Search results matching tag 'Investing'

Investing treasures buried deep beneath the South China Sea

TonySagami — Fri, 05 Apr 2013 15:10:00 GMT

China isn’t just a global economic powerhouse. It’s a global military power as well.

And it isn’t about to let anyone forget that, least of all its Asian neighbors whom it’s battling over the rights to the South China Sea’s natural resources.

Buried deep beneath the ocean floor are rich oil and natural gas deposits. China needs those rich deposits to fuel its ambitious economic growth plans.

However, five other Asian nations also lay claim to this resource-rich area. But China plans to stop at nothing to take this million-square-mile frontier for its own.

Here’s why it could very well wrest control out from under its less-powerful competitors … and how we can profit no matter which nation lays claim to these valuable undersea treasures!

Resource-Hungry China
Flexes Its Military Muscle

There isn’t a country in Asia that can match China’s military might. It has the largest-standing army in the world, but its navy is almost as impressive.

The People’s Liberation Army Navy (PLAN) is 225,000 men strong and composed of surface forces — including an aircraft carrier — submarine forces, naval aviation, and coastal defense forces.

China also owns the largest submarine force among Asian countries, consisting of eight to 10 nuclear-powered submarines and 50 to 60 diesel-powered submarines.

It’s using this arsenal to help make its claim.

Last week, China sent a powerful flotilla to a small chain of seemingly inconsequential islands off the shores of Malaysia, which is located more than 1,100 miles from its nearest shores.

China deployed some of its most-sophisticated Navy vessels to the eastern coast of Malaysia: an amphibious landing ship with armed marines and hovercraft, China’s most-advanced escort ships, and helicopters and fighter jets to provide aerial support.

Below is a screenshot that links to a free two-minute Al Jazeera video of the Chinese armada.

China is one of six countries competing to control the South China Sea
and the vast oil and gas reserves is reportedly sits atop.

Malaysia — along with Taiwan, the Philippines and Vietnam — are none too happy about China’s aggressive land grab. They have appealed to the United States for help in countering China’s aggressive attempt to seize 1 million square miles of the South China Sea.

Other than some tough talk, however, the Obama administration has done nothing to stop China.

Whatever China cannot muscle away, it is buying.

Do you remember the $18.5 billion takeover bid that CNOOC, China’s state-owned oil company, made for Unocal? That bid was blocked by the U.S. Congress — and Chevron was the eventual victor — but that hasn’t slowed down China one bit.

Since then, Chinese oil companies have been on an aggressive international energy asset buying spree. In 2012, Chinese companies spent a record $35 billion buying oil and gas assets.

CNOOC paid $15.1 billion for Canadian energy giant Nexen.

Sinopec paid $2.2 billion for the shale gas assets of Devon Energy.

PetroChina paid $1.63 billion for Woodside Petroleum, a division of BHP Billiton.

Since 2009, Chinese oil companies have spent a total of $92 billion on international acquisitions.

Energy isn’t the only natural resource that China is snapping up. China has been cutting deals for everything from coal to iron ore, cotton to lumber, soybeans to wheat, gold to uranium, and even water.

According to the International Monetary Fund, China is a gigantic consumer of natural resources and commodities. As a percent of global production, China consumed 20% of nonrenewable energy resources, 23% of agricultural crops and 40% of base metals.

In short, if it comes out of the dirt ... China wants it.

I’m not talking about a one- or two-year phenomenon, either. The rising demand for natural resources is going to last for several decades, and it’s going to be one of the most-powerful investment trends you will see in your lifetime.

That demand is a simple matter of demographics. Gary Halbert, one of my good friends and a top natural resource/commodity expert, said:

“The world population is now over 7 billion and growing rapidly, creating an ever-increasing demand for a limited supply of commodities. I’ve been in commodities for 35 years, and I’ve never been more bullish on commodities over the long-term.”

If you want to make some big money, all you need to do is get “long” China, natural resources or, even better, China as a natural-resource play.

There are several ways to do that.

Option No. 1: Bet on the next takeover targets. You could buy the stocks of natural resource companies and cross your fingers that China buys them out. But even if a Chinese buyout offer doesn’t come, these stocks should do just fine.

Option No. 2: Invest in natural resource-focused ETFs such as:

SPDR S&P Global Natural Resources ETF (GNR)

iShares Global Energy Sector Index Fund (IXC)

GlobalX Fertilizers ETF (SOIL)

PowerShares DB Agriculture Fund (DBA)

PowerShares DB Base Metals Fund (DBB)

S&P Gold Trust (GLD)

The SPDR Gold Trust (GLD) has gained 83%
in the past five years and keeps heading higher!

Or if you prefer a one-stop, cover-all-the-bases natural resource portfolio, take a look at funds such as the U.S. Global Investors Global Resources Fund (PSPFX) or the Aegis Commodity Portfolio product. (Note: I am not getting paid or receiving any compensation in any form for this mention. It is just an excellent commodity fund offered by someone I know and trust.)

It will be a bumpy ride, but I am 100% convinced that commodity prices are headed higher — a lot, lot higher — and deserve a significant piece of your investment dollars.

Speaking of Commodity Prices on the Rise …

My friend Sean Brodrick is hosting an intimate teleconference this Thursday, April 4 at noon Eastern with one of the premier precious metals investment managers of our time, Rick Rule.

And as an Uncommon Wisdom Daily subscriber, you can join them for free if you register right now. You won’t want to miss out on this intimate chat on the future of gold and other precious metals prices that includes …

Rick's Outlook on Gold Prices: It's clear gold's in a long-term bull market but prices have recently pulled back. So, where are we in the current bull market and where are prices headed over the next few months?

Reckless Money Printing: Will the dollar crash and burn over the next few months ... and how will a re-emerging European crisis affect gold prices?

How will the price of gold impact the gold miners? And where are the best opportunities right now in this explosive sector?

Plus, Sean will ask him to reveal the top five gold companies he's buying right now!

The ONLY way to attend this private Uncommon Wisdom teleconference is to click on the link below to sign up. All the details will be sent to you immediately via e-mail.

Click here to reserve your FREE spot at this premier investing event today!

Don't miss your rare chance to hear from one of the influential precious metals investors of our time!

Best wishes,

Tony

Investing in a Low-Growth World

JohnMauldin — Sun, 17 Feb 2013 23:59:00 GMT

The jury – unless you are the Fed and Ben Bernanke or the Congressional Budget Office, which cannot make lower growth assumptions without really blowing their deficit projections out of the water – is pretty well in on GDP growth: it’s going lower. Ed Easterling and I wrote a recent Thoughts from the Frontline on multiple pieces of research suggesting slower future growth. We asked the question, “So what about stock prices; will they follow suit?” Our thought was that, over time, they would.

Not so fast, says Jeremy Grantham in today’s Outside the Box. He was part of the cabal of researchers suggesting slower future GDP growth whose work we used as the basis for our analysis. Longtime readers know that I think Jeremy Grantham (who heads GMO, which now manages $106 billion – see GMO LLC for more wonderful GMO team research) is one of the smartest men on the planet as well as one of the best investors. With his usual thoroughness, Jeremy makes the case, based on in-house research, that both stock-market returns and corporate earnings growth are negatively correlated to GDP growth. At the same time, he’s not overselling his thesis:

For the record, there is also: a) a moderate relationship between higher-priced countries (on Shiller P/E and price/book) and future underperformance; and b) a tendency for more rapidly-growing countries to be overpriced. Therefore we can deduce a logically appealing (but statistically weak) tendency for overvaluation to contribute a second reason for the market underperformance of more rapidly growing countries. (Please notice how carefully said that is.)

He goes on to reiterate important points he has made over the past few months about the effect of growing resource costs on growth, and then adds:

The main new point I wanted to make was that resource costs are treated like GDP increases. Hence, prior to 2002, steadily falling resource costs were treated as a debit when of course steadily lower costs were a great help to well-being and utility. We calculated that adjusted GDP actually grew 0.2% a year faster than stated. Conversely, since 2000, rising costs were a detriment, not a benefit, as shown in GDP. Treated correctly as a negative, resource costs would have reduced real growth by 0.4% a year. This squeeze on growth will continue as long as resource costs rise faster than the growth rate of the balance of the economy.

Always careful of the ground he stands on, Jeremy then throws in a very important caveat to say:

… it is worth remembering that we don’t really know what caused resource prices to spike from 2002 to 2008 so impressively. This was a much bigger price surge than occurred during World War II! Indeed, it may easily turn out that the resource price rises will squeeze future GDP growth substantially more than our estimates.

Or not.

In any case, a careful reading of Jeremy’s work is always instructive. This one is an important think piece, as the direction and magnitude of future GDP growth will be critical as we make business, retirement, and investment decisions. Simply talking past performance is risking your future on the unlikely prospect that the future will look like the immediate past.

I am personally doing a lot of thinking and research on this topic. I strongly suspect that other significant factors will arise to play havoc with projections, in both fantastically positive and uncomfortably dire ways. I am more and more seeing the future as very “lumpy,” that is, quite uneven as to how it will affect individuals and even entire countries. For those who espouse more equality in incomes and outcomes, this is not your optimal scenario. But even with all the “lumpiness,” the average person will be much better off in 20 years – though “average” will cover a much wider spread of outcomes than it does even today. But rather than launch into that book now, we’ll let Jeremy take over.

Have a great weekend. I am enjoying being at home this week. I will be in Palm Springs at the California Resource Investment Conference, February 23-24. My good friend Grant Williams, who writes the blockbuster Things that Make You Go Hmmm… and the Mauldin Economics' Bull’s Eye Investor letter, will be there, as will the best resource investor I know, Rick Rule, along with my favorite data maven, Greg Weldon. There is a full two-day slate of speakers. The event is free to investors and is always fun, and it’s a great time of year to be in California (hate the pensions, love the weather). Come see us! You can read all about it and register at the Cambridge House website.

Your looking forward to catching up this weekend on my reading analyst,

John Mauldin, Editor
Outside the Box

subscribers@mauldineconomics.com

Investing in a Low-Growth World

By Jeremy Grantham

This quarter I will review any new data that has come out on the topic of likely lower GDP growth. Then I will consider any investment implications that might come with lower GDP growth: counter intuitively, we find that investment returns are likely to be more or less unchanged – a little lower only if lower growth brings with it less instability, hence less risk. Finally I will take a look at the reaction to last quarter’s letter, specifically about my outlook for lower GDP growth.

Recent Inputs on a Low-Growth Outlook

Some information came out after the 4Q 2012 Letter or was missed by us and is worth mentioning. First, the Congressional Budget Office slashed its estimate of the U.S. long-term growth trend from 3.0% to 1.9%! Given the source and the magnitude of the adjustment, I think it is fair to say that their number is “close enough for government work” to our 1.5%. At least it is within negotiating distance. Next, a report from Chris Brightman of Research Affiliates actually came out a week before ours and concluded that long-term GDP was 1.0%, a number that really corresponds to our 1.5% because his report has no reference to our two special factors, resources and climate, which take our 1.5% to 0.9%. I was encouraged by the solidness of his research. It also led me to an article in the Financial Analysts Journal (January-February 2012) by Rob Arnott and Denis Chaves. Rob has been writing about the effects of age cohorts on investment returns for almost as long as I can remember, with the central idea that older people are sellers of assets – houses as well as stocks – that younger members of the workforce buy. But they also include the aging effect on GDP growth, which he shows taking a real hit in all developed countries (except Ireland). They are commendably careful in suggesting that their model may be wrong. When or if you read this article, you will certainly hope that it is indeed wrong, for their models estimate from past experience a far greater drop in GDP growth than our work assumed last quarter. And they certainly attacked that aspect in far greater detail than we did. We had included in our report the effect of aging on the total percentage of the population of working age: there are simply fewer workers and more retirees in the distribution. But Rob and Denis (sorry for the liberty) introduce the incremental idea, apparently provable, that older workers lose productivity, no doubt much more in heavy manual work than, say, in writing this. But definitely alas, including all activities with dire consequences, they argue for productivity and GDP growth.

Would Lower GDP Growth Necessarily Lower Stock Returns?

This is where I break ranks with many pessimists because I believe theory and practice strongly indicate that lower GDP growth does not directly affect stock returns or corporate profitability. (At least not in a major way for, as we shall see later, there may be some indirect or secondary effects that may very modestly lower equity returns.)

All corporate growth has to funnel through return on equity. The problem with growth companies and growth countries is that they so often outrun the capital with which to grow and must raise more capital. Investors grow rich not on earnings growth, but on growth in earnings per share. There is almost no evidence that faster-growing countries have higher margins. In fact, it is slightly the reverse.

For there to be a stable equilibrium, assets, including entire corporations in the stock market, must sell at replacement cost. If they were to sell below that, no one would invest and instead would merely buy assets in the marketplace cheaper than they could build themselves until shortages developed and prices rose, eventually back to replacement cost, at which price a corporation would make a fair return on a new investment, etc.

The history of market returns completely supports this replacement cost view. The fact that growth companies historically have underperformed the market – probably because too much was expected of them and because they were more appealing to clients – was not accepted for decades, but by about the mid-1990s the historical data in favor of “value” stocks began to overwhelm the earlier logically appealing idea that growth should win out. It was clear that “value” or low growth stocks had won for the prior 50 years at least. This was unfortunate because the market’s faulty intuition had made it very easy for value managers or contrarians to outperform. Ah, the good old days! But now the same faulty intuition applies to fast-growing countries. How appealing an assumption it is that they should beat the slow pokes. But it just ain’t so. And we at GMO have (somewhat reluctantly for competitive reasons) been talking about it for a few years.

