In the last update on this subject on December 15th I reminded US taxpaying readers that I had suggested gold and municipal bonds as the Hillary portfolio last year when the Senator from New York seemed the likely next president. All the same democrat messages are now emanating out of Washington as if it were in fact Clinton III.
On the 15th I mentioned Stephanie Pomboy's Barron's article in which she said this one favored asset class for 2009 : "If you want to get long socialism, one of the next segments of the market that will be given a guarantee will be municipal bonds. That's because state and local governments are a huge share of total [gross domestic product] and employment, and we can't afford to have them down for the count."
A Bloomberg headline today reads: "Democrats May End Minimum Tax on Municipal Bonds to Spur Market." This may in itself be a fine thing, but it's humorous nonethless to find municipal bonds getting several boosts at a time when class warfare taxation increases are planned only for higher tax rate echelons. The lord of the realm taketh away and giveth too.
Since in many cases municipals are paying a higher rate than Treasurys, historically a very rare event, even people paying low tax rates might find them attractive. Uncle Sam and the City Slickers WANT YOU.
For the record I own Vanguard's national municipal money market fund and their short term 1-2 year national municipal bond fund which have tried to minimize Alternative Minimal Taxable bonds. I also own longer term municipal bonds issued in my state. And gold.
Wheat has been a major commodity for consumer, farmer, and finished goods producer since ancient times. It has been farmed and improved probably from ~10,000 BC at least in the upland Middle East and doubtless elsewhere. Wheat and precursor grains on the road to wheat were gathered forever.
There are scattered references to wheat prices in Sumerian, classical Greece and Roman Empire days. North Africa, Sicily and Egypt were major sources of wheat for Roman Italy and especially the city of Rome where wheat distribution was an important part of the socio-political pact of "bread and circuses".
There are nearly complete English monthly wheat price records from the mid 13th century in English shillings per Winchester quarter (eight bushels). This price series has been put together from many different sources, so the prices are not constantly basis the same location. Many of the early price records came from church land accounts.
The median market price for wheat in England from the mid 13th century to just after 1500 was approximately five shillings per Winchester quarter. At today's exchange rate of £1 = $1.46, 13th=14th century English wheat sold for approximately $0.045 cents, or four and one-half cents per bushel. On December 26th 2008, Chicago soft cash wheat sold for $4.39 and Kansas City hard wheat for $5.39. Wheat thus now sells for approximately 100 times its value in the 13-14th centuries. By comparison, wheat sold as low as 40 cents per bushel basis Chicago at the 1932 lows.
The chart of wheat in England shows that there have been two major price escalations since the 13th century, one from approximately 1500 to 1640, and the modern escalation from 1932 to date. Both escalations were close to tenfold from the low of the previous range to the low of the new range, from 4 US cents to 40 cents and now 400 cents. In both escalations gold valuation and circulation played a major role. Excluding the extraordinary increases during the Napoleonic wars and into about 1815 (Long Wave top), wheat prices traded in a band roughly between 25 and 60 shillings (23-68 cents) from 1640 to 1932. During most of that period, from 1717 when Isaac Newton set the price of gold at £3.17s.10½d (approximately $20.90 at the pre-1930's exchange rates), the developed world was on the gold standard. Despite the universal currency devaluations in Europe and America in the 1920's and 30's, the world remained on gold until 1971, although the standard in tatters after 1934 and more so after 1944.
Wheat increased 32 fold in price from the 1932 low of 40 cents per bushel to the 2008 high of $12.80 or 1280 cents basis December Chicago wheat. There were several bounces off the 960 level (3/4 of 1280 and 24 *40) on the way up to and down from 1280 before making a low just under 480 (12 * 40). 480 is 3/8 of the 1280 high. Wheat has just closed at 663 basis December 2009 wheat (WZ9) which just above the half-way mark of 640 which was the top of the range for wheat from 1974 to 1999. If December 2009 wheat can stay above this level it's quite possible the low is in and that the current global battle to reflate prices will be successful.
