Friday, August 29, 2008

Rules of Disengagement

No place for beginners or sensitive hearts
When sentiment is left to chance
No place to be ending but somewhere to start

Can't recall a time in the past few years where I've had so little feel for, or interest in, near term market direction. I've been elongating my time horizon for risky positions, so I'm less tuned in to the granular flickering ticks. In a world where market participants seem to be reducing time horizons and reactively trading, I prefer to increase my time horizon and pro actively invest.

Using an investor's stance, however, I currently see little value out there. Outside of some pounded down, dividend paying names in Big Pharma such as Merck (MRK) and Pfizer (PFE), nearly the entire world seems overpriced. Stocks, bonds, commodities, real estate--all have had significant multi-year, and in some cases multi-decade, runs.

Couple high priced financial assets with massive leverage and a wobbly credit market backdrop, and you have a scenario supportive of lower, perhaps much lower, prices.

The key to successful investing is buying assets at the right price in a favorable environment. Currently, I see neither of these generally.

The implication? High amounts of dry powder (read: cash) and patience. Currently, I do not possess either to the degree that I'd like, but I'm working on it. Beyond select pharma names, which I believe reflect decent long term risk:reward, and some core positions in gold and silver, my goal is to use price to my advantage to shed commodity-related and other positions and get liquid.

And then wait--perhaps for a pretty long time.

positions in MRK, PFE, gold, silver, commodities

Wednesday, August 27, 2008

No Vacancy

Relax, said the night man,
We are programmed to receive
You can checkout any time you like
But you can never leave
--The Eagles

Mr P shares his concern about the increasing power and influence of government in our lives. He offers a couple of important propositions:

a) The more power given to a central government, the lower the collective wealth.
b) The more power given to a central government, the larger the imbalances.

Mr Practical is not the first to float such claims, which can be tied to supporting empirical evidence. Over 200 years ago, for instance, a large number of American citizens voiced similar concerns about the consequences of big government that would subsequently flow from the Constitution once ratified (Cornell, 1999).

Yet, what are we prone to do in times of distress? Cede even more power to bureaucrats who likely facilitated the crisis.

At some point the potential energy accrued from strains of imbalance will turn kinetic. History suggests that this energy-in-motion will not be pleasant.


Cornell, S. 1999. The other founders. Chapel Hill, NC: University of North Carolina Press.

Monday, August 25, 2008

Back to School

Louden Swain: "Can 800 million Chinese be wrong?"
Gene Tanneran: "Frequently."
--Vision Quest

Fall term starts today. In an ongoing quest to improve market awareness, what are the most important lessons that college students can learn to enhance financial literacy?

Seeing both sides of the trade. For every buyer, there is a seller. Regardless of which side you're on, it pays to understand what the other side is thinking. This lesson, of course, broadly applies towards the need for critical thinking by individuals in a liberty-driven society.

Our markets are not free. Throughout their academic careers, most US students are taught that domesitic financial markets function freely with no interference. In reality, nothing could be further from the truth. Bureaucrats intervene in market workings constantly. Case in point: the Federal Reserve. The Fed represents a group of bureaucrats attempting to fix the price of money to the 'correct' value--since freely functioning markets would presumably produce 'incorrect' prices. Central planning at its finest, comrade.

Currency by fiat. Where does our money come from? Simple, bureaucrats create it by fiat. The US Dollar lost its last remaining link to gold in 1971. Currently, no (read: zero) currencies in the world are backed by precious metal. The implication? A worldwide confettifest of purchasing power debasement.

Leverage works both ways. Leverage can be viewed as borrowing to increase potential returns. It can also be viewed as borrowing to increase potential losses. People tend to see the former but ignore the latter--until actual losses are realized. Current financial market turmoil can largely be viewed as consequences flowing from excessive leverage.

Moral hazard. Currently, the government is in the process of bailing out homeowners that are upside down on their mortgages and lenders that extended mortgage credit. As such, excessive risk taking is not being penalized. Instead, those who were prudent and didn't take excessive risk foot the bill for the imprudent behavior of others. It's easy to see what these bailouts invite in the future, isn't it? Less prudent behavior and more risk taking, since decision-makers figure the government will come to their aid if things don't work out. This thought process reflects what is known as 'moral hazard.'

Economic/political sphere overlap. Those who think that markets and government are not related are mistaken. One of the more instructive things market participants can do is to study the history of past civilizations for the regularly occuring patterns of bureaucratic and economic behavior. Applying those historical patterns to our current situation can be revealing.

