investment tips

Deflation or hyperinflation, an investment for both at the same time

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During the market crash that began in June 2008 and ended in March of 2009, the TSX lost 50% of its peak value; the US indexes (cf. S&P 500; NASDAQ) experienced similar losses.  Other asset classes such as gold and the loonie suffered similar  losses against the mighty US dollar, as investors took a flight to “safety”.  Arguably this was a period of deflation, when most asset classes plummeted in value while the US dollar itself benefited.  It was also deflation caused by a shrinkage of credit, the sub-prime mortgage meltdown, which had the effect of reducing the quantity of money.

Since the beginning of this deflationary crisis, the US Federal Reserve has taken measures to reflate the US dollar through quantitative easing–which is the creation of new fiat currency.  Yesterday, Bernanke’s Federal Reserve promised to create another 600 billion greenbacks out of thin air, a spelling out of a promise that occurred already a couple weeks ago, causing the dollar to dive against gold, oil and foreign currencies.  This is probably only the beginning of the woes.  Some writers, such as Gonzalo Lira (see e.g., “How The Fed Gave Away $1.5 Trillion Through Stealth Monetization“), are predicting serious hyperinflation beginning in the first quarter of the new year.

Yet surprisingly, there remains a large number experts who believe that our biggest fear today is still deflation.  David Rosenberg issued another warning which appeared at the Business Insider on November 1:  “All This Talk Of Inflation Is Madness, DEFLATION Is Still The Big Threat“.

Clearly the investor needs a flexible strategy that hedges against inflation and deflation at the same time.  I personally believe that inflation is the way its going to go down; it is possible to create too much money and the Federal Reserve in its fear of another Great Depression is creating money to prevent it.  In my view, it does nothing helpful except to reduce debt by debasing the dollar.  All my life inflation has been the major threat and I’ve seen the dollar lose buying power consistently through the decades.  So I don’t really believe in deflation, particularly when Bernake has the creation of inflation as his goal.  He has no power to improve the economy, but he can destroy the dollar.

Yet because of Rosenberg’s (et al.) warning, I think it prudent to have a plan for deflation.  But how does an investor have a working strategy to beat inflation and deflation at the same time?  I’m not leaving my money in cash–that’s what you do when you believe that deflation is the only credible threat.  If you believe that inflation is the only credible threat, then you put everything into concrete assets like oil companies or real estate.  Debt is a marvelous asset class–provided that the debt is invested in a rental real estate (a mortgage) or dividend bearing stocks so that the interest can be paid.  So in fighting inflation I’m doing the following:

INFLATION

1. I maintain mortgage debt on a rental property.

2.  I maintain a stock portfolio which is 100% invested in Canadian oil and gas or gold-mining companies.

3. I maintain a positive Canadian cash balance and negative US dollar balance in my margin accounts.  As a Canadian investor, my total margin is calculated as a composite of the Canadian and US accounts.  I may hold Canadian equities in my US account.

4. I occasionally move assets from US dollar account into Canadian funds.

DEFLATION

In order to protect against deflation:

1.  I maintain ample margins in my margin accounts.

2. I have my lines of credit which protect against a margin call.  In case of a Rosenberg-predicted double dip, I have to have something to fall back on, and that’s where the HELOCs come in (both on the rental property and on the primary residence).  Yesterday, I was able to obtain 30% increase in these lines.

3. I will take profits on gains and increase cash positions as market improves (in loonies not greenbacks).

4. In case of market depression, I will use the unused lines of credit to average down on equities.

In many cases, after the 2008 crash, I was able to pick up stocks at well below shareholder’s equity.  For example, I was picking up shares of Midway Energy, which had a book value of $3.40, as low as $0.39, which is an astounding .115 price to book ratio.  In market downturns, the stocks will be oversold, and bargains will be available.  Thus, at least half of the lines of credit must be reserved for purpose of averaging down during a market crash.  The other half, of course, is reserved to meet a margin call.  No debt or obligation (such as a possible assignment on put option) is covered by the margin alone but by cash or an outside line of credit as well.

This is an unconventional strategy.  But these are not conventional times.  Most of the investment strategies that I’ve seen continue to call for a balanced portfolio–balanced between stocks and fixed income investments (bonds, savings accounts, treasury notes, gics, etc.).  Those who were burned by stocks twice in less than a decade are now being told to ease back into “risky” assets because of the fear of inflation (see for example, Rob Carrick).  But I worry that most financial columnists and advisers are not taking the risk of hyperinflation seriously enough, and their readers or clients will be burnt as a result.

Please see my financial disclaimer.

All This Talk Of Inflation Is Madness, DEFLATION Is Still The Big Threat 

Read more: http://www.businessinsider.com/david-rosenber-the-risk-is-deflation-2010-11#ixzz14JTM91NS

What is a “conservative” investor?

