Thursday, December 31, 2009

Nothin' Up My Sleeve

I remember how fascinating it was to discover that Las Vegas sports books do not bet their money on anything as stupid and unpredictable as football games. Las Vegas bookmakers try to set the line so that exactly the same number of dollars are bet on each team. The casinos are quite content with the 9% or 10% they take from the winners’ share. If too much action is falling to one team, they will change the line to attract money to the other team. Back in the old days, handicappers who messed up the line and lost too much of their casino’s money were given one way rides into the desert in the trunk of a Lincoln Continental. The casinos are not gambling with their money. They are letting you gamble with your money.

It is fun to watch stage magicians practice their craft. You know it is a trick but you can’t quite figure out how it is done. My wife and I went to see Criss Angel’s Cirque du Soleil show when we visited Las Vegas in October 2008. It was pretty amazing. At one point Criss was flying over the audience on a wire. I could see the wire in the spotlights. Then the wire broke and Criss started to fall, out of control, into the audience. People screamed, the lights went out, and a second later when the lights came back on, Criss appeared safely back on the stage. How did he do that?

Penn & Teller, a pair of famous magicians, claim that there are seven principles of sleight of hand.

The Seven Principles are:

1.Palm - To hold an object in an apparently empty hand.
2.Ditch - To secretly dispose of an unneeded object.
3.Steal - To secretly obtain a needed object.
4.Load - To secretly move an object to where it is needed.
5.Simulation - To give the impression that something that has not happened, has.
6.Misdirection - To lead attention away from a secret move.
7.Switch - To secretly exchange one object for another.

It is interesting that some of theses principles are at work in Las Vegas casinos and various investment pitches, especially misdirection. The two silver coins that began this ministry resulted in a number of phone calls from an enthusiastic but ultimately unsuccessful salesman.

His pitch began with what Penn & Teller term “Simulation.” He attempted to convince me that the value of the dollar had already collapsed to nothing and that the price of silver was artificially depressed by the Sith Lords of Scotiabank short selling the commodity. He emphasized how important it was that I buy silver at that very moment. Even I know that for every short position their must be a long position.

Before the call, his company had done what Penn & Teller term “steal,” “load,” and “palm.” They had purchased silver on the open market and were now offering to sell it to me at 16% more than they paid for it.

The whole experience was an exercise in “misdirection,” an attempt to distract my attention from what was actually happening. What they are doing is neither illegal nor is it unethical. They are living on what is called the spread. In markets, there are two prices, bid and ask. The bid price is what the market maker is willing to pay for an item. Ask is the price at which he is willing to sell the same item. For example, if an item to be sold at $21.00 is purchased at $20.00, the spread is $1.00 or 5%. In currency trades the spread is 1/100 of 1%. In thinly traded exotic small cap stocks the spread is in the neighborhood of 1% to 2%. In most stock transactions the spread is at most pennies and is invisible to the retail customer.

These companies are quite happy to sell you silver for 16% more than they paid for it. As long as they have customers who willing buy their product and a supplier (the U.S. Mint), they can make a lot of money with very little risk. I imagine they try and keep their inventory in silver at somewhere around a 30 days supply, maybe less if they practice some just in time inventory scheme.

Silver can be purchased in the form of an exchange traded fund, I Shares Silver Trust ticker symbol (SLV), with essentially no spread and a brokerage fee of $12.95 per transaction at Schwab, less than that at the on line brokerage houses. So why, Mr. Salesman, would I pay you 16% plus another 2% in shipping and handling? Silver would have to increase by 18% before I would break even. Except for the inflation years of the late 1970s, I would be pretty happy to get an 18% increase on anything over a two year period.

I always believe that it is more important to watch what people do than it is to listen to their pitch. Just for grins, I asked the salesman how much silver he owned. The answer he gave was a very low figure, much less than he was attempting to sell to me. He told me he put most of his money into rare coins. Isn’t that interesting? Zig Ziglar, the famous motivational speaker, famously observed that with one question he could determine if an insurance salesman was successful or a failure. The question, “How much insurance do you own?” He believed that if a salesman was not willing to buy his own product he would never be a success. At least Ziglar’s maxim was correct in this particular instance.

If you must buy retail silver, check out the Gaithersburg Coin Exchange. The spread there was 6%. At least that is what it was back when all this started in 2007.

