Yes, you read me correctly.  Gold, despite recently surging to new all-time highs, is a truly lousy investment.  And this is not just my view; it is the view of Benjamin Graham, the mentor of Warren Buffett and the father of modern investing!  Consider what Graham had to say about the barbarous relic in his classic The Intelligent Investor:

The standard policy of people all over the world who mistrust their currency has been to buy and hold gold. This has been against the law for American citizens since 1935—luckily for them. In the past 35 years the price of gold in the open market has advanced from $35 per ounce to $48 in early 1972—a rise of only 35%. But during all this time the holder of gold has received no income return on his capital, and instead has incurred some annual expense for storage. Obviously, he would have done much better with his money at interest in a savings bank, in spite of the rise in the general price level. The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in “things.”

Graham wrote these words just before the massive 1970s bull market in gold and other commodities, making his timing extraordinarily bad.  But his logic is still sound.  What kind of investment pays no income…yet COSTS money to store?

And contrary to the claims of the gold bugs — which tend to be based more on political ideology than actual economics — gold is nearly as susceptible to “printing” as paper currencies.  The amount of gold in circulation as coins and bullion is by no means fixed. (Just ask the Hunt brothers what happens when you assume the supply of a precious metal is fixed and you attempt to corner the market…).  New supplies of gold are mined every year, and long-forgotten pieces of jewelry suddenly reappear and find themselves at the local pawn shop when prices get high enough.  (The supply of gold is obviously less expandable than that of paper currencies, but you get my point).

It should also be mentioned again that it was the hated US dollar — not gold — that investors ran to during the 2008 meltdown.

Gold, over the long term, is a terrible investment.  But — and it may surprise you to hear me say this –  I’m not necessarily recommending that investors dump their holdings immediately.  A lot of really BAD investments can make really good trades.  The “dot com”stocks of the late 1990s were investments of such laughably poor merit that you cannot believe today that anyone was stupid enough to buy them.   But as bad as they were, a lot of traders made a pile of money riding them up to the peak of the Nasdaq bubble — if they were smart enough to sell near the top.

Gold may have already peaked, or it may well have another 50% surge left in it.  I have no idea and will not hazard to guess.  It’s impossible to say what gold is “worth” because it has no intrinsic value.  And you never know how irrationally high a bubble will take a given asset.

My advice is this: view gold for what it is.  It’s not an investment.  It’s a highly-speculative trade.  Approach it as a trade, use stop losses, and don’t be afraid to take a profit (or loss, for that matter).  But most of all, don’t believe the hype.  The arguments for gold today are the same ones used in the 1970s (often made by the same people, who never seem to go away). They were wrong then (as the 1980s and 1990s proved) and they are wrong today.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

You know the drill: stocks up, dollar down.  With investors rediscovering their appetite for risk, the dollar has lost its appeal as a safe haven and has resumed the downtrend it was in long before the financial crisis.  So, a falling dollar only makes sense with a rising stock market.  Or does it?

Check out the chart below, sent to us by Douglas Robinson at RCM Robinson Capital Management LLC.   As you can see, for the past two years, the dollar and the S&P 500 have had a strong negative correlation.   But it wasn’t always that way.

As you can see from the green areas of the chart, there have been several times in recent years in which the dollar and S&P 500 rose and fell in near lockstep.  And if you go back to the 1990s, you’ll see that while US stocks were in a bona fide bubble, the dollar was near all-time highs!

Bottom line: don’t expect the current negative correlation to last forever.  There are limits to how low the dollar can go before it starts to damage the US financial system and stock prices.  We won’t attempt to call a bottom here.  Forecasting currencies is the quickest way to an ulcer or an early heart attack.  But we can say with a fair degree of confidence that we expect the US dollar to be significantly higher against most world currencies a year from now.

