Is it time to buy US? I. Studying the fundamentals

Blogging has been a great help to DIY investors.  They can formulate their own strategies in writing, see what works, and share their knowledge with others.  Bloggers often have skin in the game; it might not be very much skin, as many are not rich people, but they are real investors and not like young journalists who don’t really have much hands on experience with trading or owning anything more elaborate than index or mutual funds in their RRSP accounts.

One of the clear reasons for thinking that many financial journalists are not particularly knowledgable about investing is that they are always engaging the advice of “experts” who are wrong most of the time.  Blogger Devon Shire is hypercritical of Robert Prechter, whose predictions are often dead wrong.  Another famous talking head is Dennis Gartman, whose own fund, HAG.TO, has remained essentially static since the fund began in 2009 while the stock indexes have greatly improved.  So why is this guy on TV?  He’s doing worse than an ING Direct savings account, where at least your money gets 1.5% interest.  The original investors of his HAG’s IPO at $10.00 are still 35 cents below water.  In the meantime, the Dow Jones and the TSX are both up about 60%.  How can a fund lose money in these conditions?  Why does Dennis Gartman get on TV and why do so many financial advisers read his famous Gartman Letter?  I think it may be because the journalists and the advisors are themselves incompetent.  At least all the many sheep following Warren Buffet around can say he is the best investor of all time.  A proven track record is actually a sign of competence.  But what proves that Gartman or Prechter know what they are talking about?

Bloggers, who have skin in the game and gain experience as they go, thus contrast with financial journalists.  Consider the Financial Post’s John Shmuel has a column with the title, “Lofty loonie spells buy opportunity”; but just a few weeks ago, he’s done columns on why Canadian stocks will outperform.  So why would he change his mind?–Or does he even see the contradiction? Well, as a journalist, he’s not actually trying to present a coherent strategy but information as it comes to him.  So I find that journalists can be great sources of information but terrible sources for eking out an investment strategy.  Why does Shmuel think that the lofty loonie spells a buying opportunity for US equities?  It seems for no better reason than that loonie is at a three year high.

Well, I did a few blogs about how and why I short the US dollar by using leverage in my US margin account to buy Canadian gold mining or oil and gas companies (e.g., abx, gg, erf, pwe, pgh).  The dividends from the oil and gas companies cover the interest charges and some.  Later, I added the selling of put options on the same equities, and reduced my overall cost of carry, because the leverage is now pushed off to some time in the future and I don’t actually have to pay interest on it today.  Has this strategy worked?  Extremely well.  Now that the loonie is at a three year high, will I now go long on the greenback or US equities as Shmuel’s article advises?  I don’t think so.  Consider the following chart (source Yahoo! Finance, straight line is mine):

What we see is that the loonie hit a low of $1.61 in 2002 and has basically improved in a nine year trend against a dollar.  Once the extremes of 2008-2009 are removed, a secular trend emerges which would suggest that the greenback will continue to move down against the loonie unless the fundamentals that caused this trend are changed.  If we looked at gold or oil against the dollar, we will see the same trend.  What we are seeing in the chart is US dollar inflation.  Not that the loonie is much better, but what happens in periods of inflation is that the cost of commodities rise.  Since the Canadian dollar depends so much on commodities, then whither commodities so the loonie.  If the price of commodities is increased by the inflation of the US dollar, can we expect this trend to reverse?  I think so if any of the following events were to happen:

(1) If Bernanke gives up QE.

(2) If Stephen Harper announces a deficit budget in the order of 150 billion or more (its is currently projected at 45.4 billion).

(3) If the US Congress makes serious cuts or attempts to balance the US federal budget.

(4) If the Chinese and other foreign investors decide to abandon Canada.

Let’s discuss each of these issues:

(1) If Bernanke gives up QE. I fully expect him to announce QE 3 in the next few months.  If he doesn’t continue to implement QE then the US government will have to make serious cuts of a trillion or so dollars from its current spending.

(2) If Stephen Harper announced a deficit budget in the order of 150 billion or more.  The Canadian population is about 1/10th that of the USA.  Therefore, the Canadian deficit would have to reach 150 billion in order to match the magnitude of the US deficits of 1.5 trillion.  I don’t see this happening under Harper’s watch.  In fact the trend is that the deficit is dropping in Canada.

