patrick.net

OO,

Great analysis. Should I buy mining stocks or metals themselves?

OO said:
Yen, for example, has not appreciated much against USD and is the only currency among the developed markets that is still under-valued.

Do you have any thoughts on the 'currency war' theory - that China may try to force the Yen up against the USD in order to make Japanese imports less competitive?

[impressive case for gold in your post, btw. I was wondering if it was too late to hedge with some GLD, but your analysis gave me some food for thought.]

SP,

China has been trying to do this without much success, because currency market is much harder to manipulate than stock market due to the sheer size. Also, its own currency is not freely exchangeable, while most of its reserve is in USD that is being rapidly inflated away, so it doesn't have as much ammunition as people think.

But more importantly, up till next June, Summer Olympics is China's no. 1 priority, so the top imperative is to keep the apparent prosperity up at all costs, and that's why PBOC is not very keen on mopping up the excess liquidity, although it is doing lip service. Fighting a currency warfare is quite low on the laundry list.

However, the biggest problem of Yen is Japan itself. Addicted to an artificially low exchange rate, its knee-jerk reaction is to interfere whenever Yen marches close to the 110 line. What it takes to break the addiction is beyond me, and that's why I only suggest taking a small bet.

The reason why I call Yen artificially low is because the cost of living in Tokyo (outside the top-prime districts) is already lower than that of the Bay Area. I always like to compare grocery and shopping costs wherever I go, and Japan's grocery cost has always been more expensive than the Bay Area except for the last 3-4 years.

Galloping,

it depends on whether you want to take on extra risk of management, mining reserve, hedging positions taken on by mining companies etc. If you just want to hedge, metal itself is sufficient. Obviously mining stocks may deliver a higher reward at a higher risk.

(not investment advice)

GallopingCheetah Says:

> Regarding COOP and CONDO, what are the
> pros and the cons of each?

CoOp Pros: The board has to approve new residents and tends to keep the riff raff out of the building. Cons: When you are ready to sell you don’t care who moves in to the building and it may be harder to find a buyer if your board is looking for a WASP who has a million in cash to buy your unit (many CoOps require all cash purchases)…

Condo Pros: You can sell your unit to anyone and the homeowners ass. can not stop anyone from moving in (even a punk rocker with no job and 100% financing). Cons: You may end up with a building full of punk rockers or people going BK since they can’t pay their mortgage after the teaser rate ends.

> I can’t stand the new constructions. Utterly soulless.

I'm with you on the horrible soulless new construction. One of these days I'll have a nice 20's home in the Bay Area (and if things go really well a Meussdorffer designed full floor co-op in SF)...

P.S. CoOp boards are weird and will sometimes turn down a buyer for strange reasons. One of my parents neighbors (rich WASPs that went to Yale and Stanford) wanted to buy a unit in a prestigious SF CoOp so they had a place to stay after events in the city, but they were turned down since the CoOp board wanted “full time residents” not people that had a $8mm place on the Peninsula who only planned to spend a few nights a month in the unit…

FAB,

Thanks. It seems to me that the best (old) buildings tend to be co-ops. I may just get one when the time comes. A co-op in the city and later a rural retreat with a few horses. I need more money.

OO,

I go for the mining stocks, because I'm a gambler.

Very interesting blogpost. (Found at CR)

http://blownmortgage.com/2007/09/16/do-you-think-chinas-gonna-forget/

When asked if the housing market is going to “come back” he frankly said, “never.” The reason? “Do you think China’s gonna forget [how screwed they got]?”

I am sure you folks read CR's post on Saudi Arabia.

http://tinyurl.com/3cp9jq
(Also has a nice graphics of Ben on a $100 bill)

Some snippets worth discussing.

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.
...
They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States
...
There is now a growing danger that global investors will start to shun the US bond markets.
...
The risk is that flight from US bonds could push up the long-term yields that form the base price of credit for most mortgages, the driving the property market into even deeper crisis.
...

Thank you Mr. Barnanke. I mean, really. Thanks you.

