(March, 2004)
COMMENTS ON PRECHTER’S VIEWS
Hi Chris. Say, I’ve just finished reading an interview with Bob Prechter that was posted on 321gold.com under the “economy” section. Anyway, I suppose you have probably read his “conquer the crash” book where he predicts that the U.S. is heading for a severe bout of deflation? This article was quite convincing but I don’t have the investment acumen that you have and was wondering your opinion if you had read it?
I was surprised to see that he predicted the fall of virtually everything (Gold and Silver is what got my attention) along with the eventual strengthening of the dollar. Is it possible that I have structured my portfolio (mostly silver/gold stocks along with physical gold) incorrectly? I just assumed that the Fed would paper the streets with dollars before letting the economy succumb to deflation but Prechter seems to thing that the Fed will stop short of that and allow deflation to happen. Any opinions?
I’ve got some S&P mini’s two year leaps (puts) at 950 and some two year NEM calls that are way out of the money ($80) that I thought would hedge against the losses I'm going to experience in my Real Estate holdings (which I am trying to sell but don't think I'll get out in time). In retrospect, perhaps I should liquidate the NEM calls and buy some more puts? Any thoughts?
I read the article you talked about, and have followed Prechter closely enough otherwise to have a fair opinion of his position.
I believe Prechter’s main thesis; that the long-accumulating asset and debt bubbles (especially the latter) eventually need to be unwound much more than they were between 2000-2002. The question is what form that will take, as well as the timing.
In the February issue, I answered a question in the Readers section (heading: “Questioning the Stagflation Argument”) that addressed my take on things. I believe that, for the most part, the Fed will continually seek to keep monetary policy easy to soften what's coming. In fact—for all the talk about how everyone's expectations are that the Fed will soon begin raising short term interest rates—it is not out of the realm of possibility that we’ll see further CUTS down the road. That might especially occur if the economy starts to slow back down more, and sooner, than is currently expected.
I believe the result of the Fed’s policies—which I'll be getting into even more in the next issue or two—will lead to a weaker dollar once the current rebound has run its course, higher prices for most commodities, etc. We could for the next year or two see the kind of “70's lite” environment I wrote about, BEFORE the deflationary forces kick back in in a much bigger way.
When they do—and they surely will at some point—I agree with Prechter that prices for most things will go down, at least initially. I believe he includes silver and gold in that equation due to what I've even written about in the past. Simply put, if consumers here and elsewhere are squeezed by a recession/deflation and have much less disposable income to spend on things that are not necessities, what's to prevent gold from also going down (together with virtually all other commodities) if people cut back on how much jewelry they are buying? Don't forget that this kind of demand still comprises the most important element of gold's demand as a commodity.
Whether gold (as opposed to silver, on which I agree with Prechter) goes down and stays down depends on a couple things. First, I guess I need to get a better sense of why Prechter thinks the dollar will rally in this environment; something I am skeptical of. Compared to other economic zones, the U.S. has much farther to fall than do other areas. Particularly if the Europeans can keep their economy and common currency together (admittedly, as I've said myself, a question) and more so, if Asia can begin to insulate itself from America's problems, there will be other currencies and economies that look safer. That should support gold, at the least; especially if as a part of the transformations world economies and markets will go through we see the unveiling of one or more currencies (perhaps China's) that have a stronger gold component behind them.
So, though Prechter's warning of everything falling may hold true somewhat, I think the chances are just as good of a dollar crisis—even amid a deflation of our economy—that would support gold eventually.
Hindsight being 20-20, I would have exited any longer-term options back at December's peak, including those on Newmont. At these levels, however—and especially as you've already ridden them down this far, and the expiration date is still out some two years—I would hang on. Even if the dollar continues to consolidate (or even strengthens) for a while, I still am quite convinced that the longer-term trends favor that position.
Likewise, I'd hang on to your S&P puts as well for the time being, although if the current correction picks up some steam and we see a 10% drop or so in the near term, I might be inclined to sell those at some point, even if the S&P does not fall as low as 950. You might then be able to let the market attempt a rally and then buy back in.
OPINION ON MICROSOFT?
Chris—I have held Microsoft for quite a while now, expecting it to finally catch up with the rebound in technology. Now I’m wondering whether I should bail, if the overall market is now going to suffer as you say.
Do you have an opinion on MSFT?
Actually I have two opinions on Microsoft. First, I would not want to own it now.
Second, once this downward move in the market runs its course, I will be giving the software giant a very serious look.
I happen to count as a virtue for Microsoft what the market has disparaged; in short, the fact that the company has a “hoard” presently of some $60 billion or so in cash and short-term investments. Some stock market bulls have exhibited behavior bordering on rage where this is concerned, believing that Bill Gates should be blowing a decent part of this wad on buying back shares, paying a higher dividend, or going on a shopping spree.
I predict that a year or two from now, owners of Microsoft will be relieved that this money wasn’t burning a hole in the company’s pocket the way some think it should be. Clearly, the management has enough sense right now—just like the manager of a certain big company by the name of Berkshire Hathaway—to realize, as my headline suggests elsewhere in this issue, that cash isn’t “trash” after all. And for all the brickbats they’re throwing right now, giddy investors who have set themselves up for another fall should ponder the fact that Messers. Gates and Buffett filled the number one and two places, respectively, in Forbes’ recent update of America’s wealthiest men.
This does not mean I’d want to own Microsoft now; and if I did, I’d
probably sell it, even though it likely won’t drop nearly as much as
most other large tech stocks. Either way, I’d be salivating at the
prospect of just how much farther that $60 billion will go later than it
will right now; and I’d be lobbying for the company to continue sitting
on its cash pile.
BOND FUND CONFUSION
You again mention Rising Rates Opportunity Pro Fund. I called Fidelity to see if they had a similar fund since all my money is with them. They have one started in 2002 the same as the Pro Fund.
I called each one and asked the return since the inception of each. Hopefully I asked the correct question and they gave me an accurate answer. The ProFund lost 21% and Fidelity’s Inflation Protected Bond Fund earned 7.6%. If the objective of each of these funds is the same it would be easier for me to get into Fidelity’s fund.
You were misinformed; the Fidelity Fund is nothing like Rising Rates Opportunity Fund.
Fidelity's invests in bonds that are indexed to inflation. As I have written on several past occasions in the newsletter, I generally do not like what are called “TIPS.” The so-called inflation protection is minimal. In addition, if you own these things outside a retirement plan, the tax burden is outsized each year as well.
Rising Rates, in effect, goes SHORT where bonds are concerned. It is intended to take advantage of an environment where interest rates are rising and, thus, bond values are falling. Its performance generally has been poor as you pointed out because rates were essentially declining during that time. The rationale for taking a couple small steps into Rising Rates NOW is in the expectation that most if not all of the decline in interest rates has already occurred.
By contrast, the Fidelity Fund can be expected to LOSE principal value if interest rates rise. About the only saving thing for it—and TIPS generally—is that declines may end up being somewhat less than in bonds NOT indexed to the government's deliberately low “inflation” measure.
WHY BEARISH ON GOLD?
You were certainly right as it turns out in suggesting that your subscribers pare back positions in gold stocks a few months ago (unfortunately, I only subscribed a few weeks ago, so missed that call.) I am curious, though, as to why you have not changed your tune now that gold has dropped as much as $40 per ounce, and gold stocks by quite a lot too. Isn’t the long term picture still good, in spite of worries you might have now?
My attitude since the long bear market for gold ended three years or so ago has been to always maintain a “core” position in gold. That is where we are back to once again, at 10% of an overall portfolio. Beyond this, I have advocated loading up somewhat when the tea leaves, goat entrails, technical and other factors have combined to make a sufficiently compelling case. Most recently, we had as much as a 30-35% exposure to gold shares up until around December 1. At that point I recommended cutting back to 15% of a portfolio; since then, I just urged that we get more defensive still.
The reason to keep a “core” position in the BEST gold stocks we can find is twofold. First, if the companies we are in have superior fundamentals, stories or both, I worry less about their short-term behavior. Second, we never know when gold could suddenly take off for any number of reasons; thus, as convinced as I was over three months ago that the party was over for a while, I would not take the position that we should exit the sector completely when the longer-term trend is still bullish.
Having said all that, two key factors argue in favor of further weakness for gold in the weeks (and months?) ahead. The first is the weakening euro, which I have already discussed elsewhere in this issue.
The second is a factor that NOBODY, as far as I know, has mentioned: the Federal Reserve now NEEDS a FALLING gold price!
I have previously written (several times, actually) that a rising gold price in 2003 served the purposes of the Federal Reserve well. It was pointed to by many as a sign that deflation was no longer to be feared; and that, among other things, it was safe for consumers and businesses to ratchet up their investing and spending.
The trouble is, a lot of other things have gone up too. In spite of the aberrational behavior of the bond market (see below), price pressures are building. Though the lousy jobs number recently and similarly lackluster economic news have taken some of the pressure off the Fed to raise interest rates, commodity prices that remain stubbornly high (if not headed higher) can’t be ignored forever.
And the trouble with all that is that—if anything—the Fed may shortly feel compelled to CUT interest rates rather than raise them. For this, it will need some cover. For political reasons, it won’t want to solely rationalize its decision by pointing to the fact that the job market just plain stinks (unless, of course, we’re talking about India.) We’ll have to have some indicator that—though other evidence might be arguing strongly to the contrary—the Fed is safe in easing monetary policy even further.
A gold price dropping to, and perhaps even back through, $380 will—I GUARANTEE YOU—be just such an “historically reliable indicator” that “inflation” remains “dormant.” Just watch; if I’m right about this, you’ll begin to hear from CNBC’s Larry Kudlow and the other usual suspects that gold is “telling” the Fed that, to really get the job situation turned around, it must ease further. Just as much, a weakened gold price would be telling the Fed that it is safe to cut interest rates more, since such a docile gold price would be “indicating” that inflation is still non-existent.
Now you and I both know this is nonsense; as the government’s very definition of “inflation” is a very bad joke. But Wall Street and most of the economic intelligentsia don’t care; and they’ll sign on to this gibberish with gusto.
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