Saturday, November 2, 2013

Focus On What You Can Control

Policy makers will always choose to push back the day of reckoning. Always.

Everyone understands what will happen if Quantitative Easing were to end tomorrow and the central banks around the world were to normalize interest rates.

Everyone understands what would happen if the unprecedented government stimulus/transfer payments were to slow.

There would be a spectacular worldwide deflationary crash, cleansing the system of the mountain of toxic debt that has built during the 70 year debt super cycle.

Because politicians and policy makers understand what will happen if the artificial stimulus were to be removed, it is always better to try and push back the reckoning day just a few hours longer. Some solution, they hope, will appear to remove the problems that are currently in place.

The problem is that when the pain is pushed back for a long enough period (as it was from 2000 to 2007), people begin to believe that the fundamental disease has actually been cured. They can no longer see the termites eating the foundation of the home and can only gaze in awe at the beautiful new paint job and pretty landscaping that has been planted out front.

Intelligent, rational people now believe that the United States stock market is rising every hour of every day because the economy is improving.

This psychological process is beyond fascinating to me. For others it is incredibly frustrating. Instead of appreciating this historic period of history, when everyone is doing the most irrational possible things with their capital in the face of clear oncoming disaster, they get angry and only want to know the exact moment when rationality will return to the markets. During the end of euphoric bursts it always feels like this time will be different. Many, unable to bear the psychological tear, give up and just join the herd.

I wake up every single morning appreciating that the reckoning day has not yet arrived. It gives me another 24 hours to prepare for the moment when gravity will return.

Along with managing a business that I own, the vast majority of my "work time" during the week is spent at one of the largest commercial real estate finance companies in the world.

I analyze the complete inner workings of transactions that are taking place every day all across the United States. To say that I enjoy my job is an enormous understatement. I consider myself incredibly blessed to have the opportunity to do what I do. I work on a floor with some of the top commercial real estate finance minds in the world. I spend my days getting into the trenches of transactions and asking probing questions to learn how and why certain decisions were made.

Why do I do this?

Because I believe the commercial real estate market is going to collapse (in many countries around the world) at some point over the next decade. My goal is to prepare myself now to be ready to purchase as much real estate as possible when prices return to realistic (and most likely bargain) levels.

Before doing what I do now, I spent years working onsite at a very large commercial real estate property physically learning how to manage the day to day operations.

My goal is to begin purchasing commercial real estate after prices drop below fair value levels and continue to purchase until they cross back over that equilibrium line (to explain what that means would take a very long time and perhaps will be a topic discussed during the next real estate outlook). If the fair or below value pricing period begins 10 years from today then the selling point would be when the pendulum swings back to manic levels (as it always does) at some point in the future. This could be 25 to 30 years from now.

Why am I telling you all this?

Because readers of this site around the world make up a part of the very small group of people that understand what is really happening. If you are reading this right now, it most likely means that you are more financially intelligent than 99% of the people on the planet. They say that 10% of the population purchases 90% of the financial books released. I would guess that ratio is more like 1% that purchases 99%.

Human psychology is an interesting beast. When someone begins to study finance and they start to understand what is actually happening around them, they become very frustrated when the rest of the world wakes up tomorrow and does not figure it out. This is a very, very, important concept. An undervalued asset only moves higher or an overvalued asset only moves lower when the market "figures it out." It does not occur a moment sooner. Due to the natural tendency of human psychology and the way our financial system is structured today, prices can move higher or lower for a very long period of time in the fundamentally wrong direction.

Try to take a step back during this process (as hard as it is) and continue to focus on the big picture. Almost every single market participant around the world is unable to do this, which is why everyone is always running the wrong direction at the worst possible moment.

The currently high price levels in many markets today (U.S. stocks, Chinese real estate, Bit-coins, etc.) can trade into a euphoric stratosphere that is almost unimaginable today. The U.S. DOW index could easily double from these current ridiculous levels. The 10 year treasury yield could fall to the 0.5% range (as the 10 year yield recently did in Japan). Shanghai home prices could triple from these levels.

Who cares?

Turn off the news and spend time with your family and friends. Spend time reading and learning today about markets and assets that are going to crash in the future (stocks, bonds and real estate).

