Investing in 2008
January 6, 2008
Last week, I talked about “contrarian” investments for 2008, which was mostly along the lines of insurance. Like CDS in January 2007, this sort of insurance is very cheap compared to its potential value in the event of general economic dislocation, or even just a local dislocation like an ice storm. I suggested a $1000 budget, which is one month of heating bills for some people. This person lived through the economic collapse in Argentina in 2001. What would he do? Read it here. You’ll notice that he recommends the exact same $100 LED headlamp/rechargeable AA batteries/solar charger combo that I suggested last week — and I didn’t read this until a few days ago. Also, I just read Michael Panzer’s Financial Armageddon, which makes similar suggestions. (Panzer has worked for HSBC, Soros Funds, ABN Amro, Dresdner, and JP Morgan.) Argentina in 2001 was just a plain-jane economic wipeout. Today, you should also be prepared for a geophysical element, whether floods, rising seas, extreme windstorms and other wild weather, earthquakes, and so forth — on top of potential economic collapse. This doesn’t mean “more preparation,” necessarily, so much as it suggests planning to make do with less. If you are just preparing for a short-term electric blackout, a gasoline-powered generator might seem to fit the bill, but if you are planning for long-term electricity intermittency, unavailability of fossil fuels, and possibly the need to relocate due to crime/floods/inavailability of food/etc., then the $100 LED headlamp/batteries/solar charger combo might be more appropriate. So, you see, you can be ready for more by having something that is simple, robust, self-contained, flexible, lightweight and cheap.
OK, enough of that. Let’s talk about financial investments. Oddly, though, the world of financial investments and the alternate “doomer porn” universe of headlamps and rechargeable batteries has begun to converge. I know of at least one Swiss asset manager who has relocated all operations to over 1000 ft. above sea level. (Remember the flooding in Jakarta? Why not New York?) This fellow says that 2008 will be the year when “the system breaks”. Jim Sinclair, a 40-year Wall Street pro, has been saying for months that the entire US financial system is at risk today, and that investors should take delivery of stock investments in paper shares. The normally circumspect, and fairly mainstream, John Mauldin said that he thinks that CDS counterparty risk (beginning with the monoline insurers) will be the big story of 2008, like CDOs were for 2007. If you’re still holding CDS, cash in your chips! At least some of them.
US Stocks: US stocks are still rather expensive — only about 10% off all-time highs — which is amazing considering the damage that has been going on. Much more potential for downside here, and what’s the upside? Especially when considered in gold terms (i.e. accounting for currency devaluation), US stocks are at high risk. Get out unless: a) you find something really exceptional, or b) you find something reasonably priced that is likely to benefit from more inflation (commodities producers mostly). No bargain hunting unless something is really cheap (like 5x earnings or 10% dividend) and financially durable, e.g. low debt and operationally secure.
Inernational Developed: Europe has many of the same issues as the US, although not so extreme perhaps. There has been a housing bubble in the UK and Spain as well, likely Italy and France, and much of eastern Europe. Banks are suffering already from US exposure, and will suffer more from domestic issues. Corporates have been struggling against a strong euro. Europe’s stock markets have shown a very high degree of correlation with the US. Maybe there will be some bargains here later. The Nikkei and Topix have been a major stinker, reflecting a weak economy and concerns about, among other things, the prospects for more tax hikes in Japan. There might be some bargain hunting to do here later. In gold terms, the Nikkei is back to its lows of 2003!
Emerging Markets: The idea that “emerging markets will do better than developed” was popular enough in 2007 that the EMs powered higher despite all the nasty stuff happening in the developed world. Now, that idea is already “priced in,” at least partially.It seems hard to imagine that the EM markets can continue to rise when all the developed world is deteriorating, or that there wouldn’t be at least some negative economic effects. Plus, valuations are much less accomodating today, generally speaking. You might find some interesting individual situations, which could warrant a small allocation. The eastern European economies seem especially robust due to their excellent tax systems.
Bonds: Ugh! Still, it may be worthwhile to keep some high-quality “cash.” Today, this means government t-bills, preferably diversified among currencies. Consider t-bills from Canada, Australia, Switzerland, Germany, etc. Traders might squeeze a few bucks out of the long end, but long-term US Treasury bonds are likely to be a disastrous investment. Individuals in high tax brackets can consider closed-end muni funds trading well below NAV. (Check www.etfconnect.com.) Look for uninsured funds, because the insurers are going to go bust. At 5% nominal yield, that works out to about 8% or even more on a tax-adjusted basis. There is some risk here as municipal finances are deteriorating, but at least you’re getting paid to take the risk. Look for geographical diversification (not all CA/FL) and a highish credit rating.
Gold: The supranational currency of mankind has matured from an ugly ducking to head cheerleader. In the future she will develop into a Hollywood starlet. Gold will be “volatile”, and sometimes it is an extremely boring and unproductive investment, but it is never risky. Silver is more of a speculator’s game, but the high silver/gold ratio (i.e. cheap silver) indicates nice potential reward for those who can handle the risk and volatility of silver. Make sure you have at least some of your holdings in the form of physical metal within your local area, not in Zurich. You might keep some in Zurich too. Or Singapore.
