What is wealth? In my opinion, the creation and destruction of wealth requires the transfer of energy. The energy it takes to make something, grow something, mine something, and eventually destroy something is what creates transient value. Since wealth is influenced by energy, wealth is subjected to the same laws of the universe as any other force. One cannot make wealth out of nothing, so it's also true when a force/asset class erodes (mountain range or real estate) or completely destroyed (dinosaurs or Lehman Brothers), some new force or financial asset class attempts to balance out that erosion or destruction.
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The financial markets have an energy transfer effect like in nature. Whether in a communist barter economy like Cuba, or a U.S. free-market economy, the creation and destruction of financial wealth exist since human nature is driven by greed: ( http://www.youtube.com/watch?v=RWsx1X8PV_A/ ). Thus, respecting and recognizing the cyclical nature of markets, and then practicing the swapping phenomenon from one asset class to another from time to time, is of critical importance to conservative portfolios/investors..
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The U.S. economy is still bleeding wealth, and unfortunately the greatest wealth loss is occurring in the largest asset class, real estate. Like crop blight to a farmer, or a tunnel collapse to a miner, it is a temporary setback that causes uncertainty, discourages recovery, but also creates opportunity.
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I am not a short term player in the market, I have a conservative long-term investment philosophy tailored to my retirement goals. It is my opinion the commodities market will offer the best chance to build or retain wealth in the coming years: ( http://www.forbes.com/forbes/2009/0525/094-investment-guide-09-best-inflation-hedges.html/ ).
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The reason why physical commodities like gold are a good place to swap some of your vanilla mutual fund money during uncertain times is because it represents concrete efforts of energy; the sum of the efforts of millions years of nature and eventual production costs. The price of commodities, through modern times, have definite bottoms. Physical Gold has never filed for bankruptcy. The spot/market price of gold has never fallen below its production cost in times of global economic strife (1931, 1981, and 2009). In terms of real wealth, the price swings as currency weakens or inflates, but the value of your investment always carries that intrinsic raw physical element, even before extraction. Gold is a force of nature that doesn't erode and bankrupt like a paper asset. Thus the physical nature of commodities are a smart swap in times of great political and economic uncertainty, like today.
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Last April, Charles Biderman gave this interview: ( http://money.cnn.com/2009/04/21/news/economy/fortune-recovery-index.fortune/index.htm?postversion=2009042411/ )
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Biderman was asked:
"In your view, what would be the single best sign that we've hit bottom"?
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"That foreclosures dry up. That'll be a sign that household wealth has stabilized. Things aren't going to hit bottom until the real estate market bottoms, and we work through all the problem homes, and people can afford the homes they're in. Then we can grow from there"..
Wise investors should pay close attention to Biderman. This is why the current quarterly increase in home foreclosures bears careful watching. This means that the 17% increase in the second quarter ( http://www.washingtonpost.com/wp-dyn/content/article/2009/09/30/AR2009093001696.html/ ) and the 23% increase in foreclosures in the third quarter reported here: ( http://www.bloomberg.com/apps/news?pid=20601103&sid=aFofq9_za8Is/ ) is good reason to predict another economic downturn in real wealth the immediate future.
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This wealth bleed continues despite unnatural government programs to halt the natural free-market economic cycle. It is my opinion the interference of the Federal Government will actually prolong the descent of real wealth and exacerbate inflation and prices of commodities like gold and oil; unfortunately most investors are too conservative to swap their equity funds into commodity funds, this has me concerned. As unproductive public dollars begotten from thin air are spent in hopes of ending the slide, it becomes a matter of dangerous socioeconomic entropy for the masses of unsophisticated investors: ( http://www.washingtonpost.com/wp-dyn/content/article/2008/11/11/AR2008111101178.html/ ).
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The Mortgage-Backed Security (MBS) market, and Collateralized Debt Obligation (CDO) market price and demand erosion locked up credit markts. Fannie and Freddie were paradoxically created by the government, and now the recent thaw has also been created by goverment officials, not free-market entrepreneurs. The more home loans go into foreclosure the more “toxic” MBS's and CDO's become and the more toxic the federal reserve's balance sheet becomes. We have already been through a couple of rounds of CDO auctions: ( http://www.bloomberg.com/apps/news?pid=20601087&sid=a5KbYLsaKQhU/ ) If this trend continues, the glut of foreclosed homes will continue to be the deepest gash that bleeds real wealth from U.S. consumers overweight in real estate.
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If the government ended the spending frenzy today, real free-market wealth creation and destruction would be allowed to coogulate the bleeding. What does this have to do with investing? Well it means younger investors would have a green light of go back into higher risk strategies like equities, hoping to catch the economy on a normal bounce. I am worried that senior citizens holding their money in the stock market, or adding more in this latest bounce, will be hurt most as they sellout at the lowest point either in 2010 or 2011. The government cannot continue to print dollars and expect the free-markets to be fooled. Inflation in the next few years will degrade the bulk of savings. I recommend investors consider swapping into inflation protected assets like iShares Barclays TIPS Bond (TIP), or a larger chunk into a commodity ETF like the PowerShares DB Commodity Index (DBC).
