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Friday, September 17, 2010

The Baby Boomer’s Case for Gold

This summer saw another bifurcated performance by the markets as the current paradox of wealth and economics continues. Trading continued its impersonation of Fay Dunaway’s character Evelyn Mulwray answering Jack Nicholson, an obtuse Los Angeles private detective J.J. Gittes, in the1974 movie classic, Chinatown.

As investors demanded answers about the state of things, likewise as in the movie, the market’s binary answer to the question of recovery or not oscillated between the economy is producing – corporate profits/recession, corporate profits/recession, corporate profits/recession. Both answers are true.

This topography is tricky for Wall Street to navigate. The economy must appear fragile enough to ensure that the two trillion dollars Bush tax-cut is extended while both the market and economy isn’t bad enough to scare off investors. The calculus to suppress the price of gold is even trickier; until it’s time for the price to rocket upward. Meanwhile, the disappearing middle class assumes that their needs are a factor in these equations.

On Labor Day, President Obama announced a tiny $50 Billion long-term infrastructure program to rebuild roads, railways, and runways. Jobs are expected to materialize well after Democrats are expecting historic congressional defeats in the November election chiefly because of a U-3 unemployment rate at 9.6% and rising. The rising U-6 unemployment figure is 16.7%. High unemployment, the reciprocal to high labor cost, is good for businesses bottom line.

The American working class’s raison d’être, ascension to middle class status became an inconvenient pursuit for the application of supply-side economics. These upper deck fans of Gordon Gecko’s brand of parasitic capitalism, also, among some of the highest paid global workers, misses the obvious internal conflict for gleefully embracing the religion of Maximizing Shareholders’ Value (MSV).

Investors and upwardly mobile workers in the last three decades were convinced by politicians and Mad Men particularly that they were not one and the same. Unfortunately, unlike a centrifuge that can separate like densities in a tube, a MSV’s thesis is extracted from today’s well paid workers on the road to prosperity and from their future generations’ standard of living.

Given this environment, baby boomers face a cacophony of advice, a cornucopia of information, and a cavalcade of confusing and contradictory data as they sail into retirement.

Once prudent, now quant post Second World War standards concerning finance and money, inculcated into our middle class formula of ideas and value system, ceased producing acceptable results over the last decade. Regrettably, zero became the average annual return on equities during this period. The return on residential real estate is even worse.

As current interest rates on certificates of deposit stay below 2% and long-term treasury obligations pay below 4%, nominal yields are an insult. Corporate debt such as IBM is being issued a few basis points above its treasury counterpart. Other corporations are contemplating issuing 50 and 100 year maturities as the markets salivate.

This year, the winning income strategy has been a portfolio of dividend paying stocks over bonds. The current risk/reward parameter, in both stocks and bonds, and the premium being offered for such an undertaking, is a disproportionate proposition, whether we recover or sink into a global depression.

We continue to witness Modern Portfolio Theory and the Efficient Market Hypothesis lose its practical value for investors, as we did so in 2008 and 2009.

Furthermore, political gridlock circles the globe as one government after another is challenged by private market forces – hedge funds, principally through Forex and credit spread trading. Irresolute leaders are making shortsighted and timid decisions.

Each passing day takes us farther from a 20th century of calibrated knowable unknowns into a 21st century of mounting unknowable unknowns which historically leads to ad hoc mischief and turmoil.

The appropriate characteristics of gold bullion and precious metals are an imbued antidote to today’s financial crisis and the correct mid-term solution for alternative investments. Yet, gold is constantly ridiculed as a “gold bug” vehicle in the main stream media.

Every financial crisis produces real gold bugs. Eventually, the inflationary 1970’s created more gold bugs faster than Ben Bernanke can print dollars. In time, this will happen again. However, the price level for gold is unremarkable, given the sheer size of the aggregate global money supply of tens of trillions of dollars, even more in outstanding debt, and ubiquitous domestic and global political uncertainty.

Any serious talk about a new global reserve currency, partially containing gold, replacing the US dollar, would implicate a gold price in the five figures range. The ownership of gold today as a core portfolio holding is not only to hedge against inflation, a rise in prices, deflation from credit contraction, but also, hyperinflation, and a collapse in a nation’s currency, to preserve accumulated wealth.

You ask why trust gold now when most financial professionals are opposed to acquiring bullion at current prices? Before reviewing some macroeconomics metrics demonstrating the logic for this decision, ask yourself: why were financial planners parroting in 2001, 2002, 2003, 2004, and 2005, that over time all stocks rise in value; did stocks obey their wishes?

Why did stock brokers and investment advisers insist that you never want to be out of the market, as recently as the second quarter of 2008, but by 2009, it was “too late” to get out? In their mind, a “blue chip” bear market would not occur. Few investment professionals could even offer sound portfolio hedging strategies with options, as protection against the unthinkable.
Were you warned by advisers that the AAA ratings from credit rating agencies were being purchased by investment product packagers - euphemistically called credit enhancements - like two-for-one call drinks at happy hour?

Did you discuss the risk from opaque and unsecured packaged investments, be they, the gargantuan publicly traded ones or the bespoke private placements, during the roaring 2000’s by your registered investment advisory firm which had a fiduciary responsibility to work on your behalf?

If you were really fortunate in making money during the 1982-2000 secular bull stock market and your net worth rose in excess of seven figures, then you probably retained a hedge fund for the fee of 2/20 to lose a portion of your principal over the last three years.

Did your mutual fund or variable annuity company recommend dollar cost averaging? What is your net worth now? How often were precious or rare earths metals suggested as an alternative investment as these unloved stepchildren posted profits year after year? Are advisers suggesting bullion and rare earths metals now; at what percentage of your portfolio?