Exhibit 1

GDP Growth Unrelated to Stock Returns

Exhibit 1, shown by us before, shows the moderately negative correlation between GDP growth by country along with their market returns. This is shown for the last 30 years only and for developed countries only, but in earlier work we went back a hundred years for some developed countries and looked at emerging country equity markets as well and all had the same negative correlations. (See Ben Inker’s white paper, “Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns”, August 10, 2012, at www.gmo.com [registration required].) When I asked my colleague Ben Inker if this was for the same reason that growth companies underperform – that they are overpriced – Ben came up with another completely sufficient explanation (in about 10 seconds): the faster-growing countries, at least for the last 30 years, have simply had more slowly-growing earnings per share. This is shown in Exhibit 2. For the record, there is also: a) a moderate relationship between higher-priced countries (on Shiller P/E and price/book) and future underperformance; and b) a tendency for more rapidly-growing countries to be overpriced. Therefore we can deduce a logically appealing (but statistically weak) tendency for overvaluation to contribute a second reason for the market underperformance of more rapidly growing countries. (Please notice how carefully said that is.)

Exhibit 2

Earnings Growth Is Negatively Correlated with GDP

Would Lower Real Rates Lower Stock Returns?

Economic theory can’t get everything completely wrong, and perhaps one thing economists have gotten partly right is that the risk-free rate has some relationship to the growth rate of the economy. If that rate approaches zero, there is clearly less demand for new capital; in fact, given accurate depreciation accounting, there would be zero net new capital required. It is also easy to see the risk-free rate settling at something around nil. The risk premium, however, might be little affected. The demand for risk capital – e.g., to replace an old plant, resulting in no new net growth – would still require that the investor expect an adequate return. If it looked likely to be less than that, he would of course withhold his capital until inevitable shortages pushed up profits enough for the corporation to get a satisfactory return, as we have often discussed.

However, and I bring up this complicated issue with trepidation, it does seem possible that in a world with both lower growth and a lower risk-free rate that the risk premium might also drop a little. A lower growth world might plausibly be less volatile because managing a world where the apparent growth is 1.5% (and real growth is 0.9%) is likely to be easier to stabilize than one (as from 1870 to 1995) appearing to grow at 3.4% but actually growing at 3.6%, almost four times higher. (Another way of stating my negative 0.5% resource adjustment, by the way, is to say that the economy’s costs are growing at 1.5% but that its utility – or something closer to utility than GDP anyway – is only growing at 0.9%.) If returns to equity holders are to fall, then P/Es must paradoxically rise to bring yields and total returns down. Yet, as always, equities have to sell at replacement cost. Therefore the books have to be balanced by returns on equity falling. This after all seems reasonable – if returns on T-Bills drop and returns to stockholders drop, then a system in balance would suggest that returns on corporate investment also drop. This adjustment would likely be modest and should only occur if a lower-growth world were to become less likely, which is far from certain, merely plausible.

Reflections on Our Work on Lower-Growth GDP

With a few months to reconsider the data, old and new, I would have framed last quarter’s issue on declining growth differently to emphasize how routine, even friendly, most of our inputs were. The main new point I wanted to make was that resource costs are treated like GDP increases. Hence, prior to 2002, steadily falling resource costs were treated as a debit when of course steadily lower costs were a great help to well-being and utility. We calculated that adjusted GDP actually grew 0.2% a year faster than stated. Conversely, since 2000, rising costs were a detriment, not a benefit, as shown in GDP. Treated correctly as a negative, resource costs would have reduced real growth by 0.4% a year. This squeeze on growth will continue as long as resource costs rise faster than the growth rate of the balance of the economy. Further, as the percentage of the GDP taken up by resources has recently more than doubled (2002 to 2012), the squeeze on the balance of the economy would also be doubled even if the rate of cost increases stayed constant. Last quarter I estimated that continued increases in resource costs from now to 2050 would lower GDP growth by 0.5%. To prevent that 0.5% effect from accelerating as the share of resources in GDP rises, the rate of resource cost increases must decelerate from the recent 7% a year to a much more modest 2% a year by 2050. (By then, of course, it might well be over the current 7% ... it is just not knowable.) As one can see, this is not nearly as draconian an assumption as it might initially appear to be and in this context it is worth remembering that we don’t really know what caused resource prices to spike from 2002 to 2008 so impressively. This was a much bigger price surge than occurred during World War II! Indeed, it may easily turn out that the resource price rises will squeeze future GDP growth substantially more than our estimates.

Although our low estimate of future GDP growth attracted attention and plenty of opposition, it was only produced as a necessary backdrop to show the potential significance of our two new points: the large deduction for a cost squeeze from resources (0.5%) and a very slight but increasing squeeze from climate damage (0.1 rising to 0.4 after 2030), which latter deduction is considered almost ludicrously conservative by that handful of economists that study the costs of climate change. Our work on the traditional aspects of GDP growth was approached by us as a necessary chore; we were not looking for trouble. Consequently, we tried to keep it simple by using the obvious data sources. “Where on earth did GMO get its pessimistic population data?” ran one complaint. Well, would you believe the U.S. Bureau of Census? And as for productivity, we extended the 1.3% average for the last 30 years out for 30 more years. This is clearly a very friendly assumption given: a) the recent 1.3% in productivity growth of the last 30 years had declined a lot from its 40-year surge of 1.8% after World War II; and b) the fact that the segment of much higher productivity – manufacturing – has declined to a mere 9% of total labor from 19% in 1980 and continues to decline. Even my one override, -0.2% a year for the next 18 years as a result of much-reduced capital spending, seems, based on econometric modeling, to be a very modest debit. For there to be so modest a negative effect needs capital spending to drift back toward normal in the relatively near future. And even then this -0.2% effect was exactly offset in our forecast by a +0.2% bonus for the unanticipated surge in fracking activity and the ensuing burst of momentarily cheap energy. So why the fuss? The resource debit merely reflects the remarkably odd GDP accounting that counts an unfortunate surge in necessary costs as a benefit, and the remaining 1.5% is merely reflecting recent data. Higher growth assumption, Mr. Bernanke should be aware, must prove longer-term improvements in productivity or, tougher yet, increased labor input.

Short-Term Behavioral Impacts on the Market from Lower GDP

Of course, in the short term there are always temporary behavioral responses. If GDP growth drops unexpectedly, corporations might easily be caught mis-budgeting or overexpanding (although this current ultra-cautious U.S. corporate system, which only reluctantly makes capital investments, is unlikely to be caught out too badly), and perhaps more importantly investors may be shocked by continuous revenue warnings, which might cause the market to sell off. Recent corporate announcements, while usually still claiming exceptional profit margins and generally hitting earnings targets, are increasingly missing revenue targets and issuing future revenue warnings. We must admit, though, that recent revenue warnings have not stopped the market from rising, nor has the unexpectedly slightly negative growth for the fourth quarter GDP.

Within sectors there would quite likely also be a shift in preferences. Growth stocks might seem relatively more attractive: “If the system isn’t growing, the least I can do is pick a few companies that clearly are still growing.” Perhaps quality franchises would also become more appealing with the logic being that at least in the transition to lower top-line revenue growth, competition would become more severe and, hence, defensive moats even more than usually desirable.

Engineered Low Interest Rates

The Fed’s negative real rates regime, designed to badger us into riskier investments in order to push up equity prices and grab a short-term wealth effect (that must be given back one day when least comfortable and least expected), has gone on for a long and, for me, boring time. This low interest rate period is serving, therefore, as a sneak preview of what a permanently lower rate regime might look like (although any permanently lower rates reflecting lower GDP growth would be by no means as low as these engineered rates that we are currently experiencing). So what are some of these effects? The artificially low T-Bill rates first work their way slowly up the curve. Next, the most obviously competitive type of equities – high yield stocks – begin to be bid up ahead of the rest of the market, as has happened. “I’ve just got to squeeze out some higher rates somewhere, anywhere,” is the pension fund plea. Then, this low rate competition begins to filter into other securities, historically sought after for their higher yields: higher-grade real estate, where the “cap rates” slowly fall; and, unfortunately, also forestry and farmland, mainly of the larger and more standard varieties that appeal to institutions, which show declines in their required yields, i.e., their prices rise. The longer the engineered rates stay below true market rates, the higher asset prices become until, yes, you’ve got it, corporate assets begin to sell way over replacement cost. Then, if the heart of capitalism is still beating at all, a long period of over-investment begins and returns are bid down and everything moves into balance, often helped along if asset prices get too high, as in 2000 and 2007, by a good healthy market crunch. (This strategy will be seen in future years as archetypical of the Greenspan-Bernanke era: badger and bully investors into taking more risk and eventually pushing assets – houses or stocks or both – far over replacement value, followed eventually, at long and hard-to-predict intervals, by exciting crashes. No way to run a ship, but it does produce an environment that contrarians like us, who can take a few licks, can thrive in.)

Stock Option Culture Messes Things Up

The normal capitalistic response described above runs smack into the new tendency for corporations to either sit on money or buy stock back (regardless of how expensive it may be!), which works in the opposite direction to create shortages, drive prices up, and, as a by-product, lower job creation and GDP growth. So where does this all come out? You tell me. All that I know is: a) if we in the U.S. don’t invest, others will and it will, in the longer run, definitely end badly; b) that even if there is a lower-return world in the future it is still better to own the cheaper assets; and c) it behooves buyers of “cap rate” type assets like real estate to realize that the current low rates are flattered by current Fed policy, which will, like everything else in life, pass away one day, leaving them looking overpriced. It can’t be too soon for me. In the meantime for us at GMO it means emphasizing care and maintaining a heightened sense of value discipline, not only in stock selection, as the whole world is once again bid up over fair value in a way so typical of the post 1994 era, but also in forestry and farmland. GMO has investments in those areas too and recognizes the need to sidestep overpricing by emphasizing the nooks and crannies. Fortunately there are more nooks and deeper crannies in forests and farmland than there are in almost any other area, certainly including stocks.

Danger of the Fed Overestimating Growth

This doesn’t really fit in with a quarterly letter emphasizing important good news, but being about the Fed, I have to make an exception. The Fed appears to be still assuming a 3% growth rate for future U.S. GDP. It would be safer and more confidence-inspiring, now that Bernanke appears to take his responsibility for growth seriously, that he at least have a reasonable growth target (preposterous as that notion is to me that the Fed should or even could affect long- term growth simply by messing about with interest rates). The growth in available man-hours has definitely declined by about 1% a year, yet Bernanke’s assumption for our GDP’s normal trend growth appears unchanged at its old 3%. Ergo, he must be assuming an offsetting rise of 1% in productivity. But why? We should treat these assumptions quite seriously for this is famously (for me) and painfully (for all of us) the man who could not see a 33⁄4-standard- deviation housing market, and indeed protested that all was normal, etc., etc., etc. (Dear handful of niggling readers, this 33⁄4-standard-deviation event is calculated on the assumption of a normal distribution, as is often done in investing, even though we [especially at GMO] know this is not true but is just a convenient statistical device. In fact, we at GMO know quite a bit more on this topic for we have studied more or less all assets for as long as we can find data and we have found a remarkable total of 330 “bubbles,” 36 of which we call “major, important bubbles,” which we define as 2-standard-deviation events, given the same assumption. Well, a 2-sigma event should occur every 44 years in a normally distributed world and they have occurred every 31 years. This is much closer to random than we had previously thought. Yes, financial asset data is fat-tailed; that is, there are more outlying events than are found in a normally distributed series, but they are not extremely fat-tailed. They show up as 2-sigma events but occur as often as 1.8-sigma events would occur in normal distributions. Extrapolating, we can assume that Bernanke’s 33⁄4-sigma housing bubble would occur, adjusted for our fat-tailed real-life history, not every 10,000 years, but somewhere more like 1 in 5,000 years! I previously used “a 1-in-1,200-year event” as a casually selected very large number to describe the 2006 housing bubble. But under challenge, these current numbers are more accurate. No, this does not mean we have 10,000 years of data or even 5,000. It is just statistics, full as always of assumptions, which in this case we hope approach rough justice. What it does definitely mean, though, is that it was extraordinarily unlikely that the extremely diversified U.S. housing market would shoot up like it did and, frankly, even more remarkable that Bernanke and his timid or incompetent advisors could miss it. This is a doubly amazing miss because his and Greenspan’s policy caused this bubble in the first place!) In comparison, his willingness to target an unrealistic 3% level for GDP growth is statistically a microscopic error, a picayune mistake. Unfortunately, though, in the hands of probably the most influential man in the global economic world, it is an extremely dangerous one. I like the analogy of the Fed beating a donkey (the 1% growing economy) for not being a horse (his 3% growing economy). I assume he keeps beating it until it either turns into a horse or drops dead from too much beating! Fine-tuning economic growth, an impossible job for the Fed anyway, is hardly likely to get any easier by badly overstating trend-line growth. It seems nearly certain, therefore, that the Fed will keep trying to whack the donkey for far too long. The likely consequences of this policy are, to be frank, over my head, but my colleague Edward Chancellor will address them briefly if I can nag him effectively.

