of 2008 (I remember the night it hit that level - it was the night Bear Stearns was sold) they had to wait almost two and a half years later for it to hit that level again (then it quickly ran to $50). If you bought on credit, you may have run out of time.


The answer to your question is a personal decision based on your financial strength, income, age, the way you handle risk, and how well you can stomach pull backs.


Here is one more personal example. Someone I know recently had a child enter college. They were in the fortunate position where they could pay for the entire cost of college through their savings.

What was my advice to them?

Take out as many student loans as possible. A student loan would provide them with a 4 year deferred loan at 0% interest. Instead of paying for the expense of college with cash they could then invest that money into commodity related assets, many of which provide a dividend paying income stream.

Again, this is not something I would recommend to everyone. It was based on their personal financial situation. The point of this discussion is to open your mind to what money actually is, something I will continue to discuss here on a regular basis, and how you can use debt to your advantage.


2 comments:

  1. I want to thank you for turning the answer to my question into a full update.
    The point that I wanted to get across is that we are now in the final stretch of our current economic system (FED going all-in).
    With that being the case, a Lehman like event and a market crash cannot happen anymore due to the FED backstopping the market. By Bernanke going all-in inflation will overwhelm the deflationary economic forces at work for the last 4 years (I too was in the deflation camp until Bernanke's last press release).
    I understand and agree with you that putting money into cash-flowing ventures beat buying and holding a hard-asset for purely inflationary gains, but in current environment I see zero risk for doing both.
    According to Rickards - in the case of pegging the new dollar to gold, investors are likely to be hit with a 90% windfall profits tax. Considering the alternatives such as real-estate and agriculture they offer a much safer investment.

    You commented that you believe residential real-estate to still be overvalued - I cannot comment on properties around the country, but I can't see prices decreasing in areas in and around NYC or San Francisco. With location being a factor do you favor one region of the country over another for either residential or commercial real estate?

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  2. I would favor regions of the country with a heavy portion of the jobs related to energy (Texas, Oklahoma, North Dakota), agriculture (the mid to midwest), or locations that have jobs tied to exports.

    I see areas such as NYC and San Francisco as very strong economies but I think they are currently over priced (the cap rates investors are paying today), and their job markets are susceptible to potential weakness (Wall Street & technology.

    Areas that are heavily tied to government jobs (DC) or areas dependent on college income are bubbles waiting to burst.

    I think based on the price investors are paying for commercial real estate today, an investor will only make money in the long run if we enter hyperinflation. That outcome is far from guaranteed.

    I understand all the reasons why people say commercial real estate is a strong buy, but I believe treasury bond yields will cross 6% at some point this decade. Therefore, I think buying a building at a 5% (or less) cap rate is too dangerous at bet.

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