From where I sit, the most important financial market lessons are 'structural' in nature. These macro forces exert very large influence on market behavior. Those who are aware of these influences will make more informed financial market decisions.

position in gold

Friday, August 15, 2008

Melting Gold

Papers in the roadside tell of suffering and greed
Here today, forgot tomorrow

Ooh, here besides the news of holy war and holy need

Ours is just a little sorrowed talk

--Duran Duran

Gold and silver have not been spared from the eye-popping declines currently being witnessed in the commodity space. Interday moves have been huge. In a few sessions, silver has declined from above $17 to under $13.
Whenever daily volatility really cranks up I like to pull up monthly charts for some longer term perspective. Using Street Tracks Gold Shares (GLD) as a bullion proxy, we can see that the recent decline finds gold resting on the uptrend line that began in 2005. A break below this support at $750ish, and technically gold could head towards the earlier, less steep uptrend that marked the initation of the bull trend in 2001. In such a scenario, gold could see $550 or lower.

Kevin Depew and others suspect that gold may see such a retracement. Can't say that I disagree, given my inclination to agree with Pepe on the deflationary mechanism in play. Back in March I sold half my paper metals positions out of respect for the deflationary scenario. Moreover, I have been out of the miners for quite some time after concluding that the economics of the mining business was just too difficult for me to grasp bullishly.

Moving forward, I have no immediate plans to add to my remaining paper gold or silver (i.e., GLD, SLV) positions (retrospectively, of course, I wish I had sold down even more of these positions last spring ;-). However, I do plan to methodically add to my physical bullion holdings. Unlike the paper, which I view purely as a trading vehicle that will be held for sale some day, I regard physical bullion as pure tangible wealth.

As such, I am diverting a fraction of savings each month towards building my physical metals stock, and view lower prices as an opportunity to accumulate ounces at lower cost.

God willing, my physical metal position will never be held for sale. Instead, it will be passed along to future family generations who will, hopefully, pick up wherever I leave off.

positions in gold, silver, GLD, SLV

Wednesday, August 13, 2008

Luft Waffle

Ninety nine red balloons
Floating in the summer sky
Panic bells, it's red alert
There's something here from somewhere else

Many claim that recent Fed interventions are undoubtedly hyperinflationary, and point to ongoing double digit annual percentage increases in broad measures of money supply as proof positive. However, these monetary aggregates don't include many derivatives (notionally valued in the hundreds of $trillions). Moreover, they don't include credit instruments on bank balance sheets that have yet to be marked to market.

Although the aggregate metrics don't account for it, many of these esoteric assets have declined dramatically in value over the past 12 months. Should the Citigroups (C), JP Morgans (JPM), et al of the world stumble into a forced selling stampede, then the magnitude of the deflation will become more apparent.

Essentially, credit and debt are being destroyed. Given the sheer size of the systemic leverage, it seems increasingly unlikely (to these old eyes anyway) that the Fed can keep the bubble inflated using the approaches employed thus far.

The only alternative may be to drop money from helicopt--I mean, super high tech jet fighters.

no positions

Saturday, August 9, 2008

Sleeping with the Enemy

Under a blood-red sky
A crowd has gathered in black and white.
Arms entwined, the chosen few
Newspapers say, it says its true.

Although some feel that the gradual loss of liberty experienced in the U.S. is due to movement away from the Constitution, a cogent argument can be made that it was precisely our Constitution, as written and ratified, that would inevitably lead to loss of liberty.

In fact, a group of individuals argued passionately in that regard during the framing process in the late 1700s. The so called 'Anti-Federalists' were suspicious of centralized governments and their proclivity to separate people from their natural rights.

Parenthetically, I find it interesting that most U.S. citizens (including yours truly) endure a dozen+ years of organized history and civics classes with little or no exposure to the other side of the Constitutional debate.

I'm currently engrossed in some summer reading to obtain a better flavor of the Federalist and Anti-Federalist arguments surrounding the Constitution and its subsequent ratification. One concept captured by University of Chicago scholar Herbert Storing's (1981) work was the Anti-Federalist belief that, over time, citizen attention drifts away from government workings and, when this inevitably occurs, bureaucrats usurp power and resources. A couple of quotes from Storing (1981) p. 52.

"'The aristocracy,' said a [Maryland] farmer, 'who move by system and design, and always under the colourable pretext of securing property, act as has been frequently said like the screw in mechanics, always gaining, holding fast what it gains, and never losing; and in the event has ever proved an overmatch for the multitude, who never act but from their feelings, and are never permitted to feel until it is too late...' Were the people always attentive, they could call unfaithful lawmakers home and send others; but they are not always attentive."

Or put more bluntly by the outspoken Anti-Fed Patrick Henry on the same page, "Virtue will slumber. The wicked will be continuously watching: Consequently, you will be undone."

As our forefathers worried, we seemingly lay asleep at the switch.


Storing, H.J. (1981). What the Anti-Federalists were for. Chicago: University of Chicago Press.