Economic Analysis from John Mauldin
- Sun, 20 Jul 2014 15:22:00 +0000: GDP: A Brief But Affectionate History - Mauldin Newsletters
“Measurement theory shows that strong assumptions are required for certain statistics to provide meaningful information about reality. Measurement theory encourages people to think about the meaning of their data. It encourages critical assessment of the assumptions behind the analysis.
- Tue, 15 Jul 2014 23:43:00 +0000: Hoisington Investment Management – Quarterly Review and Outlook, Second Quarter 2014 - Mauldin Newsletters
This week’s Outside the Box is from an old friend to regular readers. It’s time for our Quarterly Review & Outlook from Lacy Hunt of Hoisington Investment Management, who leads off this month with a helpful explanation of the relationship between the US GDP growth rate and 30-year treasury yields. That’s an important relationship, because long-term interest rates above nominal GDP growth (as they are now) tend to retard economic activity and vice versa. The author adds that the average...
- Wed, 09 Jul 2014 17:40:00 +0000: Poverty Matters for Capitalists - Mauldin Newsletters
Having taken Thomas Piketty to the cleaners a few weeks back (see “Gave & Gave … and Hay”), Charles Gave now redresses the balance with regard to the issue of economic inequality in today’s Outside the Box. He makes a forceful case that “poverty matters for capitalists”: Every US recession that I can recall was preceded by a fall in long rates, and I doubt the next will be much different. As such, do not expect the next US downturn to arise from the Federal Reserve pushing rates higher, an...
- Sat, 05 Jul 2014 18:34:00 +0000: Central Bank Smackdown - Mauldin Newsletters
Smackdown: smack·down, ˈsmakˌdoun/, noun, US informal 1. a bitter contest or confrontation. "the age-old man versus Nature smackdown" 2. a decisive or humiliating defeat or setback. The term “smackdown” was first used by professional wrestler Dwayne Johnson (AKA The Rock) in 1997. Ten years later its use had become so ubiquitous that Merriam-Webster felt compelled to add it to their lexicon. It may be Dwayne Johnson’s enduring contribution to Western civilization, notwithstanding and...
- Thu, 03 Jul 2014 00:03:00 +0000: The Delusion of Perpetual Motion - Mauldin Newsletters
In the club where all stock market investors meet every morning when they wake up, the room occupied by those who “don’t understand what is going on” is not as crowded as you might expect. I admit I’m not lonesome – I have plenty of fellow “confusees” to talk with – but I am told they are having to add some more space for the growing crowd in the “it’s a bull market and those stupid old bears just don’t get it” section of the club. This week’s Outside the Box is a selection from two essays...
Economic Analysis from Casey Research
- Tue, 22 Jul 2014 13:48:00 +0000: True or False? Seven Common Beliefs About Investing in Junior Resources - Casey Research - Research & Analysis
Many investors seem reluctant to enter the fray of investing in junior resources. While they know that the high risk of the space can bring big rewards, the risk—along with a lot of hype and misinformation about new technologies—can seem so large that none but the most fearless of investors is willing to give it a try.
Today I’ll review several beliefs most investors hold regarding junior resource investing, affirm some, and bust open a few misconceptions. This should help you become a more savvy speculator, so let’s get right to it.
Belief 1: Investing in juniors can make you rich.
True. The secret to becoming a successful speculator is being a contrarian. When everyone believes a sector is dead and is the worst place to be invested, that’s exactly when you want to invest in it. The junior resource sector is currently at historic lows, yet our portfolio is delivering exceptional returns. Imagine what our portfolio will be returning to investors when the bull market starts in the juniors.
Belief 2: The world will require less resources and energy in the future, and therefore, the resource sector will underperform.
False. The world’s population will likely grow to 10 billion by the end of the century—and the world’s energy requirements will grow much, much more. Two-thirds of the world’s population is still poor; many of them dream of living the lifestyle the Western world has taken for granted. As the rest of the world attains even a quarter of the Western standard of living, people will consume more of everything. All those things people will want will require energy… to extract or harvest resources, to ship raw materials, to manufacture finished goods, and to ship them to eager customers.
Belief 3: Investing in publicly traded resources increases good environmental practices around the world.
True. If Greenpeace really wanted to make a difference in the world, it would actually run a public company where all of its actions, investments, and policies would be transparent for all to see. Even better, it should in fact run a resource company, to set the standard in resource extraction. The fact is that the publicly listed North American companies bring the highest standards to both resource extraction and to the environment. Contrary to what the anti-resource propaganda claims, the companies that extract commodities in North America are regulated and follow strict practices and guidelines. It’s actually the prevention of the development of resources that leads to unregulated extraction horrors, such as what we’ve seen in places like Nigeria. North American energy companies develop the most modern technologies, invest in environmental studies, and have the highest standards for environmental best practices. That information is shared around the world and in so doing, it grows and develops. Greenpeace should be involved in proper scientific discussion, not propagandizing, and all media outlets should hold the group accountable for this. Investing in energy development not only enhances the peoples’ lives and the communities where the projects are located, but it also improves the advancement of science and sound environment practices—especially in the areas where barbaric, unregulated resource extraction still occurs.
Belief 4: The average investor gets slaughtered investing in juniors because the big money is made by the insiders.
True. But if you’re smart, you use this to your advantage. I’m a resource insider and have been involved in some very successful mining and energy companies. By having over a decade of experience in the sector and traveling around the world, I’ve developed relationships with the engineers, geologists, invest bankers, and brokers who know what’s really going on in the sector and have their fingers on its pulse. That’s the Casey Energy Report advantage: we know everyone in the sector and have for years… so, in our reports, you get the good, the bad, and the ugly.
Belief 5: Financial statements are difficult to read and understand.
True. The irony is, you don’t need to read the long, boring, and sometimes difficult financial statements and management, discussion, and analysis (MD&A) reports. We do it for you. Now if you want to spend hours reading financial statements that look more complicated than your own tax return, go for it. But with all the CFAs, MBAs, and other experienced analysts on our staff, I highly recommend you leave the grind to us and just enjoy the benefits.
Belief 6: Technical analysis works for junior stocks.
False. Juniors are just way too illiquid for technical analysis to be of any real benefit. There are some great merits to technical analysis, but leave it to the liquid stories—instead, stick to the proven Casey 8Ps for junior resource investing.
Belief 7: Casey Research subscriptions are expensive.
False. Now, it’s true that several of the company’s investment newsletters carry high prices, but that isn’t the same as being expensive. As I mentioned earlier, we have a deep and experienced team poring over every aspect of a sector and potential investment recommendation. And there’s my math background, decade of energy-investing experience, and insider knowledge and connections. These things make our energy letters the best in their class, just like Ferraris and Canali suits. So we charge accordingly.
What can be expensive is trying to go it alone in the volatile junior sector, reading through all those financial reports and technical analyses and trying to predict subtle shifts in energy markets. That will cost you a bundle in terms of time and energy, not to mention money lost when your hunch turns out to be wrong… and all that time, you could have been enjoying your life and pocketing gains as a subscriber to my letters.
Even though my energy letters carry hefty price tags, I can give you a free look at them—new issues, plus the entire archive, including all stock recommendations and overall portfolio performance. A Ferrari dealership won’t let you have a Ferrari for three months absolutely risk-free, but we do. I’m so confident that you’ll find the Casey Energy Report to be a great value for the price that I have no problem giving out a 3-month test drive. If for whatever reason you don’t like it, no worries: you get 100% of your money back. If you like it and make money, I know you’ll stay a happy subscriber. You deserve to be rich, and if you want to learn about energy, the Casey Energy Report is the best place to start. Click here to get started today.
