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Taylor on us Markets & Gold

August 13, 2002

To Project the future, Look in the Rear View Mirror

The GAAP P/E ratio at the end of this past week was a still very high 35.50 times. That figures out to an earnings yield of 2.87% which compares to a 10-year Treasury yield of 4.26%. Obviously, unless you think there will be an explosion of earnings for corporations in the months ahead, it is far better to be a lender to the Federal government than to be an owner of equities as represented by the S&P 500.

Why do we keep harping on the GAAP P/E ratio and Earnings Yield which uses trailing earnings? Shouldn't we be looking at earnings going forward rather than historical earnings? Well, how much credence do you think one should give earnings projections provided by Wall Street's sell side analysts these days? If you looked at Abby Joseph Cohen's forward looking earnings, and acted accordingly since about 1999, you would have been killed. But if you followed the advice of Ian Gordon' who takes a long-term view in the rear view mirror of history, going back 60 or 70 years, you would have made out like a bandit since 1999.

We also want to mention once again the excellent work of Michael B. O'Higgins who provided a process using bonds that was overwhelming more successful than equity investing, even during the greatest bull market in history. In his book "Beating the Dow with Bonds," O'Higgins devised a strategy where you buy stocks if and only if on the first day of each year, the earnings yield for stocks is higher than the 10-year U.S. Treasury plus 30 basis points. If that simple decision says "buy bonds" you then look to the gold price to indicate whether you should buy short term or long term bonds. If this year the gold price on January 1 was higher than the gold price of January 1 last year, you buy short term bonds. If gold is lower on Jan 1, than it was last year, you buy long-term Treasuries.

How well did this "rear view mirror" strategy work for O'Higgins? Well, in our March 11, 2002 we updated the performance of this strategy and surprise of all surprises, YOU COULD HAVE MADE TONS MORE MONEY DURING THE 1980'S AND 1990'S IF YOU HAD BOUGHT BONDS THAN IF YOU HAD BEEN IN STOCKS! How much better? $1,000 invested in 1972 and kept only in the Dow, would have grown to $32,303 by the end of 2001. But that same $1,000 if it were invested in the O'Higgins process would have grown to an astounding $415,302! This is not fiction. It is documented on the basis of actual historical prices.

Actually, you editor continues to us the O'Higgins process in a general way in molding my Model Portfolio. It answers a very basic question as to whether stocks are cheap or expensive. The last time they were cheap as far as O'Higgins was concerned was during the 1974 through 1980 time frame. Amazingly, he was in bonds from 1981 through the present time frame. And all he did to make that basic judgment call was to look in the rear view mirror at trailing S&P earnings and then compare that Earnings Yield (dividends + retained earnings) with the 10-year Treasury. Moreover, he did that only once each year - on January 1st.

Why have you not heard more about the O'Higgins approach? Because Wall Street doesn't like people buying bonds or gold because it kills their business. Better they keep you buying and selling stocks which they not only make a margins on. But they also make a killing on market making (often unscrupulously from the short side) and they make huge underwriting fees. But frankly, I don't give two hoots about Wall Street. It is my subscribers who I care about. And I'm telling you that on the basis of some tried and proven methods, there are ways to beat Wall Street, if you don't listen to their spin. O'Higgins has proven one way. And we know from experience that owning gold is a second way to beat Wall Street over the long-term.


Will the Fed Print Money To Buy Gold Mines?

Richard Russell made another of many interesting observations last week. He always does. You owe it to yourself to take out a subscription to this exceptionally talented and experienced market analyst. You can do it by going to In any event, Richard pointed out on Friday that during the past two weeks, the Fed created between $80 billion of new money out of thin. Then he noted that this is nearly enough to buy the entire gold mining industry which is valued at around $80 billion to $90 billion!

This observation begs an interesting question. Might the U.S. government do that one day, having pawned off its gold at very cheap prices to enrich the likes of their crony capitalist friends at Goldman Sachs, J.P. Morgan, Chase, Citigroup? Might not our increasingly totalitarian government simply create more money out of thin air and go in and buy all the gold mines the want. Or being a dictatorship, might they not simply confiscate them? Might they not insist on forcing us once again to turn over our gold bullion as Roosevelt did under penalty of $10,000 fine and 10 years in jail during the 1930's.

Of course, our government might do any or all of the above once they become desperate. There are no longer any laws in the American Constitution that the Federal government thinks it has to obey once their crony capitalist friends at the major banks feel threatened. And there are precious few liberty fighters remaining these days who would even put up a fight. Of course, our elite leaders will always make the case that it is "for our own good" that they seize assets at difficult times, just as they clandestinely are doing the same now every time they print money to bail out another country or another company. If we had more elected officials like Congressman Paul who understand the roots of liberty and value liberty over wealth, I might be more hopeful.

But in fact, at the start of this year, there were some discussions about how the Fed might respond to a deflationary problem in America. And as I recall, one of the things that was leaked out of the Fed meeting had to do with how the Fed would respond to a deflationary problem. As I recall, the idea that came out of that meeting was that the Fed would monetize everything in site and the few specific items mentioned in the Fed leak. That suggests to me that our government and their cronies at the Fed are in fact contemplating acquiring gold in the ground. This was no doubt a trial balloon sent into the air to determine how people would react and thus how they might best go about implementing this policy when the time comes they feel they need to do that.

So, as the Kondratieff winds are blowing, should you give up the hope of retaining some of your wealth by holding honest and truthful money, namely gold because the Federal government may confiscate it anyway? I think not for a couple of reasons. First, the value of these mines could go up substantially before the government acts. They may or may not give you market value for them but it is hard to see how, at the very worst, you would be worse off for owning gold and gold shares.

More likely than an immediate and outright confiscation, I could see the government passing laws that would lessen the value of your investment, such as a special tax on gold mining profits or perhaps forcing the mining firms to sell gold to the U.S. government at below market prices. Any conceivable means of theft is a possibility when times become desperate.

I would suggest political diversity may also be important when you buy gold shares. It is advisable in my view to buy companies with gold mines in various different countries around the world. Owning some Canadian stocks may not be a bad idea because Canada at least has a little independence from the U.S. though we know the goal of our elitist leaders is to form a one world government that would take away national autonomy from all of us. But for the present time at least, international diversity should lower political portfolio risks of holding gold stocks, which is one reason we are now even including a couple of firms with projects in Africa.

In summary, while gold investing could become politically risky when the monetary system collapses, the absence of gold from a portfolio is in my view a far riskier strategy.

10 karat gold is 41.7% pure gold.
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