If you have never seen Penn & Teller perform the cigarette trick, check it out. It is a hoot.

Monday, December 28, 2009

What the Oldest Live Oaks Have Seen

Jekyll Island is a small sea island located off the Georgia coast not far from the Florida state line. In the winter it is a sleepy place, the windswept beaches largely deserted except for a few hardy souls often accompanied by happy dogs. The parking lots of the five surviving beach front motels are pretty empty at this time of the year. The island has approximately 1,000 permanent residents who live in about 900 private homes and a couple of unobtrusive condominium developments. Most of the homes look to be three bedroom brick ranch style homes, the quintessence of 1960s suburbia.

In the shallow sheltered waters off the South end of the island, Atlantic dolphin search for their dinner. In the center of the island, the golf courses are all open and in use, but to call them busy would be an exaggeration. The sunlight softly filters through the Spanish moss, mature Southern pines, and the twisted branches of ancient and noble live oaks. On the lawn in front of the Clubhouse, a few bored patrons play at croquet on an immaculately trimmed lawn. In a collection of small out buildings behind the Clubhouse that once housed servants and equipment to pamper the wealthy club members, the wives and daughters of the current patrons shop for expensive geegaws.

The clubhouse, a beautifully restored, modestly sized Victorian hotel has a history. In 1886 the island was purchased for the private use of the wealthiest Americans. By 1888 the clubhouse was complete. A few especially wealthy members built their own personal 15 to 25 room “cottages.” None of these cottages were equipped with kitchens. It was expected that all members would take their meals together in the clubhouse dining room. I find it interesting that the wealthy choose the river side of the island for their clubhouse and cottages rather than on the beach where we would expect to see such a building. At one time the club members controlled 1/6 of the wealth of the entire world.

In 1910 a private rail car pulled up to an infrequently used platform in New York City. Under the cover of darkness, a powerful senator, an Assistant Secretary of the Treasury, and the nations most powerful bankers and financiers, escaped the city without attracting the attention of the newspapers. They were headed for Jekyll Island to discuss the creation of a new central bank to control the nation’s banks, money supply, and interest rates. A few years later, President Woodrow Wilson, signed the act born on Jekyll Island, establishing the Federal Reserve System and an American financial empire built upon a currency backed by debt.

I too have a history with this island. In January of 1975, we first went to Jekyll on our honeymoon. It was the only place near South Carolina that looked half way interesting where we could actually afford to stay. Since then we have returned on every tenth anniversary. On our 20th anniversary, we stayed at the clubhouse and ate at the same dining room that once served the world’s wealthiest families. Some where along the line, we started meeting my parents at Jekyll for a few days around Christmas. It is now firmly rooted as one of our most pleasant family traditions.

But everything beautiful, delightful, and dear to us is destined to change and pass away. Jekyll Island is owned by the state of Georgia and managed by the Jekyll Island Authority, one of those quasigovernmental corporations that are expected to earn a profit, but as Fannie Mae, Freddie Mac, and the U.S. Post Office has proven such entities are seldom successful. Back during the real estate boom, in 2006, the Authority planned to knock down three of the older motels and replace them with a large ambitious condo and hotel development, forever changing the character of the island. So far the three motels slated for destruction have been demolished but due to the collapse of the commercial real estate market, only one small luxury hotel has actually been constructed. It is scheduled to open in a few days. One small strip mall has serviced the basic needs of the island for 38 years. It is slated for destruction in 2010 even though the developers have dropped out of the project, due to a lack of available financing. The merchants have been told they will be provided with trailers until the new mall is complete, but they have not been promised space in the new mall. After 38 years the pharmacy containing one of my wife’s favorite selections of souvenirs, gifts, and trinkets is closing its doors forever. The pharmacist is 65 years old and can’t continue his business under these conditions. He hoped that one day he could sell his business at retirement, but now it is worthless. The effected merchants believe that this is part of a scheme to replace them with businesses favored by the developers and their political allies. This sounds about right to me.

But something does need to be done. Even before the stock market crashed, the number of visitors to the island has been declining. One of the restaurant owners told me that the number of visitors was down about 15% in 2008. This year, he expects the decline to be about 30%. He proudly noted that his numbers were much better. His restaurant is one of the few routinely patronized by the full time residents. The island’s only gas station is gone. At least 4 restaurants have been demolished. Most of the survivors have changed hands and names many times over the years. Obviously the Authority has to do something to bring in more and wealthier visitors if they are to remain a self sustaining corporation.

