Speculation vs. The Permanent Portfolio

I received a comment last week in response to my post about the possibility of a pullback in the near future.  A pullback seems less likely at the moment now after the Fed’s meeting and Bernanke’s press conference this past week.  However, I would still like to address the comment and add some more thoughts.

The question posed to me was, what would be good to have in a portfolio (presumably in the case of a pullback).  He says that his only current investments are in a 401k.

First, I should reiterate my opinion of 401k plans.  I don’t think you should ever contribute more than what your company matches.  The only exception might be is if you are trying to get your income low enough for a certain tax deduction or credit beyond the amount being contributed to your 401k.  If all you have is a 401k, I really would encourage you to do everything you can to get some more liquid funds.  If you can save some additional money, you can split it between gold and cash as an emergency fund.  If this means doing a second job for a while or cutting your costs, I think it would be worth it.  Obviously every person’s situation is unique, but I think my suggestion would apply well to most adults.

When I said that there may be a pullback, particularly in stocks and commodities, I was saying it as a speculation.  If all you have is a 401k, then you should really ignore most of my speculative advice, unless you have good fund choices and you can put a little more weighting into gold and commodities (for right now).  But a 401k is not meant for short-term trading and you may even get hit with fees for doing that.

I am a strong advocate of Harry Browne’s permanent portfolio.  I think it is good to view this as a home base.  If you put 80% of your investments into the permanent portfolio, that will leave you with 20% for speculation.  Let’s say your speculative investments do well.  For example, maybe you put half of it into silver and it has doubled in price.  If you are really uncertain about where things are headed from here and if you fear a pullback, maybe you could take the original amount you put into silver and shift that over to your permanent portfolio.

While the permanent portfolio can certainly go down, I consider it the best safety investment there is.  Cash by itself is not a safe investment because you are risking it being devalued by inflation.

Imagine playing a game where you have a home base for safety.  You can run away from the base and try to grab something, but you risk being hurt.  If you run out and get something, sometimes it is best to run right back to your safety base before trying to grab something else.  I look at grabbing things as your speculative investments.  I look at your home base as the permanent portfolio.

You should take as much time as you need at your safety base.  If you are unsure of what is going on around you, just stay put.  There will be other opportunities in the future.  You can wait for a long time before you are more certain that you can jump out and grab something without putting yourself at too much risk.

This is really a time to protect what you have.  There are a lot of risks right now and you should make sure you know them if you are speculating.  If you have absolutely no stomach for risk, then put all of your investments into a permanent portfolio setup.  You can sit back and enjoy the show while continuing to sleep at night.  If you want to take more risk, do it with a smaller amount of money.  You don’t have to hit the lottery.  Just make sure to protect the vast majority of your assets at your home base. Keep them safe from this risky environment.

Ron Paul for President in 2012

This blog focuses on money and investments from a libertarian perspective.  To determine our investments, we must study the economy.  To study the economy, we must study politics.  This is unfortunate, but it is reality.  Unfortunately, politics plays a huge role in our lives and in the economy because politicians wield so much power.  While I wish it weren’t this way, we have to deal with the situation.

There are two things that will matter more than anything else in your long-term future when it comes to money.  The first thing is your own personal decision making and the actions you take.  The other thing is the state of liberty in which we live.  I suppose you could throw in luck as a third thing.

While it may seem we can’t do much to determine the future of liberty as individuals, it is important to at least know where we are headed.

Ron Paul has announced that he will form an exploratory committee in seeking to run for president.  With the success of his last campaign, I can’t imagine that there won’t be an even bigger following, with even bigger donations this time around.  So it looks like there is a good chance that Ron Paul will be running for president.  While the general election is in late 2012 and most of the primaries will be in early 2012, this year will be the big year for him.

I don’t think Ron Paul will become the Republican nominee.  Perhaps he is thinking that he can pull off what Reagan did in 1980 after not winning the nomination in 1976.  But I don’t see the Republican Party nominating Ron Paul as their nominee.  Rand Paul would have a better chance.  The main reason is foreign policy.  There are too many pro-war people in the party.  Ron Paul’s foreign policy stance of non-intervention does not appeal to these people.  I think Ron Paul will convert some people or at least get them to examine their position more closely, but I doubt it will be enough at this point.

For the cause of liberty, I strongly believe that the solution does not lie in politics.  The system is rigged in favor of big government.  There is no way that voting will solve our problems.  With that said, I was happy when Ron Paul ran for president 4 years ago and I am happy he is considering it again.  The reason is because it gives him a platform to reach out to so many people.  Look back at 2007 and 2008 and how many libertarians were created because of Ron Paul’s campaign.