As a friend of mine says, all fiat currency is plumeting through space; sometimes one goes faster than another but in the end they are all going zero.

Remember the Bank of England sold HALF of their gold at an average price of $307 about five years ago and Gordon Brown was proud of the job he had done. A job indeed! Now the BOE says "no worries" run on the bank(s) no problem we will print more money so your money is safe. Your worhtless money is safe because we can print more.

Read the last FDIC quarterly report. They are quite proud to mention that there were no bank failures. However, more than 50 institutions merged. Why, because they failed! I had accounts at one, it is / was called Net Bank in GA. The accounts were sold/given to Everbank. I closed mine before that change when I saw the sub prime losses and a private placement of stock in the $2 range only to see it trade into the pennys a few weeks after.

No bank failures. You've got to be kidding me! Net Bank FAILED pure and simple.

StuckInBA Says:
Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.
…
They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States

Ditto for Australia, in fact -- facing inflation, and want to increase interest rates, not decrease them. There is not really a recession on due to commodity sales strength. However, I think reports of GDP growth are highly exaggerated also, and most recent GDP growth was due to lending in the property boom...

Commodities have a very significant impact on the Australian economy. When the cycle turns for commodities it will be hard on Australia.

I think AUD is a good bet if you don't have the stomach for a gamble on Yen.

My biggest forex holding is AUD in the form of simple TDs. I was actually very surprised with the last hike on Aug 8, because it was really uncalled for. There was no strong, impending reason for them raise the 6.25% to 6.5%.

I like AUD because
1) it is supported by high interest rate (NZD pays higher but NZ is a much more insignificant country in terms of resources and size)
2) Australia has a very sound financial system that rivals the best, including the US.
3) AUD and CAD are both commodity-based currencies. Australia has the biggest known uranium reserve, ranks in the top 3 for almost every kind of mineral deposit.

The downside is, AUD is the main counterpart of Yen carry trade, so whenever Yen unwinds, AUD suffers. However, the fundamentals of the currency is strong, so after 3 rounds of unwinding, it is right back to near recent high.

I pick AUD over Euro because Euro spans across many countries with different agenda and economic issues, so it is more difficult to keep track.

AUD was freely floated in 1983, as the world just stepped out from the high inflation era. It was trading in the 0.9x in 1983 and gradually came down as inflation subsided. I won't be surprised if AUD reaches above par with USD in the next couple of years, especially if AUD is able to hold off cutting rates and maintain its current spread.

Zephyr,

of course. Commodity is having its turn to shine, and it will retreat again like what happened in history before, giving way to another era of low inflation coupled with high tech breakthrough. This pattern has happened many times.

Each cycle will take at least a decade, if not two, to finish. We are just entering the mid-phase of inflation as of now.

One possible way to play Aus$ is FXA. They also have other flavors. FXY, FXC etc. Do your due diligence. Esp for filing taxes on dividends.

The exchange value of the dollar contains an element of premium as a result of being the world’s dominant reserve currency. As the Euro gains market share for reserve currency status, some of that premium moves from the dollar to the Euro. So the Euro gains and the dollar declines. At some point this shift will stop, and the subsequent value movement will be driven by economic fundamentals. Those factors favor the US dollar over the Euro.

Compared to the Euro the AUD is a more pure play. However, it is an indirect bet on commodities as well. The long-term trend should be favorable, but commodities can be volatile, and do have prolonged downturns.

Zephyr Says:
Commodities have a very significant impact on the Australian economy. When the cycle turns for commodities it will be hard on Australia.

hmm, tell that to China who wants as much iron ore as Oz can provide forever... until demand from China as the world's manufacturer subsides, I'm not sure that those sorts of commodities are going to go in a 'cycle' at all. esp with uranium on the front foot right now going forward probably for decades to come. However, a sensible govt will make sure an economy has multiple strings to its bow, such as being a financial centre (Sydney), tourism (entire east coast), less tangible exports such as English language, education, software, etc...

OO Says:
I was actually very surprised with the last hike on Aug 8, because it was really uncalled for. There was no strong, impending reason for them raise the 6.25% to 6.5%.