On the South end of the island, the sea is gradually eroding the land. The roots of the Southern pines nearest the ocean have been exposed and bleached white by the sun. As the trees slowly die and fall onto the beach, I find there is both sorrow in my heart for loss and an appreciation of what is becoming the abstract twisted beauty of nature’s driftwood sculptures. My parents are very old. Every year it is a little harder for them to make the trip from Vero Beach to Jekyll. I don’t know how many years are left before our family tradition joins the pines in the sea of forgetfulness. I hope to return to Jekyll in five years for our 40th anniversary, but no man knows how many years he is given to labor and strive under the sun.

Ecclesiastes Chapter 3

[1] To every thing there is a season, and a time to every purpose under the heaven:
[2] A time to be born, and a time to die; a time to plant, and a time to pluck up that which is planted;
[3] A time to kill, and a time to heal; a time to break down, and a time to build up;
[4] A time to weep, and a time to laugh; a time to mourn, and a time to dance;
[5] A time to cast away stones, and a time to gather stones together; a time to embrace, and a time to refrain from embracing;
[6] A time to get, and a time to lose; a time to keep, and a time to cast away;
[7] A time to rend, and a time to sew; a time to keep silence, and a time to speak;
[8] A time to love, and a time to hate; a time of war, and a time of peace.
[9] What profit hath he that worketh in that wherein he laboureth?
[10] I have seen the travail, which God hath given to the sons of men to be exercised in it.
[11] He hath made every thing beautiful in his time: also he hath set the world in their heart, so that no man can find out the work that God maketh from the beginning to the end.

Friday, December 18, 2009

Future World (Part II)

When given the choice between closed or open systems, consumers show a fierce enthusiasm for open architecture. They choose the open again and again because an open system has more potential upside than a closed one. There are more sources from which to recruit members and more nodes with which to intersect.

Kevin Kelly

There are enormous cultural, political, and economic forces pulling us together and pushing us apart in altogether new ways. I have touched on some of these ideas in previous posts such as “Future World” and “Swarm Theory.” Kevin Kelly in his seminal book, New Rules for the New Economy, observes that, “Individual allegiance moves away from firms and toward networks and network platforms.”

The implications are enormous.

Tim O’Reilly, an Internet media expert, compares our current government to a vending machine. The metaphor would equally apply to old line corporations providing goods and services, and even to churches. We look in the vending machine and make a decision if we want something offered and then a second decision as to price. If the machine offers undesirable products or if it costs too much, we just walk away. If the machine fails to spit out the desired product, we kick it or rock it into the wall in an attempt to get what we want. What if, our government, businesses, and churches could be more like the I-Phone, a platform that allows anyone to develop and offer new services and options? What if our churches could find a way to become more like Facebook or Craig’s List, or ebay or some sort of node in a new web of service, commitment, caring, and connection?

Consumers, including Americans searching for spiritual meaning, are not playing by the old rules any more unless there are no alternatives. The new loyalties are to the network not to the organization.

From a recent USA Today article by Lynn Grossman “Going to Church this Sunday? Look Around.”

Of the 72% of Americans who attend religious services at least once a year (excluding holidays, weddings and funerals), 35% say they attend in multiple places, often hop-scotching across denominations.

Among the findings: (from Pew Reseach)

•26% of those who attend religious services say they do so at more than one place occasionally, and an additional 9% roam regularly from their home church for services.

•28% of people who attend church at least weekly say they visit multiple churches outside their own tradition.

•59% of less frequent church attendees say they attend worship at multiple places.
Pew says two in three adults believe in or cite an experience with at least one supernatural phenomenon, including:

•26% find "spiritual energy" in physical things.

•25% believe in astrology.

•24% say people will be reborn in this world again and again.

•23% say yoga is a "spiritual practice."

•Forty-seven percent to 59% of Americans have changed religions at least once, a Pew survey in April found. The top reasons for most: Their spiritual needs weren't being met, or they liked another faith more or changed religious or moral beliefs.

