Jeet kune do investing IV: Venezuela

The Globe & Mail presented a contemporary example of hyperinflation in article by Frank Jack Daniel:  “Trying to survive inflation? Ask Venezuelans“.  One point stood out to me:

Over the past 25 years, its citizens have developed all sorts of techniques for stretching their money and offsetting price rises. The main rule is get rid of cash fast.

“There’s no point leaving it in the bank, it’s better to invest. I bought this car for example,” said Caracas town hall official Jorge Juarez, who leaves home at 4 a.m. to beat the snarled traffic and uses his 2007 Fiat as a taxi after work.

Mr. Juarez is in many ways a typical middle-class Venezuelan. Through a mix of hard work and shrewdness he has kept up his family’s living standard even as his salary’s buying power shrinks.

Cars are a good investment in the Caribbean nation, where gasoline is subsidized to the point of being almost free and demand for vehicles far outstrips supply. As such, they increase in value as they age, faster than consumer prices.

Cars were seen as a good investment during hyperinflation in Chili, according to Gonzalo Lira, as I mentioned in an earlier post about  why I was buying Toyota RAV4 on 0% 36 month financing.  If gold is the measure of real estate, then real estate is suffering in price even while here in Canada it is experiencing phenomenal nominal gains.  This too accords with what happened in Chili according to Lira.

NB:  this post is part of a series on Jeet kune do investing, named after Bruce Lee’s martial arts, a style which is no style.

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Jeet kune do investing (III) vs. conventional investing

I revealed offline to Mich at Beating the Index how much my portfolio (87%) is weighted towards oil and gas stocks, and only C.J.’s (my wife’s) defined contribution plan is in a balance fund.  He wrote:  “Your portfolio is high risk indeed! I imagined you would have some bonds and more utilities, you surprised me really …”  So I even managed to surprise another junior oil investor with my portfolio.

But let’s consider that conventional styles of investing are too rigid.  They present stereotypical strategies for conventional times.   If Bruce Lee had been a financial advisor, he would have advised his clients to adapt fluidly to the market–to anticipate the market’s moves and to respond in a way suited to each individual.  There are no recommended trades, for each investor is unique, with a unique set of risk tolerances, liquidity and investment goals.

I am an inflationista.  There is no doubt in my mind that Bernanke is creating money faster than the credit bubble is deflating; nor do I have any doubt anymore that the Bernanke Put is for real: no matter how fast credit deflates, Bernanke promises to pump it back up with fiat money.  Now the Bank of Canada wants to create inflation, albeit only 2%, but that they also want desperately  to keep the loonie on par with the greenback; and with these two strategies, governor Mark J. Carney will not be able to control run away inflation in Canada.  Indeed, one could argue that the Canadian housing market has already run away from him.   So now I have been investing for the last two years believing that hyperinflation is our opponent, and my jeet kune do moves must adequately anticipate and respond to that reality.

Consider these conventional strategies and how they cannot possibly succeed in time of hyperinflation:

(1) Get out of debt; (2) maintain a balance portfolio; (3) diversify your portfolio; (4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income; (5) Real estate is always a great investment.

(1) Get out of debt.

Debt is always very bad if it is high interest consumer debt (credit cards, lines of credit). But for many people their mortgage is their best protection against hyperinflation–the currency can lose value much faster than you pay off the debt or interest rates can go up.  Creditors lose in inflationary times, and so it stands to reason that debtors can win, provided that their debt is not spent on frivolous consumer goods.

(2) Maintain a balanced portfolio.

A balanced portfolio puts the emphasis on having stocks for growth and fixed income for safety.  But it is questionable whether stocks in general are a good hedge against inflation.   Warren Buffet wrote an article during the height of the last great inflationary period (1977, Fortune Magazine):  “How inflation swindles the equity investor“.  Fixed income investments are a disaster during hyperinflation, especially today, with the rate of return being so pathetic due to artificially low interest rates.

(3) Diversify your portfolio.

I am not sure that this strategy works in conventional times, supposing that such times ever exist.  Diversification is not the same as not putting all your eggs in one basket.  My portfolio includes debt, real estate, oil and gas, and gold mining companies.  But it doesn’t include anything in aviation because my C.J.’s business is in aviation maintenance.  So you won’t see me investing in Bombardier, Boeing, Air Canada or West Jet, because if one company goes down, it can have a domino effect on the entire industry.  That’s not putting all your eggs in one basket.  But those who advocate diversification suggest that the investor either own an index fund or diversified mutual fund, or a roughly equal number of stocks in each of the major sectors of the economy.  I am pretty sure this will only lead to pretty mediocre results.  I’ve noticed over the years that most investor billionaires are barely diversified, but have made their money in highly concentrated moves:  for example, Warren Buffet is mainly an insurance guy.  John Paulsen shorted sub-prime mortgages then bought gold.  Sometimes it is better to get to know one or two industries really well, and stick to what you know.