And one final note: for all of those rabid dollar bears and gold bugs who are convinced that the dollar and its guardian — the Federal Reserve — are uniquely rotten, consider this: when the world financial system plunged into meltdown in 2008, investors ran to the US dollar, not away from it.  All of the investors — including the world’s central banks — who are currently piling into gold and sending it to new highs should keep that in mind.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

More bad news from the land of the rising sun.  Deflation in Japan continues across a wide swath of goods and services, even while the country sees some of its highest economic growth rates in years.  Consider this recent Bloomberg post:  Japan Deflation Concern Rises Even as Growth Quickens

Bloomberg writes,

The domestic demand deflator, a measure of price levels that excludes the cost of imports, fell 2.6 percent in the third quarter from a year earlier, the most since 1958, Cabinet Office figures showed yesterday in Tokyo. At the same time, gross domestic product jumped 4.8 percent, the most since early 2007.

Sustained price declines threaten to curtail a corporate- profit rebound that’s already been insufficient to spur a rally in Japan’s shares this quarter.

Here are some other downright scary points in the article:

• Consumer prices have fallen for seven straight months.
• Even after seven months of gains in factory output, about one third of Japan’s factories sit idle.

It is our view, as we have written in other posts, that Japan is quickly approaching meltdown.  The country has had the loosest monetary policy in the world for nearly two decades, and fiscal spending that has been so out of control that it almost makes Presidents Bush and Obama seem prudent and responsible by comparison.

Once you enter a deflationary spiral, it is nearly impossible to get out of it.  It took World War II and the ensuing Baby Boom to get the United States out of its last period of prolonged deflation.  What could possibly pull Japan out of its current malaise?

Look at the bullet points again: prices have fallen for seven straight months and fully one third of Japans factory capacity is idle — and this is one of the premier manufacturing countries in the world!

At this point, it would appear to us that the only thing that could make prices rise again in Japan would be a massive currency crisis — and we believe that it is highly likely we will see one of those in the coming years.

All of the gold bugs and fanatical dollar bears might want to take a look across the Pacific to see what the real conditions for currency collapse look like.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Gary Shilling gave an interview with Yahoo! Tech Ticker in which he lays out a scenario very similar to that of HS Dent:







Mr. Shilling is taking a hard contrarian view here. It’s accepted as near “gospel truth” that inflation — BIG inflation — is coming down the pipeline. But where is the proof? Yes, the monetary base has expanded. But what of it? Banks, businesses and consumers all continue to deleverage. Money is being destroyed faster than it can be created. And prices, outside of volatile items like food and fuel, continue to show mild signs of deflation. We suspect that those investors currently piling into gold when it is sitting at all-time highs will soon be sorely disappointed when hyperinflation fails to appear.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The world of computing is undergoing a major shift.  Consider this fact:  The newly released Windows 7 is Microsoft’s first operating system to come with fewer features.

Yes, you read that right.  Windows is actually getting slimmer.  And the primary reason for this is the rise of internet-based “cloud computing.”  Let’s see what the Economist has to say on the matter (”Clash of the Clouds“):

Windows 7 is not just a sizeable step for Microsoft. It is also likely to mark the end of one era in information technology and the start of another. Much of computing will no longer be done on personal computers in homes and offices, but in the “cloud”: huge data centres housing vast storage systems and hundreds of thousands of servers, the powerful machines that dish up data over the internet. Web-based e-mail, social networking and online games are all examples of what are increasingly called cloud services, and are accessible through browsers, smart-phones or other “client” devices. Because so many services can be downloaded or are available online, Windows 7 is Microsoft’s first operating system to come with fewer features.

Any of you readers who get this blog post delivered to a Hotmail, Gmail, or Yahoo! e-mail address already know a thing or two about the Cloud.  Though a Microsoft Outlook-based e-mail server may be what you use at work, you no doubt appreciate the convenience of a personal e-mail account that can be accessed from any web browser anywhere in the world.

For now, most applications remain on desk tops (we tried Google Docs, Google’s online office solution, and it was horrid).  But this will likely change.  Google’s office solution will no doubt get better in the years to come, and Microsoft is moving to get its flagship Office suite available in the cloud on a subscription basis.