From a practical point of view I still cannot see any reason to change my allocations. My family lives on our savings, so this is not idle intellectual chatter. The FED and governments and central banks everywhere are chopping interest rates down to zero which affects all retired people and others living partly or wholly on their savings. This is happening faster than inflation at the consumer level is fading, but we can finally see some prices dropping.
It is still possible to earn 3-4% in funds such as Vanguard's VSGBX/VSGDX, VFIIX/VFIJX, and if necessary in the municipal VWSTX/VWSUX. These are NOT money market funds, so they can go down if interest rates rise, but they won't go down very much at all. I am still keeping several years' worth of additional necessary budget money (beyond the earnings of the above) in money market funds which pay laughably little now. I don't like to spend capital at all but if it becomes necessary, it's there. The reason I chose and still prefer Vanguard for all these funds is for their extremely low operating costs charged to you and me. When interest rates are very low, low operating costs are even more important than normally. I don't have ANY connection to Vanguard in ANY way except as a user.
Beyond these very basic income funds I have some gold and the oil and gas trusts and Hussman's Total Return Income Fund HSTRX which I have discussed before. And a smaller position in Rydex RYMFX which can be long or short commodities and bonds and currencies according to rules set by Trader Vic Sperandeo. That ~25% of the total is to guard against inflation and/or US dollar weakness. Hussman's fund mainly holds US Treasury inflation-protected notes (70%) with some currency and gold holdings. He varies these holdings according to his judgment. HSTRX and RYMFX are reasonable alternatives for the long run in small amounts.
I didn't have this entire portfolio for the entire past year, but if I had and had held them in equal parts I'd be ahead almost 7% on the year. As it is I am down 1.47% because I was a bit late getting out of some losers. Honesty is painful, but I am still happy for my family when I hear people talking about 25-50% losses in 2008.
These are faraway days from the 1990's or 2003 when 20-30% or more annual gains were possible. Now we have to scape by, and we may have to stay that way for some time. Stay small and stay safe for now is my goal. Keep solvent and ready to move if conditions warrant, but I'm waiting until the year end and early new year selling abates. De-levering continues for now. I'd rather be late to the party than go bust. These basic allocation considerations, not necessarily the exact vehicles, apply to everyone now, regardless of asset totals. Losing big is not an option.
I'm not able to post the chart of the mutual funds at the server, so here is another way to see it:
Over a year ago I posted here on the worst political outcome I could imagine happening at that time: Hillary Clinton being elected president in November 2008. The portfolio I suggested was short term municipal bonds and gold. The reasons were obvious at the time: President Clinton II would raise income taxes, and we would have inflation. Actually that probably is the worst that could have happened politically, although the Obama cabinet and sub cabinet looks extremely Clintonian at this time. But still, the past year is a lesson in humility for me on personal opinions.
Nevertheless, despite an inflation boom and a deflation bust, gold is still doing pretty well, and so are short term munis. Along the way I added short term "federales", by which I mean Treasury notes and similar duration notes of GNMA, FNM, and FRE. And I trimmed out a lot of other things like stock exposure and commodity exposure. As of Friday December 12, all accounts are down 1.58% on the year including necessary disbursements into beneficiary budget accounts. The chart shows most of those investment entities or their proxies as well as the Vanguard SP500 total return fund.
Why has a portfolio chosen for one expected outcome worked for one not expected? Was it just luck? Well, yes it was, of course. But it was also a bare bones low risk portfolio. Gold could have crashed, of course, but not two year munis and "federales". But given the high anxiety of the times, gold was a decent bet as well. Today I saw several reports, including one by Stephanie Pomboy in Barrons, exalting munis as a "pro-socialist" investment as the FEDS wouldn't ever let the cities and states go down. And every where I go I see novel explanations for why gold is an essential investment at this time.
