Monthly Archives: November 2009

Trading & Investing Strategies for the Current Environment

Posted on by Nirav
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This guest post comes from Kevin at 20smoney.com, a blog covering financial topics such as investing, money management and the development of income streams.

Despite the fact that most people tend to think that a market that has already booked a 60%+ rally is a great time to be invested in stocks, I tend to lean the opposite direction.  With such a massive run already in place, the risk/reward scenario is not nearly as good as it was when compared to earlier in the rally.  So, how should you play the current environment?

The sectors with some of the largest gains this year have been technology and financials.  As such, these sectors warrant extreme caution if you are currently long or are getting long any companies within these sectors.  If you want to be long the sector, but aren’t sure of specific stocks, consider mutual funds or ETFs such as Financial Select Spider (XLF) and Technology Spider (XLK).

If you’re looking to gain exposure in these sectors, I strongly encourage you to monitor some basic technical signals so that you can identify a clear exit point in case the broad market and/or these sectors reverse and head lower.  Watch the 20 and 50 day moving averages.  If the stock (or ETF) breaks through these key averages, be ready to exit the position.  If you don’t feel comfortable with such a strategy and want to take a more long term focus, I would then wait for a significant pullback, at least 5%, to enter your position.  Remember, you’ve already missed a large run in stocks, and you need to be careful entering a position at these levels.

If you have held stocks this year, especially in the sectors named above, you may consider actually selling some of your positions to lock in profits.  Taking profits is never a bad idea, and if you don’t want to pull out completely, simply sell half or maybe a third of your position.

If you are looking to enter other long term positions, I would point you towards dividend paying companies that will pay you to hold them.  This will help offset any losses in share price if there is a reversal in the markets.  Also consider multi-national companies that generate a significant portion of their earnings from abroad (this will help you hedge against weakness in the U.S. economy).  In this category, consider Philip Morris International (PM), Wal-Mart (WMT), McDonalds (MCD) and perhaps Microsoft (MSFT).

For me personally, I’m pretty bearish on the economy and the markets.  I’m skeptical on the strength and durability of the recovery and the stock market rally.  I believe that we have structural issues with our economy that have not been addressed and therefore will prevent real growth.  I’m not adding to any positions in the current environment, rather I’m “keeping my powder dry” waiting for much more attractive buying opportunities.  I do own gold related instruments such as GLD and GDX because I think gold has the potential to perform well in both an inflationary recovery and a deflationary environment (pretty much the only asset with this ability).

As I mentioned above, if you’re looking to try and make a few bucks on the continued rally in the broad markets, be extra careful and be ready to exit by monitoring some key technical sell indicators.  Protecting your money is a better strategy, in my opinion, than chasing returns, especially today.  If you’re a long term believer in the recovery and the future of the economy, get long some solid companies, but don’t be afraid to be patient and wait for better entry points.

Gold Is A Lousy Investment

Posted on by Nirav
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Gold hit another record today and is currently trading over $1,100 as I write this. However, it hasn’t prevented several news stories coming out about how gold is a lousy investment. Investment stalwarts from Warren Buffet to Monish Pabrai have all denounced gold as an investment.

And despite the decent performance of gold over the past 10 years, they’re correct. Gold is a lousy investment. It creates no income and just barely keeps up with inflation.

But do you know what the best performing asset class was during the past 10 years? No, it wasn’t your stock portfolio or your real estate. It was gold, and it returned a decent 270% over that period.

10-year-returns-by-asset-class

Despite its out-performance of all major asset classes, gold still gets no respect from the investment community. That’s because it is only a store of value and typically only does well in periods of currency crisis, or times of poor monetary policy.

For example, during post-WW2 Germany and in post-Mugabe-school-of-economic-policy Zimbabwe, their currencies have faced severe devaluation and gold prices sky-rocketed against those currencies. Faced with hyperinflation and an inability to buy basic necessities, people flock to gold causing the price to soar.

But that wouldn’t happen in the US right?

Economic research has shown that consumer psychology is affected by the amount of wealth people feel they have. If they’re broke and living pay-check to pay-check, but have tons of equity in their homes, they still feel wealthy. But even if they still have a job, but are upside down on the mortgage and have negative equity in their home, they feel poor and their spending decreases. Since the US is a consumer spending driven society, with spending constituting 70% of our GDP, the Federal Reserve has been trying desperately to get the consumer to start spending again.  Part of this entails propping up housing prices by keeping mortgage rates low, and another part is keeping interest rates low on non-collateralized consumer debt (that’s credit cards and student loans).

