What is a Speculator?

March 9, 2009

A speculator is a trader who approaches the financial markets with the intention to make a profit by buying low and selling high (or higher), not necessarily in that order. The speculator is distinguished from the investor, who approaches the financial markets with the intention of making a return on his capital. and does not try to predict the ups and downs of the market. In simple terms, the speculator is interested in price action. The investor is interested in dividends.

The problem with many people trading in today's markets is that they are speculators but do not like to admit that fact and persist in calling themselves investors. The idea here is that speculation is evil while investment is somewhat respectable. Not wanting to think about issues of good and evil they simply accept society's opinion and let it dominate their life.

This is a disaster because, not admitting to themselves that they are speculators, they give no thought to the issue of how to be good speculators. This was evident from the people who attended the gold conferences of the late 1970s. I often tried to warn those people, "Gold is approaching $800. It is no longer undervalued, as it was in 1970. Indeed, it gives every indication of being overvalued at the present time. This is a time to be careful."

I might as well have been talking to a wall. These people had come to the conference because they wanted to speculate. That is, they wanted to buy gold and sell it at a higher price. But they did not want to do the hard thinking that would tell them whether gold was going up or down. Gold had gone up in the past. Therefore, their emotions told them that it would go up in the future. Despite my good record they did not want to hear my dissenting voice. They gave no thought to how one predicts price movements.

The best way to predict price movements in stocks was taught by Ludwig von Mises, the head of the Austrian school of economics. Von Mises taught that whenever the central bank interferes with the credit market and moves the free market rate of interest below its true value, this causes a rise in the capital markets (i.e., the stock market). Let us take a simple example. When the U.S. central bank was created in 1914, it lowered the rate of interest from 6% to 3%. Since stock (earnings) yields are competitive with real bond yields, stock yields had to fall from 8% to 4%. But the only way for this to happen was for stock prices to double. Sure enough, from late 1914 to late 1916 the DJI went from 53 to 110.

I first applied this theory in 1969. The Fed tightened after the election of 1968. I saw rates move up and bonds decline. So I turned bearish on stocks, just in time for the bear market of 1969-70. I have been calling bull and bear trends in the stock market for the past 40 years. This does not work all of the time because a few major term market moves have other causes. But it works for about 90% of the major term moves.

I have been doing this successfully for the past 40 years. This includes some brilliant calls, such as the late 1974 bottom, the 1982 bottom, the October 1987 crash, the 1988 bull market, the bull trend of the 1990s. I turned bearish on stocks in early 2000, turned bullish again in Oct. 2002 and then switched over to gold. I am not shy about my methods and have written a book on money and credit. Somewhere over this long time period one would think that somebody in the establishment would have listened.

But, you see, they don't have to think any new thoughts. THEY ALL HAVE TITLES. The title "proves" that they know economics - even though they don't know economics. And large numbers of people are so impressed by these titles that they believe establishment economists whatever they say and no matter how many times they are wrong.

I have done a study as to who gives establishment economists their titles. Well, the first answer is, THEY GIVE THEM TO EACH OTHER. You see, Adam Smith never had a title in economics. He was a professor of philosophy. But of course the Wright Brothers never had a title in airplane design. Indeed, they never even finished high school. That was the old America where a man was judged by what he accomplished, not by his title.

Consider mutual funds. If you buy a mutual find, then you pay a fee, which includes the salary of the fund manager. But fund managers, by and large, can't do their jobs. Over time, the average mutual fund manager underperforms the market. For example, if you put $100,000 into the average American mutual fund on Jan. 1, 2000, than on Jan. 1, 2009, according to the Lipper figures, that has shrunk below $78,000. The figure is only reported every 3 months, but estimating by what the market has done since that time, today your speculation has shrunk to $60,000. And all these people can say is, "Buy and hold good sound stocks for the long pull." (The One-handed Economist's Model Conservative Portfolio is up from $100,000 to $155,000 over the same period.) If the fund managers are not doing the job, why should they get paid? If you brought your car to an auto mechanic and it came out worse than it went in, would you bring it back next time? Of course not. But that is because you are not in awe of the auto mechanic's title as you are of the fund manager's title. For this reason, most auto mechanics know how to do their jobs.