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Yesterday, Jonathan Chevreau, one of Canada’s finest financial columnists, wrote about how women are generally more “conservative” prefering safe investments, “defined as” GICs, bonds, mutual funds.  Obviously, the term “conservative” has a somewhat different meaning in conventional investment lingo than when I refer to myself as a conservative investor.  For to me, a conservative investor has to mean something different than putting your money at interest in an inflationary environment.  That should be called “risk adverse” not conservative.  But alas, risk adverse investors expose themselves to the worst asset class of all, fiat currency at low interest rates, which is not likely but certain to destroy wealth.  A conservative investor looks at a the bad monetary policy and devises strategies to beat it.

Aggresivity or Gold: what is needed in the current investment climate

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These are difficult times for investors. They are wonderful times for speculators. Speculators will make (and lose) a lot of money over the next couple of years. In my opinion, investors are likely to lose. Prudent investors might better avoid financial assets for awhile. Traditional wisdom is apt not to apply to what is coming.  Monty Pelerin, “Speculators Only”

There is the saying, “Those who remain calm while others panic, don’t know what the hell is going on.” It is a troubled time and I genuinely feel bad for what central banks are doing to people’s savings. But as Pelerin says, speculators will make and lose a lot of money. The biggest winners today are those upon whom Bernanke shines his favor, such as the big banks that borrow money from the Fed and lend it back to the US federal government, which is perhaps the biggest Sopranos-type racket going: but it’s not some kind of under the table payoffs, but it’s being done right in front of all of us and with impunity.

The 2008 market crash has been particularly devastating on people’s savings. They were forced by inflation to buy so-called “risky” instruments, esp. stocks. Then that bubble burst twice in less than a decade. Stung by this double whammy to their savings, many are still too scared to bet on the market again, and so Bernanke, and the other sovereign banks around the world are robbing them blind through their loose monetary policies; the euphemism for excess money creation is “Quantitative Easing”–it used to be called just simply “inflation”.

Loose money is also created by low interest rates.  In Canada, for example, there has been something like a 20% increase in the cost of houses since the summer of 2008, due to the Bank of Canada keeping the rates at ridiculously low rates. So you can’t sit on cash–because the riskiest investment in an inflationary environment is cash in a savings account that pays 1%. Here in Canada since the nadir of the stock market crash, such cash has lost about 19% against real estate and much more against stocks and gold.  Commodity prices on world markets are rising rapidly too.  Or rather, fiat currencies are losing their symbolic value quickly.  A interest bearing GIC, savings account or bond is recipe for a portfolio with a rapidly declining buying power.

I’ve devised an aggressive and flexible investment style to beat the coming inflation, if possible.  The stock portfolio I manage is now almost all commodities (oil and gas, gold mining), 100% Canadian-based (as I live in Canada), and I am shorting the US dollar to buy these companies. I am selling cash or margin covered puts on oil and gas, gold-mining companies (etc.) for income (which gives from 5-10% downside protection) and, because I can’t trust my margin to stay high in market downturn, I am accumulating unused lines of credit (notably my HELOC) as my hedge against deflation,with the view of seizing the day if there is a market crash. I believe the investor must be aggressive and engaged–you can’t have a “lazy” portfolio today (John Mauldin said the same in his most recent interview with Steve Forbes). The goal must be to beat inflation, and the higher that goes, the more aggresivity is necessary. Or if I had to sit out as you suggest, then I would put most of my funds into silver, gold, non-perishable foods, or other commodities–things with durative and intrinsic value (gold and silver are liquid and so are excellent choices, but you have to have a safe place to put it).

Most people’s best hedge against inflation is still their mortgage, as Bernanke’s devaluation of the dollar will also reduce everyone’s debts. It’s the Year of Jubilee, when everyone’s debts will be canceled, especially the Federal government’s. Or as Dickens says, “It was the best of times, it was the worst of times … ”

This post is a revised comment that was featured today at Monty Pelerin’s blog, “One man’s approach to investing in dangerous times“.  Thanks Monty!!

Please read my financial disclaimer, if you haven’t already.