As libertarians, we couldn’t ask for a better all-round person to get out our message.  He is honest, humble, and a great role model.  He does not come across as the typical politician.  Most importantly, he understands the issues of liberty clearly and he sticks by his principles.

It was a great move in 2007 for Ron Paul to run as a Republican.  It got him into the debates where he got incredible exposure.  Now that he is more well known and there is already a core group of supporters, I think he should run as a Libertarian (the party that is).  In a three-way race between Ron Paul, Obama, and the Republican nominee, I think Ron Paul could do some damage in attracting many independent voters and even some typical non-voters.  The best case scenario would be for him to just barely lose.  After all, why would we want him to win and inherit the total mess that there is right now?  I don’t think he will run as a third party candidate and I completely respect his decision, but I think he should ditch the pro-war Republican Party, except when he is running for his congressional seat.

Ron Paul has released a new book and he has been getting a lot of media attention in the last few days.  With his message and the internet as a tool to spread it, the future for liberty is actually brighter than you may think.  The best thing you can do to advance liberty is to continue to educate yourself and to educate others.  We will only achieve more liberty and less government when more hearts and minds are changed.  This will not happen in a voting booth.

The Fed’s Meeting and Bernanke’s Press Conference

Today was a first.  Ben Bernanke became the first chairman of the Federal Reserve to hold a press conference directly following a Fed monetary policy decision.  Perhaps Bernanke is trying to make the Fed more transparent.  Perhaps more likely, Bernanke is feeling the heat from Ron Paul and his following of Fed critics.

The Fed announced that it was maintaining the federal funds rate low for an “extended period”.  As Gary North has pointed out, the Fed isn’t really maintaining this rate.  The federal funds rate is the rate at which banks borrow from each other for overnight loans to settle accounts.  With most of the new money created by the Fed going into excess reserves at banks, most banks have no need to borrow money overnight.  They have plenty of money of their own.

Bernanke also acknowledged that the Fed would continue with its QE2 program (money creation) through the end of June as planned.  While he hinted that it would not continue after that, he also hasn’t ruled it out. Bernanke and the Fed are leaving their options open.  I really don’t think they know what to do at this point.  Bernanke is acknowledging that some price inflation is present now and he is also acknowledging that the economy has weak spots.

The reason the Fed is acting so cautious with its words and actions (not that tripling the monetary base has been a cautious action) is that these people really don’t know what to do.  The Fed is walking on a tightrope.  If the Fed keeps hiking up the monetary base, price inflation could quickly follow the monetary inflation.  With just today’s announcement, the stock market, oil, gold, and silver all shot up.  Gas is already expensive and getting more so by the day and food is probably not far behind.  The Fed really is risking a run on the dollar.

On the other hand, the Fed could pull back and stop its money creation.  It could even withdraw some of its previous “stimulus” money.  If the Fed does this, it risks a hard and deep recession and this is with the official unemployment rate near 10% already.  We should actually hope that the Fed chooses this latter course as it will be much better for the long run.

I think the most likely scenario is that we will see a lot of ups and downs and we will eventually see recession and significant price inflation at the same time, much like we saw in the 1970’s.  If we can get out of this like the 70’s, we would be very lucky at this point.

For now, I expect heavy volatility and I expect the uptrend to remain for oil, gold, and silver.  I’m a little more unsure about the stock market.  These really are unique times that we live in.  Let us hope that we don’t go to hyperinflation as that would truly be disastrous.  Let’s hope that we can slowly phase out the Fed and start using money like gold or silver as determined by a free market.

Gas Prices and Price Gouging

Here we go again.  Last week, Obama said he would set up a task force to investigate potential manipulators in the oil and gas market.  Now Obama is calling for the repeal of tax breaks (in other words, increasing taxes) for the oil industry.

Obama is a typical leftist Democrat in that he likes to speak about helping the poor and about cracking down on the rich.  Yet, for someone who really understands economics and studies his policies, his actions are about the opposite.  If Obama were really serious about helping the little guy, he could take several steps to dramatically lower gas prices.

Obama could advocate a repeal of the federal gas tax.  He could advocate the repeal of regulations on the gas and oil industry.  He could advocate the selling of ANWR and other federal lands that contain oil (and this could have the added benefit of paying off some of the national debt).  He could also stop fighting wars in the Middle East and just allow Americans to buy oil from foreigners, instead of trying to occupy other countries for their oil

Most importantly, if Obama really wanted to help the little guy with lower gas prices, he could stop signing legislation that runs up the national debt, which in turn encourages the Fed to create more money.  The primary reason for high gas and oil prices is a monetary one.  The Fed has tripled the adjusted monetary base over the last couple of years and we should be surprised that oil is only around $112.