Short term in fixed income, virtually zero in equities, and hedged in gold has worked well as it should normally work in extremely trying times. Income has taken a hit but at least current obligations can be paid out of cash and near cash if there isn't enough income.
What about the current arguments for gold? There are a number of people from quite different professional and ethnic/national backgrounds making cases for total currency and banking system meltdowns or at least long lasting economic deflations.
I grew up in investing from the late 1960's as a pro-gold person because of the inflation I saw and lived through. But I was and am a post-gold standard investor, and not an economist, so I had very little or no knowledge of how or why the gold standard really worked. In my investment era, credit just always flowed to where it was needed when it was needed. It worked, so it will always work. That was my impression and that of most of us. Buy a little or a lot of gold "just in case", just as one buys auto, health, liability, life, and homeowner's insurance. But could the whole system just evaporate? I never bought into that scenario. All the academic and market economists assured me they could "do it" right and save us in a pinch.
In the past week I have read numerous newsworthies telling me why the system is on its death bed and gold is key. An ex-FED governor (Lyle Gramley) rather calmly suggested that the FED did not have a weak balance sheet since US gold might be revalued if necessary.
R.P.W. Millar of Scotland just had a report of 2006 reposted at G. A.T. A. on gold revaluation, as in 1934 under Roosevelt: http://www.gata.org/node/4843 Millar remains pro-gold on an intrinsic value basis.
Professor Antal Fekete who was an important at-a-distance mentor to me fifteen years ago on the Great Depression has posted at length on the current acute shortage of gold as shown in the inversion of normal carrying charges for gold futures to a premium for cash gold. This historic event suggests to him that no one owning gold wants to give it up now, and that means paper money is on its deathbed: http://www.goldisfreedom.com/ (Look under Popular Economics for recent posts.)
There are others, both original, like the highly respected Gary Shilling http://www.agaryshilling.com/, and many derivative commentators of all stripes, developing this story. As my college European history professor, Frederick Artz, always asked, is this one of those turning points of history upon which history failed to turn? Or is it for real this time?
I'm just a private non-professional investor, so I can and will plead ignorance and non-licensing as excuses for not giving out definitive opinions. Each of us has to judge events and consequences based on personal needs, demands, and resources. We all walk in different shoes. I'm as worried and unclear as the next person. But I still think the Hillary portfolio makes a lot of sense as a starting point: some modest tax-free income but with some gold insurance in case of the worst outcomes. As Joan Didion wrote, "Play It As It Lays", although she was talking about ennui and we're living through tough excitement.
I missed until today your November 28 post on timing the end of the Long Wave at the Kondratieff Conference wherein you mentioned my posts at the University of Colorado Long Wave site in 1998.
In 1998 I did indeed think that the Long Wave could be bottoming. That was when hog futures made lows equal to those of 1919 and when most commodities were plummeting. Newspaper front pages and magazine covers were filled with deflation headlines and pictures. 1998 would have been "early", but it had real potential to be the disinflationary low of the "down grade". Also interest rates were making new lows and the 30 year Treasury bond futures making their highest highs since their 1981 "fall from plateau" lows. Although stock index prices are not a primary indicator of complete cycle turns, even the 1998 crash was compatible with a potential Kondratieff down grade final low. And the 1999 rises in the CRB Futures Index, long term interest rates, and stocks were compatible with the presumption of 1998 as a low.