•The percentage of people who call themselves Christian has dropped more than 11% in a generation, and so many people declined any religious label that the "Nones," now 15% of the USA, are the third-largest "religious" group after Catholics and Baptists, according to the American Religious Identification Survey last March."

It really doesn’t matter if we like these trends or we do not like these trends. With us or without us, they are happening. How can we make our churches nodes in the new net, accepting the fact that the folks with whom we want to connect believe in astrology, reincarnation, and other heterodox notions without compromising our own believes or values?

I have a friend who is considered a rather successful church builder within his own denomination. At a recent church conference, one of his peers asked him, “What evangelistic program do you use?”

The question caught my friend off guard. The only answer that came to mind was, “I answer my phone?” an unbelievable insight in only four words.

Do I answer my phone? The answer is sometimes. If I have to answer the phone at work, I always try to polite and professional or relaxed and entertaining as the situation dictates. At home sometimes I try to avoid answering the phone. Fear of telephone solicitors and other sorts of energy vampires make me thankful for answering machines. Sometimes I feel just too tired and beat up to deal with the demands or needs of other human beings.

Do companies answer their phones? Unfortunately, the answer is rarely. After spending time in “listen to the following message as our options have changed,” hell, we might, if we are very, very lucky actually get to talk to an uniformed employee who speaks English only slightly better than I speak Hindi (that would be not at all).

Do churches answer their phones? The answer is sometimes, but too often our churches are too busy off planning the next evangelical program to answer the phone.

May God have mercy on my soul.

Matthew 18:

[12] How think ye? if a man have an hundred sheep, and one of them be gone astray, doth he not leave the ninety and nine, and goeth into the mountains, and seeketh that which is gone astray?
[13] And if so be that he find it, verily I say unto you, he rejoiceth more of that sheep, than of the ninety and nine which went not astray.
[14] Even so it is not the will of your Father which is in heaven, that one of these little ones should perish.

Rumpelstiltskin Revisited

It turns out the Rumpelstiltskin is not the only strange demented creature who wants to take possession of your first born child. A recent article posted on MSN Money by Jeff Schnepper reminds us that the greedy dwarves at the IRS want a portion of your gold. Turns out that gold, silver, rare coins, works of art, antiques, and similar items are considered collectibles by the Federal Tax Statutes. This would include my holdings in GLD. Who would think that a fund bought and sold on the New York Stock Exchange would be considered a collectible?

Collectibles are taxed at a different rate than normal investments. If you purchase shares of stock and hold them for at least a year, any profit you might make is taxed at the capital gains rate of 15%. If you hold your gold shares for at least a year, it is taxed at a rate of 28%. Ouch! An asset held for less than a year and sold for a profit is considered a short term gain by the tax code. It will be taxed at your regular income rate, as much as 35%.

Because of this discrepancy in the tax code, over the last year, you would have ended up with more money in your pocket buying and selling a NASDAQ index fund rather than gold even though gold dramatically outperformed the index fund.

I don’t worry as much about taxes as I should. I am conscious enough to keep my tax free bonds in my taxable account, but beyond that I don’t spend a lot of time considering the tax consequences of my actions. I plan on doing most of my selling after I retire. Then my income and my tax rate will be lower than it is today. If I sell something today, it will be because I have made a lot of money and don’t want to get too greedy or because I have lost money on an investment and want to call it quits. I think it a good idea to first focus on ways to make some money that can be taxed. Then just be thankful that your increase has given Rumpelstiltskin and his relatives at the IRS something to tax.

Lyrics from Taxman, a song by the Beatles

Let me tell you how it will be
There's one for you, nineteen for me
Cos I'm the taxman, yeah, I'm the taxman

Should five per cent appear too small
Be thankful I don't take it all
Cos I'm the taxman, yeah I'm the taxman

If you drive a car, I'll tax the street
If you try to sit, I'll tax your seat
If you get too cold I'll tax the heat
If you take a walk, I'll tax your feet

Taxman! Cos I'm the taxman, yeah I'm the taxman

Saturday, December 12, 2009

Aren't You at Least a Bit Suspicious?