- Mon, 21 Jul 2014 13:19:00 +0000: Western Delusions vs. Chinese Realities - Casey Research - Research & Analysis
I’m off to Vancouver this week for the Sprott Vancouver Natural Resource Symposium 2014. I hope to see many of you there and be able to answer your questions in person.
Meanwhile, Jeff Clark has an article debunking some trendy arguments offered by today’s gold bears regarding one of the critical factors in today’s gold market: Chinese demand. Well worth the short time it takes to read it.
Senior Metals Investment Strategist
Rock & Stock StatsLastOne Month AgoOne Year Ago Gold 1,310.61 1,272.70 1,284.20 Silver 20.84 19.78 19.39 Copper 3.16 3.06 3.13 Oil 103.13 105.59 107.81 Gold Producers (GDX) 26.94 24.76 24.78 Gold Junior Stocks (GDXJ) 43.70 40.23 37.95 Silver Stocks (SIL) 14.24 13.19 12.39 TSX (Toronto Stock Exchange) 15,266.57 15.109.25 12,628.85 TSX Venture 1,012.24 1,008.82 914.57
Western Delusions vs. Chinese RealitiesJeff Clark, Senior Precious Metals Analyst
I don’t want to say that mainstream analysts are stupid when it comes to China’s gold habits, but I did look up how to say that word in Chinese…
One report claims, for example, that gold demand in China is down because the yuan has fallen and made the metal more expensive in the country. Sounds reasonable, and it has a grain of truth to it. But as you’ll see below, it completely misses the bigger picture, because it overlooks a major development with how the country now imports precious metals.
I’ve seen so many misleading headlines over the last couple months that I thought it time to correct some of the misconceptions. I’ll let you decide if mainstream North American analysts are stupid or not.
The basis for the misunderstanding starts with the fact that the Chinese think differently about gold. They view gold in the context of its role throughout history and dismiss the Western economist who arrogantly declares it an outdated relic. They buy in preparation for a new monetary order—not as a trade they hope earns them a profit.
Combine gold’s historical role with current events, and we would all do well to view our holdings in a slightly more “Chinese” light, one that will give us a more accurate indication of whether we have enough, of what purpose it will actually serve in our portfolio, and maybe even when we should sell (or not).
The horizon is full of flashing indicators that signal the Chinese view of gold is more prudent for what lies ahead. Gold will be less about “making money” and more about preparing for a new international monetary system that will come with historic consequences to our way of life.
With that context in mind, let’s contrast some recent Western headlines with what’s really happening on the ground in China. Consider the big picture message behind these developments and see how well your portfolio is geared for a “Chinese” future…
Gold Demand in China Is Falling
This headline comes from mainstream claims that China is buying less gold this year than last. The International Business Times cites a 30% drop in demand during the “Golden Week” holiday period in May. Many articles point to lower net imports through Hong Kong in the second quarter of the year. “The buying frenzy, triggered by a price slump last April, has not been repeated this year,” reports Kitco.
However, these articles overlook the fact that the Chinese government now accepts gold imports directly into Beijing.
In other words, some of the gold that normally went through Hong Kong is instead shipped to the capital. Bypassing the normal trade routes means these shipments are essentially done in secret. This makes the Western headline misleading at best, and at worst could lead investors to make incorrect decisions about gold’s future.
China may have made this move specifically so its import figures can’t be tracked. It allows Beijing to continue accumulating physical gold without the rest of us knowing the amounts. This move doesn’t imply demand is falling—just the opposite.
And don’t forget that China is already the largest gold producer in the world. It is now reported to have the second largest in-ground gold resource in the world. China does not export gold in any meaningful amount. So even if it were true that recorded imports are falling, it would not necessarily mean that Chinese demand has fallen, nor that China has stopped accumulating gold.
China Didn’t Announce an Increase in Reserves as Expected
A number of analysts (and gold bugs) expected China to announce an update on their gold reserves in April. That’s because it’s widely believed China reports every five years, and the last report was in April 2009. This is not only inaccurate, it misses a crucial point.
First, Beijing publicly reported their gold reserve amounts in the following years:
- 500 tonnes at the end of 2001
- 600 tonnes at the end of 2002
- 1,054 tonnes in April 2009.
Prior to this, China didn’t report any change for over 20 years; it reported 395 tonnes from 1980 to 2001.
There is no five-year schedule. There is no schedule at all. They’ll report whenever they want, and—this is the crucial point—probably not until it is politically expedient to do so.
Depending on the amount, the news could be a major catalyst for the gold market. Why would the Chinese want to say anything that might drive gold prices upwards, if they are still buying?
Even with All Their Buying, China’s Gold Reserve Ratio Is Still Low
Almost every report you’ll read about gold reserves measures them in relation to their total reserves. The US, for example, has 73% of its reserves in gold, while China officially has just 1.3%. Even the World Gold Council reports it this way.
But this calculation is misleading. The US has minimal foreign currency reserves—and China has over $4 trillion. The denominators are vastly different.
A more practical measure is to compare gold reserves to GDP. This would tell us how much gold would be available to support the economy in the event of a global currency crisis, a major reason for having foreign reserves in the first place and something Chinese leaders are clearly preparing for.
The following table shows the top six holders of gold in GDP terms. (Eurozone countries are combined into one.) Notice what happens to China’s gold-to-GDP ratio when their holdings move from the last-reported 1,054-tonne figure to an estimated 4,500 tonnes (a reasonable figure based on import data).
Value US$ B
GDP US$ B
Eurozone* 10,786.3 $450.8 12,716.30 3.5% US 8,133.5 $339.9 16,799.70 2.0% China** 4,500.0 $188.1 9,181.38 2.0% Russia 1,068.4 $44.7 2,118.01 2.1% India 557.7 $23.3 1,870.65 1.2% Japan 765.2 $32.0 4,901.53 0.7% China 1,054.1 $44.1 9,181.38 0.5% *including 503.2 tonnes held by ECB **Projection Sources: World Gold Council, IMF, Casey Research proprietary calculations
At 4,500 tonnes, the ratio shows China would be on par with the top gold holders in the world. In fact, they would hold more gold than every country except the US (assuming the US and EU have all the gold they say they have). This is probably a more realistic gauge of how they determine if they’re closing in on their goals.
This line of thinking assumes China’s leaders have a set goal for how much gold they want to accumulate, which may or may not be the case. My estimate of 4,500 tonnes of current gold reserves might be high, but it may also be much less than whatever may ultimately satisfy China’s ambitions. Sooner or later, though, they’ll tell us what they have, but as above, that will be when it works to China’s benefit.
The Gold Price Is Weak Because Chinese GDP Growth Is Slowing
Most mainstream analysts point to the slowing pace of China’s economic growth as one big reason the gold price hasn’t broken out of its trading range. China is the world’s largest gold consumer, so on the surface this would seem to make sense. But is there a direct connection between China’s GDP and the gold price?
Over the last six years, there has been a very slight inverse correlation (-0.07) between Chinese GDP and the gold price, meaning they act differently slightly more often than they act the same. Thus, the Western belief characterized above is inaccurate. The data signal that, if China’s economy were to slow, gold demand won’t necessarily decline.
