Category Archives: Economics & Politics

Analyst Quiz is Gold Overvalued Based on CPI–Go SHORT?

gold vs cpi

You just got promoted to advise Ackman; he is keen to improve returns.  He slaps that chart on your desk and then asks if shorting gold would be a good idea? Why or why not based on this brilliant analysis?  In fact, with “Deflation” fears rampant, Ackman feels gold could drop to $650.

http://www.marketwatch.com/story/gold-has-no-business-being-this-expensive-2016-02-03?siteid=rss&rss=1

Also, you read: The Golden Dilemma where two PhDs project a $350 price target.  If experts such as these predict lower prices, then should you join the pack?

Also, you find a chart that supports what your boss thinks. Yahoo!

1-Gold-vs-commodities

Unfortunately, some nut-job sends you this link: The Positive theory of gold and the The ultimate extinguisher of debt

You have until this afternoon to report back.  This tests common sense and critical thinking skills. Good luck!

A prize to be awarded.

Analyzing Banks and Liquidity; Precious Metals and 2016

Surgery

Katalepsis and liquidity  Understand what drives banking soundness and liquidity.

MM on Gold A different perspective

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Monetary History: Should Legal Tender Laws Be Abolished?

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The Supreme Court’s ruling

Hepburn v. Griswold reached the U.S. Supreme Court in 1869, five years after the war had ended. The Court ruled in favor of Griswold, holding in a 4-3 decision that legal-tender laws violated the U.S. Constitution.

The majority opinion distinguished between money and notes to pay money:

There is a well-known law of currency, that notes or promises to pay, unless made conveniently and promptly convertible into coin at the will of the holder, can never, except under unusual and abnormal conditions, be at par in circulation with coin. It is an equally well-known law, that depreciation of notes must increase with the increase of the quantity put in circulation and the diminution of confidence in the ability or disposition to redeem. Their appreciation follows the reversal of these conditions. No act making them a legal tender can change materially the operation of these laws.

The Court also explained that the power to coin money, which the Constitution delegates to Congress, did not constitute a power to convert promissory notes into money:

It is not doubted that the power to establish a standard of value by which all other values may be measured, or, in other words, to determine what shall be lawful money and a legal tender, is in its nature, and of necessity, a governmental power. It is in all countries exercised by the government. In the United States, so far as it relates to the precious metals, it is vested in Congress by the grant of the power to coin money. But can a power to impart these qualities to notes, or promises to pay money, when offered in discharge of pre-existing debts, be derived from the coinage power, or from any other power expressly given?

It is certainly not the same power as the power to coin money.

With the holding in Griswold, the federal government was left with the power to borrow to finance its operations but without the authority to force people to accept its notes at face value for the payment of debts. Thus, the American people could still protect themselves from a profligate government by expressly providing that notes and contracts could be repaid only in money (i.e., gold coin), not in federal promises to repay money.

We the people

Overturning Griswold

One year later, however, the legal situation changed dramatically. President Ulysses S. Grant, who had commanded Union forces during the war, appointed two new justices to the Supreme Court who promptly joined the minority in Griswold. In Knox v. Lee, decided in 1879, the Supreme Court voted to overturn the decision in Griswold and to uphold the constitutionality of Lincoln’s legal-tender law.

The new majority reasoned that the power to enact a legal-tender law was an implied power that fell under the president’s war powers and the power over monetary affairs that the Constitution had granted to Congress.

But as the dissent pointed out, the implied-powers doctrine cannot be used to create new powers. The war power, for example, entails the power to pay for war expenditures but the means by which to pay for such expenditures were limited to those enumerated in the Constitution, i.e., through taxes and borrowing.

As the dissent also emphasized, the congressional power over monetary affairs was specifically limited to the coinage of money and did not extend to the enactment of laws requiring people to accept federal promissory notes in lieu of such money.

In a separate dissenting opinion, Justice Stephen J. Field pointed out the obvious:

The power “to coin money” is, in my judgment, inconsistent with and repugnant to the existence of a power to make anything but coin a legal tender. To coin money is to mould metallic substances having intrinsic value into certain forms convenient for commerce, and to impress them with the stamp of the government indicating their value. Coins are pieces of metal, of definite weight and value, thus stamped by national authority. Such is the natural import of the terms “to coin money” and “coin;” . . ..