Once, shortly after we had graduated from college, I saw a friend’s younger brother, who was still in high school at the time, hit up his older sibling for some money using blatant guilt manipulation. I will always remember my friend’s reply, “Don’t call me brother with your hand in my pocket.” I constantly see similar attempts to grab my money or limit my freedom as an individual by institutions, politicians, and salesmen of all sorts. Whenever some great emergency or unbelievable opportunity is presented by an outrageous hypocrite or someone who wants you to act without critical thought, be suspicious, be very suspicious. Somehow, I believe that if I were an Islamic youth, I would be somewhat skeptical of a fat, balding, 60 year old Imam who told me of the great opportunities for dead suicide bombers in paradise. “If it is all that great,” I would think, “Why are you still alive?” I am a Christian and when I hear a preacher telling how I can become rich by giving him money, I wonder, “If you get rich by giving away your money, why don’t we have a reverse offering? I’ll let you give me some money.”

Some of the comments that might give you pause follow, but it certainly is not an inclusive list.

This time it’s different.
We have to do this for the children.
It is a crisis of global proportions.
We must act today.
We must kill the (fill in the blank) to keep them from destroying our way of life.
It's an issue of national security.

There are also lines of reasoning that should make you nervous, such as the infamous yes set.

Do you love your children?
Do you love your country?
Do you love Jesus?
Then support my efforts to (fill in the blank).

Politicians, salesmen, religious leaders, and ambitious rascals intent on separating you from some combination of your money and your freedom make their living with this sort of pitch. If you hear any of this nonsense from politicians of whatever persuasion, don’t bite the hook. Take the time to examine their claims in the light of reason and the evidence.

Recently we have witnessed the spectacle of the United Nations Climate Change Conference in Copenhagen. 20,000 international bureaucrats met with the intention on stripping the developed nations of their wealth, shutting down their industry forever, and leaving us shivering in the dark. With climategate we now know beyond a shadow of a doubt that at least a fair amount of global warming is somewhere between junk science and outright fraud. Finally the conference itself with limousines and private jets had a larger carbon footprint than the combined carbon footprint of the poorest 60 nations for an entire year (or so an article listed on the Drudge Report contends). When Obama attends such conferences it requires the use of at least two 747 aircraft, about five C5A transports, helicopters, limousines etc. Al Gore's mansion in TN (not his only property) uses more energy than 19 average American family homes. His private jet consumes gallons per mile for one person and he gripes about my 28 mpg Honda. If Al Gore really believes we are on the edge of an environmental precipice, I would expect him to be living in a tree house in Maui, wearing a hand woven loin cloth, and riding a bicycle.

Too often, political economy, supposedly based on science, leads to horrific atrocities. How many children, particularly girl children, have been murdered by China’s one child policy? What are the potential social repercussions of millions of young men who will never have a wife of their own? Zero population growth was suggested as a possible solution to global warming during this meeting. That’s interesting. Who will decide who can reproduce? Who will decide who shall be sterilized? Who will decide which children to abort or kill? How will this all be enforced?

Hitler’s science produced 6 million dead Jews. Stalin killed approximately 12 million inconvenient kulaks in the interest of scientific socialism.

We all (including this author) view the world through our mental, philosophical, and religious filters. You have yours. I have mine. As an undergraduate in U.S. History we were not taught history as much as we were taught how to read the work of historians. We were taught to ask questions like, “Who is this person and why did he present these events from this point of view?” We were taught that complex issues, such as the American Civil War could be examined from any number of viewpoints. A Marxist historian might well choose to study the shifting economic power of Northern industry as it eclipsed the monetary clout of Southern agriculture. A sociologist might choose to examine the effects of the shifting political demographics driven by immigration from Ireland, Germany, and Scandinavia. A Southern apologist might focus on the States Rights issue. An American Black historian of my generation who lived through the civil rights movement would likely see the war in terms of slavery and race. Try to become aware of your own blind spots and remember politics is about power and who is going to control that power.

According to Ryan Lizza of The New Republic, “When Alinsky would ask new students why they wanted to organize, they would invariably respond with selfless bromides about wanting to help others. Alinsky would then scream back at them that there was a one-word answer: ‘You want to organize for power!”

Now let’s take a moment and consider the case of a man whose belief, actions, money, and words were perfectly congruent.