In an effort to stem the free-fall in the housing market, the Federal Reserve has been trying to keep the interest rates for mortgages as low as possible. Historically, the Fed has tried to manipulate the short-end of the yield curve by adjusting the shortest of short-term rates – the Inter Bank Overnight Rate (also called the Federal funds rate in the US. The UK has something similar called the LIBOR). This is supposed to have a trickle down affect the interest rates of long-term interest rates (such as the 10 year and 30 year Treasuries).  The rates for 3o year fixed rate mortgages are impacted by the rates on the 10 year Treasuries. So by keeping the federal funds rate at zero (or 0.2% which is close to 0%), mortgages rates should stay quite low. However, given the fact that this is not a typical economic scenario, the fed isn’t quite sure that mortgage rates would stay below 5%. So it has been buying billions of long-term Treasury bonds as well as mortgages, which is a quite a bold move away from its historic stance. When the 800 pound gorilla starts buying bonds, the prices rise and the yields go down.  When the Federal Reserve decides to buy $300 Billion dollars worth of mortgages and government bonds, something is definitely wrong with the economy.

I’m  interested to see the effect on mortgage rates once the Fed stops buying Treasuries and mortgages.

The government is increasing its deficit spending at a steady clip. If this continues, eventually we will be unable to repay the debt and barely just able to service the debt. Obviously this is not a viable long-term strategy, but it doesn’t look like there is any other back-up just in case helicopter Ben’s strategy of throwing money at the problem doesn’t pan out.

Clearly, we are currently in a crisis period in regards to fiscal policy and gold prices are likely to keep going up. During times of good fiscal policy, gold does nothing. This does not seem to be one those times.

A well-known hedge fund manager (and world poker champion) David Einhorn shares the sentiment.  And someone else who agrees with him is Liu Mingkang, chairman of the China Banking Regulatory Commission. He recently said, “Low U.S. interest rates and a weaker greenback have “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

Someone I know who works at a very well-known bond fund company recently advised me to sell my gold holdings. He advised me the same thing last year when gold was only $800/ounce. And I told him the same thing I said last year – Not yet.

Disclaimer: I’m long gold/silver bullion, gold mining stocks and short long term treasuries.

Gold breaks $1,100: Does It Matter?

Posted on by Nirav
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Last week, gold prices briefly touched $1,100/oz before settling just under that number.  Apparently the Indian government decided to sell US dollars and make a 200 ton gold purchase from the IMF, which created the spike in gold prices. Right now, the spot price for the yellow metal is $1,106.

price_of_gold

The IMF still has another 203 tons of gold to sell and the hot favorite to make the purchase has been China.  However, according to a report by Reuters, its a lot cheaper for China to buy domestically mined gold than purchase bullion from the IMF at the current spot price. According to Li Yang, a former adviser to the People’s Bank, “China’s gold is much cheaper than that.”

You may not realize it, but China is the world’s No. 1 gold producer, and its mine costs are much less than $1,100 per ounce. And given China’s propensity to put national well-being over any private individual or firm, they’re likely to just pay for the gold being mined at cost, which would be a lot lower than the spot price.

According to another Chinese Central Bank official,

China is the world’s biggest gold producer, so there’s no urgency for us, as there is for India, to snap up big volumes whenever they come onto the global market. It’s cheaper for us to buy gold from the Chinese market, but it doesn’t help diversify our huge foreign exchange reserves.

To diversify our portfolio, we should spend dollars on things like gold. But the catch is that even if China bought half the world’s annual gold supply, it would only cost a few tens of billions of dollars, which is tiny compared to China’s huge reserves.

China has 2.27 trillion dollars in reserves. Spending 25 Billion a year buying gold is chump change. The question that’s relevant is whether they will, because that will put upward pressure on gold prices.

While no one knows whether China will or will not buying gold on the open market, the one thing we do know is that the monetary base of the US Dollar is growing exponentially making each existing dollar less valuable. Check out this graph from the St. Louis Fed:

money_supply

While its not obvious from the graph, the monetary base has in the past year. Its true that this money hasn’t worked its way in to the economy, but if and when it does we should expect higher inflation and a spike in prices of real assets like gold, silver and real estate.

If I had a few trillion dollars, I’d be buying a few hundred tons of gold every year!