… The power to coin money is, therefore, a power to fabricate coins out of metal as money, and thus make them a legal tender for their declared values as indicated by their stamp. If this be the true import and meaning of the language used, it is difficult to see how Congress can make the paper of the government a legal tender.

Field placed the constitutional issue in a historical context:

The statesmen who framed the Constitution understood this principle as well as it is understood in our day. They had seen in the experience of the Revolutionary period the demoralizing tendency, the cruel injustice, and the intolerable oppression of a paper currency not convertible on demand into money, and forced into circulation by legal tender provisions and penal enactments.

Field also pointed out that the Constitution had not delegated to Congress the power to impair private contracts.

With Knox v. Lee the seeds were sown for a monetary revolution in American life — a revolution that would bring the inflationary plunder and moral debauchery that have characterized nations throughout history. The revolution began with Lincoln. But it would culminate in one of most massive assaults on private property in U.S. history — President Franklin Roosevelt’s nullification of gold clauses in contracts and his confiscation of gold from the American people.

It is impossible to overstate the significance of the Franklin Roosevelt administration’s confiscation of gold and its nullification of gold clauses in contracts. It is one of the most sordid episodes in American history. To get an accurate sense of Roosevelt’s actions, it would not be inappropriate to compare what he did with the domestic economic policies of a later 20th-century ruler, Cuba’s socialist president, Fidel Castro.

On April 5, 1933, newly inaugurated President Roosevelt issued Executive Order 6102, which prohibited the “hoarding” of gold by U.S. citizens. Americans were required to turn their gold holdings over to the federal government at the prevailing price of $20.67 per ounce.

Pursuant to Roosevelt’s executive order, anyone caught violating the law was subject to a federal felony conviction, 10 years’ confinement in a federal penitentiary, and a $10,000 fine. Soon after the confiscation, U.S. officials announced that the government would sell its gold in international markets for $35 an ounce, thereby devaluing the dollar by almost 70 percent and immediately “earning” a potential profit of almost $15 an ounce on the gold it had confiscated.

Two months later, Congress enacted legislation nullifying gold clauses in both government and private contracts, thereby requiring creditors in such contracts to accept devalued paper money in payment of such contractual obligations, even though the contract itself stipulated payment tied to gold.

Reflect for a moment on the significance of what Roosevelt did. Gold coins and gold bullion were private property, just like a person’s automobile, clothing, home, and food. On the mere command of the president of the United States, federal authorities simply confiscated gold holdings that were the private property of the American people and made it a grave federal offense to own such property in the future.

Read The Federal War on Gold

Your thoughts on a better monetary system. Why not let the market choose money and set the price?

 

Contrarian Investing (Part II)

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“Bull markets are born on pessimism,” he declared, they“grow on skepticism, mature on optimism, and die on euphoria.” –John Templeton

John Templeton paid attention to the emotion of the stock market. The first half of his philosophy was “The time of maximum pessimism is the best time to buy.” When everyone else was selling, he bought low during the Depression and in 1939 at the onset of World War II . . . and he made millions.

The second half of his philosophy was “the time of maximum optimism is the best time to sell.” He sold high during the Dot.com boom when everyone else was still buying. Founded in the 1950s, his Templeton Growth Fund averaged 13.8% annual returns between 1954 and 2004, consistently beating the S&P 500.

I think there are a few ways to make many times (10x to 100x +) your money over a long period of time.   The first would be to own emerging growth companies that have owner-operators who are both excellent operators and capital allocators who grow the company profitably at a high rate over decades.   The business generates high returns on capital while being able to deploy capital into further growth. Think of owning Wal-Mart in the early 1970s or Amazon after its IPO or 2001.   There will be a post on 100 to 1 baggers soon. I prefer this approach.

Wal-Mart 50 Year Chart_SRC

The second way would be to buy distressed assets and then improve those assets or create efficiencies by creating economies of scale. Carlos Slim, Mexican Billionaire, would be an example of this type of investor. Think activist investing. Note that Carlos Slim has operated at times as a monopolist in a government protected market.  Most of us do not have his options.