The fact is that demand is projected to grow for reasons largely unrelated to whether their GDP ticks up or down. The World Gold Council estimates that China’s middle class is expected to grow by 200 million people, to 500 million, within six years. (The entire population of the US is only 316 million.) They thus project that private sector demand for gold will increase 25% by 2017, due to rising incomes, bigger savings accounts, and continued rapid urbanization. (170 cities now have over one million inhabitants.) Throw in China’s deep-seated cultural affinity for gold and a supportive government, and the overall trend for gold demand in China is up.
The Gold Price Is Determined at the Comex, Not in China
One lament from gold bugs is that the price of gold—regardless of how much people pay for physical metal around the world—is largely a function of what happens at the Comex in New York.
One reason this is true is that the West trades in gold derivatives, while the Shanghai Gold Exchange (SGE) primarily trades in physical metal. The Comex can thus have an outsized impact on the price, compared to the amount of metal physically changing hands. Further, volume at the SGE is thin, compared to the Comex.
But a shift is underway…
In May, China approached foreign bullion banks and gold producers to participate in a global gold exchange in Shanghai, because as one analyst put it, “The world’s top producer and importer of the metal seeks greater influence over pricing.”
The invited bullion banks include HSBC, Standard Bank, Standard Chartered, Bank of Nova Scotia, and the Australia and New Zealand Banking Group (ANZ). They’ve also asked producing companies, foreign institutions, and private investors to participate.
The global trading platform was launched in the city’s “pilot free-trade zone,” which could eventually challenge the dominance of New York and London.
This is not a proposal; it is already underway.
Further, the enormous amount of bullion China continues to buy reduces trading volume in North America. The Chinese don’t sell, so that metal won’t come back into the market anytime soon, if ever. This concern has already been publicly voiced by some on Wall Street, which gives you an idea of how real this trend is.
There are other related events, but the point is that going forward, China will have increasing sway over the gold price (as will other countries: the Dubai Gold and Commodities Exchange is to begin a spot gold contract within three months).
And that’s a good thing, in our view.
Don’t Be Ridiculous; the US Dollar Isn’t Going to Collapse
In spite of all the warning signs, the US dollar is still the backbone of global trading. “It’s the go-to currency everywhere in the world,” say government economists. When a gold bug (or anyone else) claims the dollar is doomed, they laugh.
But who will get the last laugh?
You may have read about the historic energy deal recently made between Chinese President Xi Jinping and Russian President Vladimir Putin. Over the next 30 years, about $400 billion of natural gas from Siberia will be exported to China. Roughly 25% of China’s energy needs will be met by 2018 from this one deal. The construction project will be one of the largest in the world. The contract allows for further increases, and it opens Russian access to other Asian countries as well. This is big.
The twist is that transactions will not be in US dollars, but in yuan and rubles. This is a serious blow to the petrodollar.
While this is a major geopolitical shift, it is part of a larger trend already in motion:
- President Jinping proposed a brand-new security system at the recent Asian Cooperation Conference that is to include all of Asia, along with Russia and Iran, and exclude the US and EU.
- Gazprom has signed agreements with consumers to switch from dollars to euros for payments. The head of the company said that nine of ten consumers have agreed to switch to euros.
- Putin told foreign journalists at the St. Petersburg International Economic Forum that “China and Russia will consider further steps to shift to the use of national currencies in bilateral transactions.” In fact, a yuan-ruble swap facility that excludes the greenback has already been set up.
- Beijing and Moscow have created a joint ratings agency and are now “ready for transactions… in rubles and yuan,” said the Russian Finance Minister Anton Siluanov. Many Russian companies have already switched contracts to yuan, partly to escape Western sanctions.
- Beijing already has in place numerous agreements with major trading partners, such as Brazil and the Eurozone, that bypass the dollar.
- Brazil, Russia, India, China, and South Africa (the BRICS countries) announced last week that they are “seeking alternatives to the existing world order.” The five countries unveiled a $100 billion fund to fight financial crises, their version of the IMF. They will also launch a World Bank alternative, a new bank that will make loans for infrastructure projects across the developing world.
You don’t need a crystal ball to see the future for the US dollar; the trend is clearly moving against it. An increasing amount of global trade will be done in other currencies, including the yuan, which will steadily weaken the demand for dollars.
The shift will be chaotic at times. Transitions this big come with complications, and not one of them will be good for the dollar. And there will be consequences for every dollar-based investment. US-dollar holders can only hope this process will be gradual. If it happens suddenly, all US-dollar based assets will suffer catastrophic consequences. In his new book, The Death of Money, Jim Rickards says he believes this is exactly what will happen.
The clearest result for all US citizens will be high inflation, perhaps at runaway levels—and much higher gold prices.
Gold Is More Important than a Profit Statement
Only a deflationary bust could keep the gold price from going higher at some point. That is still entirely possible, yet even in that scenario, gold could “win” as most other assets crash. Otherwise, I’m convinced a mid-four-figure price of gold is in the cards.
But remember: It’s not about the price. It’s about the role gold will serve protecting wealth during a major currency upheaval that will severely impact everyone’s finances, investments, and standard of living.
Most advisors who look out to the horizon and see the same future China sees believe you should hold 20% of your investable assets in physical gold bullion. I agree. Anything less will probably not provide the kind of asset and lifestyle protection you’ll need.
In the meantime, don’t worry about the gold price. China’s got your back.
You don’t have to worry about silver, either, which we think holds even greater potential for investors. In the July BIG GOLD, we show why we’re so bullish on gold’s little cousin, provide two silver bullion discounts exclusively for subscribers, and name our top silver pick of the year. Get it all with a risk-free trial to our inexpensive BIG GOLD newsletter.
Gold and Silver HEADLINES
A surge in gold imports widened India’s trade deficit in June by 65%, to an 11-month high of $11.76 billion. Apparently, the Indian government knew this was coming; by keeping gold import duties at 10%, it is maintaining its misguided efforts to battle the trade deficit.
A senior official in the Finance Ministry’s Department of Revenue called the trade deficit spike a cause of concern, stating “I do not think we can take a risk by cutting duties.”
“The government fears a repeat of last year’s record rise in gold purchase, which pushed the rupee down to near 69 against the dollar,’’ said Mohit Zaveri, a bullion trader. “Though the Prime Minister Narendra Modi had earlier said that any action on gold should take into account the interests of the public and traders, not just economics and policy, giving hope to the gold jewelers’ lobby, by not changing the import duty structure in the budget, Modi has ensured that a repeat performance is not in the works.’’
The bottom line for now is that the gold market in India won’t change anytime soon; official imports will remain suppressed, and smuggling will continue to thrive. Further, we’ll probably see more strikes by Indian jewelers, where business conditions remain challenging due to the import restrictions, which have led to metal shortages in the country.
After Winning the Silver Fix, CME Goes for the Gold (Mining.com)
The Chicago Mercantile Exchange (CME), the company that won the Silver Price mandate in partnership with Thomson Reuters, now intends to bid for the administration of the century-old London gold fix benchmark, again in partnership with Thomson Reuters.
CME Group’s director of metals products, Harriet Hunnable, said they may turn the price-setting conference call into an electronic auction. Currently the fix is calculated twice a day on telephone conferences at 10:30 a.m. and 3 p.m. London time. The calls usually last 10 minutes, though they can run more than an hour.
You’ll recall we predicted this possibility two weeks ago.
According to the Silver Institute, investment and industrial demand for silver both rose in the first half of 2014. ETF holdings rose by 7 million ounces, and global silver bullion coin sales were up 4.5% in the first quarter. US Mint sales of American Eagle silver bullion coins held near-record sales levels of 24.1 million ounces for the first six months of 2014, just shy of the 25 million sold in the first half of 2013. However, silver bar consumption “appears to be easing so far this year after a strong showing last year.”
