inflation

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

Posted by

0

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

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

Posted by

0

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.

Pecans: a sign of coming hyperinflation

Posted by

0

The US and other western countries including Canada, have devalued and are intentionally devaluing their currencies in a vain attempt to remain competitive in the world market.

China is now buying up pecans, about a quarter the North American production, causing the price to shoot up by about 50%.  The Globe and Mail reports:

China bought about 100 million pounds (45 million kg) of pecans in 2009. That was about one quarter of the total pecan crop in the U.S. and Mexico, the world’s largest producers. And it compares with less than 5 million pounds roughly five years ago. The strong demand has sent prices for some pecan varieties soaring to $6.50 (U.S.) a pound, from $4.25 in January, according to Mr. Zedan.

Imagine when China raises the value of yuan against the dollar.  When that happens all commodities will shoot up in price as there will be suddenly a billion consumers with significantly increased buying power.  Meanwhile, forget about those pecan and chocolate cookies we used to eat as kids.  That will become a luxury item.  Food is skyrocketing in price and the Federal Reserve calls this “deflation”.

What if we made nuts the bellweather of inflation?  They are certainly a better indicator than the CPI.

CPI is a lie

Posted by

3

The government inflates the currency and then determines the rate of inflation, the so-called CPI.  But the CPI is a lie.  It is supposed to be at or near zero in the US and yet prices for most necessities are increasing.  This year, for the second year in a row, Social Security benefits will not rise for American senior citizens.  So reports Market Watch:

Understand that the CPI does not measure everyone’s cost of living. Rather, it is designed to represent changes in the market basket of goods and services bought by the average household each month.

However, seniors’ market basket is different. It consists mainly of such items as food, energy, taxes, transit fares, tolls and, of course, health care, such as insurance, doctors, prescription drugs, hospitals, assisted living and nursing homes.

These costs are not falling — they are rising quite rapidly. As a matter of fact, health-care costs are just about the only item that did not dip for even one month during the recession.

Shadowstats.com has alternative to the CPI to measure using the data that was in force in 1990, which gives a current inflation rate of about 8%.  Thus, Americans depending on Social Security are rapidly falling behind and the reason is that the CPI is a lie.

The Chief Export of the United States: the US dollar

Posted by

2

A few days ago I had a discussion with Andrew regarding whether money is a commodity.  I tended to think of it as an intermediary which made trade possible.  It is far more efficient to trade in dollars than it is to determine what the price of oil should be in corn, iron ore, oranges or rubber.  Therefore, as a store of intermediary value, the trade between trades, money is not really a commodity–i.e., it is not the goal of trade but the vehicle or means to achieving the goal.  So I trade my labor for dollars, and then, my dollars for goods, and so forth.

While reading, “It’s the Money, Stupid: Papering over our economic problems” by Jeffrey Bell and Sean Fieler, it dawned on me something that had puzzled me for many years.  I wondered how the United States has been able to maintain 30-year trade deficit with other countries.  Bell and Fiehler argue that a paper money system, rather than being able to better smooth out downturns in the debt-based business cycle, has become debt itself:

… there is no viable way to maintain the Fed’s current role as guarantor of short-term financial stability and still reform the paper money system so as to remove its tendency toward the unsustainable accumulation of debt. For the paper money system that the Fed manages not only encourages debt, the system is debt.

They continue:

The self-perpetuating feature that has kept this perverse system alive is the dollar’s position as the world’s reserve currency. Before the dollar assumed this role between the two world wars, gold—something of independent value and no particular country’s liability—was used to settle international payments between central banks and composed their primary reserve asset. But with the dollar performing those functions, its oversupply has often been absorbed abroad. So Bernanke and his predecessors in the paper-dollar era have been able to print a lot of new dollars, over time inevitably driving down the global value of the dollar, without necessarily generating domestic inflation. That is the enabler of, among other things, relatively painless federal budget deficits. For a red-ink-hemorrhaging Greece or California, the specter of default is always on or near the table. For Bernanke and Congress, colossal deficits are just another day at the office.

Clearly, then, the US is able to maintain the trade deficit because the dollar itself has become sought after international intermediary of trade, not only between US citizens within the borders of the United States, but between citizens of diverse countries trading commodities in dollars on international markets.  The dollar has thus been a useful product.  Furthermore, many countries have vast reserves of US currency and some private citizens living in countries such Russia and Argentina, hold vast sums of US dollars.  So I have finally to suggest that Andrew was right and that we can see money as a sought after commodity in and of itself.  It is a commodity that facilitates trade and makes it possible to quantify, albeit in relative terms, the market prices of diverse currencies and commodities, as well as thousands of products.  The dollar has therefore made the trade deficit possible because the Federal Reserve has had the unique advantage of creating new money as the world’s needs grew.  Countries like China and Japan have trade surpluses with the United States and have built up huge dollar reserves which they can now use to buy supplies or invest.  The dollar itself has been the chief export, and so therefore, there has never been a real “trade deficit”, but rather, a willingness of trading partners to accept the greenback itself in exchange for the goods that they were peddling.  The US has obviously been the winner in this trade since the cost of creating dollars is minimal, especially as compared to the real goods that have been traded from abroad.

Clearly, this is a unique and privileged position that the US dollar enjoys.  It is however not carved in stone that the international community will always trade in dollars.  The Federal Reserve is squandering this status, because it is determined to keep the US afloat by creating trillions of dollars more.  But like any commodity of which there is an oversupply, the value of the dollar will plummet, and then its usefulness as an intermediary of trade will disappear.  At that point the privileged status of the dollar as the chief export of the United States will be lost and there will no longer be a “trade deficit”.  When that happens, goods from other countries will be difficult to obtain, and hyperinflation in the United States will be the inevitable result.