However, the events of 2000 and 2001 invalidated my presumption. Clearly there were still substantial deflationary pressures. Most of the orthodox Kondratieff Wave analysts from the 1970's on had forecast 2003-04 as the most probable time for the next low. Frost and Prechter, in their seminal Elliott Wave book of 1978, had reproduced Julian Snyder's famous chart originally published in International Moneyline in the mid 1970's. This chart projected the low after 1973 as coming "near year 2000". With gold and CRB having made lows in 1999 and second lows minimally higher in 2001, it seemed simply a matter of time before all the rest fell in line and the bottom was confirmed. With the stock market collapse in 2002, and demand already picking up in Asia after their 1997-98 debacles, it was clear to me that the low was just about in place. I recall discussions with you all through that period from 1998 on about the fact that the wave low might not be a V bottom but be over a period of time, indeed just as tops tended to be prolonged in the "plateau" topping period. This is my version of Snyder's chart which I made in 1998:
In any case when the stock market began bottoming in 2002 and with the 2003 retest of the 2002 lows, and when everything else had bottomed, it looked like the 1970's orthodox prediction of a wave down grade low for 2003-04 was indeed correct. And up we sailed out of very oversold and sentiment-debauched low in 2003. I felt 100% certain we had bottomed, and gradually the perma-deflationists had to admit that inflation was back and join the up grade wave.
The first clue that all was not well with the up grade wave was in 2005, and this was the big bond rally which came to be known as the "Greenspan Conundrum". Interest rates ought not to have been dropping so drastically when inflation in commodity prices and gold was ramping. There were many "explanations", most prominently the Chinese buying of US bonds with their bountiful net trading profits. But it was still somewhat disquieting for the Kondratieff phasing. Then in 2006 there was the first gold spike and very quick correction from ~730 to ~530 and the sharp stock market correction. Most commodities quickly took off again thereafter except for some base metals (those not exchange-traded). Bonds began to fall but did not even get the low of 104 on the long bond futures as they had done in 2003-2004. So the Greenspan Conundrum was still tantalizing Kondratieff wave analysts.
I had been gradually backing out of stocks all year in 2007 but had stayed in gold and commodities and added on. But I began writing about what I started calling a "vacation from inflation". After June 2007 we not only had another manifestation of the Greenspan Conundrum, but gold stocks were lagging gold badly. I anticipated a six month to perhaps as long as 18 month "vacation from inflation". I did not yet sell off my commodity funds and stocks, but I put tighter stops all around.
I was not surprised by the March and July highs this year, but I certainly did not expect the crash in commodities we have had! I was thinking perhaps 15-20% and 6-18 months. Ominously bonds began rising as well. Arbitrarily I drew a line in the sand for the long bond futures at the 2003 high of 123, roughly comparable to 4% in yield. If we were truly in the long wave up grade phase, then bonds shouldn't fly above the 2003 bond high and below a 4% rate low. At least bonds should not go above and stay above 123 for more than a few days. I bought TLT and EDV and sold them when the bond got to 123 basis the December bond futures.
Well, it has happened. Bonds are well above 123, and commodities and stocks have crashed as well. I put some of my personal experiences into this, which can be in read in more detail at the blog, to show that one can trade the wave even if you turn out to be incorrect. I was incorrect. The "vacation from inflation" is a lot more than that, and I see you have wrestled with it as well. The 1830's, 1896, 1949, and 2002/03 wave lows had seemed embedded and sealed forever.
As you know, Walt Whitman Rostow, the MIT economics professor and economic historian who later became national security advisor to Lyndon Johnson, always felt that the recession of 1953-1954, not 1949, marked the real final economic low of the deflationary down grade from 1919/20. As you suggest, perhaps 2008-2009 will be the final low after all. Since a full cycle is as long or longer than the normal investing career of most individuals, few of us have seen a full Kondratieff cycle and still fewer a cycle and a half. The neat schematic diagram of Julian Snyder, reprinted by Frost and Prechter and many others, that all knew so well, was far too simple. The topping process of the last (or this?) wave lasted from 1973 to 1980, and this bottoming process may have lasted from 1998 (or 1999 if we pick gold) until now. In a bottoming process like this both deflationists and inflationists will be correct at different times. Since 1999 the inflationists have mostly been right, but the deflationists got their innings in this year!