On the industrial demand side, among the sectors that showed encouraging growth were ethylene oxide production, photovoltaic, and semiconductor industries.
“These two categories, investment and industrial demand, are important to the strength of the silver market, and last year accounted for a combined 77% of total silver demand,” the Silver Institute said.
Recent News in International Speculator and BIG GOLD—Key Updates for Subscribers
- This top-notch mine-building team has shown outstanding progress. Of particular interest is that amid all the strong increases in production, the increase in gold output is greater than the increase in copper. Watch this company, as we expect more good news to come.
- Production and recoveries are about to increase dramatically for this Best Buy, which is bullish for the shares, but until we have the proof on the bottom line, it remains a highly speculative pick.
- Production from this company is set to grow by at least one-third next year, and if a planned merger goes through, it’ll more than double by 2017. All this and the stock remains undervalued.
- One of our new picks announced a drop in production and in its recycling business. Is this concerning?
- Fri, 18 Jul 2014 10:50:00 +0000: How to Get Paid $28/Hour for Delivering Pizzas - Casey Research - Research & Analysis
You can earn a higher salary than the average college graduate by delivering pizzas.
Just move to Stanley, North Dakota and reply to this Craigslist ad:
Then hope Jimmy’s hires you.
If you don’t get the job, all is not lost. Plenty of businesses in northwestern North Dakota are offering lucrative pay. Even notoriously stingy Walmart is starting new hires at $17 an hour:
Why are these businesses so eager to hire? Because business is booming. And business is booming because they’re near the Bakken, which is at the heart of America’s energy resurgence.
It’s good old-fashioned economic stimulus. Oil companies, sensing an opportunity to profit, are luring workers to North Dakota by paying them top dollar. These workers then eat pizza and shop at Walmart. The result is a booming local economy.
Notice what is not part of this equation: the government.
Contrast North Dakota to the growing list of US cities that are attempting to force wages higher via minimum-wage increases. Seattle passed a minimum-wage increase to $15/hour. San Diego hiked its minimum wage to $11.50/hour. Washington DC’s minimum is rising to $11.50/hour, too.
Chicago mayor Rahm Emmanuel wants his city to adopt a $13 minimum wage. Activists in Los Angeles are now calling for a $15 minimum.
I could keep going, but you get the picture.
There’s all the difference in the world between wages rising because of increased production and a government forcing wages higher by edict. The former is good for everyone. Even though $56K/year plus generous benefits seems expensive for a deliveryman, Jimmy’s is happy to pay it, because the company expects to turn a profit.
But when a government outlaws jobs below a certain wage, only a lucky few win. Doug French will elaborate on that point in a minute. First, let’s take a quick look at where this trend is headed.
Not only do 63% of Americans favor raising the federal minimum wage to $10.10, Obama already raised it to $10.10 for a lucky subset of Americans. Yes, Congress is deadlocked on whether to raise the minimum wage, but that’s never stopped Barack before. With a stroke of the pen, he issued an executive order raising the minimum for federal contractors to $10.10 beginning in 2015.
It’s clear that the federal minimum wage is headed higher. What’s less obvious but equally important is that another, separate increase in the cost of employment is also coming.
Remember the “or else” provisions of Obamacare that threaten most employers to either provide health care to their employees or pay a penalty? They kick in by 2016, and they’ll add at least another $1.05/hour to an employer’s cost of hiring an employee.
Put it all together, and the minimum cost to hire a worker is likely to jump at least 50% soon, as illustrated by this chart I snagged from the most recent edition of The Casey Report:
The coming “all in” minimum wage of $12.17/hr equates to about $30,000 per year.
Which prompts the question: What’s going to happen to the roughly 70 million jobs in America that cost employers less than $30,000 per year?
The answer: they’ll disappear. As I mentioned last week, French McDonald’s workers know this all too well. To combat rising labor costs, McDonald’s has been installing kiosks to replace some of its French employees. France’s minimum wage is about $12.12/hour.
This trend—the automation of low-skill human labor—is just getting started in America, but it will soon kick into overdrive. As the cost of low-skill human labor becomes prohibitive, businesses will search for mechanized substitutes. And the first call they’ll make is to the automation company we recommend in the newest edition of The Casey Report.
If you’ve eaten at TGI Friday’s, used the self-checkout machines at Walmart, or printed a boarding pass at the airport in the last 10 years, you’ve used this company’s labor-saving products. Click here to subscribe to The Casey Report to ride this secular trend with us. Labor-saving automation is the trend of the future, and now’s the time to get positioned.
I’ll now pass the baton to Doug French to continue the minimum-wage discussion. Then you’ll find a fun story from subscriber N P Chaudhri about a lucrative scam created by a communist cab driver.
Minimum Wage: Human Loss for Political GainDoug French, Contributing Editor
Those advocating government force always have a study to point to, to help make their case. Supporters of a higher minimum wage are citing a new report by the Center for Economic and Policy Research (CEPR) as evidence that raising the minimum wage really doesn’t kill jobs.
13 states raised their minimum wages on January 1 of this year. Through the first five months of 2014, the average change in payrolls for those states was 0.99%. In the 37 states with unchanged minimum wages, the change in payrolls averaged 0.68%.
“New Analysis Debunks Claim That a Higher Minimum Wage Kills Job Growth,” sneers the Huffington Post headline.
USA Today was a bit more evenhanded:
CEPR acknowledges this analysis is far from scientific and draws no direct link between raising the minimum wage and payroll gains. Still, “it does provide evidence against theoretical negative employment effects of minimum wage increases,” CEPR researcher Ben Wolcott writes.
Whatever the theory, however, higher minimum wages cause real people to get fired.
Sacked by the Minimum Wage
College student Adam Folsom wrote in the Detroit News back in 2008 about being a victim of Michigan’s minimum-wage increase. Adam was making $6 an hour at Hope College’s Office of Career Services. His boss called him just before the scheduled increase to $6.95 would take effect and told him the budget was too tight to accommodate the higher wage.
“I would have liked to continue working at $6 per hour, and Hope College was willing to pay me that,” Folsom wrote. “But the state of Michigan says I do not have the right to work for that amount of money. Hope College and I are not allowed to negotiate a contract that is satisfactory to both of us.”
Liberty.me’s Jeffrey Tucker tells the heartbreaking story of working with a handicapped boy named Tad at a Texas department store, long before Jeffrey became the giant of Libertarian thought he is today. One day a new labor department sign was posted in the store’s break room, announcing an increase to the minimum wage.
Tad was very happy to read the sign. He thought he was getting a raise.
But a day after the increase went into effect, Tad wasn’t at work. When Tucker asked the store manager where his friend and coworker was, the manager turned solemn and put his hand on his young employee’s shoulder. He told Tucker how much he liked Tad and wanted to help him. They even attended the same church.
But the store’s margins were thin. He simply couldn’t afford to keep the mentally and physically handicapped Tad on the payroll at the higher minimum.
Tad never knew what hit him.
Tad and Jeffrey’s employer evidently didn’t know about the 14(c) provision in the Fair Labor Standards Act, which I mentioned a few weeks ago. The 14(c) carve-out undermines any intellectual argument supporting minimum wage by exempting anyone “whose earning or productive capacity is impaired by age, physical or mental deficiency, or injury, at wages which are lower than the minimum wage.”
A Law Not for Employment, but Disemployment
Why are proponents of higher minimum wages so stingy? They must know that the proposed $10.10/hour isn’t enough to fund an acceptable standard of living. If raising the minimum wage won’t cause unemployment as they claim, why don’t we jack it up to $20 an hour, or $50, or $100?
“It is obvious that the minimum-wage advocates do not pursue their own logic,” economist Murray Rothbard wrote, “because if they push it to such heights, virtually the entire labor force will be disemployed. In short, you can have as much unemployment as you want, simply by pushing the legal minimum wage high enough.”
Indeed. It isn’t a coincidence that minimum-wage agitators stop just short of calling for a minimum wage that would put members of important voting constituencies, like union labor, out of work.
Political Gain for Blocking Low-Cost Competition
Maybe minimum-wage champions aren’t dimwitted after all. Maybe they’re malevolent. Maybe they understand that a higher minimum wage prices marginal laborers out of work and into government dependence… while at the same time lowering competition for favored voting blocks.
Economist Walter Williams quotes white unionists during South Africa’s apartheid era, who argued, “in absence of statutory minimum wages, employers found it profitable to supplant highly trained (and usually highly paid) Europeans by less efficient but cheaper non-whites.”
Williams points out that minimum-wage increases reduce training opportunities: we gain skills through on-the-job training. Minimum-wage laws squelch these opportunities.
And while the left constantly screams about discrimination, the minimum wage aids racists because it lowers discrimination costs. Williams uses the example of two workers—one white and one black—applying for a job. If the minimum wage is $9 per hour and the employer prefers white workers, the cost to discriminate is zero. “But if it were legal for the black worker to offer a lower price, there’d be a cost to discrimination,” Williams writes.
Doing Harm All Around
The real question is: how many more jobs would have been created but weren’t in the 13 states that hiked their minimum wages? And how many jobs would be created in all states if the minimum wage was abolished?
As the great Henry Hazlitt put it:
You cannot make a man worth a given amount by making it illegal for anyone to offer him anything less. You merely deprive him of the right to earn the amount that his abilities and situation would permit him to earn, while you deprive the community even of the moderate services that he is capable of rendering. In brief, for a low wage you substitute unemployment. You do harm all around, with no comparable compensation.
It’s not possible to pay labor more than it produces. Hiking the minimum wage is a policy stunt in search of political favor. It benefits some while harming the most vulnerable in society… who often mistakenly think they will benefit.
Higher wages can only come from production, efficiency, and capital formation—not from government decree.
By N P Chaudhri
I dropped in to see my poor old mum last Sunday. I had just taken some people to the airport, and her place is sort of on my way back.
It’s terrible, really, that I never go to visit her specially. That is, actually plan a visit and look forward to it. But she doesn’t seem to mind. She’s always pleased to see me, and as it was a Sunday night, there wasn’t much else going on. She lovingly prepared me a boil-in-the-bag beef stew and dumplings for supper, and we had a good long talk.
As usual, she quizzed me on my plans for the future. To her, my future consists of two things: marriage and a career (or at least a regular girlfriend and a regular job). She doesn’t approve of my devotion to casual sex or my job as a lowly minicab driver.
She also told me of her own woes, which boil down to loneliness and a lack of money. She wants to get a job, but there’s not much she can do; she’s only ever been a housewife. She has very little self-confidence. Cleaning work is all she can find in the local paper, but it’s too physically demanding for her.
She asked me for the umpteenth time to please help her find a suitable job. I said I’d keep an eye out.
“All right Mum, I’ll look out for a nice job for you,” I lied. “I have to get back to work now.”
Getting back to work simply meant getting back in the car, calling the controller on the radio to let him know where I was, and heading back to base. I heard not a peep from the radio, which presaged a very slow night. Sure enough, when I walked in, I found a den full of drivers chain-smoking and waiting for the phones to ring, while being blithely entertained by Zero-Seven Joe.
Joe’s terrific, always good for a laugh. Everyone likes him. He’s tall and handsome and always looks and smells fresh and clean and healthy. He came to London about four years ago from Gruziya in the former Soviet Union, near the Turkish border. He’s got plenty to say, and we all enjoy talking to him.
Joe is very direct and quite unembarrassed to ask the kind of questions that the rest of us often want to ask but feel awkward asking. He’ll say, “How much money you made tonight?” or “When you last canoodle with one of the drunk customer?”
None of us really minds that he consistently makes more money than the rest of us, because it’s not due to any obvious favoritism from the controllers. He just gets more in tips because of his personality. Plus he drives fast and knows his way around.
I know London very well; I’ve been cabbing for 12 years. Joe knows it better, and he’s been cabbing for just 3.5 years. He takes his work seriously and is studying for “the Knowledge.” He’ll be driving a black cab within a couple of years, making quadruple his current income.
Joe, lovable though he is, is brainwashed. Born in rural Russia, communist propaganda got him early and never let go.
There’s no getting through to him. He asked me, “What for you need 50 different kind of bread? Bread is bread!” In reply, I offered a provocative list of concepts: “Variety, quality, taste, freshness, abundance.”
His response was at once typical, ridiculous, and irrefutable: “You just givin’ me words. Nothing else, just words.”
He was right, but all I could do was give him some more words. “Well, about these words,” I said, “let’s take ‘abundance.’ Here we have plenty of bread. In Russia people have to queue for days outside supermarkets full of empty shelves. What are your words on that?”
He walked away laughing, then came back with, “You didn’t tell me you been in Russia and seen with your own eyes. Nobody starving there, my friend. Nobody homeless like here. You all been brainwashed by CIA and FBI and McDonald’s and Coca-Cola.”
With that conclusion, he gave up for the time being. He must have thought there was no getting through to me.
Among Joe’s numerous inconsistencies, he drinks four or five cans of Coke every night and gets take-away from McDonald’s three times a week. And for all I know, he may well be selling Russian Federation military secrets to the CIA. He is, after all, intelligent. And it’s not unintelligent to place self-interest above ideology.
Joe also likes to share his thoughts with other intelligent people. I am the only other reasonably intelligent person at the cab office. The other cabbies only talk about sports and cars and celebrities. Joe and I have real discussions.
One day, Joe told me a deplorable secret.
The conversation started innocently enough. “How you done last night?” he asked. I told him I’d made about 70 quid.
“It’s dire,” I told him. “If you can’t take 100 a night, it’s a waste of time. It’s been like this for weeks, months. They’ve taken on too many drivers. I’ve got to move on.”
“Where you gonna go? Same everywhere, innit. I be honest with you, I don’t want you to leave. I enjoy working here, I have a lot of good argument with you. When you gone, who’m I gonna argue with? Other drivers all talking bullshit cockney rubbish.
“So what you not making money. Money is only paper. People are more important than money. Anyway, I’m surprised you rely on this job. You should be using your brain.”
“You are a capitalist—you always tellin’ me capitalist system is better—so a capitalist got to make money, innit? The system messing you up, so you got to mess them up. Everybody messing each other here, my friend.”
Joe is always forthright, never tedious. But his constant attacks on what he sees as Western ideology get old, because I don’t always want to defend it. So I just said, “So what am I gonna do?”
He thought for a moment, looking at me intently and puffing away on a fat and horribly misshapen roll-up.
“You try to teach me what is the meaning of irony. That everybody getting it wrong, yeah? Like that American, Alanis Morissette, sing that song Ironic all stupid, yeah? But I understand good. I got a real example: It is ironic that a communist got to teach a capitalist how to make money!”
“I never tell anyone this,” he began, “because I learn you never trust anyone. But I make exception on one condition.”
He paused, scrutinizing my face, and especially my eyes, for signs of untrustworthiness.
“Which is?” I prompted.
“Which is you got to take some money. I give you some cheques, you got to cash them.”
“You want me to cash some dodgy cheques for you, for which I get paid some commission?” I replied.
“Not for me. For you. No commission or any bollocks. I givin’ them to you. It’s yours. The money’s yours. That’s it, nothing more. Easy.”
I was suddenly thrown into confusion. On the one hand, I didn’t want to appear so gullible as to believe such an offer could be genuine. On the other hand, Joe is so crazy that he might actually be serious.
I decided to bite. “All right. That’s a deal.” I held out my hand for him to shake.
While we were shaking hands on this most extraordinary deal ,I searched in vain for signs of devilry in Joe’s face. The handshake itself was noteworthy: It lasted about half a minute. And for most of that time, Joe wasn’t so much shaking my hand as just holding it firmly in his. I had the feeling that we were entering into a solemn pact.
It was nearly seven o’clock by now. There were no more jobs booked until eight, so we decided to call it a day and go to Joe’s flat, where, I was told, all would be revealed.
And what a revelation! Just seeing his flat was an eye-opener. It was a huge place in one of Fulham’s best mansion blocks. The rent must have been more than twice what he made from cabbing. He had TVs and gadgets and gizmos in every room and a Bang & Olufsen hi-fi system with speakers all over the place.
It was obvious that he had recently and quite suddenly found himself with more money than he knew what to do with.
“Right, I think I got to tell you everything,” he began. “In my country we say that life is just a game. You don’t need to take it too seriously. So, when I arrive here, I still got the same attitude but it’s a different game. I don’t know the rules. Plenty of jobs in Russia. But I couldn’t find any decent job here.
“Then I borrowed £500 from my girlfriend to buy that Sierra piece of junk and started to minicab. OK, that’s fine, I do all right. I like this job; it’s very easy. I don’t need to get my hands dirty. I meet plenty of girls, all of them flirting with me. Good. I work hard.
“But then blind lady pulls out in front of me, and I crash. Not only I lose my new car, but I broke my foot. So I got to stay home for two months. I was thinking what can I do?
“Then I saw an ad in local papers saying “You can work from home.” So I order this directory that cost six pounds—£5.95—and it changed my life.”
He waited for some suitable expression of interest from me, which I found difficult to give. Of course I was fascinated, but the directory of homeworking opportunities sounded so unglamorous and unexciting that it deflated my interest.
“Aren’t you going to offer me a cup of tea, Joe?” I said in an effort to subdue the sense of impending anti-climax.
“Of course I get you a cup of tea. Forgive me, I am a bad host.”
When he returned with the tea I told him I knew exactly what was in that directory: advice on how to sell drugs or pornographic videos from home. He laughed and said I would never guess. And he was right.
“There was nothing in there. All rubbish,” he said. “Sewing, knitting, collecting tins and cans, collecting old newspaper, stuffing envelopes, stuffing cuddly toys, buying and selling crap on Internet. All rubbish waste of time. You lucky to make £25 in a day.
“Instead, I decide to do what he’s doing. Sell these stupid homework books. But I write in my ad they will make £100 a day, with a full money-back guarantee.”
“I tell them my book gonna pay for itself in half a day, so I sellin’ it £50 each. The same rubbish they sold to me for six pounds, I just photocopy it and put some staples in. If they ask for refund I tell them sorry business gone bankrupt and I got cancer. They don’t bother with court for £50.”
I was shocked to hear this. I don’t normally worry about get-rich-quick scams because the victims, as well as being stupid, are usually greedy or lazy or both, and need to be taught not to expect more than they deserve. But this was a bit different. It was preying on people who were prepared to work hard but, for whatever reason, had to stay at home. I thought it was despicable.
However, I didn’t show my emotion for two reasons: one, I was honor-bound to fulfil my part of the bargain we had struck earlier. And two, I’d come up with an idea for a very similar scam years before (against less helpless victims), but never put it into operation because I hadn’t been able to devise a safe way of cashing the cheques. So I was curious to learn how Joe had managed to cover his tracks.
“You have an alias,” I said.
“Of course, man. I am Bernard Norman, pleased to meet you!”
“And you persuaded a bank to open an account for you in that name?”
“No, you must be joking. Is almost impossible now in this country. I heard from people you could do it 10 years ago, but now? No way. I found a better, simpler way. You gonna admire me for this. You gonna think I’m a genius, but really it was just luck.
“I didn’t really know what I was doing. Yeah, I knew I had to have a different address—a house with lots of individual apartment where I have a front-door key to pick up mail. That was easy, the first place I stayed when I came here. That was in Kilburn. I kept the front-door key. That was perfect because nobody got any official record of me livin’ there and so many students and unemployed coming and going all the time. I just go there every few days and collect the cheques.”
“And do what with them?” I interrupted. “They’re made out to Bernard Norman. You can’t deposit them. And even if you had a friend named Bernard Norman, he couldn’t cash them for you because the police would be onto him as soon as the first punter complained. There’s no way around it unless you can get the suckers to leave the top of the cheques blank.”
“Surprisingly a few of them do that, but that’s not it. I made up this false name, Bernard Norman. But in the ads I thought it would look better to say Bernard Norman Associates, or BNA for short.”
“Oh my God!” I screamed exultantly, stopping him short.
I’d been racking my brains on this problem on and off for several years, but never so furiously as in the last half-hour. Now, when I suddenly guessed the answer on the strength of that final clue, I was euphoric.
“You are a clever bastard,” he said. “It is a pleasure doing business with you.”
Joe didn’t need to explain anything else. He left the room to fetch several thousand pounds’ worth of cheques payable to BNA for me and everything fell into place. Even our wacky deal made perfect sense. Joe had been troubled by vague doubts and fears as to whether he could really get away with the scam. But he respects my judgment. If I’m prepared to cash the cheques in the same way, it must be safe.
Joe is a hypocrite. With all his talk of socialism and putting people before profit, he rips off the desperately poor and doesn’t see anything wrong in that. I’m not much better now that I’m an accomplice, but perhaps the most horrible part is discovering that I don’t have the moral strength to resist. I am completely seduced by the easy money.
I don’t even have the excuse that the victims are just faceless strangers. One of the cheques was from my own poor old mum.
I am not a communist, and I don’t believe anyone ought to get something valuable—including information—for nothing. If you want to know how to draw upon funds from cheques made payable to BNA, and how automated, clearing procedures allow the existence of such a beautiful loophole, send me a cheque for £50,000.00 made payable to BNA.
I promise to explain it fully and to your total satisfaction, or refund your money.
Steve the Dinosaur Slayer
Steven Spielberg’s slaying of this poor Triceratops sparked outrage on Facebook:
John Oliver Roasts Obamacare in Oregon
A bit of salty language in this excellent send-up:
That’s It for This Week
Have a great weekend!
Managing Editor of The Casey Report
- Thu, 17 Jul 2014 11:29:00 +0000: The Worst Investment Advice I’ve Ever Heard - Casey Research - Research & Analysis
The world is rife with awful advice on finances. Everyone from your slimy brother-in-law who cannot seem to hold down a job but always has a hot stock tip to your neighbor’s dippy daughter who barely eked out her communications degree before landing a sales job with the local Edward Jones branch is up for telling you what to do with your money. And what most of them are telling you is wrong.
But this band of motley fools can be forgiven… until they grab a bullhorn and hold themselves out as experts despite their deficiencies.
I recently read an article from a journalist purporting to be a finance expert. He maintained that your down payment on a house should be the maximum you can manage—a preposterous argument that ignores the basics of good finance. Like so many reporters, when they jump out of the objective and into the opinion fray, they come out looking like asses. Worse in this instance is that people could lose their homes from following such bad advice.
This is what former Reuters reporter Felix Salmon wrote:
Linda’s advice, remember, was to maximize the amount that you are forced to pay every month: to “borrow as much as you can reasonably afford.” The problem with that is that the amount you can reasonably afford today is not always the amount you can reasonably afford tomorrow. So when your income unexpectedly falls, or when your expenses unexpectedly rise, suddenly you’re at serious risk of losing your home. The lower your monthly payments, the more likely you are to at least have a safe roof above your head in the event of something like a job loss or a family emergency.
He even goes so far as to portray those who would borrow more and put less cash down as “acting black,” since minorities tend to be more likely to have their homes underwater than Caucasians. In addition to his unfortunate choice of metaphor, Mr. Salmon misunderstands the difference between borrowing more than a property is worth and smartly deploying leverage.
Putting down less, as his colleague Linda proposes, is often the better choice. In fact, a smaller down payment can actually help you avoid default, not increase that risk.
Look at it this way: When we evaluate a company for investment risks, one of the first things we scrutinize is the “current ratio,” or the amount of cash a company has to cover debts it has coming due over the next year. If a company has a low current ratio, like 0.5, then it’s short on cash and likely to either fall behind on its payments or have to raise cash at the expense of its investors. A low current ratio is a bad sign.
However, if a company has a high current ratio—say 2.0—then it has plenty of money to service its debt and cover other expenses on top of that.
If you took Mr. Salmon’s advice, putting as much cash as possible toward your down payment, and looked at your finances like we do a company’s, you’d score poorly.
Imagine you’re part of a young couple, just into your first jobs and buying that first house together. You have a little over $50,000 saved, you did the math, and you can afford to buy a $250,000 house.
In Mr. Salmon’s world, you’d put down $50,000 (20%), borrow $200,000, and wind up with a mortgage payment of about $1,275/month with normal property taxes included, at today’s average mortgage rates.
However, if your bank will go for it, think about putting down only $10,000 instead. You’d have to add in $100 for mortgage insurance at that level, plus a little higher base, bringing those payments up to $1,475/month.
Why then, if it’s $200 more expensive, is Mr. Salmon’s advice dead wrong? Simple: time to recover.
Under Mr. Salmon’s scenario, let’s say two years in you lose your job. Hopefully you’d have put that mortgage savings right into the bank and saved $200 per month for a rainy day fund, i.e., $4,800, or enough to cover your mortgage for less than four months.
Considering that as of last month, the feds pegged the mean duration of unemployment at over nine months, that’s not much of a cushion. You might find yourself taking any job you can land—flipping burgers at McD’s, maybe?—just to make sure you don’t fall behind on those payments and lose the $50K in “equity” you had to a foreclosure.
However, if you’d borrowed more—even if the extra $200 a month came directly out of your piggy bank instead of your paycheck—then you’d have $35,200 remaining to cover your mortgage, or about two years of payments at the higher rate. That’s a much more realistic time to find a comparable job to replace your old one, allowing you to negotiate with confidence.
By borrowing less, you bought yourself much more time to adjust to changing circumstances. If you stretched your down payment instead, you would have failed to self-insure against the risk of income loss and made an unwitting bet that in the next decade you were unlikely to need the extra margin of safety—as it would take that long for your payment savings to catch up to your cushion in the best-case scenario.
In managing your own finances, try to look at the situation as a company would. Don’t starve yourself for working capital, for cash. All that does is increase your default risk, not decrease it. Instead, strike a healthy balance between maintaining a cash cushion and taking on debt.
The unexpected will happen. And when it does, what matters then is not whether your payments are a few points lower. It’s whether your capital reserves will last for two months or two years. The more time you buy yourself to react, the more likely you can land on your feet. And the only way to buy yourself time is to increase your current ratio, to make sure you have enough cash to service your debt.
Mr. Salmon is right in one regard: he puts a high emphasis on peace of mind. But what yields more peace of mind: paying a few bucks less each month and risking your bank account being near empty when bad times come; or knowing you can weather a storm, even if it lasts much longer than average?
I just wish he’d put as big an emphasis on math as he does on psychology…
Unfortunately, there’s a lot of similar-quality advice in the financial world. The only way to protect yourself from taking on bad habit after bad habit is to learn how to separate good, logical financial advice from uninformed opinion.
There is no universal rule to apply here, but you can certainly catch 80 to 90% of the bad with one simple axiom: do the math. Any financial decision is best made by running the numbers on both sides of the coin. What happens in the best case, and what happens in the worst? See what the outcomes are for yourself, and use them to judge.
There are no shortcuts when it comes to money. Advice either adds up, or it doesn’t.
And never trust a blogger, journalist, pundit, or analyst who doesn’t do the same. Any financial advisor who fails to look at risks and rewards in pure dollars and cents is clouding the issue with unnecessary fluff, and probably trying to obscure the facts that contradict his case.
That said, be wary of false mathematical prophets as well. If someone paints an overly rosy picture, always check the inverse, too.
The same principle applies to your investment portfolio. At Casey Research, we’ve long preached rational speculation—the idea that a smart investor can both aim to beat the market and reduce risk by concentrating on a handful of high-potential investments instead of the “spray and pray” approach that most brokers and financial advisors take.
Compare the two models. Imagine you have a portfolio of any size… $10,000 or $10 million.
If you invest Wall Street’s way, you put 80-90% of your net worth into equities, mostly index funds that mirror the overall US or global markets, with a small amount allotted to fixed income.
What’s a reasonable expectation of gains? Well, the US stock market has returned on average about 7% a year over the last century… 9.9% if you only track the S&P 500 and factor in dividends.
How much can you potentially lose? Wall Street’s way, every year you risk nearly all of your assets in highly volatile markets. In 2008, the Russell 1000 Index, which tracks a large number of stocks at the mid-end of the market, lost 37.4% in a year. The S&P 500 was down 37.2%.
Over the past 100 years, on at least half a dozen occasions you would have lost 20% or more in a year. Double that for 10% or more. And we all know how it’s been in recent times, with losing years in 2000, 2001, 2002, and 2008. Unfortunately, losses compound faster than gains—if a market goes down 25% in one year and up 25% the next, then you don’t break even. You’re still down 6.25%.
On the other hand, if you invest like a rational speculator, you carve off 10% of your portfolio and laser in on an investment opportunity or a handful of them that you think can return 100%+ in the next year. The rest of the money, it’s up to you, but we recommend a diversified basket of low-volatility assets—something that won’t rock up and down 37% a year. (Your broker may hem and haw, but that’s only because chances are he’s going to make 90% less money if you only put 10% of your assets into the market.) Fixed income is a great category to consider here, with much lower volatility and stable long-term returns. If interest rates rise again, even CDs, money markets, and the like could easily fill that role.
Now, what would it take to see a 2008-type loss in your portfolio—a loss so bad it takes years of winners to recover from? With a rational speculator’s approach, you’d have to lose 80% of your investment four years in a row. Of course, that would mean not only were you colossally wrong over and over again, but you’d also ignored the basics of speculating: actively managing your investments, controlling your losses, and riding your winners. Had you done that and restricted your maximum loss to an easily manageable number like 40% (we’re being conservative here) or 4% of your overall portfolio, it would take you year after year of consistent misses to end up with a 2008-like hole.