The second answer about titles in economics is that a half century ago they were bought out by the bankers. Specifically the Manhattan Bank (later merged into Chase-Manhattan and then into J.P. Morgan) established a chair of economics at Harvard University for John Kenneth Galbraith. Galbraith was one of a group of crackpots who said that, if the bankers are given the privilege to legally counterfeit money, this is the road to plenty for the society. Harvard was not going to hire Galbraith on its own. But when the Manhattan Bank waved around its money, they grabbed it. Using the prestige of Harvard (which they had just bought and paid for) these bankers took over the economics departments of first the most prestigious and later all the schools of economics in the country. Today there is hardly a teacher of economics in the country who knows any economics. This is why their students - who become the fund managers - cannot do their jobs.

So the first thing that you, as an up-and-coming speculator, need to know is, who are the experts who really can do their jobs and who are the phonies who try to impress you with their titles? This is the American way. You start off with whatever level of knowledge you have. You explore, you listen, and you test what you hear against the facts. If a theory works, that is supporting evidence that it is true. If it doesn't work, then it isn't true.

For example, John Maynard Keynes stole his economic theory from two Americans, William Trufant Foster and Waddill Catchings who, in 1928, wrote a book called The Road to Plenty. The road to plenty for a society, Foster and Catchings said, was to abandon the gold standard and base the economy on paper money. Foster and Catchings never caught on because they were too conservative. Keynes was smart enough to disguise their theory as liberal and progressive. In this form, he taught it to John Kenneth Galbraith and the other crackpots of the day. Well abandoning the gold standard was not the road to plenty for our society. We broke the last tie to gold in 1971, and real wages in America peaked in 1972. Now the country is getting poorer. When America was based on a gold standard (1788-1933), it had the greatest economy of any country in the world at any time of history.

So the theory adopted in 1971 did not work. And the economists who promote this theory do not know economics. Abandoning the gold standard was certainly the road to plenty for the bankers and for Wall Street., but it was not the road to plenty for America. While the stock market went up, the real wages of the average working man went down.

Let us consider retirement. Today a lot of Americans look to the stock market for their retirement. This was not true prior to 1933. Retirement as an institution was created in America by Noah Webster (who gave us the American dictionary). In 1785-86, he toured the 13 new states and convinced key legislators to legalize the paying of interest (at least in the North). People than started saving and taking their money to the savings bank, where it earned them a steady 5% (real) interest. If you earn 5% interest over a 49 year working lifetime (16-65), your savings are multiplied by four times. And this multiple of four means that it is possible for the average person to save enough for retirement. Retirement became an institution in America (and Britain) starting in the early 19th century.

But the stupid "economists" of today do not even know what retirement is. Retirement is a period, usually near the end of one's life, when one stops working and lives off of one's savings. Retired folks consume wealth, but they do not produce wealth. Now let me ask, how it is possible to have large numbers of people in the society consuming when they do not produce?

Noah Webster's answer was that during all the time these people had been saving money, their savings were used by businessmen (taking loans from the banks) to buy/build machines (or other forms of capital) which increased the per capita productivity of the average worker. Some of these machines were very powerful and increased productivity by 50-100 times. So the saver had contributed his share to a 50-100 factor increase in the wealth of the world. Paying him fourfold was a very modest price. Thus the consumption of the retired class was produced by the new, younger workers, who were enabled to produce so much because of the better machines, which in turn were made possible by the savings of the retiree.

That is the way that the system used to work. But in 1933, FDR switched from a gold standard to a paper money system, and from that day to this real interest rates on riskless investments in the U.S. have been 0%. (Today nominal rates are 0%, and real rates are negative.) As a result, Americans have pretty much given up savings.