Note: Eric is my long time friend and Long Wave colleague who runs the conference at:
Much has been written recently about the losses caused to banks and corporations from the necessity of marking mortgages and other derivative debt to the current market price on a regular "fair value" basis. If a bank owned a mortgage, or whatever type of package or derivative, some of the FASB and international bank rules required carrying the asset on the books at its current market value even if it was still making regular payments, and regardless of credit rating (with some adjustments permitted there). So as prices of good and bad debt fell off the table this year, the asset side of the balance sheet was being decimated.
But what about the liability side of the balance sheet? With interest rates collapsing this year, and particularly in the past three months, what is the effect on the "fair value" of higher rate debt? If a bank or corporation issued debt at 7% and the rate is now 4%, the market value of the debt has risen dramatically. If a bond was issued at $1000 per bond at 7%, and ignoring credit and other considerations, and the interest rate falls to 4% (just for example), the bond would theoretically rise to $1750, all else being equal. Of course all sorts of factors enter into bond prices, so let's say the current value of the bond in the market is only $1500. Still, the mark to market rule would seem to demand marking the liability to $1500, not the $1000 due at maturity. Why? Because that IS the market price, and if the company had to redeem its bond early to reduce debt for loan coverage or other reasons, that's what it would have to pay in the market, unless they have preferential early redemption clauses, just as it would get less than face value for the depreciating mortgage bond it bought at par if forced to sell it. In this case of a liability during falling interest rates, if forced to redeem it early, the company or bank would have to pay 50% more than what it sold it for.
If they have enough bad assets marked to market lower, and appreciated liabilities marked to market higher, they'd be bankrupt in no time. And so many corporations really are bankrupt at present and some have been for years. But they are not as rigidly required to mark their liabilities to market. FASB 157 says this: "This Statement clarifies that a fair value measurement for a liability reflects its nonperformance risk (the risk that the obligation will not be fulfilled). Because nonperformance risk includes the reporting entity’s credit risk, the reporting entity should consider the effect of its credit risk (credit standing) on the fair value of the liability in all periods in which the liability is measured at fair value under other accounting pronouncements, including FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities." So the "non performance risk" at maturity or before is at the discretion of the reporting corporation, and the market price NOW is not used. So if the bond is trading at $1500 and payoff at maturity is $1000, the liability will be rated at $1000 or lower, not at $1500 which is the current market price. The net effect is to overestimate assets and underestimate liabilities. This in turn makes it look like the corporation has a lot more capital than in fact it has. It may be bankrupt, but it has phantom capital on the books as will be apparent when it goes bankrupt or merges and its bonds are due and payable or must be realistically valued or assumed.
Your eyes are glazing over, but that is how crooks pull one over on you. The corporation (or bank) has an asset they bought for $1000 that pays 12% but is now worth $500 because of credit risk in a bad market, and a liability they issued at $1000 that they pay 7% on that is now worth $1500. But they are carrying the liability at $1000 on the books. So they are not losing just $500 but $1000 on the transaction. The real clearing or liquidating loss is $1000 on a $1000 investment. Nothing has been bought or sold so they have $1000 less net capital than they are reporting. Multiply this by billions. That's where we are.
Collapsing interest rates are bleeding the capital out of companies via their debt. The lower the rates, the higher the market or liquidating value of their debt, bearing in mind the spreads between corporate and government debt which continue to rise. The point simply is that corporate liabilities keep increasing as interest rates fall while bad assets are falling. At some point the curtain is pulled and the corporation fails. The creditors of the corporation's debt are left only with the bad assets. Big deal you say, but the corporation appeared to have adequate capital and it actually didn't.