Possibly trying to cool an 'overheated market' being either mortgage lending or general private sector borrowing in households or businesses. It's hard to know who they are trying to punish and why with their interest rate lever... Certainly the govt was aghast at the increase due to popularity effects in an election year, and many voters had apparently voted for the conservatives based on their promise to somehow magically control interest rates and keep them low... I know many swinging voters with high mortgages who believed them and voted almost exclusively with the hip pocket nerve are now talking about voting for the other side...

Headset,

The cost of debt is a fundamental cost for everyone because whether you have debt or not, your government has lots of it, and most of the businesses and individuals who sell goods and services to you also have lots of debt. Their interest costs are passed on to you in their prices and in taxes.

So, lower interest rates can lower your costs even if you have no debt. In addition, lower interest rates are favorable to employment.

Different Sean,

Do you really think that China will be immune to cycles?

I do not. And with all their over-investment, rampant corruption and other market inefficiencies, when they do get their inevitable cyclical decline, it will be a big one. In fact, with their existing internal stress and demographics the unemployment from a downturn is potentially a political regime changing event, and a time of risk for war.

BTW, China is the #3 manufacturing economy of the world. Japan is #2, and #1 is the good old US of A.

Justme,

In response to your earlier question: Yes, my personal investment returns are without any IPO windfalls or one-time big deals.

My returns do vary dramatically over time, with some years bringing 50% to 100% returns, and others a loss of 5% to 10%. I make my money by betting big (with lots of leverage) when I think the economy will do well. And I duck for cover to minimize my losses when I expect trouble.

My main investment vehicle is real estate (which is why I lose money in some years). I also invest in stocks.

I only invest long – no shorting, and no puts or calls. When I expect declines I sell to pay off debt and go to cash or bonds (as I did for the entire 2000 to 2003 stock market decline). After a decline I jump in heavily using leverage (as I did with stocks in early March of 2003, and real estate during 1998 through 2003).

My current asset allocation is 38% cash, 36% real estate, and 26% stock. With very little debt, I am poised and waiting for another buying opportunity.

I play the cycles, getting in and out. You know, classic market timing – which any good investment advisor will tell you can’t be done. Well, they are wrong about that.

Most people (and the market in general) tend to be too superficial in their analysis and oblivious to changes until they finally over-react to them. This causes volatility that is a great opportunity for the informed investor who can calmly exploit this condition to achieve above average returns.

As Rudyard Kipling said (roughly): “If you can keep your head when all about you are losing theirs… …yours is the earth and all that’s in it…

If you felt screwed as a saver, don't feel bad. You have been promoted. You will now be screwed as a tax payer as well !

http://biz.yahoo.com/ap/070919/paulson_mortgages.html

As has been pointed out this is worse than the rate cut. Not only the USD is tanking now, but the bond market is going to be suspicious about FNMA issued securities as well. This cannot be good for the housing market. The more they try to help, the more they mess it up.

But let's come to the point. This is not designed to help homeowners and FBs. This will only allow Paulson's former employer to unload some junk during the temporary-yeah-right phase.

You have to admire their talent. Neither Bernanke nor Paulson are fools. They are doing their job perfectly. Only people who call them idiots are those who do not understand what that job is.

And as Warren Buffet said (roughly): "Be fearful when others are greedy, and greedy when others are fearful."

Some further comment on the Fed Funds target rate:

The Fed cut their target rate because they have finally become more concerned about the economy than inflation. They now realize that the shit is about to hit the fan!

More than a year ago I predicted that the economy was headed for a near recession starting in late 2007. I expect the economy to be at its worst (but mild doldrums) in the first half of 2008.

Given the recent economic conditions, the Fed Funds target rate is punitive to the economy at anything above 4.0%. And it is neutral to the economy at 3.75-4.0%. So, after almost two years of being above that range (including about 15 months at 5.25%) we have no likely escape. A recession or near recession is almost a sure thing at this point.