The third way would be to buy deeply-distressed, out of favor, cyclical assets and then resell upon the top of the next cycle. Gold mining is a difficult, boom/bust business, for example–see Barrons Gold Mining Index below. All businesses are somewhat cyclical, but commodity producers are hugely cyclical with long multi-year cycles due to the nature of mining-it takes years and high expense to reopen a mine and even if I gave you $2 billion and several years, you and your expert team may not be able to find an economic deposit. Note the five-to-ten year cycles below.

gold mining bgmi

We are focusing on the third way, but in no way do I suggest that this is for you. You need to be your own judge.  There is a big catch in this approach, you need to choose quality assets and/or companies with managements that do not over-leverage their firms during good times or overpay for acquisitions during the booms (or you could choose leveraged firms but be aware of the added risk and size accordingly becasue when a turn occurs, the leveraged firms rise the most). You also need to seek out a period of MAXIMUM pessimism which is difficult to do. How do you know that the market has FULLY discounted the bad news?  Finally, YOU must be prepared to invest with a five-to-ten year horizon while expecting declines of over 50%. That concept alone will make you unique.   Probably most will turn away from such requirements.

We pick up from http://csinvesting.org/2015/12/14/contrarian-dream-or-nightmare/.  Before we delve into the technical aspects of valuing cyclical companies, think about what it FEELS like to have the CONVICTION.  Here is an example:

We last studied Dave Iben, a global contrarian investor, in this post: http://csinvesting.org/tag/david-iben/.   You should read, Its Still Rock and Roll To Me at http://kopernikglobal.com/content/news-views and listen to the last few conference calls at the right side of the web-page.   Note Mr. Iben’s philosophy, approach, and Holdings. His portfolio is vastly different than most money managers or indexers. But being an contrarian takes fortitude and patience. Kopernik Global performance since inception:

koper spy

Next preview the readings below.

First you need to understand Austrian Business Cycle Theory to grasp how massive mal-investment occurs. Why does China have newly built ghost cities? Distortion of interest rates causes mal-investment (the boom) then the inevitable correction because the boom was not financed out of real savings.

Why is the bust so severe for mining/commodity producers?   Read Skousen’s book on the structure of production.  Think of a swing fifty feet off the ground and 200 feet long.   If you are sitting near the center of the swing’s fulcrum (nearest the consumer), then the ups and downs are much less than being on the end of the swing furthest from the consumer (the miners and commodity producers).

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Boom/Bust Austrian business cycle theory.pdf
Damodaran Valuing Cyclical Commodity Companies.pdf
Must Read Structure-production.pdf

Sorry: here is the Hooke book (chapter 19 on resource companies)

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Even if you are an expert in valuation, investing in a cyclical company can be lethal: Vale: Go Where it is darkest (Damodaran)

ValeBig Vale

Then Throwing in the towel on Vale. I am not picking on Prof. Damordaran because we all make mistakes, and he graciously has provided a case study for us.  Study the posts and the comments.

Can you think of several research errors he made (BEFORE) he invested?

Remember in the prior post, the long-term chart of the CRB index showing commodities at 41-year lows since the CRB Index is below 175 or back to 1975 prices?  Then why, if gold is a commodity,  doesn’t gold trade at $200 or at least down to $500 to $700 as the gold chart from that time shows?monthly_dollar

Why, if gold is money, doesn’t gold trade in US Dollars at $15,000 or the estimated price to back US Dollars by 100% in gold?  You can change the amount to $10,000 or $20,000, but you get the idea.gold monetary base

 

Gold during the boom of 1980 rel. to Financial Assets in 1980 the price of gold at $800 per ounce allowed for the US gold holdings to back each US dollar then outstanding.

Try thinking through those questions.  Can we use what we learned from gold to value oil?

I will continue with Part III once readers have had several days to digest the readings and at least three readers try to answer at least one question.  Until then……………………….be a contrarian not contrary.

Update on 21/Dec. 2015 http://fortune.com/2015/12/21/oil-prices-low/

When is the news discounted? Search for the marginal seller

Crude-Oil-Returns

Energy-Sector-52-Week-Lows

 

Energy-Sector-Below-200-MA

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When you read about weakness in emerging market and commodities AFTER 50% price drops, there might be a chance of the news ALREADY in the the pricing structure.