Luke 19: 1-10

[1] And Jesus entered and passed through Jericho.
[2] And, behold, there was a man named Zacchaeus, which was the chief among the publicans, and he was rich.
[3] And he sought to see Jesus who he was; and could not for the press, because he was little of stature.
[4] And he ran before, and climbed up into a sycomore tree to see him: for he was to pass that way.
[5] And when Jesus came to the place, he looked up, and saw him, and said unto him, Zacchaeus, make haste, and come down; for to day I must abide at thy house.
[6] And he made haste, and came down, and received him joyfully.
[7] And when they saw it, they all murmured, saying, That he was gone to be guest with a man that is a sinner.
[8] And Zacchaeus stood, and said unto the Lord; Behold, Lord, the half of my goods I give to the poor; and if I have taken any thing from any man by false accusation, I restore him fourfold.
[9] And Jesus said unto him, This day is salvation come to this house, forsomuch as he also is a son of Abraham.
[10] For the Son of man is come to seek and to save that which was lost.

Rumpelstiltskin! I Know Your Name

Recently I received an emailed article from a friend of this blog championing a return to the gold standard and embracing the principles of the Austrian school of economics to limit the abuses, excesses, and follies of our current government, fiat currency wherever it can be found and government power in general. It was a fine emotional rant. I was at least somewhat sympathetic to its spirit and content. Of course, run out and buy gold was an underlying assumption of the article.

There is no reason gold should be money anymore than oil or large rocks, but for over 5,000 years people have believed gold is money, so gold is money. Even if gold is the king of commodities, it is still just another commodity, a commodity I might add, that has few real productive uses. Its true value is ultimately its perceived value. Gold is often thought of as a hedge against inflation but that is not completely accurate. The price of gold peaked at something over $1,000 an ounce in 1980 and then over the next 20 years collapsed to about $250 an ounce. All those years we had inflation but no run up on the price of gold. More recent studies have found a close correlation between the price of gold and fears of an economic upheaval. In the years following the election of Ronald Regan, the economy in general and the stock market in particular enjoyed an unprecedented bull run. Even in the months following the Y2K technology bust in 2000 these were good times. People were happy and optimistic, employment was high, and real estate prices only went up. Today, by contrast, the stock market is down, real estate is a bust, unemployment is high, and the value of the American dollar is threatened by our horrific deficits and the bailouts of the financial and automotive industries. People are frightened, angry, and pessimistic. Historically, these are good times for gold.

Gold is one of the few or perhaps the only commodity that over the course of history has been manipulated by great nation states for their own purposes. The price of gold can be driven up or down significantly when a country, for its own reasons, buys or dumps gold by THE TON rather than by the ounce. This is one of the driving factors for the current run up in the price of gold. Lately, China has become a little nervous about the enormous amount of questionable American debt they hold in their portfolio. They can’t dump it without destroying the value of their holdings and ending their plans to become an industrial superpower at our expense. Therefore, like me, the Chinese government is hedging their position in US Treasuries with the purchase of gold, copper, and other commodities. In a recent article found of Yahoo Financial, the author reports, “Last month, for example, India's Central Bank bought 200 metric tons of gold from the International Monetary Fund. India's gold spending spree cost the country $6.7 billion. While the exact price per ounce they paid isn't known, India's purchases were made between October 19-30, suggesting a purchase price between $1,000 to $1,040 per ounce.”

Will this bull run last forever? The values of all commodities rise and fall over time. Gold is no different. The aforementioned article by Ron DeLegge observes, “The creation of the first gold Exchange Traded Fund (NYSEArca: GLD) back in 2004 was a true turning point in gold's modern history. Before that time obtaining market exposure to gold was limited to owning the asset in some physical form or owning gold stocks. GLD changed everything by making gold an easily accessible asset. Today, with the click of a button, a person can buy 'paper gold' in the form of a gold ETF.

Even though gold soared, not much actual trading of physical gold has been taking place. In contrast, with $35 billion plus of assets and growing, the SPDR Gold Shares ETF dominates the market in paper gold trading. Could its success also become its downfall?

While GLD has converted millions of investors into goldbugs, its intraday liquidity can easily convert them into gold sellers. Once the number of new gold buyers dries up, who will be left to keep the gold market heading higher? Like any market, the contagious effect of selling pressure can quickly turn gold into an unwanted asset.”