Today I build my cash position and steadily purchase fundamentally strong assets that have seen their prices clobbered and currently have incredibly low sentiment. These assets could change daily depending on sentiment levels and price but some of them at this moment are silver, gold mining shares and certain types of agriculture. These assets will most likely be lower in the short term. That's great; I will buy more.

I spend my time studying, reading, learning and watching. Booooooring.

This is the easy time where you don't really have to do anything. Let the rest of the world chase bubblicious technology stocks higher with no earnings. Let them have fun. Economic textbooks and financial models will be completely rewritten in the years ahead when the great reset arrives.

Focus on the things you can control. Time and the invisible hand will take care of the rest.

Tuesday, October 29, 2013

China Is Shifting Their Growth Strategy

The economic landscape of the world leading up to 2008 followed a very simple process: The United States ran a very large current account deficit with the rest of the world, specifically OPEC and Asia countries. In exchange for paper I.O.U.'s, the world worked very hard to produce oil and manufactured goods to send to the United States.

This process was thrown into chaos during the 2008 financial crisis when U.S. consumers hit a wall with their ability to borrow and spend. The U.S. current account deficit is 58% lower than its peak in 2007.

While the United States has been the most obvious benefactor of this economic relationship (Americans send worthless I.O.U.'s in exchange for goods that other countries work hard to produce), countries such as China have also achieved their desired goal: growth.

China's share of world GDP has risen from 1.4% in 1992 to 19.3% 20 years later. Their growth has been staggering.

The 2008 crisis shook up the world and allowed many countries to see that their existing growth model was inherently unsustainable. Over the past five years China has begun the process of shifting its dependence off the United States. They are not making any violent or panicky moves that would disrupt their current growth, and by taking actions in a slow and methodical manner it has allowed the process to go almost completely unnoticed.

China has begun to set up currency exchange relationships with numerous trading partners around the world that will eventually allow them to bypass the use of the U.S. dollar. The following shows the dollar value of daily currency use. China has moved from non-existence in 2001 to number 9 on the list today.

They have begun to accumulate gold, heavily. The last time China updated their gold holdings was in 2009 when they reported having just over 1,000 tonnes (this number shook up the gold community at the time because investors were shocked at how rapidly China was accumulating). Based on import data that can be pieced together from various sources it is estimated that their reserves have grown by 200% to 300% if not more since 2009.

China keeps this information very secret for good reason; if the rest of the world knew how much gold China was accumulating, traders would front run their purchases. This would drive the price of gold higher making it more expensive for China to buy.

It is the opposite of what has occurred with U.S. treasuries. A large part of the move lower in treasuries over the past five years has not been due to the actual buying from the Federal Reserve, but other investors front running their purchases and selling the treasuries to the Fed at higher prices.

The chart below shows China's gold imports from Hong Kong. Net of exports, China has imported 741 tonnes in 2013 and may finish this year alone importing over 1,000 tonnes.

China is focused on making their growth strategy more consumer based. This is great news for the people in China who will now be able to consume the goods that they produce instead of shipping them abroad for an I.O.U. which will never be redeemable for any sort of value.

A strategy that has not been approached by Chinese leadership (yet) would be to provide some form of a social safety net under their work force. The people in China work hard to save money because they know they will need that money should times get tough. One of the reasons the United States people have been so willing to spend all their money (and then borrow more) today in exchange for the ability to spend in the future is that they believe if anything goes wrong the government will always be there with a safety net.

Another strategy to boost consumer demand would be to allow their currency to strengthen. China recycles U.S. dollars to artificially hold their currency lower, which boosts exports. Many continue to believe that it is China that is providing the safety net under U.S. treasury prices. China's treasury holdings peaked at about $1.3 trillion in early 2011 and have tracked sideways since. The buyer that has taken their place is the Federal Reserve, which has provided China time to put their plans to work.

As discussed above this process will continue at a very slow pace and will go unnoticed by people who still live under the paradigm that existed before 2008. While China faces incredibly tough challenges in the years ahead and will face a very bumpy road (as the U.S. did in the early part of the last century), those with a long term view will benefit greatly from the understanding of how tectonic plates are shifting today.

Stephen Roach discusses China's new growth model:

h/t John Mauldin, Wall Street Journal, Zero Hedge

Peter Schiff Reviews The U.S. Financial Relationship With The World