Monday, May 10, 2004
For investors who'd rather be smart than lucky
Goldbugs and BuffettPoor Warren Buffett! What's a guy worth $40 billion supposed to do with all that money when the global investment climate just plain stinks? Some say he's been a size buyer of Comex silver, and that merely by taking delivery on his futures contracts he could instantly double the metal's price. If true, he'd better do it soon, since, after last week's bloodbath, silver could use a white knight. Spot quotes have dropped 35 percent since early April, meaning that if Buffett is actually sitting on silver, he has taken a savage beating in the last few weeks.
Face Major Dilemma
Of course, we can't be certain that he even owned any silver. But I'm not buying the argument that the silver market is not big enough for players of Buffett's size. Estimates place the world's stock at 150 million ounces, or about $840 million's worth at Friday's prices. Although that would represent only about 2% of his net worth, it does not necessarily follow that Buffett would disdain silver any more than he would the shares of a promising small-cap company with a 20-million-share float. It all adds up, even the little $10 million crumbs.
Putting aside the matter of whether the Sage of Omaha took a plunge in silver - or, according to more recent rumors, bailed out of it - the question remains: What is the world's most successful investor to do with such a huge wad of cash? Or perhaps more to the point, what could he -- or anyone else -- do with such a vast fortune? Or even a small one? We can rule out the hot-money game for starters, since chasing the asset-of-the-month just isn't Buffett's style. Or is it? Not by design, for sure. But what if every place he turned for shelter were to quickly become an investment minefield?
We can reasonably infer that this is not a hazard Buffett is likely to have dodged, given his well-publicized aversion of late for U.S. stocks and the dollar. We should nonetheless give him the benefit of the doubt on the performance of his stock portfolio, since the Dow Industrials are trading only slightly lower than they were when the year began. But with regard to the dollar, after having shifted a reported third of his cash into foreign currencies, Buffett would appear to have been in the wrong place at the wrong time, at least since mid-February. That's when the greenback commenced its strongest rally in nearly a year -- a rally that continues to this day and which on Friday was spitting fire.
Exit Currencies Now?
So, does he pull out of currencies now? And if the answer is yes, where should he park his billions next? In REITs? Eurobonds? Commercial real estate? Asia? Or should he shop around for a hedge fund that can handle a billion-dollar client. The Catch-22 is that any asset manager with half of Buffett's brains would also have the good sense to decline his billions, since there are precious few sure things out there right now in which such considerable sums can be confidently deployed.
A few months ago I would have said that anyone diversifying out of dollars couldn't possibly go wrong. But I'm not so sure now, and I will tell you why. My reasoning is based on lessons learned during the twelve years I spent on the options trading floor, and my speculative conclusion has less to do with economics than with the sometimes extreme irrationality of securities markets. Longtime subscribers will know that I've been sounding a deflation theme for years, not only in my newsletter, but in essays I've written for Barron's, the San Francisco Examiner and other financial publications. At the outset, I was inclined to think that a deflation-bound economy - particularly a global one - would create the most challenging investment environment imaginable And so it has. I have always believed that deflation would bring, not money-making opportunities, but rather a prolonged period of economic adversity during which even the savviest investors would be challenged to hold onto 30%-40% of their original net worth.
Deflation Promises Few Bonanzas
I was laying it on a little thick, perhaps, just to make the point. But not now; for if the likes of Warren Buffett can get hijacked doing what is very arguably the right thing, then what chance do the rest of us have of protecting our nest eggs, never mind making a bundle? This is mainly because there is no easy way to leverage a deflationary bust. If it were otherwise, my friend Howard Hill, an expert's expert on the subject of securitized debt, would have come up with a way to short the residential real estate market with ten-for-one dollars.
It is absolutely crucial to understand that deflation will not be dot-com mania in reverse. There will be no penny shares whose value increases ten-thousand fold, nor will there be pictures of "Deflation's Newest Billionaires" on magazine covers. At best, as asset values fall, the most astute investors will be the ones who can resist buying the formerly $6 million Aspen ski chalet for $4 million. They will have the imagination to see that the same house could conceivably go begging for $400,000 before deflation has run its course.