(3) If the US Congress makes serious cuts or attempts to balance the US federal budget. This won’t happen until a cost cutting president gets elected.  It may actually never happen.  But the new Republican House is arguing over small cuts which won’t make any difference in a 1.5 trillion or so deficit.  Cut a few hundred billion out of that, and you are still over $1 trillion.

(4) If the Chinese and other foreign investors decide to abandon Canada. Right now, China, Korea, Thailand, Japan are all pouring money into Canadian resources.  Heck, foreigners are even buying our sovereign debt.  I see this trend continuing, as Canada has what these economies need, commodities.

The economy in the US is bad.  I’ve lost money in the US in a bad real estate deal started in 2008.  You won’t see me fall into that trap again unless the secular trends change.  My feeling is that my reasons for shorting the US dollar haven’t changed because the loonie has improved to $1.03 US.  This is a sign of secular trend not a buying opportunity for US stocks.

And if you ask me why I expatriated from the US?  I’ll tell you now that it’s so that at least one of my dad’s four children will still be able to take care of him in his old age.

Update:  Why pick on the Financial Post and John Shmuel?  David Berman has a similar article at the Globe & Mail: “Bruised greenback an opportunity for Canadian investors.”  Like Shmuel, he makes it clear that the US dollar is at a low but doesn’t seem to deal with any of the secular trends that put it there and then irrationally states:

It seems likely that the worst of the freefalling is over, given that the factors that drove the dollar down – including massive deficits and stimulative monetary policies – will probably move in reverse as the economy improves.

But he provides no actual proof that the US economy is improving.  That’s just baseless optimism as far as I can see.  Personally, I doubt that the damage of the QE that Bernanke’s already done has run its course.  Some inflationistas believe that when the economy actually improves, that’s when we will see the full effect of monetary inflation, because then velocity and credit will also expand.

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).

Canada’s currency manipulation: the inmates are in charge of the loonie bin (update 2)

UPDATE 2:  I asked Denis, my economist friend, how much of the US treasuries is owned by the Canadian government and how much would be owned by the private sector, and he suggest consulting the Bank of Canada balance sheet.  It is clear that the total assets on the balance sheet are 60.8 billion, which means that there is no way that the government of Canada could have lent $134 billion to the US, and that most of the ownership of these US securities must be in the Canadian private sector and can be explained by covered interest arbitrage.  Nevertheless, the reason why this arbitrage happens is because the Bank of Canada has kept the interest rates at low levels and is therefore to blame if the loonie is inflating like crazy.  Denis provided me with the following chart of interest rates:

UPDATE:  Thanks to the comment by blogger 101 Centavos, I finally asked my local Canadian economist if he could tell me what the number $134 billion means.  He says it is not the Canadian government alone that holds this debt, but all Canadian holders both sovereign and private.  I am going to try to reach him by telephone for clarification.  Meanwhile, in the words of the ever opinionated Emily Latella of Saturday Night fame, “Never mind”.

[Please note: the updates above are intended to substantially correct  what follows, which is the original post]

I am thinking about writing a blog for the American Thinker about the announcement that China would spend another 5.4 billion in the Canadian resource sector, this time to buy 5.4 billion of Encana’s natural gas holdings.  My view is that China’s purchases of Canadian resources is more about diversifying themselves out of US treasuries.  But  I found a table updated in November 2010, which shows that the Chinese have actually increased their US treasuries by $265.3 billion since November of 2009 (the chart only goes back that far).  Meanwhile, one stat jumped off the page.  In that same period, Canada has increased its holdings of US debt by $84 billion! I am shocked.

Canadians greatly fear the death of the manufacturing sector.  So now they will tolerate this.  But I am dismayed and shocked that our government is manipulating the Canadian dollar so that it will not rise against the US.  The immorality and the bad management of this situation is beyond words.

A couple years ago, I thought that given the bad fiscal policy of the US government would lead to the loonie soaring against the US dollar.  But now I see that rather than allow that to happen, the Canadian government is subsidizing the American lifestyle and the American bubble.  So that finally explains to me why the loonie remains at par and why price inflation is slow to happen in the US–why price inflation is happening in Canada the same as elsewhere in the world.

US dollar not accepted from Tourists in India: Anectdotal evidence of inflation

My in-laws have traveled to India four times.  In their first trip in 2004, vendors happily quoted them prices and accepted payment in US dollars.  They returned from their last trip a few days ago to say that vendors no longer accept US dollars.  Is this another sign that US dollar is losing its status as the reserve currency of the world?

The Chief Export of the United States: the US dollar

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.