Optionality

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There is a joke that illustrates the value of optionality

An investment banker and carpenter are sitting next to each other on a long flight. The investment banker asks the carpenter if she would like to play a fun game. The carpenter is tired and just wants to have a nap, so she politely declines and tries to sleep. The investment banker loudly insists that the game is a lot of fun and says, “I will ask you a question, and if you don’t know the answer you must pay me only $5. Then you ask me one question, and if I don’t know the answer, I will pay you $500.” To keep him quiet, she agrees to play the game.

The investment banker asks the first question: “What’s the distance from the earth to the Saturn?” The carpenter doesn’t say a word, pulls out $5, and hands it to the investment banker.

The carpenter then asks the investment banker, “What goes up a hill with three legs and comes down with four?” She then closes her eyes again to rest.

The investment banker immediately opens his laptop computer, connects to the in-flight Wi-Fi, and searches the Internet for an answer without success. He then sends emails to all of his smart friends, who also have no answer. After two hours of searching, he finally gives up. The investment banker wakes up the carpenter and hands her $500. The carpenter takes the $500 and goes back to sleep. The investment banker is going crazy from not knowing the answer. So he wakes her up and asks, “What does go up a hill with three legs and comes down with four?”

The carpenter hands the investment banker $5 and goes back to sleep.

Go find bets like that!

A Trading Parable

Once upon a time, a man and his assistant arrived in a very small town and spread the word to the townspeople that the man was willing to buy monkeys for $100 each. The people knew there were many monkeys in the nearby forest and immediately started catching them. Thousands of monkeys were bought at a price of $100 and placed in a large cage. Unfortunately for the townspeople, the supply of monkeys quickly diminished to a point where it took many hours to catch even one.

When the new man announced he would now buy monkeys at a price of $200 per monkey, the town’s resident’s redoubled their efforts to catch monkeys. But after a few days the monkeys were so hard to find that the townspeople stopped trying to catch any more. The man responded by announcing that he would buy monkeys at $500 after he returned with additional cash from a trip to the big city.

While the man was gone, his assistant told the villagers one by one: “I will secretly sell you my boss’ monkeys for $350, and when he returns from the city, you can sell them to him for $500 each.”

The villagers bought every single monkey, and they never saw the man or his assistant ever again.

Irredeemable Currency Collapse

Dollar black hole

Talks on our monetary system

more: Leveraged Bubbles

 

Question: Inevitable Currency Collapse?

Premise 1: All dollars are borrowed into existence.  The Fed, for example, creates dollars to purchase government bonds, which, in turn, are paid in dollars, but those dollars are backed by debt.  Around and round we go.

Premise 2. The debt can’t be extinguished, so debt grows while the marginal utility of debt declines.  You borrow $100 from the bank, then repay your bank with $100 then your cash declines by $100 and the bank’s loan balance declines by $100.   But what happens to the $100 used to buy a tool for your business. Now the tool maker has the $100.

Can the debt be paid back out of current income?  When the marginal utility of debt reaches zero or a negative number, then the dollar has to collapse since the value of the debt will have to decline until collapse.   Ernest Hemingway, said, “We go broke in two ways. First slowly and then suddenly.”

How does the dollar die? It drowns in debt.  The money supply may even be decreasing as debt defaults, but the value of other debt collapses and thus the dollar. Remember that all dollars are backed by the balance sheet of the Federal Reserve.

I am not saying that the dollar will collapse tomorrow but what will stop the inevitable?   Since all other currencies are a derivative of the reserve currency, the US Dollar, you will see greater stress in foreign currencies before the dollar shows the same level of decline.

Question 2: legal tender laws were eliminated and people could choose their own money, would interest rates remain LOW and  S T A B L E?  How would rates fluctuate?

Long-Term

Hint: note how relatively stable interest rates were between 1880 and 1913.  What set the rate of interest?

Question 3: Does a long-term decline in interest rates hurt businesses? How? What adjustments would you make as an analyst in such an environment?

Prizes to be determined.
The end game?

I will send out the Value Vault keys as promised to the folks who have made requests over the past week.

HAVE A GREAT WEEKEND!

The Secret to Success: Being Ridiculed on Social Media; Hedge Fund Analyst Quiz; The End

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Jesse Felder, a Contrarian Trader   Listen to the podcast and explore The Felder Report

Hedge Fund Quiz

The only way to win a date is to become a hedge fund analyst.  Your interview process requires you to analyze a real estate/mining company.