Investment Implications

Courtesy of the above Fed policy, all global assets are once again becoming overpriced. This reminds me of the idea sometimes attributed to Einstein that a workable definition of madness is constantly repeating the same actions but expecting a different outcome! But, as always, asset prices are not uniformly overpriced: emerging markets and, we believe, Japan are only moderately overpriced. European stocks are also only a little expensive, but in today’s world are substantially more risky than normal. The great global franchise companies also seem only moderately overpriced. Forestry and farmland, which is not super-prime Midwestern, is also only moderately overpriced but comes with our nook and cranny sticker attached. But much of everything else is once again brutally overpriced. Notably, U.S. stocks (ex “quality”) now sell at a negative seven-year imputed return on our numbers and most global growth stocks are close to zero expected return. As for fixed income – fugetaboutit! Most of it has negative estimated returns on our data, and longer debt, as always, carries that risk that may be slight in any period, but is horrific if it occurs – accelerating inflation.

When one combines the apparent determination and influence of those who do the bullying with the career risk and short-termism of the bullied and the desire of the general public to believe unbelievable good news, these overpricings can go much further and the Fed can win another round or two. That’s the problem. A clue to timing would be when we begin to hear more passionate new era arguments: profit margins will always be higher; growth will snap back to 3% for the developed world; and new ones I can’t think of ... maybe “when the discount rate is this low the Dow should sell at, perhaps, 36,000.” In the meantime, prudent managers should be increasingly careful. Same ole, same ole.

What Will NY Traders Think Of Currency / Metals Rally?

ChuckButler — Mon, 26 Nov 2012 17:50:18 GMT

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In This Issue.

* Currency / metals trade flat.

* Yen halts slide. for now.

* Foreign Investors flock to China.

* Frank on the Fiscal Cliff.

And, Now, Today's Pfennig For Your Thoughts!

What Will NY Traders Think Of Currency / Metals Rally?

Good day. And a Marvelous Monday to you! I hope your Thanksgiving Day and weekend was grand. We began decorating the house inside and outside. I just love it this time of year, when the houses all get decorated, and lit up. The markets were open on Friday, and last night, so it's back to business as usual this week. Did you see the highlights of the football game in Miami yesterday? The water sprinklers started a cycle right in the middle of the game! Instead of having a play of the game, they had a "spray of the game". HAHAHAHAHAHA!

Well. The currencies and metals had a field day on Thursday in the foreign markets. It became very clear to me that the foreign traders are all about taking the dollar lower when there is no fear of a U.S. reversal. It also has become very clear to me that the U.S. market participants are fighting Big Ben Bernanke and the Fed Heads every step of the way. How so? Ahhh grasshopper. We should know by now that The Fed is in on the Gov't's wish to have a cheaper dollar in order to pay debts with cheaper dollars, and that's why they've carried out 3 rounds of Quantitative Easing (QE), one round of Operation Twist, have kept interest rates near zero for a very long time, and have stated that they will remain there for some time to come.. All these things have been done to weaken the dollar, but. the U.S. market participants (not me!) aren't letting that happen. Well, they've allowed a lot of it to happen the past 11 years, but. there's more work to be done. Just get a Fed Head on the Butler patio, and we'll get the truth! Oh, and I can. handle the truth!

So, the currencies and metals rallied on Thursday in the foreign markets and then attempted to hold on in Friday's sessions. Here in the U.S. on Friday, the senior traders all took the day off to make it a 4-day weekend in the Hamptons, and the junior boys and girls were left to trade, which meant "don't screw anything up!" And they didn't. there was some profit taking that happened, but other than that, the volume was Olive Oyl thin.

The overnight markets of Asia and Europe haven't really had any direction, as they all wait to see what their U.S. counterparts think about this currency and metals rally. If anything, the currencies and metals are weaker by a small margin this morning. For instance, Gold is down $4, as I write, and the euro is flat.. I'm actually a little surprised that the euro is flat and not getting hammered this morning, given the goings on with Greece this past weekend.

On Friday, it appeared that there would be an agreement on the measures of the latest bailout payment to Greece. But then this past weekend there was a story in the press regarding a Greek deal that didn't sound so much like a "given".. compared to what was being said on Friday. Putting uncertainty right smack dab in the middle of this trading session. And we should all know by now that the markets don't like "uncertainty". But. as I said, so far this morning, the euro has shrugged off this news and is trading flat on the day.

The Japanese yen halted it slide the past two trading sessions. I'm actually surprised a bit, for it looked as though the yen was ready for a nice long ride on the slippery slope. And it still is headed in that direction, but has paused for the cause. That's a good thing for investors looking for an exit door with yen. At least the exit doors haven't gotten overcrowded yet. But seeing the latest minutes by the Bank of Japan (BOJ) could send the crowds in that direction. The new members of the BOJ sounded very dovish, and proposed the wording changed in their statement, to reflect their dovish position. I don't know how the BOJ could make their current easing measures any more accommodating. But apparently the new members of the BOJ think so..

Well.. I've been telling you about the economic recovery in China for some time now. so I liked seeing a story on Reuters this past weekend about how foreign investors are flocking back to the Chinese economy and markets. They have pumped $4 Billion into Chinese equity funds in the past two months. The article quoted a few investment analysts who believe that China is a better value right now than it was 5 years ago, and undervalued VS the rest of Asia. Don't look at me and be confused. I told you China would recover faster than everyone else, because they had a treasure chest of reserves and the ability to direct where those funds for recovery would be spent. And that's exactly what's going on here.

The currency rally of late last week, pushed the Aussie dollar (A$) back above $1.04. this currency has gone back and forth through the $1.04 handle for a couple of months now. And Let me remind you that I told you that $1.04 seems to me to be a good value for the A$... There's not much in the way of data expected from Australia this week, except one report later in the week, so the A$ will struggle to hold on to $1.04.

In fact, I would think that the Thanksgiving Day rally in the currencies and metals will be on tenterhooks this week. Remember, the Fiscal Cliff is closer to us by one week, and there's been no word from D.C. of a deal to avert the Fiscal Cliff. Remember, what I told you about the Fiscal Cliff. that the markets are scared to death that it will bring about major problems for the U.S. economy and there could very well be a repeat of 2008, where investors flock to the so-called safe havens of dollars and Treasuries.

Two currencies that have been on my hit parade for some time now. Norwegian krone and Swedish krona continue to be tarred with the same brush as the euro. I'm concerned about the next Riksbank (Sweden) meeting in December, where I'm pretty sure we'll see another rate cut. And therefore, right now, I prefer Norway over Sweden. But, to me that's like saying I prefer one thing over another, but still like both! Sort of like me preferring one Beatles song over another.

I was reading an article by Vedran Vuk, who's taken the conn of David Galland's weekly letter while David relocates his family. Vedran is a smart cookie folks. and he had this title to his article, which I thought was very clever. "Even if Gold is Stupid, It's Still Smart". And then he goes about explaining how it's to everyone's preferences, and who's to judge the preferences of others? I liked his article very much, because it helps explain why there still millions of investors that don't own Gold.

Speaking of Gold. At $1,751, which is where it's trading right now as I write, it looks very expensive. But if you ask the 20 or so Gold analysts that write about Gold, the large majority of them would tell you that Gold is cheap compared to where they see it going. I don't know if Gold is going as high as some of the analysts say it will go. But, what I do know is that Gold is a store of value. I don't get all caught up in the price of Gold, except when the price manipulators take it down. I like it for its store of value and wealth.

The U.S. data cupboard gets caught up this week, and will have a truck-load of data to look starting today with some minor reports but heating up tomorrow . So, with no data anywhere today, it will be interesting to see how the senior traders here in the U.S. view the currency and metals rally from last week.

Then There Was This. I was delighted to see an email from my long time friend, and Big Boss, Frank Trotter yesterday. I told you that he's an excellent writer, and here's a treat for us. Frank's thoughts. "As both the fiscal cliff of legislation approaches and just the reality that fiscal policy needs to be dealt with, another potential is starting to creep out of hiding. We have long said that politicians have three alternatives when it comes to fiscal policy: 1) Cut spending and be run out of office; 2) raise taxes and be run out of office, or; 3) keep on the same pathway and plan to debase the currency so that debts can be paid back with money that has less purchasing power. Smart politicians have for many years selected door #3 creating the situation we have before us today. Now #4 may come into play.

One solution for national politicians has been used before but certainly has the potential to become the primary tool. Maintain current revenue policy and push the spending programs back onto state, provincial, and local governments. Hard liners on both sides can claim victory: no increase in taxes as and the deficit shrinks, no loss in benefits sustaining promises made. Instead of kicking the can down the road we'll see hot potato on rocket fuel. We'll see how this plays out but watch out for the shifting shell game." - Frank Trotter

Chuck again. I love it when Frank sends me notes for the Pfennig!

To recap. The currencies and metals rallied hard late last week, with the U.S. senior traders all out for a 4-day weekend. It will be interesting to see how the NY traders want to take this rally. The currencies and metals have drifted a little weaker overnight, as they wait to see the outcome too! The Japanese yen halted its ride on the slippery slope, but for how long? And foreign investors are flocking back to the Chinese economy and markets.

Currencies today 11/26/12. American Style: A$ $1.0440, kiwi .82.10, C$ $1.0065, euro 1.2960, sterling 1.60, Swiss $1.0760, . European Style: rand 8.8770, krone 5.6675, SEK 6.6330, forint 217.40, zloty 3.1710, koruna 19.51, RUB 31.01, yen 81.05, sing 1.2250, HKD 7.75, INR 55.72, China 6.2250, pesos 12.98, BRL 2.0775, Dollar Index 80.23, Oil $88, 10-year 1.66%, Silver $34.19, and Gold. $1, 751.00

That's it for today. Well. did you hear that J.R. Ewing died? Yes, Larry Hagman died this past weekend. Wasn't J.R. Ewing the guy you dislike, unless he's on your team? You bet! I remember a group of friends would all get together on Friday nights to watch Dallas. Pretty funny thinking about that now. Well, my beloved Missouri Tigers football team unmercifully ended their season on Saturday. I think the coach lost his team this year, as they appeared to be going through motions on Saturday. At least the basketball team is off to a good start! And I'm going crazy not seeing hockey on the TV. That's a shame that hockey will lose a ton of fans this year, just like they did the last time their season was wiped out by owner/ labor problems. Oh well, as someone that I love dearly says. "it's only a game". And thanks to Jerry, Alex and Kathy for a great job on getting the lights on the house yesterday! And with that. I thank you for reading the Pfennig, and hope you have a Marvelous Monday!

Chuck Butler

President

EverBank World Markets

1-800-926-4922

1-314-647-3837

The Economic Boom, Investing Potential Here Defies Gravity ...

TonySagami — Fri, 16 Nov 2012 19:13:00 GMT

I love Malaysia — its people, and the food. More importantly, it is a vibrant, growing country with some excellent investment opportunities. I’d like to share some of them with you today in this special report and video update from its capital city of Kuala Lumpur.

Malaysia, with almost 30 million citizens (that’s about the population of New York and Pennsylvania combined), is the 29th-largest economy in the world. It’s also the third-largest in Southeast Asia ... behind only Singapore and Indonesia.

And Malaysia is enjoying an economic boom that almost defies gravity. In the last quarter, the Malaysian economy grew by 5.4%.

Below is a short video I took in Malaysia. You’ll be able to get a look at Malaysia’s domestic consumer economy via a walk-through the Kuala Lumpur City Center, or KLCC Mall. You can see for yourself how prosperous a nation Malaysia really is.

Click on the image above to view it now.
Or if you prefer, here is a direct link.

Speaking of Prosperity ...

Much of Malaysia’s economic boom is fueled by the country’s rich abundance of natural resources — mainly tin, copper, timber, palm oil, rubber and oil.

In the screenshot above, you’ll see behind me the twin Petronas Towers. That’s the home office of Petronas, which is a state-owned oil company.

Petronas has the responsibility of managing ALL of Malaysia’s oil and natural-gas assets. And depending upon what ranking you follow, it is somewhere between the 70th- to 90th-largest company in the world.

Petronas is so large, in fact, that it occupies 100% of one of the towers behind me.

There is so much oil in Malaysia that Petronas provides 40% of the government’s TOTAL revenues in the form of a special dividend.

Think about that. That would be like the U.S. government owning ExxonMobil (XOM) and getting a whopping 40% of total revenues from one single company.

That would solve our budget woes right away, wouldn’t it?

But Petronas is just one piece of Malaysia’s very healthy economy.

Asian Tiger No. 5?

You might have heard of the four roaring “Asian Tiger” economies — Singapore, South Korea, Hong Kong and Taiwan. Malaysia, which is ranked 12th in the World Bank’s Ease of Doing Business index for 2013 (up from 14 in 2012), is sometimes called the fifth Asian Tiger. Here’s why ...

In October, the Asian Development Bank raised its forecast for Malaysia’s GDP from 4% to 4.6%, despite cutting its overall forecast for the rest of developing Asia, largely on the strength of its export industry.

Malaysia has achieved 14 continuous years of trade surplus, and nearly 70% of those exports go to its Asian neighbors. This makes it fairly immune from the problems in Europe and the U.S. In fact, only 8.3% of Malaysia’s exports are to the United States.