Okay, if you can't get 5% real interest on your savings, what do you do to retire? The answer, for too many people, is the stock market. But quite frankly, the stock market is a long way from being riskless. In the 19th century, no one thought of getting his retirement out of the stock market. In the days of Charles Dow, the DJI went back and forth between 50 and 100. There was no long term trend. In our own day, the rise in stocks from DJI 800 in 1982 to DJI 14,000 in 2007 was caused by three factors: 1) Wealth was transferred from the worker to his employer as wages lagged the rise in prices. 2) Wealth was transferred from the saver and retired person to the debtor (again the large corporation) by continually declining interest rates. 3) Capital goods (stocks) were given a higher valuation in relation to consumer goods, again because of declining interest rates. But the essential factor was missing. There was no saving and creation of better machines. A society cannot get richer by the technique of one part stealing from the other part. It can only get richer by the creation of wealth. The auto industry is a good example. What made the auto industry great was that Henry Ford figured out how to make good cars inexpensively. Every car that rolled off his assembly line represented a gain in wealth for the society. A car that had cost $2000 now cost $400. What do auto executives do today? Do they figure out better ways to create wealth? No, they go to the Government and say, "Steal from the poor and give to us." And the President says, "I am the friend of the poor. Here's the money."

So taking your retirement out of the stock market is a foolish plan. The stock market is a group of people speculating against each other. It has much the aspect of a neighborhood poker game. Some may win, but some will lose. And at the end of the night, the average player has broken even. You can't retire by breaking even.

The error of those who say that over the long pull stocks always go up (or who said this in 2007) is that they take too short a time frame as reference. The correct proposition is that stocks always go up as long as the quantity of paper money is increased. But whether the paper money will be increased or decreased is a political decision (made by the Fed).

And the important factor influencing the Fed's calculations is the fact that we are now in the (second upswing of the) commodity pendulum. Commodities got horrifically undervalued (in real terms) in 1999-2001. They are now recovering from that undervaluation but are still low in real terms. If you want to know what is going to happen to the U.S. economy, then you have to study the history of the 1970s (not the 1930s). Do you remember when Paul Volcker increased the money supply by 17% in 1986? Do you remember when Alan Greenspan increased the money supply by 15% in 1993? We did not get corresponding increases in the Consumer Price Index from those increases in money.

The reason was that commodities were then on a downswing, and the commodity declines undercut the consumer price increases. That is also what happened in the 1960s. But now commodity prices are on the rise (the decline of '08 being a small blip on the long term chart). As commodities recover their highs (as gold has already done) and then go higher yet, the Consumer Price Index will rise explosively. Of course Bernanke has not helped this situation by recently doubling the monetary base. When the rise in consumer prices becomes intolerable, the public will demand someone to come in and stop what they call inflation (actually depreciation of the currency). Then the Fed will be forced to come in and tighten. A tightening Fed may seem far away today, but it will eventually come. And then we will see a stock market decline which will make the past 1½ years seem like child's play.

At the One-handed Economist, I try to practice rational principles of speculation. I am a gold bug now but am not committed to always being a gold bug. (I was a gold bug through the 1970s and said good-bye to gold in 1980. I played it in and out through the '80s and '90s and then turned long term bullish again in 2002.) Right now I am very impressed with the technical strength shown by gold. It has led all other commodities on the rebound from their late 2008 lows and has already recovered back to its all-time high. Other commodities will follow. Further, many gold bugs have commented on the lagging of the gold juniors. What they do not realize is that the market is conservative in the early stages of a bull move, and the fact that gold traders are sticking to the blue chips is a sign that this gold bull has a long way to go. The juniors will have their day, but that is quite some time down the road.

What you get from me is my best opinion at all times. I am not like those gold bugs of the 1970s who just hung on and on through the dismal '80s and '90s. When I turn bearish on gold (which I do not expect to do for quite a while) you will be the first to know (if you are a subscriber). You may also visit my web site, www.thegoldbug.net, (no charge) where I blog on social issues of the day from an economist's point of view. In the One-handed Economist, you get those hard-nosed predictions about where the various financial markets are going and what is the best move to make at this time.

The purity of gold is measured in carat weight.

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