The reason that gas prices are so high is due solely to the Fed and the federal government.  Obama is trying to find a scapegoat for his failed policies by blaming oil companies and speculators.  He can talk about manipulators of the market, but the people he is talking about serve a legitimate function to the market process.  These people help the pricing process be more accurate and help direct supply and demand.  If speculators are right in driving up the price of oil, then it is signaling the market to find more supply and to cut back its use.

Meanwhile, the politicians of both major parties serve a function of distorting the market and making everything more expensive.  Then they talk about a problem that they created and try to pass the blame to anyone but themselves.  They are trying to take advantage of the ignorance of the general public.  I really do hope that most Americans wake up to this scam and realize that they are voting for the real enemy.

Silver Nears $50

Today, the price of silver nearly reached $50 per ounce.  This is right around its all-time nominal high reached in 1980.  The run in silver over 3 decades ago became a bubble.  It all collapsed with a series of events, including Volcker’s Fed stopping the crazy money creation.  This also collapsed the gold price in dollars during that time.

After reaching a high of over $49 in early trading this morning, silver pulled back a little.  It is showing high volatility at this point, with huge gains made in just the last couple of months.  If you don’t have any silver or silver positions and you are looking to enter the market, now is a risky time to do it.  Silver will probably go above $50 soon, perhaps this week, and it may have further to run in the near-term.  But it has gone up really far and fast and you should not be surprised to see a significant pullback.  Whether the pullback will start at $50, $60, or some other number, is hard to say.

Although the U.S. dollar is depreciating significantly due to the Fed’s monetary inflation (now QE2), it is still wise to hold some cash on reserve.  It is always good to have some liquid money and you should have some on hand for pullbacks.  If silver ends up pulling back to, say, $40, then it will be a great opportunity to accumulate some.

On the other hand, if silver continues running, you might want to consider taking a little in the way of paper profits.  If you have a big position in silver or silver investments, then it might be time to consider a slight reduction in your position to lock in some paper gains.  50 dollars is a milestone and somewhat symbolic, so maybe that is the magic number to consider locking in some gains.

I still see the longer term trend being up for gold and silver.  Silver will be far more volatile.  You will get greater gains during the run-ups, like now.  You will also feel the pain more in the pullbacks with silver.  Until the Fed stops creating new money and the DC politicians are forced to address the debt, then precious metals will do well.  You should always hold a core position in your portfolio of gold and gold related investments.  I recommend 20 to 25%.  Silver is more speculative, but having 5% in silver may be a good idea.  With your speculative money in precious metals, remember to take some paper profits on the run-ups and to buy on the pullbacks.  We will continue to see fierce volatility due to the uncertainty of the dollar.

How Much Wealth Do You Need To Be Wealthy?

This is a hard question to answer.  First, notice that the question is about wealth and not money.  The reason is because of the constant depreciation of money.  We live in a world of fiat currencies where central banks are continually creating money out of thin air.  So we could say that having one million dollars makes you wealthy, but that may not be true 10 years down the line.

Another similar question is how much wealth you need to retire.  Again, it is hard to measure with money.  It is not like you can just buy a bunch of 30 year bonds and live off the interest.  If the dollar is devalued, then your fixed interest payments may not be enough.  We also don’t know what future interest rates will be and we can’t accurately determine what rate of return we will get on our investments.

We could measure wealth in gold, but even that can be a problem.  Because of the instability of fiat currencies, gold fluctuates wildly.  You can have bubbles in gold, at least in terms of dollars and other fiat currencies.  The price of gold went down in the 1980’s while prices went up.  The price of gold has gone up 5 times of what it was 10 years ago, but consumer prices have not risen that much during that period.

Gary North has written an article on debt.  The particular part of this article that I want to point out is his comments on housing.  He discusses someone who needs $5,000 a month before taxes in order to retire.  He says, “I tell them that they need about six 3-bedroom, 2-bath houses that generate $1,000 a month net income before income taxes.”

I think Gary North has hit the nail on the head with this one.  It really is a good measure of wealth and a good measure of what you need to retire.  If you own real estate that can be rented out, then you will be paid in dollars (or whatever money your country uses).  Since you use dollars to buy consumer goods, this is a good measure.  But it also solves the problem of inflation.  As the dollar depreciates, rents will go up.  Some of your other expenses like property taxes and maintenance may go up as well, but the increase in rent should far exceed this.

I am not saying that you need to buy real estate in order to retire (although I’m not discouraging it either).  What I am saying is that it is a good measure of wealth and you can use it as a yard stick.  If owning six houses, with no mortgage, will net you $1,000 a month and that is enough to live on, then you can calculate how much money you need right now.  If such a house sells for $150,000 where you live, then you need approximately $900,000 (6 x 150,000).  I would round it off to one million just to be safe.

But you have to make sure you invest it wisely to make it last, especially with inflation.  To protect your wealth, I have two recommendations: real estate as mentioned above and Harry Browne’s permanent portfolio plan.  Both of these plans help protect you against a falling dollar.

Will There Be a Pullback in Gold?

Gold has hit an all-time nominal high of $1,500 per ounce.  Silver has hit $45 per ounce, just short of its all-time bubble high of about $50.  For those who have been paying attention, it does not come as a surprise.  The Fed has tripled the adjusted monetary base in the last few years and the federal government has been adding about $1.5 trillion in new debt each year for the last couple of years.  The worst thing (and the best thing for gold) is that there is no sign of this madness stopping.

Yesterday, there was a piece on LRC featuring an interview with David Galland.  Galland is part of Doug Casey’s group at Casey Research.  If you haven’t read this interview, it is definitely insightful.  To sum it up, Galland is warning that there could be a big policy shift in the short term.  While his long-term outlook has not changed (more inflation and higher commodity prices), he thinks there could be a pullback in the not-so-distant future.

While I’m not making any predictions, I think his analysis is reasonably sound and I think the scenario he outlines is not only possible, but reasonably likely.  Galland is saying that there will be no QE3 this year.  He is expecting an announcement, perhaps following the FOMC meeting at the end of April, that the Fed will stop buying government debt.  The Fed will either cut QE2 short or just let it play out but not buy any more after that.  Just such an announcement could cause a big pullback in the stock market.  It would also likely strengthen the dollar.  In turn, gold and silver could see a sharp pullback.

I would give this scenario at least a 50/50 chance of happening right now.  I agree with his assessment that if the Fed does announce that it will stop buying, then we will see a significant pullback.  Unfortunately, it is hard to predict what the Fed will do.  I have already been surprised at just how much the monetary base has increased, so I shouldn’t be shocked if the Fed does do something as stupid as QE3.

Regardless of what happens, Galland believes that the long-term trend will hold.  If the Fed does hold off on QE3, then it will just come later after the economy goes through another round of beatings.  If Galland’s short-term prediction doesn’t hold and the Fed starts QE3 right after QE2, then expect gold, silver, and oil to go to the moon faster than even goldbugs could have imagined.

Is the Stock Market Up Because of QE2?

There are a lot of reasons to be bearish against the stock market right now.  Unemployment is still near 10% (according to government statistics), banks are holding back when it comes to lending, and there is an overall anti-risk and anti-investment mentality right now in the business world, especially because of excessive government.

There is one reason for the stock market to go up.  That reason is the Federal Reserve creating new money out of thin air.  So to answer the question in the title of this post, yes, the stock market is up because of QE2, along with QE1 before it.

I have argued before that an increase in the overall stock market is due to monetary inflation.  While the stock market does not necessarily track the money supply in the short term or even the intermediate term, there is a strong correlation in the long term.  If the Fed kept a completely stable money supply where it did not increase it or decrease it at all over a long period of time, then the stock market would trade in a relatively narrow range.  If there is no new money to bid up prices, then the prices won’t be bid up.

For those who understand Austrian economics, or for that matter Chicago school economics, you are aware that the overall price level changes because of changes in the money supply.  If there were no changes in the money supply, prices, in general, would not go up in a free market.  In fact, in a free market, prices would actually fall due to the increases in production and technology.  If you accept this fact for consumer prices, then it should not be much of a stretch to apply the same thinking to asset prices.  So while certain stocks may go up or down in price, the overall stock market would stay relatively flat if there were no changes in the money supply over a long period of time.

This is why you should not use the stock market as a predictor of the overall economy.  The stock market has been going up big time for the last couple of years.  But this is following the initial bailouts and a doubling of the monetary base.  Now we have QE2 (more money creation) that is supposed to last 8 months (until June).

This is why I have been hesitant to recommend large short positions.  I certainly think there could be some severe pullbacks in the stock market and a small short position might turn out to be a good speculation right now if you get in and out rather quickly.  But overall, it is hard to fight the Fed on this one.  The monetary base continues to go up and this new money is going to go somewhere.  Things like gold, oil, silver, and food are going up, but you can add the stock market to that too.

This is why we should not judge the Japanese economy too harshly based on its stock market.  It has been down or flat for the last two decades, but you can partially chalk that up to the fact that its growth in the money supply has been much tamer than elsewhere.