The country has grown to be quite prosperous. Its per-capita GDP is $15,600 per person. To give that some perspective, the per-capita GDP in China is $8,500 and $11,700 for Brazil.

The ONLY Asian countries with higher per-capita GDP numbers are Singapore, Japan and Korea.

As you can imagine, rising prosperity here is translating into consumer spending and strong retail sales.

Keep a Close Eye on These Consumers

In my service The Asian Century, I show subscribers how to make money from the powerful buying patterns of the Asian consumer. And in Malaysia, consumers are also doing their part to this insatiable consumption beast.

Here’s one good reason why you want to watch this group. The Malaysian government is providing incentives to keep its domestic economy humming. For example, the pending 2013 budget proposal even includes a $65 rebate for 1.5 million of its low-income citizens to purchase smartphones.

However, the real opportunity for investors right now is with the existing Asian buying class.

As they earn bigger paychecks and consume more products ... many of which are made (or designed) here in the United States ... they are providing huge profit opportunities right here on the U.S. exchanges.

In fact, my subscribers just grabbed up to a 66% gain in three weeks in an option play on a U.S. beverage maker, plus up to an 18% return on an Asia-based casino stock in just about eight weeks.

To see why I call this The Asian Century, and to find out how you can get on board my next play on this prosperous — and potentially profit-making — consumer class, simply click here now.

Best wishes,

Tony

The Quest for Certainty

JohnMauldin — Mon, 29 Oct 2012 17:34:00 GMT

The Problem with Dynamic Condition-Dependent Multipliers
Measuring GDP
The Economics of Assumptions
Investing in an Uncertain World
South America, New York, North Dakota, and Greece?

“As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”

– Albert Einstein

“To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear …"

– Friedrich Nietzsche

“Very few beings really seek knowledge in this world. Mortal or immortal, few really ask. On the contrary, they try to wring from the unknown the answers they have already shaped in their own minds – justifications, confirmations, forms of consolation without which they can't go on. To really ask is to open the door to the whirlwind. The answer may annihilate the question and the questioner.”

– Anne Rice, The Vampire Lestat

The last two weeks we have been looking at the problems with models. First we touched on what I called the Economic Singularity. In physics a singularity is where the mathematical models no longer work. For example, models based on the physics of relativity no longer work if one gets too close to a black hole. If we think of too much debt as a black hole of sorts, we may understand why economic models no longer work. Last week, in “The Perils of Fiscal Cliff,” we looked at the use of fiscal multipliers by economists in order to argue for or against governmental economic policies. Do you argue for austerity, or against it? There is a model that will support your case, most likely using the same data that your adversary uses.

These letters have generated a great deal of positive response and conversation. While I very rarely suggest to readers to go back and read previous letters, but reading these may help you appreciate why it is so difficult to understand what is happening in the global economy today.

This week, in a somewhat shorter letter, we once again consider the vagaries of measurements and models. Growth of the US economy, we are told, was 2% last quarter. That number will of course be revised, but what is it we are measuring? Should we attach any importance to the measurement at all? The short answer to the last question is yes, but it is important to understand that there is no certainty in that number. Or at least not any certainty according to the generally accepted meaning of that word.

The Problem with Dynamic Condition-Dependent Multipliers

I use the above subhead with a great deal of irony. I garnered that phrase from a rather insightful letter from my friend Rob Arnott (founder of Research Affiliates, whose brilliant work is used to manage over $100 billion). I am going to start this week’s Thoughts from the Frontline with his letter, with my comments inserted in brackets [and italicized]. He was responding to last week’s letter on the problem with economic forecasts. Incidentally, Rob and his family spent five days in Italy with me this summer. There were many late-night discussions (and lunchs and dinners) about this topic.

“Most fiscal multiplier data is simplistic, trying to convert dynamic condition-dependent multipliers into static multipliers [i.e., if you adopt this tax cut or that spending increase you will have a very specific effect on the economy]. Why? Because that makes economics, economic forecasting, and policy prescriptions pretty simple and easy to explain to reasonably intelligent people. In so doing, ignore the impact of:

the starting levels of debt, magnitude of deficits, rate of change of demography

[This is important and at the root of Economic Singularity. If you start with massive debt, as the Greeks or Spanish have, stimulus spending has much less effect than if you have a very small debt. There is a significant difference between the economic policies of Japan and Brazil, for instance, because of the age of their populations. What works in one country may be counterproductive in the other.]

different multipliers between taxes and spending, and between increases or cuts in either [The academic literature suggests that there is a clear difference between the effects of income taxes and consumption taxes on the economy. Trying to use a one-size-fits-all multiplier on taxes or spending is bad economics. Much easier, of course.]
differential multipliers for temporary vs permanent tax changes (the mythical temporary tax cut and its famously useless multiplier)
different multipliers for categories of fiscal stimulus (bridge to nowhere – bad; repair creaking bridge between economic centers before they collapse – better)
the effects that employment policy choices can have on the fiscal multiplier (i.e., let’s not forget the role of the private sector!).

“Move away from a static multiplier, and there are so many possibilities.

“Most of the factors that affect multipliers are not easily controlled by government; and most changes inflict pain before they deliver their promised benefits. Reciprocally, changes that deliver immediate benefit carry a daunting long-term price tag.

“Consider the vicious cycle embedded in fiscal multipliers. If aggregate tax rates are 50% (between income and VAT and property taxes, not to mention regional or city taxes) in most of Europe today, a multiplier of 2 creates infinite feedback [which brings us to a Point of Economic Singularity where the models will produce silly results, so economists just assume away any such condition].

“… in such a world, you could boost taxes by 1% of GDP and watch GDP drop 2%, producing no more tax revenue than before; rinse and repeat, until you’re beyond Greece. At Hollande’s 75% rate (80% if the wealthy actually spend anything and incur VAT), you hit this cycle if the multiplier is 1.25. And will the multiplier be affected by tax-rate levels? Of course. Higher taxes strangle the private sector so that the multiplier for incremental change in tax rates will increase. [Note: Rob is not arguing for the use of the specific multiplier, just pointing out that a single-variable multiplier can seriously distort the models.]

“The right answer is to not get into this mess to begin with. After we’ve blundered into this situation, the predictable political reaction seems to be, ‘I can’t inflict pain on my watch. Every pain must be immediately rewarded by gain.’ With a dearth of useful alternative ideas, this leads to the ‘kicking the can’ nonsense, which makes the eventual implosion far worse.

“The right answer, once we’re already on the gurney, needing glucose to stay alive, but needing to shed the consequences of past glucose overdose, is only a little more subtle. First, we adopt the Hippocratic Oath: ‘First, do no harm.’ E.g., do nothing that carries lasting consequences that might exceed the near-term benefits.

“So, what are the possibilities?

One thing is to try to understand dynamic condition-dependent multipliers, even roughly, over multiple time spans. As the economics profession seeks simple models that can win Nobel Prizes, they’ve let us down by doing far too little of the work on condition-dependency or horizon-dependency.
Absent convincing models on the multipliers, do not dismiss common sense! Would borrowing and spending another $10 trillion produce a positive multiplier for next year? Of course. Over five years? Of course not. It’s no different from a family that boosts the GFP (Gross Family Product … i.e., family run-rate consumption) by buying a car they can’t afford. Would stimulus diverted to pork projects boost near-term GDP more or less than long-term debt? The latter is pretty obviously the correct answer. It’s no different from a family deciding to buy bling rather than upgrading to a more reliable commuter car. Common sense trumps mathematical models, every time.
Apportion austerity *and* stimulus, short-term pain and gain, in measures that deliver maximum deficit reduction, ideally without deep recession. E.g., stimulus spending has an okay short-term multiplier, but it almost always delivers more long-term debt than near-term economic stimulus; spending cuts reverse this effect at a cost of near-term recession. Tax hikes, if perceived as permanent (they usually are), have a terrible long-term multiplier; tax cuts reverse this … unless the bond market is spooked by default risk.

“Liberalizing private sector labor laws is very underrated, because we have attached such a deeply ingrained [public sense of what is “right” and “fair”]: [Labor laws] have a vast multiplier whenever regulation actively discourages new job creation, as is true throughout the developed world. Get rid of the minimum wage? How dare you?!?! But, suppose it’s replaced with a negative income tax that allows flat rates at all income levels. In effect, we’re replacing a regulatory minimum wage, imposed on employers and discouraging employment, with public funding of a minimum wage, supplanting much of the public welfare bureaucracy. [This is one of Rob’s more interesting proposals and would go a long way towards alleviating youth unemployment, a topic near and dear to this Dad’s heart. If you can hire a teenager for relatively little cost, you can give them a job and training that will make them more productive later in life.]

This means we can combine a high-multiplier positive policy choice, delivering immediate positive GDP gains, before (perhaps mere weeks before) instituting a lower-multiplier adverse policy choice, like cutting public spending, that has known long-term benefits at a cost of short-term pain. The combination can offer goldilocks outcomes. [Or, what Rob might not argue, raise taxes while cutting spending in a compromise to control the deficit.]

“None of this happens without clear leadership at the top. While my libertarian political leanings are well-known, there’s catnip in the sensible solution for both parties. But, I doubt any of this will happen in time. We ‘hire’ our political leadership for their perceived ability to respond well to crises, not to anticipate and avert crises. Why would I say this? Because averting crises usually requires short-term pain for long-term gain. And no politician who deliberately imposes pain, successfully deflecting a crisis, will ever get credit for the success. Why? Because no one ever sees the crisis that didn’t happen!”

It is here that I am more optimistic than Rob; and as my friend Newt Gingrich emphasized when he sat in on some of those late-night sessions in Tuscany, most politicians on all sides of this debate recognize the sheer magnitude of the disaster that it would be to avoid dealing with the deficit in what has now come to be the near term. Admittedly, they have different solutions, but they recognize the problem (note that I said most politicians – certainly not all). While Rob is right that no politician can run on a platform of cutting the things you like and raising taxes, if we’re not prepared to do something very much like that in the first part of 2013, the Fiscal Cliff we talk about will seem like merely stepping off a curb, compared to what comes next.

Measuring GDP

We will circle back to this discussion in a minute, but let’s visit this week’s announcement that GDP rose by 2% in the last quarter, up from 1.3% in the second quarter, which itself ended up being revised down almost 2% from the initial estimate. My guess is that we will see the same downward revisions over the next few months, as the other economic data last quarter was not robust. But clearly, we are not in a recession, just a Muddle Through Economy, as predicted here.

A 2% number is not bad, but there is more to it when you look at the underlying components. A large factor in the quarterly growth was defense spending, which leapt by a quite robust 13%. Personal consumption was up just 2%. Then there is inflation. If you think inflation was 2%, then the GDP number is overstated by 0.5%. Couple that with normal defense spending, and growth would have been less than 1%. That would not have been a political winner.

Inflation can be measured in several ways. GDP data does not use the Consumer Price Index, which shows inflation of more than 2%. You can get a much different GDP depending on what inflation number you use, and those numbers are dependent on what assumptions you make about how to figure inflation.

And while we all seem to use GDP, is that really the measure that makes the most sense in today’s world? Might we be better off targeting Gross Domestic Income, rather than looking at a consumption-based number like GDP? And isn’t Gross Private Production what we really need, rather than just an indicator that includes changes in government spending? At the end of the day, government spending can only be a function of what is produced in the private sector.

The Economics of Assumptions

We all want to have numbers that are “real.” But economics is different from accounting. Economics makes assumptions in almost all of the models it uses, and those assumptions come with biases. How many discussions do we get into that proceed along the lines of:

“Look at this statistic. It clearly goes up [or down] with GDP [or employment or…]. Therefore, if we could just fix ‘X,’ we would solve the world’s problems.”

For instance, I can clearly demonstrate to you that raising taxes on the rich will have no effect on their spending, if I use just one or two correlations in certain time frames. Throw in a few good stories, and the obvious conclusion is that we should raise taxes on the rich again and again. Just ask Monsieur Hollande – it’s their fair share.

Then I can just as easily show you that raising taxes on the rich will result in serious economic calamity. “Just see what it did in this situation. And see what cutting taxes did there.”

The counterargument then runs that your interpretation misses some other factor, so your conclusion is wrong. And so on and on. This goes back to the quote from Anne Rice at the beginning of the letter. While her character was talking about another form of knowledge, the observation applies doubly to economics. Here it is again:

Human beings seek certainty. We actually get an endorphin rush when we get an explanation for something we do not understand. Whether it’s religion, politics, philosophy, a crossword puzzle, or economics, we want to be able to come to a definite conclusion that we think is correct. There is psychological rest in certainty, along with the physiological rewards). Models, even flawed ones, give us the illusion of certainty. We need to be careful of what illusions we cling to.

Economics becomes quite a problematic discipline when it tries to create mathematical models that are supposed to guide political philosophy and praxis. So many assumptions have to be made to get to a result, that basing policy on a simplistic model is dangerous.

One size does not fit all, and past performance really does not indicate future results. The entire economic environment must be taken into consideration. We cannot extrapolate simplistically from the Reagan or Clinton years and say, “If we just reverted to those policies, we could get the same results.” Only if you could change all the other variables that are beyond the control of the government!