(4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income.

This bit of conventional wisdom has cost people a lot of money.  The last two years has provided pathetic yield on fixed income and meanwhile we’ve been in a great bull market.  Hyperinflation is going to wipe out whatever seniors have left and they’ll be saying a final “good bye” to their wealth.  The reason why this strategy is wrong is it has an imaginary understanding of what is a high risk investment.  Stocks are considered high risk and fixed income, low risk.  But in hyperinflation, there is nothing more certain to destroy a portfolio than fixed income investments.

(5) Real estate is always a great investment.

The sub-prime mortgage crisis has done much to destroy this myth.  For me, real estate has been a wash in the last two years.  The rental house we bought is up $70,000; but the commercial building in Texas which I bought with my brother has zero equity, is not breaking even, and $70,000 of my initial investment is basically a write-off.  But many people think that real estate will maintain its value in a time of hyperinflation. Gonzalo Lira trounces that myth in an article demonstrating that during hyperinflation the high interest rates and the unwillingness of creditors to lend out a rapidly devalued currency, destroys real estate prices.

Meanwhile, as of this moment, my concentrated jeet kune do portfolio is 86% above book.  Commodities go up during hyperinflation; so my stocks are nearly all in Canadian commodity companies (oil and gas, gold, and sugar).

Jeet kune do investing II: Toyota RAV4

I consider a car a consumable not an investment.  Yet as an investor who strives to have “no style” –like Bruce Lee’s Jeet Kune Do, a style which is no style–today I signed a deal to buy a second RAV4 in two years.  This is not a necessity.  We do have the flimsy excuse that my assistant’s car has given up the ghost and he can now purchase my 2001 Pontiac Montana which probably has at least three years of life to go.  I could have driven it for a lot longer.  But here is why I’ve decided to buy the RAV4 now instead of waiting:

The price was identical to last year’s purchase, though the financing was a little different.  Toyota was under a lot of pressure last year because of all the negative publicity and Congressional scrutiny.  I chalked up this political harassment to Toyota’s main competitor being the US government itself, seeing as Obama had just bought two car companies, GM and Chrysler with taxpayers’ money.  So I felt that the bad publicity and the political harassment was unfair, and that Toyota was like a value stock, and besides, C.J. (my wife) needed a car.  You buy a value stock when you know the fundamentals are sound, but the market has abandoned it.  Toyota, which had become the number one car manufacturer in the world, had never offered 0 % financing until last year, when we bought C.J.’s RAV4 with 48 months 0 %; and this year’s RAV4 I’m getting at for 36 months 0 %.

Once I drive that car off the lot next week, Toyota Credit will have floated us over CDN $70,000 at 0 % (my RAV4 and the remaining debt on C.J.’s).  Why is that a jeet kune do move?  Because in times of inflation or hyperinflation, debt is the best hedge.  I am anticipating that cars are going to go up in price in the next few months because of commodity inflation, and 0 % financing will be an historic anomaly because credit will become increasingly expensive–to be honest I was surprised that anyone would still offer 0% today.  I expect the US dollar to experience hyperinflation in the near future.  The Canadian loonie will likewise experience high inflation, though not hyperinflation, as the Bank of Canada seeks desperately and unsuccessfully to keep the loonie at par with the greenback.  My gut feeling is that inflation will pay for all of the depreciation on both of these vehicles, and three years hence we will have become the clear winners, for we will have paid Toyota back in devalued currency.   If not, well, we will have paid no interest on the loans, so no big deal.

Finally, when hyperinflation hits the world and believe me, I think it is already well under way, people will be desperate to get their hands on real goods, for their currency will be increasingly worthless–and the bottom may fall out of the real estate market too.  As for cars, they are a real good.  Consider this anecdote from the colorful South American hyperinflationista, Gonzalo Lira:

A true story: In ’73, at the height of the Allende-created hyperinflation, an uncle of mine, who was then a college student, was offered an apartment in exchange for his car. That’s right—an apartment. He owned a crappy little Fiat 147—a POS if ever there was such a thing—but cars in Chile in the middle of that hyperinflation were so scarce, and considered so valuable, that he was offered an apartment in exchange. To this day, my uncle still tells the story—with deep regret, because he didn’t follow through on the offer: “That Fiat was in the junkyard by ’78, but that apartment still stands! And today it’s worth nearly a half a million dollars!” Actually, I think it’s worth a bit more than that.

