Don’t Be Fooled!

Go onto just about any mainstream website… Marketwatch, The Street, Seeking Alpha… and you’re pretty much guaranteed to find some article either a) bashing commodities and gold b) plugging stocks, financials in particular, or c) both. There is good reason why what we are experiencing is called a “Suckers Rally”.

Traders are once again more insecure about a possible loss of opportunity (market bottom) than in safety (possibility of loss). I find this astounding in the sense that this is precisely what differentiates investors from speculators. (By the way, Buffett didn’t make his money in Citigroup).

What I usually do in times as these is look objectively at each proposition and ask myself if, trends aside I would be interested in owning it. For the sake of an unbiased decision we will discount any future speculative gains (profit expectations from the issue itself).

In each we will look at the two most important factors in any purchase: Safety and Profit.


Safety – Only an enterprise that lives up to the highest standards of sound business should ever be bought by an investor. Otherwise, what saves the investor from owning a business that may in time go bankrupt? If you wouldn’t lend the company money, you definitely shouldn’t own it!

Profit – A higher share price, other than speculative gains, is a result of either a) an increase of earnings or, b) dividend yield (if the company offers one). The general trend for many companies right now isn’t too promising. Earnings are falling or, in some cases, none existent. Additionally, prices have yet to fall to match such conditions, thus creating price-earnings ratios far above the norm (15x). In terms of dividends, it is hard to find companies of sound structure offering attractive yields.

Conclusion – When factoring in just a small dose of macroeconomics one can easily see that the picture is not pretty and that the Bear market may have just begun. With further earnings disappointments, dividend cuts and some brutal corporate failures on the horizon, the shorts-covering-come-Bulls-sh*t-rally seems just as absurd as the boom that preceded it. With most analysts seemingly bullish it is obvious where they’re interests lie – a chance to get out! We expect a bottom somewhere closer to 8,500.

Real Estate

Safety – Here’s my fundamental problem with property: Leverage, tons of it. For some reason, people who would never ever buy stocks on margin, finance their gold, or Heaven forbid buy commodities futures, somehow found it perfectly logical to buy a home with 5, 10 or 100 times leverage! Some buyers didn’t even need to provide a down-payment! There is some serious downside before we see any major bottom (and a demise to the “Real Estate never goes down” slogan).

Profit – Investors make money either through a) rent or, b) development. An investor should perceive his investment in terms of return: Home Price/Earnings from Rent. Financing a mortgage should enhance this return, not attempt to replace it. With the average home price around $200,000, and average rent a tad over $1,000, the expected gain from rent is a mere 6% – barely outperforming inflation, and for the time being: interest rates.

Conclusion – Throw in a down-trend in housing prices and defaults expected through 2011, and its clear that while real estate is one of the best investments to have, now is not the time to buy in.


Safety – This element is more one of endurance, than of safety. If one has done his research well and has strong reason to believe that a decent return can be secured (after fees, storage costs, roll-overs, etc.) then commodities as a general class offer great potential to the adequately positioned investor.

Profit – Commodities growth is a spread of both a declining currency and increasing speculation. The trend is strong and there will be many opportunities of profit in the coming years as the two meet. Relative to equities, commodities lag with regard capital inflow and there is much room for billions from equity-based investments.

Conclusion – Keep your eyes open! Oil may still reach its targets of $200, dragging Sugar and Heating Oil higher. Grains, Metals and Meats are being consumed increasingly by the BRICs, and Lumber may rebound as soon as the housing market finds its footing.


Safety – When we look at bonds, the first thing we want to know is the soundness of the entity that is securing it, (be it Sovereign, Municipal or Corporate). The problem we encounter when we do so is that along with the falling values of these bonds, is the inefficiency of their ratings. Regulation has allowed under-grade, or even junk, material to get included in even the highest grades of debentures.

Profit – In general the investor seeks a bond with the safest return. This has generally been the U.S. Treasury Bonds. These issues to date offer an embarrassing yield of less than 3% – over for longer term! This translates into negative equity when the standard CPI is discounted (how much more so real inflation figures).

Conclusion – In 1981, the investor could have bought a Treasury Bond that yielded over 15%! This would have dwarfed the Dow’s returns of 11%. That was then. Today, with all the debt that the government has piled up, even if it were running at 15%, would it be worth the risk?

Which brings us to…

Precious Metals

Safety What can be safer than holding something of real intrinsic value, that doesn’t spoil, is seldom bought through financing, and has been a currency since the times of kings? Gold and Silver are the ultimate currencies that have been excepted, no matter when, no matter where.

Profit – The precious metals investor does not invest for gains, but rather for wealth preservation, maintaining its value over time, regardless of economic scenarios. As capital flows out of equities into metals, they have become subject to speculation in times of uncertainty. When suggesting their real value, the inherent belief is that prices of fiscal assets always reform back to their previous origins. (Think Dow/Gold ratio).

Conclusion – Precious metals are known to have performed very well, when the economic climate contracts. Current times should prove should be no different. Gold is often bought by those seeking refuge for capital, while silver has always had an extra lining of speculative power (in kind for the excess storage required).

Economic Climate Change
What we have seen over the previous months and, probably experience over the coming years, is a genuine contraction of credit and will be billions of losses in the making. Many, many factors remain uncertain, for instance the possible bankruptcy of major financial institutions, manufacturers, and possibly the U.S. Government, along with the world’s reserve currency – the U.S. Dollar.

To believe that so many have ridden the credit wave for so long, and have already paid the price is foolish. To believe that the excess and correction of the Tech Boom and the greatest stock market rally since the 1920s has been weighed off is sheer lunacy. To imagine that while corporate earnings fall, unemployment rises, housing corrects (dragging with it the financial industry), and consumers are on the brink of (what may turn out to be) the greatest recession since the 1930s — while financial shares stage their greatest rally in history, seems like a paradox in its own right. Or is it?

The damage has been done and there is nothing that can stop the inevitable from occurring, other than dragging out the pain in terms of time rather than in terms of severity.

The next time you think of buying a share in any financial company, just think first: “Who is going to secure the $5 Trillion (that’s Trillion) of mortgages that are being held on the books of the two largest brokers in the world? Who will bail them out?” When we have our answer, then maybe it’s time to buy.


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