Furthermore, there are economies of scale that can be exploited.  As the Economist writes, “Why should every company or university set up and maintain its own mail server when Google or Microsoft can do it more efficiently?  Companies are already happy to rely on utilities to provide electrical power, after all.  Cloud computing will do the same for computing power.”

The beneficial result should be cheaper computing and higher productivity.  And a nasty recession with deflationary forces putting pressure on profits give companies every incentive to accelerate this process.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

We’ve commented before about Netflix and its business model.  We’re not a big fan of Netflix’s core business model, and we think it has only a few more years left it in at most.  In the age of fast downloads, it simply does not make sense to mail DVDs back and forth.  (Netflix also has an on-demand movie download service, which has promise.)

At any rate, while Netflix’s original business model is well on its way to obsolescence for digital media like movies, it may yet have potential for “old economy” industries.  The New York Times had an article about two young Harvard MBA graduates who started a “Netflix type” web business that rents designer dresses: “Haute Couture, Available Through the Netflix Model.”

This is an interesting idea.  It has long been possible to rent high-end women’s dresses for events (and men’s tuxedos too, of course).  But there has never been an online mail-order site for it.  The Times writes,

Rent the Runway is a recession-era twist on the Internet rent-by-mail model, which has been used for things like textbooks and video games in addition to movies. Unlike those utilitarian items, however, the dresses offer a touch of Cinderella — on a budget….

Rent the Runway is betting that its shop-by-Web convenience and the appeal of its top-quality fashions will persuade women across the country to rent a dress for a special occasion without trying it on beforehand.

It will be interesting to see if this business prospers.  It’s difficult to buy (or rent) clothes without trying them on.  This is hard enough for a standard pair of jeans, let alone tailored clothing.  Fashion is also a notoriously fickle industry.

At any rate, we’re not so much interested in this particular business as in the larger trend it could represent.  Recessions are a time of vicious creative destruction in which old business models are destroyed and new ones created.  It would be ironic if Netflix’s core business failed yet inspired copycats that revolutionized other industries.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

“People respond to incentives, although not necessarily in ways that are predictable or manifest,” write Levitt and Dubner in their new book Superfreakonomics.  “Therefore, one of the most powerful laws in the universe is the law of unintended consequences.”

Their book, which is a sequel to their surprise bestseller Freakonomics, is a great series of case studies on unintended consequences and, on a higher level, understanding consumer behavior.   It’s surprisingly one of the funniest books I’ve read in years.  I found the book so entertaining, I pretty well put my life on hold this past weekend to finish reading it.  (My rapid reading of the book was, in itself, a beneficial unintended consequence of my recent buying of my Amazon Kindle.  The convenience of owning a Kindle has enabled me to read much faster and cover a lot more material.  Don’t underestimate the benefit of having a portable library in your briefcase.)

Some of the book’s chapters are better not mentioned in this blog (a large section of the book is dedicated to analyzing the economics of prostitution, calculating the marginal costs and benefits added by pimps, among other topics).

Below are some of the tamer subjects covered Read the rest of this entry »

We are shocked — SHOCKED! — to find that Bank of America and other large institutions did not respond to Treasury Secretary Geithner’s entreaties to lend more freely:  “Geithner Saying ‘Be Like Buffet’ Can’t Make JP Morgan Lend More.”

Bloomberg writes,

While financial institutions including Citigroup Inc. and Bank of America Corp. have received more than $200 billion in capital from the government, they are limiting loans at a time of mounting unemployment, rising company bankruptcies and increasing regulatory oversight. Commercial and industrial lending has dropped 17 percent since October 2008, according to Federal Reserve data.

Economic growth will be slower and short-term interest rates will stay lower for longer than economists and investors expect because of banks’ reluctance to lend, says Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York. Bank profits may be restrained and bond prices boosted as institutions put money into safe Treasury securities rather than making riskier, more lucrative loans.