I have something on the order of 3.7% of my investments (excluding my house) in gold and silver, mostly in gold equivalent shares (GLD) and another 1.5% or so in a Canadian gold mining stock. I am shooting for about 5% in gold. When inflation kicks in (and it will) I just can’t say when, gold will skyrocket. Right now gold is experiencing a technical correction (short term drop). If it goes low enough, I will buy some more.

The problem with looking to gold for your salvation is the United States government confiscated all privately owned gold in the 1930s, at a price lower than its true value. They did it once they can do it again. Having a few gold and silver coins buried under the hog trough is comforting but in a real Road Warrior scenario, you want to own shotgun shells, gasoline, and cigarettes and bar soap for trading purposes.

If our currency was completely backed by gold there would be too few dollars to fund the follies of our government but there would also be too little money to fund legitimate business expansion or even the purchase of family homes. Maintaining the balance has been a problem for capitalism since Bumpus stored his two gold pieces in Vincenzo’s vault.

Buying gold and silver systematically in small quantities is probably a good plan even if there is a short term drop, but then I am not a registered professional advisor and if I was all that smart, I would be rich.

A good meditation for all of us, from the twelfth chapter of the Gospel according to Luke:

[15] And he said unto them, Take heed, and beware of covetousness: for a man's life consisteth not in the abundance of the things which he possesseth.
[16] And he spake a parable unto them, saying, The ground of a certain rich man brought forth plentifully:
[17] And he thought within himself, saying, What shall I do, because I have no room where to bestow my fruits?
[18] And he said, This will I do: I will pull down my barns, and build greater; and there will I bestow all my fruits and my goods.
[19] And I will say to my soul, Soul, thou hast much goods laid up for many years; take thine ease, eat, drink, and be merry.
[20] But God said unto him, Thou fool, this night thy soul shall be required of thee: then whose shall those things be, which thou hast provided?
[21] So is he that layeth up treasure for himself, and is not rich toward God.

Sunday, December 6, 2009

The 800 Pound Gorilla and You

Just thinking a little about the 800 pound gorilla and you. Of course compound interest is the 800 pound gorilla in our financial life. Do you want to fight him or do you want him to fight for you? There are some great free calculators on the Web. I was playing with a few of them this morning. I encourage you to check out your own numbers.

Some loan numbers

$10,000 in credit card debt, no additional purchases,
3 years pay off 16% interest
$351.57 a month Total payoff $12,656.52

$10,000 in credit card debt, no additional purchases,
5 years pay off 16% interest
$243.18 a month Total payoff $14,590.80

Here is something scary to think about. If you want to pay $100 a month on that credit card, you will never pay off the debt. The number of payments is infinite. $200 a month pays off in 83 months. Total payoff $16,600

$300,000 mortgage 30 years 5% interest
$1,610.46 a month Total payoff $579,765.60

$300,000 mortgage 30 years 6% interest
$1,798.65 a month Total payoff $647,514.00

Now let’s put the gorilla to work for you

Some annuity numbers

$100,000 assume conservative 5% growth and a 30 year payoff
Pays you $6,505.14 a year Total payout $195,154.20

$100,000 assume the usual 8% growth and a 30 year payoff
Pays you $8,882.74 a year Total payout $266,482.20

Some systematic savings numbers

$10,000 initial investment, add $100 a month,
Assume the standard 8% growth for 30 years Total $254,129.08

Now the same calculation with a reasonable 401K type contribution

$10,000 initial investment, add $500 a month,
Assume the standard 8% growth for 30 years Total $840,038.86

Now we are talking real money

Saturday, December 5, 2009

The Value Trap

"In the short-term, the markets are like voting machines, but over the long-term they are like weighing machines."
Benjamin Graham

As readers of this blog know, I am trying to learn how to practice what is generally called value investing. I try to buy stocks the same way I buy anything else, the best quality and the lowest cost. Sometimes my schemes work, sometimes they don’t. Today I would like to discuss one of the traps that is a danger to value investors. I have stepped into this particular trap on two occasions.

As is recommended on the Motley Fool website and many other places, I like to see three attributes in a company

1)Sustainable competitive advantage – Some story line that makes this company special. Coca Cola’s brand name, Chevron’s size and global reach, Hong Kong and Shanghai Bank’s penetration of China without the corruption common in that country.

2)Free cash flow – Almost all of my stocks pay dividends. I like it when companies pay me to own their stock. I don’t quite trust companies that want to keep everything for their own greedy managers. I know. I know. Start up technology stocks need to reinvest profits into new products, but when does it end? Apple has been around for about 30 years and they are still not paying a dividend, unacceptable.

3)Great management – A visionary leader and competent employees is the ideal but I would accept a high level of competence and energy in the workforce, anything but a bored bureaucratic management and a hostile workforce, GM comes to mind.

Then, of course, I look at the stock. My eyes are immediately drawn to three numbers on the financial Web page for that stock. These are somewhat related to the first list.

1)Price Earnings Ratio – Generally, I want this number to be 20 or lower. It is the price of a share of stock divided by the earnings for a share of stock. Historically, the PE ratio for the New York Stock Exchange averages around 16. A high PE number could indicate a stock that is overvalued. Again, this is not true for new companies, particularly in the pharmaceutical or technology areas. In such a case people are paying a premium for future earnings. Sometimes a company is losing money. Then it has no PE ratio. That is not a good thing.

2)Dividend and Yield – The dividend is simply how much the company gives you in a year for owning their stock. Let’s say the dividend or a particular company is $1.00per share. Now divide that number by the cost of a share, let’s say $25.00. The yield on this imaginary stock is 4%, a pretty good return. I tend to believe that a sustainable dividend kind of puts a floor under the value of a stock. This generally but not always true.

3)Free Cash Flow – Basically, FCF is the net profits minus the capital expenses, something like your take home salary minus the mortgage payment. I really like FCF because it pays dividends. It is nice to get 3% or more for my money without too much risk. These days I am barely paid anything for leaving money in the Credit Union. Another nice thing that companies do with FCF is stock buybacks. When the company is buying shares in its own stock that generally indicates the mangers think it is a bargain. When they are buying millions of shares this makes the price go up. Be careful, sometimes managers do this to hide some weaknesses that will ultimate doom the share price. (Note the quote at the beginning of this article.)

The knowledgeable reader will notice a glaring weakness in the last list, one that bites me from time to time. I tend to ignore growth. There is another ratio that should be in any quick look at a stock.

Price Earnings Growth – The PEG ratio is the PE ratio divided by the company’s growth percentage. Let’s say a company has a PE ratio of 20 and it has been growing at 10% per year and you expect it to continue to grow at that rate. The company has a PEG of 2. The lower the PEG ratio the more likely the stock is a bargain. As an engineer and an embittered old cynic, I have a problem with this number. I am very comfortable with interpolation, the art of taking two know points on a graph and estimating the value of an unknown point between the two known points. I am not so happy with extrapolation. A trend is a trend until it is no longer a trend. The line on a graph may be linear up to some point and then take a wicked curve in the opposite direction. When I plug a number into the denominator of the PEG ratio, do I use history and extrapolate, or do I just make a guess after looking into my crystal ball? Neither option appeals to me.

Back when I started learning how to invest, I bought a small amount or Merck, the drug company, at a little over $70 a share. Merck had a competitive advantage (valuable drug patents), plenty of free cash, and at the time it was considered the best managed company in the country if not the world. Merck had a low PE ratio and paid a righteous dividend. The knock on Merck at the time was growth was expected to be flat, as they did not have any new potential blockbuster drugs in their pipeline. I thought great management and scientists would take care of that problem. I was wrong. Merck continued to drop and I continued to hold. I thought it would come back but then the Vioxx class action lawsuits started and Merck fell from the sky like a wounded duck. Finally in disgust, I sold at a little over $30 a share. Merck paid a dividend every year I owned it. Just guessing, something like $1,000 or more over those years. During the time I owned the stock, Merck sold one of its divisions and I made something over $500 on that sale. So in reality I only lost a little over $2,000 and I got something like $500 back from Uncle Sam in the form of lower taxes, so my actual loss was something like $1,500 (plus the taxes I paid on the dividends).

The morals of this story? Dividends are like an umbrella. When the rains come they will help keep you dry but when Hurricane Katrina (the Vioxx lawsuits) hits a company, your little umbrella is going to be blown away. If you ignore growth and what the collective wisdom of the market believes about growth you better be very good or very lucky.

Lord Maynard Keynes once gave some advice to people like me who tend to be buy and hold investors. “In the long run, we are all dead.”

Hey! Let’s be careful out there.