In the style that is no style, the jeet kune do investor must be able to anticipate the future.  The best way to do that is to study the past.

A note of caution:  this is not a recommendation to the esteemed readers of this blog to go out and buy a car.  It relates to our personal circumstances and investment style–or no style (see Jeet kune do investing I).

Commodity inflation is caused by monetary inflation

Cullen Roche of the Pragmatic Capitalist in his Dec 23 blog (via the Business Insider) made the claim that the rise in commodity prices has nothing to do with quantitative easing (emphasis his):

Well, I think it’s becoming pretty clear where the commodity price inflation is coming from – China and genuine economic strength.  The entire inflationist argument in the United States has been pretty much dead wrong for over two years running – whether you believed in hyperinflation, high inflation or default due to “money printing” you have been well off the mark.

Yet the inflation markers Roche is looking at exclude explicitly food and energy prices.  As one commenter on Gonzalo Lira’s latest blog points out, the media and the Federal government are lying:

Further the media and the FED are blatantly lying about inflation. Look at this CNN article that uses the slight [sic] of hand approach when talking about China’s inflation problems [Chinese inflation spikes on food costs].  After talking about the dangers China faces with it’s inflation it states in the article “Compare that with the United States, where the CPI has been sluggish for months. In October, the U.S. CPI increased a modest 1.2%, according to the Bureau of Labor Statistics. Excluding the volatility of food prices, the U.S. CPI rose 0.6%.”

So when it’s in China it’s inflation and when it’s in the US it’s not.  I’m not making this up.

But the fact is that somewhere around QE1, the Chinese stopped buying US debt and have been diversifying their holdings.  They are, for example, investing in oil companies in Canada.  This has resulted in a tremendous dilemma for the US.  How can they keep the behemoth of the US government running without that the Chinese invest in the Federal debt with their US dollars, made through the trade surplus with the US?  The answer is QE2, and Gonzalo Lira estimates that 60% of the new US treasury debt is now bought by the Federal Reserve.

And now, the problem of food inflation is much worse than ever.  Today, both the Financial Post and the Globe & Mail have prominent articles on the recent food inflation numbers.  Of course gold is holding around $1375; oil around $88; but these may end up skyrocketing in price soon.  Blame it on speculators if you like.  But this has everything to do with QE1,2 … infinity.  For the Federal government is now monetizing its debt and there is nothing even the newly elected Congress can do about it.  Even if they refuse to raise the debt ceiling, the government will just borrow the money from the Social Security and nothing will stop Bernanke from monetizing old debt as it expires.  When a government does this, they can expect commodities to increase: heating fuel, food, gasoline, textiles and eventually electricity.  These are the very things that we eat, wear and burn to live.  Now it’s happening and all over the media there is denial–not just the Pragmatic Capitalist, but all over the major media, even smart smart people like Niall Ferguson are still claiming that deflation is the problem.  But excuse me, when people can’t afford to eat anymore, that’s a problem isn’t it?  Are they stuck on stupid?

What happens during hyperinflation?

1.  Commodity prices, especially food, soar

In Weimar Germany food inflation was severe.  A bag of potatoes could buy a grand piano.  People used all of their disposable income just to put food on the table.

2.  Financial markets are highly volatile

The stock market in Weimar Germany would soar and plummet.  But in the end, shares in stocks lasted while the Weimar mark became worthless.  Commodity prices, though in a secular bull market, will remain volatile with huge swings as it rises steadily upward.

3. Gold and silver retain their value

In Zimbabwe, everyone who is able is a gold panner so as to buy food, for it is now possible to buy food with gold dust.

4. More stable currencies are desired

Many countries around the world use US dollars because their own currencies are so unstable.  Apparently US dollars are now legal tender in Zimbabwe.  In Weimar Germany, it would have been useless to own the likewise hyperinflated Austrian kroners instead of marks, but useful to own US dollars or Swiss Francs.

5. Real estate is uncertain asset

It may be worthwhile to own real estate debt just before an hyperinflationary period, for the value of that debt will plummet faster than interest rates can rise.  But it is also probably true that rental income will not keep up with inflation.  I read a story about hyperinflation in Chili in which a man was offered a condominium for his car.  The condominium, according to the author, is now valued in the hundreds of thousands, while the car sits in a junkyard.