Bank executives are not fools (the lax mortgage lending standards of the mid 2000s notwithstanding).  When they look at the economic environment — even after recent improvements — they do not like what they see.  Rather than lend money in a risky, uncertain, and politically-charged environment, many would rather keep their funds in US Treasuries.

This is why, despite the record expansion of the monetary base, we had yet to see convincing signs of inflation.  When risk appetites wane, credit creation stops, and the velocity of money slows.  And that is where we continue to find ourselves today.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Despite being in “bunker mode,” in which virtually all non-essential spending has been trimmed or eliminated, consumers have continued to buy shoes by the box loads (see “A Not-So-Guilty Pleasure“).

The question begs to be asked: Why?

The New York Times writes “Retailing executives and analysts offer varying, occasionally wacky, explanations. The one favored by many of them is that consumers consider shoes more of a necessity than, say, dresses, cuff links or handbags, so people feel less guilt about buying them.”

Shoes are generally cheaper than most of the other items mentioned. Perhaps this is a better explanation, however:

Shoe buyers for major retailing chains said sales were also driven by styles for children and babies, especially during the back-to-school months. Children regularly grow out of shoes and parents, while willing to sacrifice when it comes to themselves, are typically loath to scrimp on their children.

When a child’s foot grows, you really have no choice but to buy shoes for him.  In this sense, children’s clothes can be thought of as a recession resistant sub-industry, particularly given the recent surge in births.  This recent baby boomlet gives the market for children’s clothes strong demographic support in the next decade.   Even if an adult man or woman is content to turnover their wardrobe a little less frequently when times are hard, some amount of spending is needed for their growing kids.  They might buy cheaper brands and buy fewer pieces overall, but some amount of spending is going to happen.  You can’t rightfully send your kid to school with sleeves and pants legs that are half a foot too short.

The Times also had another interesting theory to explain the resiliency of shoe sales:

Among the more curious explanations proffered for the relative strength of shoe sales is that women — who make up the lion’s share of the American shoe market — get an emotional lift from shoe shopping in a way they do not when trying on jeans and cocktail dresses.

During depressions, people are…well…depressed.  The “retail therapy” of shoe buying might create a sense of escapism from current economic woes.

At any rate,  this goes to show that in a bad economy, pockets of strength can be found in some unexpected places.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

A friend of mine looking to sell his home in suburban Fort Worth got a rude awakening.  The estimated market value of his home dropped $20,000 almost overnight.  When he asked the realtor what happened, he found out that the last comparable sale in the neighborhood was a foreclosure.  And even though that foreclosure price was not a “normal” market price, by virtue of being the last sale in the neighborhood, it became the new market price, dragging every other home in the neighborhood down.

The greatest benefit of a liquid market is it role in allowing “price discovery.”  The interactions of buyers and sellers send the signal of what an object is worth via the clearing price.  But the key here is “liquid.”  When sales are infrequent, prices become stale and no longer reflect reality.

In the housing market, this can be seen in a couple different ways.  If demand is in freefall and it’s been a while since there was a sale, the “market” price will grossly overstate the “real” price.  But likewise, if demand is relatively strong but the last sale was an aberration (such as a low-ball foreclosure sale), the market price can understate the real price.   In either event, it can make the sale of a house complex and downright tricky to negotiate for both buyer and seller.

The NY Times ran a good story this morning about this topic: “Getting Real About Home Prices”

The Times writes,

Even in the best of times, it’s hard for individuals to objectively value their homes, which often reflect their sense of self and personal style. Making things even more difficult has been general market inactivity lately, if not paralysis, which has provided little in the way of pricing guidance. But by using online resources, investigating neighborhood trends, consulting real estate experts and perhaps even asking the opinions of brutally honest friends, homeowners can arrive at a reasonably accurate appraisal even in these uncertain times.

Of course, as the Times tells us, in the end “the value of a home is the price the buyer is willing to pay.” And in most areas, it is still very much a “buyers market” in the sense that sellers have very little negotiating power.  This is not something we see changing any time soon.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy