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

 We gave - yes gave - the car companies $70 billion dollars.  We gave Wall Street firms, through payments to AIG and then back-stopped lending facilities, over $4 trillion dollars.  Who can’t “make do” on that kind of money?

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

Opposite Kristof is Gail Collins, writing about the recent outrage over screening for breast cancer in women between 40 and 50.  She does not give the situation a full sounding, just more or less relates her own story of having been tested routinely, given a clean bill of health, and then finding a cancerous lump through self examination. 

The reason I link these two is because they (Medicare and extensive screening for cancer) are great examples of programs that continued to grow in what and whom they covered without a check on how expensive the care was.  Kristof’s article is quite sarcastic, presenting the worries of detractors as totally misplaced.  Really?  The program is bankrupt, and expected to be trillions of dollars in the red over the next 20 years.  Is that a success?  Medicare began overrunning its cost estimates in the first year of existence and never looked back.  The pledge of the government at the time was that it would never add a dime to the federal deficit.  Sound familiar?  The fact that it took four decades to teeter on the brink of catastrophic insolvency is a success?  This is the old story of a man jumping off a 100-story building and at the 25th floor someone asks, “How’s it going?” and he replies, “Pretty good so far.”  This was used by Reagan to describe Social Security, although I don’t think he originated it.

As for breast cancer screening, the new report added one element to their previous findings - the cost of screening and treating false positives of all the women who are between 40 and 50 but do not have cancer.  The estimate was that for every 1,900 women screened between 40 and 50, 1 has cancer.  For women over 50, it is 1 in every 1,300 screened (approximately).  So the extra 600 screened and some treated or subjected to biopsies, etc. for what turns out to be not cancer leads to such increased cost as to make it not worth it, in the eyes of the committee.

This is rationing.  Did the committee draw the right conclusion on breast cancer screening?  I don’t know.  Can there be a “right conclusion?” 

We do not have unlimited funds.  Medicare has worked off of the premise that we do, because Congress has failed in its cost containment efforts, self destructing every time (see the Dr.’s Fix that is currently in front of legislators).  Medicare is a failed program not because it did not provide care, but because it cannot be sustained, and never, ever, could, even at inception.

Screening for breast cancer in women 40-50 saves some lives.  Screening for prostate cancer in men does as well.  Are the effective in terms of cost?  Those decisions are the difficult ones that we will have to make.  None of the snarky comments in the NYT, the WSJ, or elsewhere can change the facts.   We do not have unlimited funds.  We are aging as a nation.  Our method of providing healthcare today comes at such a cost as to be unsustainable at every level.

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

That disappointment is being telegraphed by retailers as they try to get ahead of the game.  Among the strategies being employed are preemptive strikes (Walmart pricing items at $10 or less, and early price cuts on desired items like TV’s) and limited offers (thin inventory).  While these approaches might make the bottom line attractive as a percentage, they do nothing to help the top line grow.  Revenue growth is the deal.  And it’s not happening.  Saks and Target both reported year-over-year declines in sales for stores open more than a year.  That story is playing out across the retail sector.

The consumer is telling us something.  Expect less.

What we did not expect was that once the US stock market showed its dark side in the tech bubble and crash of 2000-2002, the asset bubble in the US would find what seemed to be safer ground - housing, and then later on commodities and some international venues - leaving US equities to more or less languish for the rest of the decade.  Even though US equties performed poorly, there was still a tremendous bucket of investment assets looking for an outlet that had promising returns.  After the crash of 2008-2009 we have all gotten religion about housing.  Many are wary of commodities after the drubbing they took late last year and this spring.  But we still must invest.  We are compelled to find a place to put those assets that we are saving for tomorrow.  As US equities rise and the Fed pursues its Zero Interest Rate Policy (ZIRP), we are seeing more funds flow into stocks.  With the onslaught of ETFs that are based on commodities and foreign markets, these areas are seeing tremendous inflows as well. 

It is hard to make a case that this level of investment is warranted.  For all of the talk of a rebounding economy, so far it is speculation of a bottom and ensuing move higher.  But the markets have already priced in a substantial rebound, acting like the forward indicator that so many say it is.   What happens if this turns out to be wrong?  Where do the funds go next?

We don’t have experience with this one; we are breaking new ground.  Never has there been a time when so much accumulated wealth could move so quickly among investment choices.  If we are correct in forecasting an extended period of slack global demand, which in turn would mean paltry earnings for financial securities, where will capital fly to next in the great chase for returns?  Cash is not a very attractive alternative if your future depends on earning 7-8% per year.  This question will haunt us as individuals, and many professionals as pension managers, in the years to come.

Of course the problem with bubbles is that no one knows exactly when they will end, so in order to remain competitive many people participate even though they are wary of the fundamentals.  I’d imagine that many of us fall into just this category.   I think the key is to remain as flexible as possible, willing to protect your investments at a moment’s notice.  Investing has just gotten much harder than it was for the last 25 years. 

Charles Sizemore, CFA

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

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

Professor Kenneth Couch did a small and obviously not exhaustive study of workers in CT and found that those returning to work after a period of unemployment were taking an average of a 40% pay cut.  As the WSJ reports, in previous downturns the pay cut was not as large, and it still took 6 years for workers to regain 80% of their previous pay. 

In the next 12 months, look for wage growth to go negative.  The implications for foreclosures and consumer spending are obvious.