Rolling over puts: when to buy to close a put option

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I use the following spread sheet to determine when and whether to buy back a put option (please note that commissions are calculated into the costs and original premium):

expiry symbol market strike # Current
premium		 comm cost original
premium		 gain/
loss		 % gain/
loss		 days at
start		 days
remaing		 time
remaining		 composite
Jan 2012 abx $47.02 $45.00 3 $5.95 $13.74 $1,798.74 $2,656.21 $8.85 $857.47 32.28% 620 446 71.94% 104.22%

The number in red is the price to buy back the option, and $857.47 is the difference between the original premium and the cost to close.  The composite number in the last column is the percent gain or loss plus the percent of time remaining.  When that number is at 100% the buy back is neutral.  You neither win nor lose on the contract.  If the number is negative, I would normally not buy back the option for I would sooner take possession of the underlying upon expiry–I should be comfortable owning the position in the underlying or I wouldn’t be selling the put option in the first place.  If the final number is above 100% then buying back the put can be done without disadvantage, because the time decay and percent of gain still add up to 100% as on the day the put was sold.  Here are the circumstances I use to buy to close:

(1) Buy to close a put if the composite number adds up to over about 135%.  This means that the premium has plummeted because the underlying has increased rapidly in market price.  At this point it becomes interesting to buy back and realize fast gains and then use the margin value to sell another put.  Gains can be multiplied by doing this.  So for example, I sold 2 puts on RY and bought it back 8 days later as such:

apr 2011 ry $45.00 2 $2.55 $12.49 $522.49 $827.49 $4.14 $305.00 36.86% 233 225 96.57% 133.42%

Less than four percent of the time had passedt, and yet there was 36.9% gain on the position.  The composite was at a very nice 133% and I didn’t have to wait another 225 days to re-risk the capital, which I used in turn to sell a put on PWE:

Mar 2011 pwe $21.43 $19.00 5 $0.70 $16.24 $366.24 983.74 $1.97 $617.50 62.77% 197 161 81.73% 144.50%

The composite number was an astounding 144.5% after only 36 days.  I repurchased the put.  Thus, the total realized gain over $305 + 617.50 = $922.50/$9500 (captial at risk)= 9.7% gain in a period of 44 days, which represents a 80% annualized gain.  This shows how it can be lucrative to buy back a put option.

(2) Buy to close a put when it only costs about $50 and there is more than about 60 days remaining.  Since most of the original premiums for me are in the $700 – $1000 range, it makes sense to buy back something that has so much time left on it but costs so little to buy back–less than $1 per day.  When its more than $1 per day, it’s probably better to let it expire worthless.

(3) Buy to close a put after losing confidence in the underlying.  TA was downgraded at TD Waterhouse and Scotia Capital.  I bought back the position as follows:

dec 2010 ta $21.00 $20.00 5 $0.26 $16.24 $146.24 $508.76 $1.02 $362.52 71.26% 232 88 37.93% 109.19%

The composite number was still at an advantage to me, but I had lost confidence in the underlying and did not want to take the position if the put expired in the money.  I still came out ahead on this one by $362.52.

So far these are the guidelines that I use to buy to close put options and would appreciate any pointers or questions that people might have to make in the comments.

Dennis Gartman’s Third Rule of Trading: A commentary

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Dennis Gartman’s Third Rule of Trading:  “Learn to trade like a mercenary guerrilla.”

A guerilla is a warrior.  A mercenary is a warrior who fights not out of loyalty or patriotism but for money and profit.  So one would assume that Gartman is saying not to stand by a company that you like, nor a trading strategy, if its not working.  Be flexible, because you’re in it not to prove a point but simply to make money.  So he writes, “We must indeed learn to fight/invest on the winning side, and we must be willing to change sides immediately when one side has gained the upper hand.”

I’ve read other financial writers that say that people are often irrationally loyal to a company whose stock they invested in.  My mother-in-law told me once that she thought it was basically immoral to short a stock, like you were betting for the downfall of a company or something.  Regent College professor Paul Williams feels that one of the main problems of the market place today is the disconnection between the people–creditors, companies and clients alike; indeed, the stock market is one big anonymous place where traders can determine the ultimate fate of a company, sometimes in a matter of minutes, and that is all done outside of relationships with the other stakeholders, the workers and the management that may be ruined in the process.  And yet that is the system.  So I suggest that Gartman is correct.  The anonymity of the market means that I can make the decisions that support my own solvency as opposed to what is going to help the companies whose stock I decide to buy or sell.  I am indeed a mercenary ready to switch sides.  This anonymity leads to the greater efficiency–and yes, perhaps, the brutality–of the market; decisions can be made not out of emotion, personal relationships, tribal loyalties, politics, patriotism or idealism, but simply because they are financially viable.  This means that if Nortel, Enron, or BreX go down the tubes, I don’t have to go down with them, but I sell them and find something better to invest in–and hopefully, I do it before it is too late.  This efficiency ultimately is good, in my view, and leads to great prosperity because the winners are the best companies and the losers are not viable.  If you want a road to mediocrity and poverty, then create a system that rewards losers and punishes the successful (such as socialism or bailouts).

I made the decision in 2008 to sell my shares of Microsoft.  Yet my sister works for Microsoft.  I didn’t tell her about my decision to sell, and we are still talking to one another.  Isn’t the anonymity of the market wonderful?