The Fed can’t stop it now – they waited too long. It takes about nine months for a change in monetary policy to begin to have a measurable effect on the economy. And the recession or near recession is knocking at the door! They are now playing damage control, and they are behind the curve (just as I expected they would be).

I don’t make the economic rules, I just use them to anticipate the markets and make money.

If we were in a continuing natural and neutral state of market conditions (without the previous bubble right behind us) the normal interest rate profile would include: Fed Funds at 4.0%, 2 yr Treasury at 4.25%, and 10 yr Treasury at about 5.0%. This is my target for the fabled “reversion to the mean” that people talk about.

OO:

That's interesting about the CPI and valuation of gold. I tried doing that too but I don't trust the CPI.

So instead I used census data for the median annual wages of all working Americans, which they had annual data for, then figured out how much labor would be required to purchase an ounce. By that measure gold is a little bit above the median right now.

Zephyr :

Fed Funds at 4.0%, 2 yr Treasury at 4.25%, and 10 yr Treasury at about 5.0%

That seems entirely reasonable. I wouldn't be surprised if the rates are cut all the way to 3.5, in half point stops.

So why are you not moving your cash into stocks ? Eventually the recession would end. In spite of the rally yesterday, there is enough fear adn worry in the market. The panic buying is not even started. I think we will have more dips in coming months to accumulate for long term. But I am not waiting for them. I am going long on technology. And I will keep buying at every dip.

Reserve Bank of India is having a hard time preventing the appreciation of Indian Rupee.

http://tinyurl.com/yqhjwv

OO,
I think we will see a moderate rise of inflation on a worldwide basis in the years ahead. We have already obtained the bulk of the deflationary benefit that can come from bringing the previously sequestered communist labor into the world economy.

Zephy, I think you are full of it, to put it politely. No one makes 26%/yr return over 20+ years. If you did, you would have turned 1k into 1/3M in that time. No one does that well, not even Warren Buffet.

StuckinBA,

I sold a bunch of stock in June and July, and then started to buy again in late August on the dip. During September I sat tight as the market rose on anticipation of the rate cut. I was hoping the Fed would disappoint the market - causing a sell-off for me to buy into. Now I am thinking this is a sucker's rally on the exuberance of the rate cut. I expect the economy to falter, and stocks should slip with it - for a while. However, I do expect stocks to pick up before the economy looks good. So I will be buying again before long. I am also keeping money ready to buy real estate bargains at the bottom - a more sure thing, and a better return on equity in the long run.

sybrib,

I used official CPI as an evaluation tool because I want to be conservative. We all know that CPI is understated, if you use the real inflation rate over the years, gold adjusted for 1974 or 1980 price will be even cheaper.

I don't think median salary is the right measure, because throughout history, gold has always been a hedge for the richer class. Only rich people have enough left-over savings and need hedge to preserve their purchasing power. The poor just live from hand to mouth. Also, gold shouldn't be used by someone without much savings as a hedging tool because it generates no interest income but incurs storage cost. If you insist on using income, you should use the income of the top 20% who can comfortably afford some yellow metal sleeping in the garage doing nothing for years.

Zephyr,

I don't think we will see moderate inflation. Moderate inflation is reserved for strong currencies. I think we will see very high inflation, but not hyperinflation because we still have superior military power.

There is of course no point arguing over which scenario will materialize, only time will tell. We just lay our bets.

Zephyr Says:
Do you really think that China will be immune to cycles? ...with all their over-investment, rampant corruption and other market inefficiencies, when they do get their inevitable cyclical decline, it will be a big one. In fact, with their existing internal stress and demographics the unemployment from a downturn is potentially a political regime changing event, and a time of risk for war. BTW, China is the #3 manufacturing economy of the world. Japan is #2, and #1 is the good old US of A.

I think it will be more immune to cycles as a centralised command economy with a massive export base and fewer 'free market' features. For that reason regime change is also relatively unlikely, due to the repressive nature of the govt. Regarding the prospect of war, who would they start a war with, and why? Unless it was in competition for the remaining oil resources of the planet, or other commodities. We are talking the shape of things to come in several decades time, when the world will probably be a dramatically different place in terms of resource usage.