Gold the Perfect Hedge?
For many of us, the big question is whether gold will prove to be the perfect hedge against a deflationary bust that has been taking shape for more than ten years. I had thought it would until recently. After all, I reasoned, the U.S. dollar is already intrinsically worthless, and it is therefore only a matter of time before everyone figures this out and stampedes into tangible assets, especially bullion. But what about deflation, you ask? Isn't cash supposed to be "king" when incomes and asset values are falling? My stock response has been that this deflation will be very different from all the others: that it will be the first in history to have occurred in a fiat-money world. The inevitable result would be a dollar that finds its true value, falling to the threshold of worthlessness as the price of gold soars commensurately. As for most other classes of assets, they too will fall, seeking price levels tied to their income value.
The no-brainer in all of this is that the dollar can only go lower. This must be so, we see, because the U.S. trade deficit is gargantuan and still growing, the Federal budget is spinning out of control, and, in any event, private, corporate and pubic debt have grown too large to service without the help of a rip-roaring inflation. If we had Buffett's money, then, we'd all probably have done what he did: diversify heavily out of dollar assets.
'Worthless Dollar' Could Surge
But Buffett - and millions of other investors, most particularly precious-metals bulls -- could be very much mistaken in assuming that a weak or even worthless dollar cannot soar, at least for a while, for reasons wholly unrelated to its fundamental value. As a floor trader, I saw this happen time and again when the shares of poorly run or even criminally mismanaged company went ballistic. Many of them. after initially falling for fundamental reasons that were widely recognized, soared 30% or 40% in mere days. The cause almost invariably was unrelated to the company's fortunes; rather, it was the result of egregious, fleeting imbalances between supply and demand. The demand came from shorts who, having bet the stock would fall, were stampeded into covering their positions when the stock started moving against them. As for supply, it dried up almost completely when shareholders realized they had the bears on the ropes.
I have seen this occur on the trading floor too many times to ignore the possibility it could happen to the dollar. As I explained here recently, most of the world's hundreds of trillions of dollars of debt is denominated in dollars, and this debt represents, implicitly, a massive short-position against the dollar. As such, all borrowers of dollars should be praying for inflation, since it would allow them to pay back what they owe in cheapened money. They could also pray for the one other thing that might do the trick - a dramatic rise in incomes over and above the rate of inflation. Miracles do happen.
Murphy's Law and Debt
But unless Murphy's Law is suspended for the next ten years, we can be reasonably certain that borrowers are not going to get off quite so easily, especially since all it would take to crush them is a rise in lending rates. I'm not talking about 15% mortgages, either, or even 10%. If residential property values and incomes were to fall even slightly, a five- or six-percent mortgage would for most homeowners become a crushing burden.
This is the very crux of the coming deflation as well as the basis for a potentially sensational rise in the dollar that almost no one expects. As a mechanism to cleanse the economic system -- to cleanse capitalism, if you will --- the scenario has the "virtue" of outfoxing not only gold-bugs who trust that the dollar's inevitable decline will make bullion far more precious, but also financial world-beaters like Warren Buffett, who perforce do not come naturally to the notion that cash may be the best asset to hold for the next several years.
Dilemma for Goldbugs
A strong dollar - one impelled by uncontrollable market forces rather than by Fed whim - seems the most likely catalyst for a deflationary collapse, albeit the one least expected. What it implies is dollar rates rising to extraordinary levels in real terms, with foreign money pouring in to take advantage. If this should come to pass, there will be a dearth of double-your-money bets, and even financial wizards like Warren Buffett will be challenged to withstand the violent, tidal shifts in asset values. For gold bugs, such a volatile period would pose a particular dilemma, since bullion's eventual rise, though absolutely assured, would come only after the pain of deflation had caused the central bank to shovel money out the door. Meanwhile, we should not pretend to be mystified if the dollar's supposed bear rally steepens and bullion remains leaden. A "worthless" dollar may yet have the last laugh on all those who have rightfully disparaged it.
Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers' initials will be used unless express written permission has been granted to the contrary. All Contents © 2004, Rick Ackerman. All Rights Reserved. www.rickackerman.com
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