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I am obviously very concerned with inflation in late 2010. Official numbers for inflation are weighted 30% to the cost of homes ( http://infoproc.blogspot.com/2005/02/housing-and-inflation.html ). As home prices fall, it will keep “official” inflation low and fool many. Please remember home prices have little to do with the value of the dollar in the international market, nor do home prices have any correlation to the value of gold or oil on the world stage.
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Here's proof wise investors are worried about inflation: ( http://www.ft.com/cms/s/0/a28ac2fc-bda7-11de-9f6a-00144feab49a.html/ ). The system is being injected with public capital as lending rates remain at Zero Japan: ( http://www.bankrate.com/rates/interest-rates/prime-rate.aspx/ ).
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The crude oil and natural gas markets will continue to be volatile and weigh on consumers' discretionary spending decisions in months ahead. Right now oil is in a vicious upswing, and I would be very concerned if the move continues through $100/barrel with no improvement in employment or home prices: ( http://www.oil-price.net/ ).
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As I wrote in my last installment for this blog, I predict “hovering” action for the U.S. equity market/S&P over the next several months, as the $787B stimulus and $2.3T budget has negative consequences long-term, yet short-term it's difficult to fight against such a tsunami of liquidity. You can still make money in the equity market by taking advantage of the bounded ups and downs, always remembering there are two sides to the market: long and short. Yet I chose to transfer 25% of my portfolio into inflation protected assets mentioned above.
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My personal circumstances do not allow for day trading and watching CNBC's experts. I wrote this piece for an audience that respects long-term conservative investment strategies that even anti free-market Administration's offer. The transient nature of financial instuments is fascinating, and the energy transfer mechanism of greed should influence forward-thinking investors to swap asset classes based on supply and demand principles first.
Simon Jester.
15 comments:
Simon, I agree with everything you wrote so far. Very nicely done.
Avi
My fiance Cheryl and my I do see real estate as trouble. We thank you for the detailed word.
Bill C.
Like your last article, this one is better.
Mikey in Chicago
Until which month do you see the S&P hovering to in 2010?
J.P.
Do you believe crude oil will break through $100 before nat gas $6? thanx
Paul the ex Goldman trader
IYO, who would be better for free market? Paul, Romney, Palin, McCain, or someone else?
Mary Ann
Simon, if you had to choose 1 investment to put your money into today, what would it be?
Facebook Matt
I like the take on asset destruction and creation. I hope to see you write more pieces.
Jerry P. and wife Genie
Really good information ! Thanks a lot for this useful post !Good post!
You should write more about this!
I agree Alexis, Simon is a great thinker. Not sure whether he understands day trading, but he makes very valid arguments about active portfolio management.
Adam
The idea that commodities cannot fall in price below their cost of production is nonsense. Many years ago I was VP Planning for a major commodity producer and for sure the price often was below our cost of production.
A more realistic statement would be that the price of a commodity will not drop below the variable cost of the highest cost producer necessary to balance supply and demand.
You are stuck with your fixed costs but generally will not produce if your variable costs exceed the price. But even then you have to factor in the cost of reducing production (laying off people, mothballing facilities) and the cost of rehiring and retraining people and rehabing facilities and companies do not like to layoff their employees. So for a short time prices can even fall below variable costs.
It would not hurt if those writing on a subject understood a little economics.
Hey smart ass "mothball VP":
Your past title doesn't impress me one bit. What I interpreted Simon to mean is the "supply and demand" factor of a raw commodity, esp gold, has an intrinsic value like no paper asset. I think the piece had many valid and interesting points, esp regarding real estate. To criticize one area shows your short sightedness and perhaps pent up frustration with Nobama.
Jack in Miami
Former VP,
Remember that I wrote this piece to explain my long term wealth retention strategy. This isn't about price dips and highs, it is about retaining wealth through the coming troubled years.
What you say is true, sometimes the market cost will dip below production cost, when there is a glut on the market this can happen, or when demand dries up. Both situations turn it from a sellers market to a buyers market (supply and demand).
This happens quite a lot historically in the oil industry, especially since there are so many worldwide producers competing against each other.
No company will continue to produce at a loss unless there is a longer term payoff for such an action. People are greedy, not stupid.
But in the longer term the price will rise over the cost of production. If it didn't then the item in question will cease to be a commodity (think of animal feed, much more profitable in 1870 than 1970).
The intrinsic value of a bar of gold or barrel of oil is going to still be the same no matter the change in price (barring a sweeping technological change). Price fluxuates, but until we stop having an oil based economy or huge gold veins are uncovered then the value is protected.
I hope this clears some things up.
Simon Jester
Amiable brief and this post helped me alot in my college assignement. Gratefulness you on your information.
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