Models can be useful, but they are not exact. They give us a sense of direction. Using them is more like navigating by the North Star than using a GPS system. The more variables that enter into the actual situation, the less likely we are to be able to come up with that one “easy-button” policy prescription.

In the end, the only real tool we are left with is common sense, guided by our models and an appreciation of history. We “know” that, in general, the lower the price the higher the demand. If you tax something, you will get less of it.

We get that we can’t let financial institutions run amok. There have to be some protections for the public. Debt is useful until it becomes a burden, and we have to be careful in how we use it. We can come up with dozens of such truisms, based on common-sense wisdom.

We elect politicians and then expect that somehow the world will improve in accordance with their promises. What we really need to do is try to see what general direction they are leading us in and base our votes and our personal decisions on whether we like that direction. But to trust an economist, or even worse a politician, with a model? That can be dangerous.

Let’s close with a quote from my favorite central banker, Richard Fisher, who is president of the Dallas Federal Reserve.

“It will come as no surprise to those who know me that I did not argue in favor of additional monetary accommodation during our meetings last week. I have repeatedly made it clear, in internal FOMC deliberations and in public speeches, that I believe that with each program we undertake to venture further in that direction, we are sailing deeper into uncharted waters. We are blessed at the Fed with sophisticated econometric models and superb analysts. We can easily conjure up plausible theories as to what we will do when it comes to our next tack or eventually reversing course. The truth, however, is that nobody on the committee, nor on our staffs at the Board of Governors and the 12 Banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody – in fact, no central bank anywhere on the planet – has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank – not, at least, the Federal Reserve – has ever been on this cruise before.”

We indeed have not been on this cruise before as a nation and as a world. We know what happens when one country or another runs up against the limits of borrowing power. But when the bulk of the developed world does? Another cruise, indeed.

Investing in an Uncertain World

I’ve been writing about the virtues of absolute-return investment vehicles, such as hedge funds, for years. Markets continue to remain uncertain, and investors are increasingly seeking ways to achieve more consistent returns but with less downside risk. Equities still represent the greatest potential for long-term outperformance over bonds and cash; yet the road looks bumpy, and most investors tend to be biased toward long-only equity. Offsetting some of that long-only exposure with a long/short equity strategy may potentially help create greater risk-adjusted returns – or, in other words, help create a smoother path.

The long/short equity strategy is one of the oldest and most popular hedge fund strategies, in terms of quantity of assets under management. The strategy has attractive characteristics over traditional long-only equity approaches, including the potential ability to capture a significant portion of the equity upside while minimizing drawdowns and protect capital. Equity long/short is also a highly opportunistic, liquid, and transparent strategy that makes it appealing to many. My partners at Altegris have recently written a paper on the long/short equity strategy, “Long Short Equity: Opportunism in the Best Sense of the Word.” The paper provides a terrific overview of the long/short equity strategy – how the strategy works, what the potential portfolio benefits are and, most importantly, what investors need to look out for when assessing long/short equity fund managers. The crux of the long/short equity strategy is that, while it seems intuitive to investors, it requires a highly skilled, well-disciplined manager.

To learn more about long/short equity, all you need to do is fill out a very simple form at the Altegris L/S Equity Website to access the new Altegris paper. For my readers that are financial professionals, this is great paper to share with your clients.

South America, New York, North Dakota, and Greece?

I am off to Brazil in ten minutes, as I finish this on my iPad aboard the plane. After Brazil I’m on to Uruguay and Argentina, on a speaking tour with my South American partner, Enrique Fynn, who will also let me have a day trip for some fun in Uruguay. And then I get to spend five days with my partners at Mauldin Economics, David Galland and Olivier Garret, at the resort they have developed with Doug Casey (and others) in northern Argentina. I hope to relax a little while there and get some pleasure reading done.

When I am back I will go to NYC, where we will do the Post-Election Summit Conference with some of my really smart friends, and try to figure out what we can learn about the next few years from this election. Nothing certain, you understand, but we will try to get the direction right.

I got to spend some quality time this weekend with Gary Sanchez, my good friend and dentist, who is from Albuquerque. Really thoughtful guy and quite the inventor. Among other things, he designed the chair I sit on when in my Dallas office, and which has really helped my back. It is one of the things I really miss when on the road. If you sit as much as I do and are looking for a great chair, you might check it out, here.

I was talking with Dylan Grice of Societe Generale this week, and he had just been to Greece. We decided that we might try to visit Greece together in January, on the tail end of my trip to Scandinavia for a speaking tour for Skagen Funds. It has been decades since I have been to Greece, and I would like to see what is really happening on the ground, rather than just hearing secondhand. It is a thought, anyway.

Speaking of endorphin rushes, I get one each time I hit the send button; but I have never finished while sitting on a plane about to take off – until right now. So I will trust that Charley and the team at Mauldin Ecnomics will clean this up and get it to you first thing Monday, while I read and try to get some sleep on the night flight to Sao Paulo.

Have a great week. I know I will.

Your comfortable with being uncertain analyst,

John Mauldin

subscribers@mauldineconomics.com

Will Investors Oust Obama? 4 Predictions for a Romney Victory

TonySagami — Fri, 12 Oct 2012 17:07:00 GMT

Will the incumbent or the challenger take the nation’s top title just 28 days from today?

Whatever the outcome, you have access to a number of ways to guard and, more importantly, enhance your prosperity. Today I’d like to start exploring what we might be able to expect with one of those outcomes by sharing four predictions for the stock market, the fiscal cliff crisis, taxes and the national debt.

Best wishes,

Tony

P.S. On Nov. 7, you can know EXACTLY where to invest your wealth based on who occupies the White House for the next four years. That’s the day we’ll be delivering our brand-new “Election Day Survival and Prosperity Guide” — tailored specifically to the election’s outcome.

This post-election profit guide is filled with a presidential-focused batch of potential money-doublers designed for either a Romney or an Obama win. You don’t need to wait till the elections are over — you’ll be covered either way when you reserve your copy today!

Into the Matrix

JohnMauldin — Sat, 07 Jul 2012 16:45:00 GMT

High P/E, Low Returns
Deflation
Into the Matrix
Conclusion, Again
Home Again, New York, Singapore, and Back to Newport

(Bull's Eye Investing Ten Years Later, cont.)

What does the current environment of earnings and valuations tell us about the prospects for the US stock markets in general over the next 3-5-7-10 years? This week we have part two of "Bull's Eye Investing Ten Years Later," which we started last week. These two letters have been co-authored with Ed Easterling of Crestmont Research. We take a look at research we did almost ten years ago as part of my book Bull's Eye Investing,updating the data and asking,"Are we there yet? When will we get to the end of the secular bear market?" We will start with a few paragraphs from last week's letter and then move right along.

High P/E, Low Returns

In Bull's Eye Investing we explained that high market valuations (P/E) necessarily drive low long-term returns. This occurs because periods that start with high P/Es often end with lower P/Es, eating away at returns. Further, high-P/E periods have low dividend yields. As a result, we could write with confidence nine years ago that subsequent returns would be well below average.

In all cases, throughout the years, the level of returns correlates very highly to the trend in the market's P/E ratio. The P/E ratio is the measure of valuation as reflected by the relationship between the prices paid per share to the earnings per share (EPS). Higher returns are associated with periods during which the P/E ratio increased and lower or negative returns resulted from periods during which the P/E ratio declined.

This may be the single most important investment insight you will get from this book. When P/E ratios are rising, the saying that a "rising tide lifts all boats" has been historically true. When P/Es are dropping, stock market investing is tricky; index investing is an experiment in futility. As we will see in later chapters, in these secular bear market periods, successful stock market investing requires a far different (and sometimes opposite) set of skills and techniques than is required in bull markets....

Given the current and recent level of P/Es, the prospects are not encouraging for general market gains (the emphasis is on general or index funds) over the next two decades. This dismal outlook is not from some congenital bear perspective; it corresponds to the series of factors driving the current secular bear market.

Although P/E has declined over the past nine years, from 26 to near 20 (using the Shiller method), stock market valuation remains relatively high. Almost everything in chapters five and six of Bull's Eye Investing remains true today. The market has chopped around with fairly typical volatility. P/E is in the lower end of the red zone rather than above it. Most importantly, currently high valuations portend low returns from here.

How low? That depends upon the outlook for deflation or higher inflation.

Our crystal balls are showing us different things on that question, although our fundamental conclusions are the same. Ed sees moderate probabilities for either higher inflation or deflation. On his optimistic side, he even allows for the prospect of continued price stability for quite some time. John, however, sees flashing danger signs of upcoming deflationary pulses, to be followed later by higher inflation. He outlined his reasoning in Endgame.

So, together, we have several scenarios. We have some side bets as to who will be right; but more importantly for you, none of the outcomes deliver good overall equity market returns, because we are still at a relatively high P/E.

By the way, neither one of us really expected inflation to stay relatively close to price stability for this long. It was clearly a possibility, but one without precedent. Yet we also knew that such historically good news would not provide good returns. The fundamentals of high valuations don't allow it.

What does the current situation tell us about the economic hazards and risk in today's stock market?

Currently, inflation is near levels of price stability. There are three potential scenarios: it can be expected to rise, to fall, or to remain constant over the next decade or two. History suggests that if inflation rises or if it falls into deflation, P/Es will fall and thus stock market returns will be disappointing, perhaps significantly so if you are expecting 9 percent compound growth in order to be able to retire in 10 years.

If inflation remains constant at near the 1 to 2 percent level for a decade, it will be unprecedented. Look at [the first chart, Secular Markets Profile] again. See if you can find a period of stable, low inflation. [Actually, don't waste your time.]

Even if inflation remained constant at current levels, the expected return from stocks over the next decade given the current P/E valuation levels would be dismal.

If history once again repeats itself, the cycles will lead to a lackluster period of a decade or two, then a period of solid and consistent gains. Oh, to be young again! The graduating classes of today will be matriculating into investment adulthood near the expected start of the next secular bull market. In the meanwhile, many will struggle with hopeful periods followed by great disappointment.

(I should note that Ed is younger than I am, but I for one do expect to be investing and writing at the beginning of the next bull cycle and have every intention of living through at least another few cycles. –John)

During these periods, the traditional sources of investment information will go on touting the next, just-about-to-break wave of hope. It will be useful to keep in mind their built-in biases. If the weather reports were being supplied by sunglasses manufacturers, would you not be wise to be skeptical?

Deflation

One of the key insights from Bull's Eye Investing is that both deflation and inflation are bad for stock market valuations. Both conditions have a negative effect on P/E. Past secular bear markets ended only when the run of deflation or high inflation turned back toward the low inflation of price stability. The impact of the inflation rate on P/E is highlighted in Crestmont's "Y Curve Effect."

In Bull's Eye Investing, we explained:

In the past 50 years, the financial markets have known only inflation and could hardly conceive of deflation in well managed economies. For much of that period, the Fed has sought to slay the inflation dragon – ever mindful in its monetary policy that inflation seemed to be a one-way force. Like gravity or the accelerator of a car, the laws of economic nature seemed only to know acceleration. The Fed's tool kit included techniques of restraint, brakes on inflation.

"Deflation" is a broad-based decline in general prices over time that results from a decrease in the quantity of money in relation to the available goods. It generally is known to occur when there is a general money supply contraction. Deflation can often occur following a period of excess supply or capacity beyond demand with a pervasive psychology of delayed spending or due to economy-wide debt reduction (or debt destruction). This digression onto deflation is important because the laws of financial gravity pull in an opposite direction once an economy crosses the threshold of zero….

The Fed's primary tool to reduce the spread of inflation is to reduce the supply of money, generally by making money more expensive. One way that the Fed can discourage money growth is to raise interest rates. To stimulate the economy, the Fed eases off of the brake and allows the money supply to grow. This is often accomplished by lowering interest rates to stimulate the demand for (and supply of) money. However, since investors, consumers, and business can step aside when interest rates get to zero by staying in cash, interest rates generally cannot go negative.

As a result, near the point of the inflation/deflation threshold, interest rates stop working to control money growth. Beyond lower interest rates, the impact of deflation on an economy can be debilitating. As demand slows, production declines, unemployment increases, monetary velocity decreases, and a general malaise overtakes the economy. Deflation does not need to cause a depression, though it does create a drag on the economy. As a result, earnings suffer and the future outlook is less certain with little control available to the Fed to restore the economy to a more healthy state.

Furthermore, the market does not receive the benefit of a continuously increasing P/E ratio as interest rates further decline while inflation nears zero. As the prospect of the cliff nears, valuations begin to suffer. Once the day turns to night and the deflation goblins are running amuck, P/Es start falling like a boat anchor toward levels generally reached in periods of high inflation and interest rates….

As inflation moves toward high positive or significant negative levels, P/E ratios are predominantly depressed. In other words, as prices move away from price stability (the fork in the Y), P/E ratios decline. As inflation or deflation trends back toward a condition of relative price stability, near one percent inflation, P/E ratios expand.

Again bear in mind: An environment of deflation will present very low interest rates– yet the low interest rates will not produce high P/E ratios. There will be a point as the economy is sliding into deflation that interest rates will continue falling, yet P/E ratios, as if they sense the inevitable, will begin to fall as well.