You look first at the balance sheet (Thanks Mr. Graham).   You notice that this mining company bought claims under a ski resort (Park City, Utah) where it bought acres in 1907 at five dollars an acre.

Then you notice that the company issued 20-year corporate bonds when interest rates were 9% for AA corporates about fifteen years ago.  Now similar companies can issue bonds at 5%.

How would you conduct your analysis? Good luck.

Interest rate decline

The End

So how will it all end? Dollars are created by computer key stroke when the Fed buys bonds, but the dollar is backed only by bonds (and a tiny bit of gold) and the bonds are payable in Federal Reserves Notes (the dollar) or just another form of debt. So debt is created to buy debt which, in turn, is payable in debt. Whoa?! No way this could ever be a problem. It’s magic. One thing bothers me, though, why do we need legal tender laws TO FORCE people to use dollars? I got a bad feelin’ on this.

But WHAT if more and more debt creates less and less “GDP” (let’s pretend it means something–govt spending creates economic growth, Ha Ha.) until each dollar of debt creates 0 or negative GDP growth. The Fed has to print to pay interest on the debt or the tail consumes the tiger.

Hemingway: We go broke slowly, then suddenly!

Anyone using CPI to gauge reality needs a reality check. You are a fool to buy gold as an “investment against “CPI inflation.” You own gold as a form of money to store wealth IF you lack confidence in central planning. So when it all comes down is when gold goes into permanent BACKWARDATION in gold. Holders of gold go NO BID on dollars. But don’t worry, the dollar derivatives like the Yen and the Euro will be earlier casualties. Meanwhile hope that the dollar rises against in order to buy more ounces. For others, Pray.
Now those who read the above my disagree, but know exactly fiat currencies do NOT go to 0 (or NO BID).

Venezuela in Collapse; What we are reading

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Venezuelas Crisis Nears Tipping Point  The failure of socialism and interference in free exchange reaps a bitter harvest for the people. 
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10 THINGS WE’RE READING & WATCHING:
      3.   John Paulson on Gold – Reuters
      4.   Bill Ackman on CEOs – CNBC
      5.   Crossfit’s Business Model – Quartz
      6.   A Conversation with Peltz and Ackman – Jim Cramer (CNBC)
      7.   Viewing Stocks As Bonds

 – Donald Yacktman

     9.   Podcasts: The Innovator’s Dilemma
      10. Letters: FairholmeTocqueville | Third Point | ML | GMO
HAVE A GREAT WEEKEND!  Sign up at support@investorvantage.com for news on investing.
The End of the Central Bank Mal-Investment now comes deflation. 

Capitulation Part II

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Gold-Miners-Compound-Return (1)

An Epic Bear Market in miners

Mining securities are not the thing for widows and orphans or country clergymen, or unworldly people of any kind to own. But for a businessman, who must take risks in order to make money; who will buy nothing without careful, thorough investigation; and who will not risk more than he is able to lose, there is no other investment in the market today as tempting as mining stock.” – Charles H. Dow (1879)

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There is NO REASON to own gold! (NOW, they tell us!)

No hope for gold holders

Global dollar stress might be causes gold price crashes.

The “price action” for gold is bad!  The price of gold went down.

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Why not be happy and say that the dollar buys you more gold because of this:

Chart-2-basis-and-cobasis

The holders of physical bullion are not selling, but futures traders are–see the red line rising which is the co-basis.  If I hold gold in stock, but sell futures to lock in the price, then co-basis represents the difference between the bid price for spot and the offer price for futures.   Leveraged futures traders are selling futures but bullion holders are not de-stocking (selling).  The selling in gold futures has brought epic extremes in prices of miners relative to gold/silver. EPIC quantitative easing may be a factor.

Video: Sellers in action:SELL ‘EM!

BAML commodities

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Does Gold represent good “value?”

Gold to S&P 500


Ratio gold to sp

Only you can answer that question. Don’t confuse gold (money) as an investment. If you couldn’t find a margin of safety in the current stock market, you might own gold because you believe gold relative to dollars is safer, holds purchasing power better, more stable, etc.

See Value Investors Hate Gold

For those technical wizards out there, note that silver did not “confirm” the price decline in gold yesterday.

Capitulation

Just remember (thanks www.monetray-metals.com)

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