What to do?

Perhaps it’s a good time to hoard large stores of food before the prices get completely out of hand.  Either that or an investor must have something that can be used to barter for food, such as wine or precious metals (in bullion–bars or coins), gold and silver.  In my view, the Canadian loonie may serve the role that the Swiss Franc did in Weimar Germany.  It is true that the loonie has suffered laughable interest rates, but the Canadian economy is resource rich and those economically healthy parts (e.g., China) of the world are pouring their money into the economy up here and are abandoning US debt.  So it might be good to have some Canadian money or some Swiss Francs.  I wouldn’t bother with the Euro at this point.

“Printing money” is a worn out metaphor: reflections on what is real

Our current economic system confronts us with a metaphysical dilemma.  Niall Ferguson writes in The Ascent of Money (30-31; emphasis mine):

Today, despite the fact that the purchasing power of the dollar has declined appreciably over the past fifty years, we remain more or less content with paper money … Even more amazingly, we are happy with money we cannot even see.  Today’s electronic money can be moved from our employer, to our bank account, to our favourite retail outlets without ever physically materializing.  It is this ‘virtual’ money that now dominates what economists call the money supply. … Anything can serve as money, from the cowrie shells of the Maldives to the huge stone discs used on the Pacific islands of Yap.  And now, it seems, in this electronic age nothing can serve as money too.

Gary Shilling has maintained that the electronic money that the Federal Reserve has been creating has remained on the bank books as excess reserves because the banks are too afraid to lend it out.  On the other hand, Gonzalo Lira has argued that all the virtual money that the Federal Reserve created and used to buy up toxic assets was in turn lent to the Federal Government by the banks.  Then, the Federal government spent that virtual money on government employees, welfare recipients, medicare, social security, food stamps etc.  Thus, Shilling misses a big point that the bank’s toxic assets and debts of the government have been monetized by this arrangement–and the virtually inflated money is now already in circulation, forcing up the prices of commodities.  Lira calls this phenomena “stealth monetization”: in Weimar Germany, people needed wheel barrels to carry their money.  Today, all that virtual money can be carried in a credit card or a food stamp debit card.  I would estimate that over 95% of my transactions are done with virtual money.  The scary thing is that now central banks are able to create stealth inflation, while lying about the inflation rate which they erroneously confuse with their manipulated Consumer Price Index, because most of the money that exists today is not real–it is not even printed on paper presenting the people with a tangible, visible clue as to how fast it is expanding.  At least in Zimbabwe today, three zeros are added at each new print run–this is inflation that you can see. The US Federal Reserve, the Bank of Canada and the other central banks today create virtual money which gives us nothing tangible with which to see the inflation which is taking place.  The Federal Reserve, until a few weeks ago, was keeping its books a tightly guarded state secret, and so no one except the members of the cabal knew how much virtual money Bernanke was creating or who benefited from it (see Monty Pelerin and My Budget 360).

Now I think of my virtual trading account in which I create virtual wealth through electronic trades on a virtual trading floor, where after three days virtual money and virtual shares change hands.  Then it is recorded in a virtual trading e-confirmation and I’m provided a monthly e-statement with my virtual holdings.  I have healthy net worth, but only as long as others are willing to accept my virtual money, or I can liquidate my virtual assets which are in the form of stock shares that my brokerage account holds for me electronically.  I feel that my investment life is trapped in the Matrix, and I wonder when someone will offer me a choice between the red or the blue pill.  “Welcome to the real world”.

There are today investors insisting upon physical delivery of precious metals.  Banks have perhaps taken massive short positions, selling virtual gold and silver without having much or any of the real stuff.  The word on the street, e.g., is that J. P. Morgan has a massive short position in silver (see Eric Fry); Mish argues that J. P. Morgan probably has a hedged position, but he is admittedly speculating:

If JPM is hurting as the silver bulls claim, pray tell why does it not show up somewhere? Where is the proof JP Morgan is naked short silver?

To be fair, I do wish JPMorgan would comment on this. Why don’t they?

Why don’t they indeed?

Is it possible to create virtual inflation?  What would it look like? I know this: the metaphor of saying that the central banks are “printing money” is worn out and does not adequately reflect the vast quantity of virtual wealth that has been create ex nihilo.  So I suggest we call it instead “virtual money”–or the like, so that we the people can began to get our heads around what the banks are doing to our assets.