The Y Curve Effect is consistent with modern financial principles relating to stock market valuation, specifically the dividend discount model and its variations. The model asserts that the value of a stock today is equal to the price that an investor would pay to receive the future earnings and to realize a certain rate of return. As a result, the current earnings and future growth are discounted at a specified rate of return. As interest rates decline, the discount rate declines, and a higher value results.

That being said, however, in periods of deflation, future earnings may be expected to decline. Therefore, even though interest rates and discount rates are low, higher levels of deflation depress the expected future earnings. This gets discounted into the price and the result is a lower valuation and lower P/E ratio. As depicted by the scatter plot diagram [above], the Y Curve Effect does not indicate a specific level at which the impact of deflation overtakes the impact of lower interest rates on the P/E ratio. Nonetheless, this is a powerful, counter-intuitive force to consider in low interest rate and potential deflationary environments.

There weren't many analysts writing or talking about deflation back then. There were still fewer, if any, so extensively applying it to stock market valuations. Nine years later, after getting close to deflation several years ago, we are again likely to confront that risk. This time (John, especially, thinks), we may succumb to its evil force. The result will be lower P/Es and significant market declines. This would certainly cause the secular bear market to accelerate toward its end. Past secular bears did not end until P/E fell below 10. There is no reason to think that this secular bear will be any different.

Into the Matrix

Readers of the hardcover edition of Bull's Eye Investing will remember that it included addition unique to investment books. In chapter five readers found a full-color, three-leaf pullout of one of Crestmont's most-recognized charts. The Matrix is a colorfully insightful mosaic of more than 5,000 historical investment periods over the past century. It presents the returns and more for every starting year and ending year since 1900.

The most powerful aspect of the Matrix is its ability to highlight the pockets of above-average and below-average returns for investors with decades-long horizons, while also demonstrating the calm, long-term average available only to investors with century-long horizons. When Bull's Eye Investing was published, the early signs of a secular bear were just appearing on the edge of the chart. With the Matrix now updated with nine more years of results, it's becoming clear that this may be one of the worst periods of stock market returns.

Let's take a moment to explain the layout of the chart. There are three columns of numbers down the left-hand side of the chart and three rows of numbers across the top of the chart. The column and row closest to the main chart reflect every year from 1900 through 2002. The column on the left side serves as our start year and the row on the top represents the ending year. The top row has been abbreviated to the last two numbers of the year, due to space constraints. Therefore, if you want to know the annual compounded return from 1950 to 1973, look for the row with the year 1950 on the left and look for the intersecting column labeled "73" (for 1973). The result on the version titled "Taxpayer Nominal" is 8, reflecting an annual compounded return of 8 percent over that 23-year period. Looking out another nine years, the return for 32 years drops to 6 percent after tax. (Note: Crestmont revised the Matrix to include lower transaction costs after 1975; thus, the updated Matrix reflects a 7-percent return for the 32 years). If we were to use "Taxpayer Real" for the same period, returns would drop to 2 percent. Also, there is a thin black diagonal line going from top right to lower left. This line shows you what the returns are 20 years after an initial investment. This will help you see what returns have been over the "long run" of 20 years.

Also note: the return number for the above example appears in a cell that is shaded light green. The color of the cell represents the level of the return. If the annual return is less than 0 percent, the cell is shaded red. When the return is between 0 percent and 3 percent, the shading is pink. Blue is used for the range 3 percent to 7 percent, light green when the returns are between 7 percent and 10 percent, and dark green for annual returns in excess of 10 percent. This enables us to look at the big picture. While long-term returns tend to be shaded blue, shorter-term periods use all of the colors.

Additionally, some of the numbers are presented in white, while others are black. If the P/E ratio for the ending year is higher than the P/E for the starting year – that is, if the P/E ratio was rising– the number is black. For falling P/E ratios, the color is white. In general, red and pink return cells most often have white numbers, and the greens and blues have black numbers. The P/E ratio for each year is presented along the left side and along the top of the chart.

This theme of rising and falling P/E ratios and the corresponding rise and fall of the stock market is one we are going to return to again and again. If you can understand this dynamic, you will be far ahead of most investors in the race to a comfortable retirement.

Finally, there is additional data included on the chart. On the left side of the chart, note the middle column of numbers. And across the top of the chart note the middle row. Both series represent the index values for each year. They are used to calculate the compounded return from the start year to the end year. Along the bottom of the chart, Crestmont included the index value, dividend yield, inflation (Consumer Price Index), real GDP, nominal GDP, and the 10-year annual compounded average for both GDP measures. For the index value, keep in mind that the S&P 500 Index value for each year represents the average across all trading days of the year.

Down the right side, there's an arbitrary list of developments for each of the past 103 years. In compiling the list of historical milestones, it was quite interesting to reflect upon the past century and recall that the gurus of the 1990s actually believed that we were in a "new economy" era. Looking at the historical events, it could be argued that almost every period had reason to be called a "new economy." But that's an argument for another day.

For perspective, here's a small image of the version of the Matrix that was included in the book. The full-sized image of "Taxpayer Nominal" (and all other versions) can be found on the Crestmont Research website, at http://www.crestmontresearch.com/stock-matrix-options/.

First, don't try to read the numbers in the image below. Instead, treat it like a Magic Eye chart. Just look at the color pattern. You will note that the pockets of reds and greens along the center horizon reflect high- and low-return periods. In Bull's Eye Investing, the lower right-hand corner of the chart included only the first two columns of red. The addition of nine more columns makes it clear that this is a significant secular bear. Given current valuations and expected future returns, we're likely to see a lot more red columns before the secular bear ends. The observations from Bull's Eye Investing remain true today.

Quoting from the book:

As we consider the story that the matrix begins to tell, several observations are initially apparent. There are clear patterns of returns relating to the secular bull and secular bear cycles. The periods of red and pink alternate with periods of blue and green. Once the new period starts, it tends to persist for long periods of time. Though the very long-term returns have been positive and near average, investment horizons of 10 years, 20 years, and even longer aren't long enough to ensure positive or acceptable returns.

Note also that we've recently completed the longest run of green years in the past century. Though we've had a couple of down (red) years lately, it has hardly helped to restore the long-term average to "average." We have quite a distance to go to complete what the mathematicians refer to as "regressing to the mean." As you look back over the past 100 years, there has never been a period where "the "red bear" stopped after a few short years and morphed into a "green bull."

Secondly, when you look at the "Taxpayer Nominal" chart, you will notice that the returns tend to be in the 5 to 7 percent range [only!] after long [again, repeat the word long several times] periods of time. Often nominal returns are 5 percent or less over multiple decades. Again, the charts clearly show the most important thing you can do to positively affect your long term returns is to begin investing in times of low P/E ratios.

Conclusion, Again

We concluded chapter six with a summary section titled "What Does It Mean?" It was definitive. We did not pull our punches and did not hesitate to be specific about the environment in front of us. Low returns, slow growth, and declining P/Es – they have all happened, but they are not over.

As we've discussed here through charts and writings, the current P/E for the stock market is near the level where all previous secular bears started. Since the inflation rate did not diverge far from price stability over the past nine years, we made only minor progress on the P/E path toward lower levels. We have clearly been in secular-bear waters, nonetheless. This also means that our expectation of a "decade or more" of secular bear conditions was not overstated. When I wrote Bull's Eye Investing, the P/E level was still high, after the decline of the early 2000s. It was still so high that the magnitude and/or the duration of this secular bear were destined to set records. We concluded:

For the past two chapters, we've considered statistical, cyclical, and fundamental reasons that stock market returns are likely to be less than average over the next decade or more. However, a sharper near-term retreat could hasten the next cycle. The confluence of factors that produced the historic secular bull market of the 1980s and 1990s is now positioned to leave few options for consistent near-term returns.

What we are saying is that P/E ratios are going lower–potentially much lower than current ratios. This can happen by either the market moving sideways for a long period of time as earnings growth catches up or a drop in prices to where P/E ratios are consistent with a secular bear market cycle bottom.

If inflation returns and interest rates rise, P/E ratios will trend downward. If deflation takes hold and economic malaise results, P/E ratios will also tend downward. Even if inflation and interest rates remain low and stable, the growth rate in the economy and earnings is likely to be below average, as we remain in the Muddle Through Economy for an extended period of time. This would mean that the market could move sideways for a considerable period of time waiting for earnings to catch up.

In each of these instances, especially given the existing high P/E ratio of the stock market, returns from equities can be expected to be below average or negative for many years. This is consistent with the bull and bear secular market analysis detailed in the previous chapter. As well, the environment will be volatile and choppy, consistent with the profile of secular bear markets.

Sadly, the period of low or no returns is not likely to be over soon. P/E has a long way to decline before the end of this secular bear. We can get to the lower P/E ratios that typify the end of a secular bear market and the beginning of a secular bull market by either going sideways (with lots of volatility) for a long time, while earnings continue to rise, or we can see a serious collapse of the price of stocks in a short cyclical bear market. While we suspect the former is more likely, given the various crises afoot in the world and a US government that has the potential to not respond correctly, a serious cyclical bear market cannot be ruled out.

Either way, the next few years or perhaps the entire next decade will be frustrating for investors, as the market continues its rollercoaster ride to nowhere. And given the correlation between US markets and world markets, the coming period is likely to be frustrating in more places than just the US. But savvy investors with diversified and well-developed portfolios will not only ride out the storm, they are likely to achieve investment success. There will be winning stocks and strategies in even the worst bear markets. An emphasis on absolute returns and alternative investment portfolios will be rewarded. Hang on and prepare for interesting times.

************

As we wrap up, we should note that Ed wrote a must-read book about secular stock market cycles. Unexpected Returns: Understanding Secular Stock Market Cycles is theauthoritative book about long-term market cycles and the fundamental reasons that they occur. The book is packed with extensive full-color charts and graphs and is written for all investors. Here's a link to it at Amazon: www.amazon.com/Unexpected Returns.

And John has condensed Bull's Eye Investing to a version for Wiley called The Little Book of Bull's Eye Investing, in which he focuses on the basics of secular cycles and absolute-return investing. The book is just out, and you can get it at your local bookstore or at www.amazon.com/Little Book of Bull's Eye Investing.

Home Again, New York, Singapore, and Back to Newport

This will be hitting your inbox while I am on the plane back to Dallas from Rome, where I am writing this letter tonight. I will be home a week and then catch a flight for meetings in Cincinnati, jet on to New York for a few more meetings, and then catch a night flight to Singapore on Singapore Air, in one of those well-reputed first-class cabins. I have always wanted to do that; but SA is not part of One World Alliance, so I fly to Asia on AA or Cathay, which are also quite nice.

I am in Singapore only a few days and then back to New York for a night (with, of course, a few more meetings, and somewhere in there I must write your weekly Thoughts from the Frontline – maybe on the way from Singapore to Frankfurt, and then sleep on the leg to NYC). Rather than fly on to Dallas and then turn right around and fly back to Rhode Island, I will simply stay in NYC and then hop over to Newport, Rhode Island on Sunday, pre-shipping a suitcase of clean clothes there, so I don't have to pack for two weeks. The tricks we learn…

I get a lot of people asking how I can travel so much (and why). I totally agree that I travel too much. The problem is that, in isolation, each trip makes so much sense. For instance, this summer, during the last week of July, I am going to get to participate in something that I find both very exciting and a unique honor. I have had the privilege of getting to know Andrew Marshall over the last few years, first in small groups and then privately. Mr. Marshall runs something called the Office of Net Assessment for the US Defense Department, and reports to the Secretary of Defense. He was appointed by Nixon in 1973, and every Secretary of Defense and US President since then has reappointed him. He is now 90 years old and shows no sign of slowing down. A few hours with him will get you right up on your toes, as he has worked with such a long list of forward-looking thinkers over the decades that it boggles the mind. He recalls seemingly every conversation. (On the matter of aging and continuing to work and keeping your act together, he is my official hero.) In the futurist world he is legend. The institutional memory he carries with him is beyond value. Essentially, the ONA develops and coordinates net assessments of the standing, trends, and future prospects of US military capabilities and potential, in comparison with those of other countries or groups of countries, so as to identify emerging or future threats or opportunities for the United States. Think of it as an internal planning think tank for the Department of Defense.

Every now and then ONA gathers a small group of thinkers to present analysis on their personal fields of expertise, and then develop a paper based on their findings. This year I have been invited to attend and speak. I will be in Rhode Island for a very full week, the day after I get back from Singapore.

My only request of them was to be able to listen to the other presentations and interact with the presenters in the evenings. They said yes. How could I not go? What kind of idiot would I be to pass this up? I get to sit in one place and listen to experts from very diverse backgrounds, hand-picked by Andy Marshall, speak on topics that will affect the future in ways I have not yet even thought about (and some I have not even considered). We will also deal with the usual topics of all kinds of technologies, geopolitics, etc.; and in the afternoons and evenings we'll gather in small groups. Although it is not clear what I will be allowed to write about that week, I will be taking notes.

So you ask how my schedule gets so busy? This is how. There are just too many cool things I have the opportunity to do, and I don't want to pass them up!

Trequanda in Tuscany was wonderful. That little village is so very relaxing to me. I stayed home most days, and my guests used the villa as a base from which to explore. But we did make it to Siena a few times, especially for the Palio, which is quite the spectacle (http://en.wikipedia.org/wiki/Palio_di_Siena). Well worth taking in, if you ever get the chance.