There are no guarantees that the U.S. stock market will keep going up, but if the Fed keeps creating new money out of thin air, it is hard to bet against it.

S&P Cuts Outlook on America’s AAA Debt

Standard & Poor’s cut its outlook on U.S. government debt.  It is keeping its AAA rating for now, but the rating is going from stable to negative.  The stock market reacted to this news with a sharp decline.

Next thing you know, there will be a report that politicians sometimes act in a corrupt way and people will be shocked by the news.  If you detected some sarcasm, it is because this news is not news at all.  The only thing newsworthy about it is that some in the establishment are starting to at least acknowledge that there may be a problem (and yes, S&P is part of the establishment).

If S&P were really honest, the U.S. would have lost its AAA status many years ago.  There is no possible way that the current debt will be paid off, unless it is done through massive inflation (which is, in a sense, a default of its own).

I suppose that it’s a good thing that more people are realizing that there is a major problem that has been created by DC.  The current course is unsustainable and something is going to change.  A lot of people are going to be unhappy, whether it is people having more taken from them by the government or people losing out on their free lunches.

The politicians in DC will continue to run up the debt until one of two things happen.  Either the law of economics will eventually force them to cut because the Fed can’t create any more new money without risking hyperinflation, or Americans will put an end to it.  For Americans to put an end to the reckless spending, we will need to see more than a few tea party people elected to Congress.

If Americans really desperately wanted lower spending right now, then it would happen.  The problem is that the opposition to big government is not strong enough right now.  Even if it is an even split, guess which way the politicians will come down.  Americans need to stop worrying about voting the “right” people into office.  Instead, they need to educate themselves and help educate others.  Americans need to stop depending on government and expressly withdraw their consent.  If half of Americans turned into minarchists and/or anarcho-capitalists overnight, then the federal government would just about dissolve in a short period of time just based on public opinion.  This would hold true for any country.

Why Gold is a Good Hedge Against Inflation

Last week, I received a comment about gold/ commodities being an accurate gauge of inflation.  The beginning of the comment was as follows:

“I’m a novice on this, so forgive me if I’m off-base, but your statement that created money goes into hotspots (and the idea of bubbles) seems to conflict with my understanding of commodities.  I thought that commodities were an accurate gauge of inflation, so gold (and oil) going up, would indicate a devalued dollar, not an artificially created ‘bubble’ in oil (or gold).”

Let me attempt to clear this up.  While gold has a certain correlation with inflation, it is not a direct correlation in the short-term.  If you want an investment as a “hedge” against something, then you want it to react strongly.  For example, TIPS (bonds that adjust for price inflation) are not a good hedge against inflation.  Even if you put half of your portfolio into TIPS and price inflation started raging, then only that one half of your portfolio would stay even with price inflation.  The other half would be vulnerable.  If you want to find a good hedge against severe price inflation, then you need to find something that will go up at a faster rate than the rate of price inflation (in the short-term).

This is where gold comes in.  Just like real estate, gold will have a strong correlation with inflation over long periods of time.  But over shorter time frames, there is not necessarily a strong correlation.  Gold was a terrible investment from 1981 until 2001 and yet there was positive price inflation in every year, although it was relatively low when you compare it to the 1970’s.

When you look at the 1970’s and you even account that it was during a time when it became legal again for Americans to own gold, you can see that the price of gold went up far in excess of the inflation rate.  If you had put all of your money into gold when it became legal and you held it until 1980 before it crashed, you would have made a profit in real terms.  Adjusted for inflation, you still would have been way ahead.

This is why gold is such a good inflation hedge.  Gold tends to rise and rise dramatically during times of uncertainty and times of high inflation.  It is also a canary in the coal mine when it comes to future price inflation.  When people are worried that the Fed will create a lot of new money out of thin air in the near future, they turn to gold to protect their savings.  In times of high inflation (and we do have high monetary inflation right now), gold will do especially well.  If you have just a quarter of your investments in gold, then it can make up the difference for your other investments that aren’t keeping up with inflation.

As for bubbles, I don’t think gold is currently in a bubble.  There is no mania yet.  The only mania I see is trying to get people to sell their scrap gold for cash.  In a mania, you would see people trying to come up with cash to buy gold.  While I do think that gold can be a “hotspot” for newly created money, it does not mean that the price of gold is about to come crashing down.  There are logical reasons why gold is going up significantly right now.  People are afraid of the future and afraid of fiat currencies (particularly the U.S. dollar).

In conclusion, during times of unusually high inflation, you should expect gold to go up at a rate that is even greater than the inflation rate.