If you come within spitting distance of your target, making an average gain of, say, 60%, added to a stable return with a fixed-income portfolio of something like 4%-5% annually in this environment, you can easily outpace the annual return of the S&P 500. Miss by half, and you still have a solid gain. All the while, your absolute maximum possible loss was just 10% of your portfolio, not 100%.
Looking for stronger return potential? Make it 80% low volatility and 20% speculation (we recommend looking at it like two 10% slices, and spreading them across more than one sector so you don’t become too exposed to one area). In that scenario, a 4% return on the fixed income and a 50/50 success rate on the speculative slices of your portfolio in finding stocks that either double or flop would yield a 14% total return.
You can adjust as you see fit for your goals (looking for 25% returns?) or your risk tolerance (cannot stand to lose more than 5% a year?).
Rational speculation isn’t for everyone. It takes a keen eye for opportunity or a guide you trust. It takes the ability to see the forest for the trees and understand that big volatility in a small part of your portfolio is much less risky than putting everything on the line and crossing your fingers that another 2008 isn’t right around the corner. It can be remarkably freeing psychologically when you know more of your money is safe.
That’s why we advocate that investors start by assessing their risk tolerance. How much can you afford to lose and still come back to fight another day? Choose a few sectors in which speculate… ones where you believe you can find the kinds of returns to balance the risk you’re willing to take.
Of course, at Casey Research, we’ve spent decades building up our expertise in three areas where we see exactly such opportunities: early-stage gold and other mining stocks; energy exploration stocks; and tech stocks. Those are areas in which we’ve delivered consistently over the years. Even with a two rough years for metals and mining behind us, for example, International Speculator has consistently delivered the kinds of stocks that easily return these kinds of gains per position.
But I would be remiss if I didn’t nudge you in the direction of Casey Extraordinary Technology, our speculative technology research service. Since the day we started publishing, we’ve put up an average annualized return per closed position of 63%. Seven out of every ten stocks we’ve picked have been winners, consistently year after year of publishing. As part of a well-managed speculator’s portfolio, Extraordinary Technology could easily help you outpace the stock market’s typical gains with a fraction of the total risk. Take the service for a spin yourself, completely risk-free. Follow along with our trades for the next 3 months, inspect our complete unedited track record, and see for yourself that there is a different way to manage your money—one where the math works in your favor, not your broker’s.
- Wed, 16 Jul 2014 06:16:00 +0000: The Stress Tests That Could Stress Markets - Casey Research - Research & Analysis
The PIIGS are back.
Well, at least the ’P’ is back. Portugal’s stock market has dropped 17% in the last month, thanks to Banco Espirito Santo’s (BES) troubles.
BES is Portugal’s largest bank. Or rather, it was Portugal’s largest bank. Now it’s a penny stock. Investors began playing hot potato with BES stock when auditors discovered “irregularities” on the books of BES’ parent company. Things only got worse from there, culminating with the Portuguese central bank ordering BES to remove and replace its top executives.
Portugal’s problems reminded investors that Europe’s banking problems have not been fixed. The Eurozone still suffers from the same issues that caused its financial crisis. Namely, eighteen countries with diverse economies and divergent priorities are all trying to share one currency. That can’t work, no matter how hard the ECB wishes it will.
Today’s guest contribution comes from Martin Fluck, who’s studied and written about the global financial markets for 20 years. Below, Martin argues that the Eurozone appears to be slowly slipping back toward crisis… and tells us about an event approaching this autumn that could tip Europe’s fragile banks over the edge.
Managing Editor of The Casey Report
The Stress Tests That Could Stress Markets
By Martin Fluck
If you thought the Eurozone crisis was in the past, think again.
Last week, news that Portuguese bank Banco Espirito Santo was in trouble shook markets. Europe’s financial markets remain jittery, because its banking system is still fragile. Europe’s banks still haven’t repaired their balance sheets, so they’re not willing to lend to each other… never mind lending to small and medium-sized businesses.
The EU is publishing the results of its latest stress tests in October. It hopes the results will restore trust and boost lending to the private sector. But I think the tests might backfire and trigger a fresh crisis.
Should the tests be conducted honestly, they’ll reveal bad loans on overvalued assets. That’s a problem for the Eurozone, because unlike the US, it has no capital in reserve to recapitalize its banks.
The tests are supposed to be as credible as those carried out in the US, but the suspicion is that they have once again been designed to paper over the fact that the entire EU banking system is insolvent. Remember: Belgian Bank Dexia got top marks in Europe’s last round of stress tests in 2011, but Dexia had to be nationalized and then wound up soon after.
This time around, the tests do not even consider the possibility that the Eurozone could end up in a deflationary debt spiral. That’s the real threat everyone’s most terrified of, given that the ’recovery’ is losing momentum.
It’s a near mathematical impossibility that the weakest members of the Eurozone can grow their way out of their debt. If deflation takes hold—as it has already in Greece and Cyprus, and is close in Portugal, Spain, and Italy—all bets are off.
Right now, the omens aren’t good. The ECB’s monetary stimulus is not being transmitted to the countries where it’s most needed. The Spanish and Italian corporate sectors, dominated by smaller firms that are dependent on banks for finance, must pay much higher borrowing costs than small firms in northern Europe. In May, household loans in Europe declined at the fastest rate ever recorded—and the largest decline in lending to non-financial corporations occurred in Italy and Spain.
Since ECB president Mario Draghi said he’d do “whatever it takes” to save the euro in 2012, real inflation-adjusted lending rates for nonfinancial businesses have actually risen steadily. In Spain, rates are back up to their 2009 peak:
The Eurozone remains unstable, because its monetary system is flawed. The euro allows stronger countries like Germany to benefit from lower borrowing costs, capital inflows, and the immigration of skilled workers. Meanwhile, higher real interest rates in weaker countries push them ever deeper into deflation. Unless the Eurozone is prepared to become a United States of Europe and raise taxes at a European level, Europe will never experience an economic convergence.
But we know that Europe’s politicians are never going to give up their national sovereignty to create a genuine fiscal, political, and monetary union. They couldn’t even agree to share risk across national lines by forming a proper banking union.
As growth slows, the ECB is getting desperate. It lowered its benchmark interest rate to 0.15% and introduced negative interest rates on bank deposits in June. Neither will make much of a difference. Nor would quantitative easing, even if the ECB could overcome Germany’s opposition to it. Businesses and consumers are already maxed out, and the ECB has already monetized banks’ excess collateral.
We learned from the Latin American debt crisis in the 80s that a country couldn't overcome a debt crisis without addressing its debt overhang. The Brady Plan accomplished this for Latin America in the early 90s. But Europe has yet to realize it. The euro crisis is now in its fifth year, and investors should brace for sovereign defaults.
Perhaps Italy and Greece will force the issue. History shows that heavily indebted countries are most likely to default, once they have achieved primary budget surpluses—like Italy and Greece have. In the face of 26.7% unemployment and growing political extremism, the temptation to quit the euro must be growing.
The belief that the euro has been saved is lulling investors into taking on too much risk, as they did in 2007. Whatever the outcome of the EU’s stress tests, it’s only a matter of time before the Eurozone debt crisis re-erupts.
Martin Fluck has spent his career in London, taking a critical look at global investment themes and stocks for leading news publications and investment firms. A financial commentator and investment writer, he has a background in macroeconomic analysis and equities research. Martin grew up in Europe, Africa, and Asia, and holds a degree in economics from the University of East Anglia and a master’s degree in finance from London Business School. When not fretting about the global outlook, he likes to go surfing in Costa Rica.