Vincente Lualdi is a reader and one of my million closest friends. He convinced his wife the contessa, Dr. Francesca Fumi, who has a doctorate in the history of art, to take us to Siena, the city where the first banks were formed and where the oldest continuously operating bank still welcomes customers, to view the nearly 700-year-old records of banking transactions in beautifully bound books. What a treasure, and one not seen on many tours. My deep thanks to Vincente and Francesca for their patience with my questions. History and art unfolded as we went from room to room, with the illustrated book covers depicting events or people of the times. As the centuries passed, the covers turned into actual paintings. Seven hundred years of banking details – wow.

A couple of other people should be thanked. We stayed once again at the La Casa dei Fiordalisi. It is a remarkable place, with six bedrooms; and the chefs they can arrange, plus the regional restaurants, are simply over the top, with one regional destination place, il Conte Matto ("The Mad Count") 50 yards from the door. Plus the obligatory little lunch place, pizza, and small stores. A full food store is only a few miles away.

And for the second year in a row we went to the Castiglion del Bosco, a famous winery and resort founded by the Ferragamo family and run by my friend Simone Pallesi. Fabulous spa and sports facilities, sitting above the ruins of a 1,000-year-old castle tower. You should plan to spend at least three (we spent five) hours at the Ristorante Campo Del Drago. One of the finest meals of my life. Someone told me afterwards they had brought over 17 different items/courses, each better than the last. The weather was perfection, and we sat outside for much of the time.

It is just hard to do any better than that evening. It was helped by conversations with Newt Gingrich, Neil Howe, David Tice, and others; and the topics ran the gamut. Though we got home late that evening, and others, we were regularly up even later, talking through the topics of the day.

If you can get to Castiglion del Bosco, you should; and they welcome both families and corporate retreats. Tell Simone I sent you! My closest friends might find a bottle of wine at their table (we must stick together). You can learn more at www.castigliondelbosco.com.

I have a lot to think about the next few weeks. I find I needed this time away more than I thought. I will try and make myself take more time to relax, and not get burned and stressed out. Maybe a week in August somewhere not hot, where I can work and write and work out!

It is time to hit the send button. I know the weak employment numbers beg for a comment, as does the ongoing scandal over LIBOR price fixing. Maybe one of the amazing things about that one is that it took so many decades to come out. It looks like the guilty parties are going to be everywhere. This is going to get ugly, uglier, and then get nasty. We're talking some serious malfeasance. LIBOR sets interest rates for $350 trillion in bonds and debt. The level of trust has to be there or the whole thing breaks down. And what are we to make of the apparent participation of the regulators? And central banks, whose jobit is to manipulate rates, asking for help to do their work? Really? This is a most interesting story and one we will follow closely. It has serious implications for the little guys and not just the largest banks.

Time to hit the send button. My flight is in a few hours and I need to get a little sleep. Have a great week.

Your wondering why we can't get great Italian gelato in Texas analyst,

John Mauldin

subscribers@mauldineconomics.com

Bull’s Eye Investing (Almost) Ten Years Later

JohnMauldin — Sat, 30 Jun 2012 21:42:00 GMT

Bull’s Eye Investing (Almost) Ten Years Later
Reliving the Past Nine Years
Are We There Yet?
High P/E, Low Returns
Tuscany, Italian Football, and Two German Losses

It's been almost a decade since I co-authored with Ed Easterling of Crestmont Research some research in this letter that later became chapters five and six ofBull's Eye Investing. Although the ten-year anniversary of the book is actually 2013, the current vulnerabilities in the markets encouraged us to revisit the material a bit early, to prepare you for what lies ahead. Reflecting back to yesteryear gives us the opportunity to assess the accuracy of our insights.

I am in Tuscany at the moment, watching the sun set over the Tuscan hills; so I will thank Ed for doing the heavy lifting in this letter while I get to relax, although there is so much going on and I am such a junkie that I am forced to get my current-events fix every day. I must say, the news certainly provides some very pure adrenaline rushes. But more on that at the end. For now we take the longer view of the stock market that I first wrote about at the end of the last century, and to which Ed added some real meat in early 2003.

But first, I am pleased to be able to announce the release of the rest of the videos of the 2012 Strategic Investment Conference, co-sponsored by my partner, Altegris, which we held last month. David Rosenberg (and many attendees!) said this was the best conference ever, featuring a world-class lineup of economic and financial leaders. Our very enthusiastic attendees created a roomful of energy that the speakers seemed to feed off of, and everyone brought their "A" game. It really was quite special. And now we have the videos.

Those of you who are members of my special program for accredited investors, called the Mauldin Circle, can access the conference videos by going to the "My Information" section at the bottom of your personal home page, when you log into www.altegris.com. I can't think of a better way to sharpen your investment outlook than to partake of the insights of some of the best minds in the world, including Dr. Lacy Hunt, Niall Ferguson, David Rosenberg, Jeffrey Gundlach, Mohamed El-Erian ... not to mention your humble analyst.

In order to view the videos, you must be a member of the Mauldin Circle. This program has replaced our Accredited Investor Newsletter Program. My partner Altegris and I have worked hard to enhance the program, which now includes access to webinars, conferences, special events, videos, accredited newsletters, and presentations featuring alternative-investment managers and other thought leaders and influencers.

The good news is that this program is completely free. The only restriction is that, because of securities regulations, you have to register and be vetted by one of my trusted partners, which in the United States is Altegris, before you can be added to the subscriber roster. This will be a quite painless process (I promise). Once you register, an Altegris representative will call you to provide access to the videos, presentations, and summaries from the speakers featured at our 2012 Strategic Investment Conference.

Click here to initiate your membership in our exclusive Mauldin Experience Program. After you have talked with the Altegris representative, you'll be able to view the first set of five videos, featuring Dr. Lacy Hunt, Jeffrey Gundlach, Niall Ferguson, David Rosenberg, and Mohamed El-Erian, as well as the final set featuring Dr. Brock, our two all-star panels (one with Marc Faber), and yours truly. I think you will find the presentations particularly relevant this week. And now, let's think about secular bear markets.

Bull's Eye Investing (Almost) Ten Years Later

By John Mauldin and Ed Easterling

Our discussion of a coming secular bear market almost ten years ago was not hypothetical forecasting, but rather it was a discussion about the fundamental factors that drive stock market returns. Even though it is challenging to predict the market over months and quarters or even a few years, we believe the data shows that the stock market is quite predictable over some longer periods. Those periods are the secular stock market cycles of above-average bulls and below-average bears.

In the opening paragraphs of chapter five, in bold emphasis, we wrote:

We will make the case that it is more useful to analyze stocks during secular bear markets in terms of value than in terms of price... These cycles generally take a generation to work their way through the investor public, have significant magnitudes of becoming undervalued and overvalued, and have significant implications for the way that investors should approach each of these periods.

We emphasized that:

Further, we show that volatility and frequent large rallies are the norm and not the exception, thus giving the astute investor some terrific opportunities. Finally, we will make a connection between inflation, interest rates, and stocks that will give us further indications of the direction of the stock and bond market in the coming decade.

If the cycles of the past century continue to repeat, most of the first decade (or more) of this century will experience a secular bear market – an extended period of generally down or sideways and choppy stock market conditions....

These periods in the past have been the result of market valuation cycles represented by the P/E ratio. The valuation cycles have resulted from generally longer-term trends in inflation toward or away from price stability. The short-term, somewhat random, market gyrations are the result of then-current circumstances and market forces wrestling stock prices around a gravity line of the broader cyclical trend.

What did P/E do over the past decade and where is it today? What does it tell us about the future? What new insights can we glean by adding nine years of history to some of the charts and graphs in the original chapters? In addition to chart updates, there are quite a few new charts here from Crestmont Research. Well, there is a lot to review as we look back over the past decade, with an eye on the next decade.

Reliving the Past Nine Years
For a good overview of the past nine years and this secular bear market, here's an update to Table 5.6 in Bull's Eye Investing. When we wrote the chapters in 2003, the charts and graphs were current through year-end 2002. At the time, P/E was a lofty 26 –though it had come down significantly from bubble levels in the 40s. To reduce the distortions to P/E caused by the earnings cycle, earnings (E) were normalized using the approach popularized by Robert Shiller at Yale (which uses earnings over a ten-year period). The resulting P/E is often called the cyclically adjusted P/E, or P/E 10.

http://www.crestmontresearch.com/docs/Stock-Secular-Chart.pdf

There are several points to emphasize in the chart above. This secular bear (so far!) has been relatively calm compared to historical secular bears. The typical bear has more negative years than positive years (only 42% positive), yet this cycle so far has had more positive years (58% positive). The gain and loss years have been more muted, with gains and losses averaging around two-thirds of normal levels.

Certainly this secular bear has not been calm as we have experienced it in real time, but the relative calmness compared to past cycles may be an indicator of what lies ahead before the bear retires.

Some investors certainly do think the current secular bear has been extreme. Here's what it has brought us so far:

http://www.crestmontresearch.com/docs/Stock-This-Secular-Bear.pdf

The pattern and process have not been very different from what we expected in 2003. As we wrote in Bull's Eye Investing,"... volatility and frequent large rallies are the norm and not the exception" in secular bear markets. Here's the previous secular bear (1966-1981) as an example. Yes, the 54% decline by 2009 was greater than the 45% in 1974, but the pattern of numerous short-term surges and falls had again repeated.

There is another approach to assessing volatility that was included in Bull's Eye Investing. Table 5.1 revealed that the stock market is much more volatile than most people realize. Rather than use confusing and boring statistics, we took more of a layman's approach. We highlighted that the market moves up or down more than 10% annually in almost 70% of the years. It moves more than 16% in either direction in half of all years. So what has happened so far in the present cycle?

Crestmont has updated that volatility analysis through 2011, and it now reveals new insights by breaking out separate details for bulls and bears. It is striking that overall volatility is relatively similar for secular bulls and bears. Note the frequency inside the 10% and 16% ranges. In both secular bulls and bears, nearly 30% and 50% of the years fall inside the respective ranges. The difference is that bulls predominantly have upside years, while bears have more downside years.

The results so far for this secular bear have been a bit different. First, there have been more inside years – another indication that the first part of this secular bear has been a bit tamer than usual. Second, notwithstanding the crisis plunge into 2009, the downside years have been under-represented. Why?

So far, this secular bear has not made much progress through the fundamental process that a secular bear must undergo. As we highlighted in Bull's Eye Investing, "The valuation cycles have resulted from generally longer-term trends in inflation toward or away from price stability." Other than an occasional flirt with deflation or inflation over the past decade, we're stayed relatively close to price stability. There are certainly lots of pressures building for deflation and inflation, either of which would drive this secular bear to its den. But for now, the choppiness has us in a bit of a holding pattern. The stock market's gyrations and underlying earnings growth over the past nine years have driven P/E from the mid-twenties to the low twenties, but the market has yet to experience the full process of valuation declines in the face of an adverse inflation rate trending into deflation or high inflation.

Are We There Yet?
Here are two new charts from Crestmont Research that explain how we got here and just how much farther we have to go. The charts reflect the normalized P/E ratio for the S&P 500 Index for all secular bull and secular bear cycles since 1900. The lines on the charts show the price/earnings ratio (P/E) over the life of each secular cycle.

First, note that secular bulls start when P/E is low and end when P/E is high. Similarly, secular bears start when P/E is high and end when P/E is low. In the charts, the low range is designated with green shading and the typical high range is shaded red.

Look at the secular bull of the 1980s and 1990s. It is as though that secular bull ran its course through the mid-1990s, then P/E more than doubled again. The already high P/E ascended to the bubblesphere.

Compare the two graphs. Every secular bear cycle prior to our current one followed a secular bull that ended with P/E in or near the red zone. That set the starting point for every subsequent secular bear. But this time, the super secular bull of the late 1990s ended nearly twice as high – it was a major bubble. The past twelve years saw the bubble popped and P/E restored to levels typically associated with a low inflation rate. It has taken more than a decade to wear away the effects of the late 1990s extremes.

The current valuation of the stock market is relatively high, but it is not overvalued, considering today's conditions. Low inflation-rate conditions should be accompanied by relatively high P/Es. But if deflation or high inflation (or both) are likely upcoming, the market is very expensive. On the other hand, if the inflation rate happens to remain near price stability, then this secular bear could remain active a while longer – but how likely is that?

High P/E, Low Returns
InBull's Eye Investing we explained that high market valuations (P/E) necessarily drive low long-term returns. This occurs because periods that start with high P/Es often end with lower P/Es, eating away at returns. Further, high-P/E periods have low dividend yields. As a result, we could write with confidence nine years ago that subsequent returns would be well below average.

In all cases, throughout the years, the level of returns correlates very highly to the trend in the market's P/E ratio. The P/E ratio is the measure of valuation as reflected by the relationship between the prices paid per share to the earnings per share (EPS). Higher returns are associated with periods during which the P/E ratio increased and lower or negative returns resulted from periods during which the P/E ratio declined.

Although P/E has declined over the past nine years, from 26 to near 20 (using the Shiller method), stock market valuation remains relatively high. Almost everything in chapters five and six of Bull's Eye Investing remains true today. The market has chopped around with fairly typical volatility. P/E is in the lower end of the red zone rather than above it. Most importantly, currently high valuations portend low returns from here.

How low? That depends upon the outlook for deflation or higher inflation.