Remember that gold never really goes up, it’s currencies that are going down. In normal times, there is always something “going up,” but conservative investors are often happy to stick with something they understand, like bank CDs. However, in an inflation, those bank CDs can go effectively to zero. You can’t “stay safe” by keeping everything in cash, when the value of cash is sliding lower. Conservative, fixed-income-heavy investors need some kind of inflation strategy, which includes at least some gold. Just figure out what your allocation is — let’s say 30% in inflation hedges — then figure out some reasonable approach to this allocation, like 10% gold, 10% commodities producer stocks, 5% silver and 5% ag/softs or commodities index ETF. For the other 70% in “cash,” you could go with 35% USD cash and 35% other currencies, such as euros, cando, Swiss francs, aussie, etc.
Gold and silver miners: Undervalued today, these could become very sexy going forward. Historically, they haven’t had much correlation with general equities. However, real economic problems, such as unavailability of fuel, could severely curtail operations, and the early-stage projects need a constant supply of new capital. Nobody needs to mine gold, if you know what I mean. And nobody needs to finance early-stage exploration. At some point, you might be better off with plain bullion, which doesn’t have any valuation or operational issues. I think we’ll get at least one more major upleg here.
Energy: The big producers have huge cashflow, low debt, reasonable valuations and benefit from inflation. That’s what we’re looking for here. I’m still a fan of natgas, although it has been taking a while to get up off its back. If we get a selloff to under $80 on the front-month futures, it would be worth looking into the out-year futures for long-term holdings.
Metals: Perhaps more downside to go as economies slow further, but they could make quite a comeback. I’m with Peter Grandich, looking for a $2.00-$2.50 bottom in copper and then up past $4.00. With gold at $800+, $2 copper is a lot cheaper in gold terms than it was a few years ago.
Ag/softs: Way more upside potential here, although it might be nice to wait for a pullback. The DBA ETF is a nice way to get exposure. Food is the new global crisis, says one watcher (the fact that it has been widely reported shows that consensus thinking is evolving in this direction). And yet, as we’ve documented, grain prices, measured in gold, are still a tiny fraction of their average during the 1900-1970 period. If there really is a grain shortage problem, and low inventories and bad harvests indicate there may be, then the real (gold) price will probably go up several multiples from here.
Jim Rogers made the point in his book Hot Commodities that one of the nice things about direct commodities investing is that you don’t have to worry about all the fuss of corporate operations when you buy commodities directly. That might be something to think about going forward. In the event of serious economic difficulties, there may be things that are bad for producers (no diesel to deliver crops from fields means a total loss for growers) but good for commodities prices (shortage causes price rise). Also, stocks have a valuation which typically reflects cash flows and an implied discount rate. Commodities have a valuation as well (expensive or cheap), but it is not as dependent on interest rates and so forth. In 1974, you could buy Exxon at a 10% dividend yield. The stock’s valuation was crushed, along with the general market, even though oil prices soared.
Other kinds of investments: Think of things you can own directly, instead of something that depends on layers of abstractions and counterparties. Some sort of rental property can provide steady income in the currency of the day, whether dollars, gold, silver, euros, gasoline, or wheat. Producing farmland has become expensive, but abandoned farmland (particularly in the Northeast) is still cheap. Or, a small home business that can expand later. Beer or alcohol is easy to make, can be done at home with little investment, and would seem to have a universal market. Or maybe some solar panels could provide a local electricity source. Or the classic inn or boardinghouse. Property in a foreign locale is favored by many. You might even just try traveling to a foreign locale that seems promising, and getting to know the area, which would make it easier to relocate there permanently if you had a need to.
A friend of mine once lent me a book written by his father, which was a family history. This family had been landowning aristocrats in Poland. They owned a huge estate, manned by a whole village full of peasants, and were very wealthy. When the Nazis invaded in World War II, the estate became a local military headquarters. The family fled eventually to southern France, where the father joined the French resistance. In time, they escaped France by slippng through the Pyrenees into Andorra and Spain, and thence on to North Africa and Casablanca. The father continued to fight, in a British regiment of foreign fighters. After the war, it was impossible to return to Poland, as the country had fallen into the Soviet sphere. The family’s last bit of capital was a pair of diamond earrings. This was used as a down payment for a house on the outskirts of London, which needed some repair after the German bombings. The roof over the kitchen had an open hole into which rain would fall. In time, the house was repaired and the house was turned into a small inn, from which the family rebuilt their fortunes.
Inflation and the Fed: When it takes more dollars, or euros or pounds or yen, to buy gold, that means the value of currencies is falling. When the value of currencies fall, that’s inflation. The amazing thing, today, is the lack of concern about inflation. With gold making new highs, the Fed is talking about cutting rates more aggressively, which shows complete disdain for currency quality and the consequences of inflation. We could witness a very rapid collapse. At the same time, other governments are not too happy to let their currencies rise much more against the dollar due to trade/competition effects. The UK and Japan are pretty clearly against further currency rises. The ECB is a bit more willing to allow a strong euro, but they are under pressure from industries suffering from forex consequences. If the USD, GBP and JPY all fall against the euro (instead of just the USD), or in other words if the euro is the “odd man out,” and at the same time the eurozone economy is slowing, that could make things very uncomfortable indeed. That’s why I don’t see any currency as a very good alternative to the dollar, and indeed the dollar might find a bottom vs. other currencies.
As much as possible, try to train yourself to see beyond the fantasy world of nominal prices denominated in floating currencies, and focus on the real world of prices in gold. As you know, we do this all the time around here. Other people are starting to catch on. Here’s an article from the New York Sun, Gold Value of Apartments Sinks. When you do this, you see that hardly anything has done better than gold (except a few other commodities), and since gold never really goes up, what we are really doing here is attempting to lose as little money as possible during an inflationary episode.