The credit crisis and market meltdown of 2008 has been officially named the Great Recession: to show investors that the event itself was manageable and that the extent of probable damages to the economy and the markets were quantifiable. Both of these conclusions were premature, then, and untrue now.

The carnage inflicted by the swift collapse of the 2003-2008 Structured Investment Vehicle (SIV) gold rush was unlike any market/economic contraction witnessed by contemporary investors. The last financial upheaval of this magnitude experienced by investors was the 1930’s Great Depression. Each event was unique. Mark Twain quipped once “History doesn’t repeat itself - at best it sometimes rhymes”.

The comparative “rhyming” components between 1929 and 2008 crashes includes the shift in wealth distribution to the top 1%, reckless amounts of leverage, and a underwriting frenzy of securities for fees over an organic economic benefit.

In 1928, the top 1% share of total pre-tax income was 23.9%. In 2007, the percentage was 23.5%. Prior to the 1929 crash, stocks could be margined up to 90%. In 2007, homes could be mortgaged up to 125%, with stated income, alone.

After the First World War, country bonds were issued by Europe, South America, and Asia, sold to everyone by Wall Street, and experienced massive defaults which exacerbated the 1930’s global depression.

In the roaring 2000’s, orgasmic inducing fees overrode prudence, as sublime to ridiculous derivatives were packaged and sold around the world by Wall Street, causing countries such as Iceland, Ireland, and Greece to become nearly insolvent. Yet, in 2009, Wall Street paid out $149 billion in bonuses, roughly 1% of our $13 trillion dollar annual GDP.
Worldwide demand for gold is rising. From gold bar dispensing machines at the Frankfort, Germany airport and the Abu Dhabi Emirates Palace Hotel, to Exchange Traded Funds (ETFs) such as GLD and SGOL.

The US Mint 2009 Ultra High Relief Double Eagle Gold Coin has sold out. Rust was discovered forming on the Bank of Russia’s 2009 "St. George the Conqueror" .999 fine coins. The supply/demand curve for gold is moving outward. New highs for the price of gold have been made recently in all major currencies.

The interest on debt and the debt itself, without raising taxes is unsustainable. This “new normal” will wreck the US economy and the government’s questionable AAA credit rating.

Not China, not Russia, not North Korea, not Iran, not terrorists...According to Admiral Mike Mullen, the Chairman of the Joint Chiefs of Staff, the "single biggest threat" to American national security is the US national debt, which is either $8.85 trillion (public debt), $13.4 trillion (total national debt), $20 trillion (total debt including GSE debt), or $124 trillion (total debt including unfunded obligations), depending on one's definition of the word "debt."
Washington Post: August 27

The amount of debt that the US has outstanding is troubling but our debt structure is even worse. In FY 2010, the US Treasury issued $2 trillion in treasury obligations. One and one-half trillion dollars was in rollover debt and $500 billion in fresh issuance. These numbers can only rise in the short term. We are a hopelessly credit driven, not cash oriented, transactional society.

Our credit structured economy, of which, 70% of GDP, is consumer driven. Income utilization for the bottom 95% is primary for debt servicing. Government policies favors continuously buying goods and services by consumers while optimistically believing such activity occurring increases wealth and while reduce debt.

This spiraling upward is the conveyor bell for individual upward mobility. Absent GDP growth, expansion quickly turns to contraction, then, disinflation, and deflation. Except for a few speculators, ultimately, a loss in personal net worth ensues.

Likewise, when the amount of debt becomes too great to service from current cash flows, the economy and asset prices will collapse to sustainable levels. That process can take years. Meanwhile, except for a few speculators, ultimately, a loss in personal net worth ensues. Rising interest rates someday will destroy this current economic model.

The critical mistake made in measuring the totality of legitimate outstanding debt leading up to the 2008 meltdown was underestimating the degree of dishonesty employed by accounting gimmicks, reckless amounts of leverage, lax regulatory supervision, and offshore transactions to hide levels of risk.

Another mistake make in addressing the problem, once uncovered, was paying off legally dubious derivative claims with the moral and ethical weight of Las Vegas betting slips, suspending mark-to-market accounting, or smuggling over two trillion dollars in worthless toxic debt onto the books of the Federal Reserve Board, thus, guaranteeing nasty consequences in the future.

In essence, saving individual companies instead of the financial system itself is delaying final closure to the financial crisis.

The looting of our economy was the gravest of matters and was performed with full knowledge and consent. These mortal sins were the exclamation mark on this recent period of greed and avarice.

A global economy so sophisticated, and so interconnected, and has the wherewithal to produce such wreckage compels us to abandon or greatly curtail our unfettered mercantilism policies. Otherwise, the next seismic event will be greater.

The unintended consequences of callous policies pursued by special business interest and executed by rented elect officials shall radically change who we are as a country over the next decade. We can recover from this tremendous hole we find ourselves in but it requires great leadership and political will. Until then, a greater financial divide will broaden and deepen between the haves and have not’s.

Rationing of goods and services will flourish. Political stability will deteriorate, as unemployment trends higher, tensions will build, and the first 21st century generation will be lost to economic depression cloaked inside an arithmetic mean. That is the price we shall pay.

Baby Boomers’ choices must mirror where we are going, not where we have been. Paper assets in 2000 and real estate in 2006 crossed over from being an ally to an enemy to wealth accumulation for the average investor, and will continue to do so, for years to come.

In anticipation of this global redistribution of wealth, and as global US market share declines to the benefit of emerging markets, the supply/demand curve for precious metals and rare earths will fundamentally raise the floor on the price of gold. The US dollar’s purchasing power will also decline over time.

Baby boomers planning on living for the next 20 years must really consider gold as a core long-term holding in one’s portfolio, and not just a short-term trade or a token position, to maintain your family’s net worth, purchasing power, and liquid asset needs.

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