Next week we will return to a few more paragraphs from Bull's Eye Investing, and then we will explore the implications of the entire analysis.

By the way, Ed has written a must-read book on the likely outcomes of the stock market over this decade. It enables the reader to see the impacts of key factors on their outlook. Probable Outcomes is packed with details and extensive full-color charts and graphs. Here's a link to it at Amazon: www.amazon.com/Probable Outcomes.

And John has condensed Bull's Eye Investingto a version for Wiley called The Little Book of Bull's Eye Investing, in which he focuses on the basics of secular cycles and absolute-return investing. The book is just out, and you can get it at your local bookstore or at www.amazon.com/Little Book of Bull's Eye Investing.

(For the record, Ed is the author of Probable Outcomes: Secular Stock Market Insights and the award-winning Unexpected Returns: Understanding Secular Stock Market Cycles. He is President of Crestmont Research, an investment management and research firm, and a Senior Fellow with the Alternative Investment Center at SMU's Cox School of Business, where he previously served on the adjunct faculty and taught the course on alternative investments and hedge funds for MBA students. He publishes provocative research and graphical analyses on the financial markets at www.CrestmontResearch.com, one of my favorite websites.)

Tuscany, Italian Football, and Two German Losses
I am in Tuscany tonight, in a little town called Trequanda, staying in the same villa as on previous trips. It is an idyllic location, with each trip providing ever more delights upon which to feast my eyes and soul. This is the third year I have come back to Tuscany and the first time since I was a kid that I have been to the same spot even twice on vacations. This is truly a special place.

This year I have a number of friends coming to stay for a time, helping to create an ever-growing and always interesting collage of ideas and anecdotes. The conversations have been inspirational and thought-provoking. And perhaps it helps that the news has been so, well, entertaining and such food for discussion. More on the guests and our conversations next week, but for now I will close with couple of notes.

On Sunday night we wandered over to the next little village of some 400 souls, called Montisi. We had dinner in the town square, where we watched, with half the town, Italy play England in the Eurocup soccer quarterfinals. I watched the growing tension as the two teams played to a tie and then went into two overtime periods, which ended with the score still even.

This necessitated a "shoot-out," which is a man-on-man match between one player trying to get the ball past the goalie. He is close enough that it requires both players to commit to a strategy before the action – at this high level of soccer there is no time to change once you commit. It is a total mind game, and one that requires skill and experience.

There were five alternating attempts, with the crowd cheering and groaning with each shift of the momentum tide. And then all of a sudden, with a block here and a miss there (including a marvelous soft "dink" shot by an Italian, totally catching the English goalie by surprise), Italy had drawn ahead. The level of emotion was profoundly moving to me. As an American, I can only relate it to the US-Russian Olympic hockey game in 1980, when a young, overmatched US team took down the Russian juggernaut.

And then Thursday night we watched Italy take on Germany in the semifinals. Germany was a 2-1 favorite, although one of my dinner guests offered 4-1 odds, which found a few takers. Given that I know so little about soccer and that betting against a 2-1 favorite on a one-time bet seemed a tad rash, I demurred but offered to hold the wagers.

I should have taken the plunge. Somehow, Italy stepped up and simply outplayed the Germans. And amusingly, as I was watching the game in Europe, the US markets were still trading; and this morning David Zervos sent me this note: "... as I was watching Italy vs Germany yesterday something very odd happened just as Balotelli scored his second goal. At that moment, when it became clear that the Germans were going to lose, the [S&P 500] shot up from 1308 to 1323. It then occurred to me, when Germany loses, spoos [the trader term for the S&P 500 index] win!"

And then Germany seemingly lost again today, as Italian Prime Minister Monti (and Spanish PM Rajoy) simply refused to allow any resolution at all to pass at the summit until Merkel agreed that the eurozone must jointly back Spanish banks without Spain having to guarantee the debt. And while there must have been relief in Madrid, there was also joy in Dublin, as the Irish are now in line for a similar deal, which will cost at least €64 billion. Of course, with Germany's agreement, every taxpayer in Europe is now on the hook, and not just in Germany. But it was a necessary condition if a fiscal union is to be formed and the eurozone is somehow to be salvaged.

Perhaps Monti took courage from his football team, but he certainly got Merkel to back down. By my count, that is Merkel at 0-2 in recent contests. Interestingly, I was in Madrid on Saturday with good friend Alberto Dubois, who invited about ten of his friends to join us. Quite the group of very serious Spanish businesspeople in the room, mostly C-level and chairman types. After the usual questions and conversation about my views on the world, I turned the tables and started interviewing them.

I may write some more about what happened, but two items leapt out. They unanimously and emphatically agreed that Spain would do whatever it takes to remain in the eurozone. A breakup of the eurozone was simply not something they could contemplate. "It would be a total disaster for Spain," said one, and everyone nodded.

"But what if Germany decided to leave on their own, as the price of staying was going to be too high?" I asked. Again, they were adamant that Germany would not leave and a fiscal union would be worked out. Perhaps this was a self-selected group of friends, but I was struck by the passion with which they argued that the euro would survive. They simply could not imagine a breakup.

I was not convinced they were right, but I left with a few things to ponder. And then today, Merkel backed down. And the markets leaped for joy on the news, even though the very thorny details have to be worked out. Germany loses, the market rises. How long can this trend last?

It is time to hit the send button. It is now quite late and as I wrap up I still feel the glow of six hours of fascinating conversation that postponed the completion of this missive. Oddly, I find I have been able to resist the powerful pull of the marvelous Italian wines that have been set on tables here and there this week, but the real temptation was cheap Italian Prosecco during the day. Go figure.

Have a great week. On Monday we will take in the famous Palio horse race in the square in Siena, along with some 250,000 people crowded into a very small place. Quite the tradition, going back to the mid-1600s. Fortunately, we have a balcony or two from which to watch. But enough. Have a great week! I certainly will.

Your wondering why I am not here for at least a month analyst,

John Mauldin

subscribers@mauldineconomics.com

How to Invest Your Mother's Money – And Keep Your Peace of Mind

DougCasey — Tue, 12 Jun 2012 15:08:00 GMT

By Jeff Clark, Casey Research

I manage one of my mother's IRA accounts, and when it comes to investing, she doesn't like to take a lot of risks. I guess the same would be true for most of our mothers – and maybe for many of us as well.

Unfortunately, after surveying today's investment landscape, I see numerous risks – stock markets seem propped up and vulnerable, many major economies have low or suspect growth, and many currencies are being actively devalued or weakened by government actions. Even the number of options to park money is limited since investors can't earn a reasonable interest rate.

The easy solution would be to keep her in cash. But I'm convinced she'll lose significant purchasing power over the next few years with this strategy. This is the risk we all run; while having a healthy level of cash is imperative, an all-cash portfolio won't keep up with even low rates of inflation.

So, I must abide by my mother's low risk tolerance and play defense. But without some offensive investment moves that include a shot at great gains, her money is just sitting in a boat with a small leak.

Where can we get low-risk offense? Quality gold stocks, of course. However, they've been weak longer than expected, and many investors are frustrated with their performance. Would I really buy gold stocks with my mother's nest egg right now?

Yes, and here's why.

I have a strategy that will both reduce risk and hand us big gains when our industry turns around. And it can be summed up in one phrase:

Buy the next big producer before it becomes one.

Buying gold stocks certainly isn't risk-free. Yet we can minimize the risk and capture higher returns by selecting companies that are on track for big growth.

First, risk is smaller with companies that expect to see large increases in production over the next few years. How? Because even if gold flounders for awhile, they will still grow into bigger companies. Bigger companies command larger market caps.

Second, when our industry rebounds – and it will rebound – these stocks will outpace most other mining stocks, handing us the biggest profits.

A good example is Yamana; gold producers in aggregate (as measured by GDX, the Gold Miners ETF) are down roughly 26% over the past year, while Yamana is up about 12% (through April 24). Why? Because of the company's growth expectations.

I'm convinced that this is the optimal strategy to maximize our returns in gold stocks.

It's time to be picky with our investments. Whether our motivation is to reduce risk or capture leveraged returns, focusing on the best of the best is the ideal strategy for both the short and long term.

Which stocks are "the best of the best?" And what's the best way to get into gold right now? The 2012 Gold Investor's Guide will help answer these questions, plus many more. It's an invaluable asset, especially in today's economic climate – and the sooner you act, the greater your profit potential.

Investing in Education a 'No Brainer' for Chinese

TonySagami — Fri, 01 Jun 2012 17:16:15 GMT

I was less than 2 years old when my parents divorced in 1957. My 20-year-old Japanese mother suddenly found herself living in a strange country with no family, friends, money, food or place to live.

Yet instead of returning to Japan where her family and friends were, she scratched, rummaged and scavenged enough to make a new life for us in America. Why?

My mother knew that a half-Japanese, half-American child had limited opportunities in Japan. It wasn’t like it is today; the wounds from World War II were too fresh. I would have never gone to a top university or landed a top job.

Even though my mother barely spoke English and seldom had more than two nickels to rub together, she fiercely held to the idea of the American dream. “In America, anybody can get rich if they work hard,” she told me.

And she was determined to have me prove her right.

Putting the ‘Earn’ in ‘Learn’

My mother ordered me to sit in the front row right in front of the teacher’s desk. She gave me almost-daily lectures on the importance of education, and punished me severely if I brought home anything less than an A. My mother was a big believer in corporal punishment and I got the spankings of my life for anything less than straight-As.

For someone who started off as a homeless immigrant, my mother saw all her children grow up to achieve great professional success. I am sad to say that my mother died seven years ago from cancer, but I preach the same lessons about education to my children to this day.

Those same lectures about education are given every day all over Asia, especially in China, because academic success is a top cultural priority even despite the effects of the global economic slowdown.

Spending on Schooling
Shouldn’t Slow Down

Consumer spending in China is still robust but there’s no question that it’s slowing down. The latest numbers for April showed that retail sales in China grew by 14.1% on a year-over-year basis.

While that may sound good compared to the sluggish U.S. retail sector, it is the lowest number in 14 months and far-below expectations.

Chinese consumers are becoming more-selective with their spending but, according to a new survey from A.C. Nielsen, education is one thing that they don’t skimp on.

3 Facts About China’s
Changing Spending Habits

You may think of Nielsen as a U.S. company, but they do business all over the world, including China. Nielsen, which provides data on consumers’ spending and viewing habits worldwide, surveyed 3,500 Chinese people from a range of backgrounds. Its newest survey of Chinese consumers disclosed some important facts:

Although Chinese consumer confidence rose in the first three months of 2012 to its highest level since 2005, making China the world’s fourth-most-optimistic nation, willingness to spend remained flat.
China’s consumers are cooling toward discretionary spending, even on important things like food, clothes, holiday gifts and entertainment. Spending on all those categories dropped from the previous quarter.
Consumers were willing to devote more money to only two areas: Savings and education.

That last piece of data tells you how important education is in China.

Most Chinese students don’t finish until 5 p.m. or 6 p.m., watch little television and play very few video games. They are prohibited from working before the age of 16, so they can concentrate on school. Plus, most students attend tutoring classes after school and on Saturdays.

“Very rarely do children in other countries receive academic training as intensive as our children do. So if the test is on math and science, there’s no doubt Chinese students will win the competition,” said Sun Baohong of the Shanghai Academy of Social Sciences.

Plain and simple, the education sector is an all-weather, recession-resistant, steady growth winner and there is a way to profit — HANDSOMELY — from the Asian obsession with education and academic success.

10 Chinese Education
Stocks for U.S. Investors

Did you know that there are 10 Chinese education stocks listed on the NYSE and Nasdaq? Yup ... and here they are.

ATA Inc. (ATAI) provides computer-based training courses to pass professional certification exams such as banking, insurance and accounting.
Ambow Education Holding (AMBO) has a unique combination of hands-on personal tutoring supplemented with online training.
ChinaEdu Corp. (CEDU) is the Chinese equivalent of the University of Phoenix, offering online college degrees.
China Distance Education Holdings (DL) offers online education and test-preparation courses in accounting, law, healthcare, construction, engineering and information technology.
China Education Alliance (CEAI.PK) sells “education resources” online, a fancy name for a huge database of informative practice exams.
ChinaCast Education Corp. (CAST) actually owns several Chinese universities and is expanding its enrollment with online degree options.
New Oriental Education & Tech. Group (EDU) is the largest English and college entrance exam preparation school in China.
TAL Education Group (XRS) is the largest private educational tutoring company in China.
Noah Education Holdings (NED) sells electronic education materials, and distributes its content primarily through handheld digital learning devices.
Xueda Education Group (XUE) is also a private tutoring company but differs from TAL Education in that it tutors university students as well as high school students.

As you can see, there are several ways to profit from the Chinese obsession with academic excellence.

I should disclose that my Asia Stock Alert subscribers currently own New Oriental Education and many are sitting on more than a 200% gain. That’s a big return, but I think there are more profits yet to come in these shares.

That doesn’t mean you should rush out and buy New Oriental Education or any of the other above-mentioned stocks tomorrow morning. The education sector has been hot, and most of these stocks have already had big gains.

I recommend that you wait until they go on sale or wait for my buy signal in Asia Stock Alert before committing any new money.

But make no mistake, educational services is a sector that should deliver big, big profits.

Best wishes,

Tony