Many analysts I know suggest that China will be THE superpower in the world inside of 10 years. I can't speak for US or Japanese manufacturing bases, given the sheer size of the Chinese export market as a proportion of production, and price competitiveness. Japan increasingly manufactures in Chinese factories these days. The US seems to bully any countries which are becoming ascendant in manufacturing on price, such as Japan and China, by insisting they revalue their currency or similar. I don't know what threats are made behind closed doors, but it would either be import tariffs, boycotts, cancellation of treaties, or threat of use of military force.

euro just broke 1.4

DS,

China will NOT become the next superpower within 10 years, I can assure you that. This is a country that I am intimately familiar with, and I can bet all I have against such a possibility. 70 years, I am not sure. But not in 10 years.

Australia's strength is not to sell to China alone. By being the quarry of the world, Oz should cater to as many customers as possible, be it China, Japan or India. If China fails, someone else will rise to fill the void. You don't need to bet the farm on one country.

True inflation = CPI x 2 + 2%, in my book...

since the days they started tweaking it in earnest...

Jimbo,

Believe what you want. My statements are truthful. And my returns are not as unusual as you seem to think. Take a look at some of the better than average companies in the US for reference.

Most of my money has come from real estate. In fact, my returns are not unusual for experienced real estate investors who use a lot of leverage, as I do. Keep in mind that my gains are only taxed at disposition, and only at capital gains rates. BTW, 1k invested for 20 years at 26% becomes 102k, and at 25 years is 323k.

I have also benefited significantly from timing my purchases at low points in the market, and selling near the tops. For someone who spends many hours each day studying the markets, and has done so for more than 30 years, this is not as hard as it sounds.

As for Warren Buffet, he is a much better investor than I am. Making high rates of return is easier on smaller amounts of money. Doing the same with tens of millions per deal is much more difficult. Keeping hundreds of millions invested at better than average returns is far more difficult than doing so with millions.

Australia’s strength is not to sell to China alone. By being the quarry of the world, Oz should cater to as many customers as possible, be it China, Japan or India.

That's what BHP's CEO was saying on CNBC. Very bullish. Alas, I sold way too early.

Whoops, Correction: Warren manages tens and hundreds of Billions - not millions.

At work I am responsible for more than a $billion of assets and I am not able to achieve the same ROE there as I do with my much, much smaller personal assets.

OO Says:
China will NOT become the next superpower within 10 years, I can assure you that. This is a country that I am intimately familiar with, and I can bet all I have against such a possibility.

hmm, must change my analysts... They are already a superpower, just not THE superpower. You don't see the population of 1.x billion, arms buildup, renewed capitalist enterprise, consistent 9% p.a. growth and snaring an increasing share of world commmodity consumption with unique deals in Africa and elsewhere as creating an economic and military superpower? hmm...

Australia’s strength is not to sell to China alone. By being the quarry of the world, Oz should cater to as many customers as possible, be it China, Japan or India.

Any supplier will do their best to sell to whoever's buying at the most favourable price, in a global marketplace (subject to security restrictions in the case of uranium, embargoed countries, etc). Australia doesn't have every kind of resource there is, but right now demand for iron is high from China. More recent industrialising 'Asian tiger' economies these days I suppose include Indonesia, Vietnam, Thailand, etc, along with the more established S. Korea, Japan, etc. India has been relatively slow to industrialise in a big way, even with its English language advantage. I name these as countries in the immediate region, which makes freighting of commodities easier and cheaper...

OO,

I hope that the actual inflation is higher than I am expecting. I would make more money in an environment of greater inflation.

But, I am expecting the effects of globalization to continue to mitigate the inflation pressures, even if it is by a diminishing factor.

Zephyr Says:
In response to your earlier question: Yes, my personal investment returns are without any IPO windfalls or one-time big deals.

With the exception of the windfall of the housing boom? That's how my folks have made their biggest gains...