This is a highly simplified explanation, but the principles are valid and clear
The US Treasury issues its debt in US Dollars and the debt is non-callable, unlike the situation with some or much corporate debt, so when its interest rate falls in half, the market value of its debt doubles. Its interest rates fall during deflation when its tax inflow also falls due to a falling GDP. If the long bond interest rate falls from 6% to 3%, which it has nearly has done since 1999, its book debt value doubles in price even as its ability to pay that debt falls. The same is true for a householder with large debt/income or debt/asset ratios. This is why deflation and falling rates (same thing) are self-replicating or reinforcing. This has been going on for 27 years since long term bonds were issued at over 15% in 1981! The US Treasury has been bankrupting itself for 27 years and is increasing the pace recently as bond rates collapse. It's great for people who own long term government bonds unless they have bonds about to expire. They were getting 6-8% ten to twelve years ago, but could only get about 3.25% now if they had to reinvest the payoff. So bond investors have less value (due to inflation) and will earn less income on it if they reinvest in similar current bonds. It's a financial loss in every way, except for bond speculators. They can borrow short term at falling rates and gain long term at magnified falling rates all the while earning the high coupon payment on the original debt.
This is exactly what happened in the US in the 1930's and 40's, and has been happening in the US since 1981 and in Japan since 1990. AND therefore US T Bond total returns (capital gains + coupon payments) have outperformed the total return SP500 (including reinvested dividends and NO paid taxes deducted) for 20 years! Who says bonds are boring and stupid?
Given all of this, tell me, if you can, WHY the FED and government are trying to push interest rates even lower? Most corporations are actually bankrupt already, and the US and most other governments are also bankrupt when "marked to market" on both the asset and liability sides of the ledger. Oooooops, the waltz band is about to stop playing and are leaving the stage playing since they haven't been paid.
Bottom line: Own zero coupon long US treasury bonds with a large offsetting cash gold position. I'll leave it to you when and how to buy. I'm not an adviser.
The history of stock and bond yields (using the ten year Treasury note as the bond yield proxy) from 1870 to 1958 was that stock yields were always higher than bond yields. Since 1958 bond yields have always been higher than stock yields. Bernstein was amazed that this crossover occurred in 1958 during a sharp recession. It was unusual for bond yields to rise during a recession.
Although Bernstein, as quoted in Hulbert's article today at MarketWatch, "sees no clear answer" why the flip flop of yields occurred in 1958 or now or which state is "normal" (higher bond yields or higher stock yields), he did say this: ".....the correlation between the two series has been high when inflation is high and volatile; the correlation has been low when inflation is low and steady. In other words, in order to predict the correlation between stock and bond yields, you need only predict inflation (that is if you are capable of making consistently accurate forecasts of inflation)."
Since inflation has been my primary interest over the past three decades, I emphasized that aspect as key. As we have seen in the past month it is fears of deflation, and the official responses to it, that have driven the ten year treasury yield sharply lower from about 4% down to 2.73% today! At the same time and under the same fears, the stock markets have similarly collapsed sending the S&P500 stock yield sharply higher. I have felt that it was not impossible to predict longer term inflationary and deflationary trends. However the recent startling collapses of bond yields and stock prices are causing me to re-evaluate my prediction of future inflation. I'm still undecided whether the bond/stock yield crossover this past month will stick or is a temporary shock.
Asness feels the real cause of the crossovers was volatility avoidance. As stocks became steadier during the great growth markets from the late 1950's to 1973, stock volatility declined and investors were calmer holding stocks. At the same time bond prices began to fall and their yields rose and it became more dangerous, and volatile, to hold bonds. Both bond and stock yields rose in that period, and both kept up with inflation, but stock prices rose while bond prices fell. Dividend yields fell on a trend basis from 1929 to 1999 since when they have turned up.
It seems likely that Bernstein is correct in mentioning both inflation and volatility as likely causes for very long term yield crossovers. Deflation fear and volatility are currently driving the relationship.
My expectations earlier this year were for a pullback in crude goods (commodities) and CPI (Consumer Price Index) after five to nine years of inflation, depending upon which commodity or index. I thought it would last 6-18 months and be modest. The CRB Index of US-traded commodities made double lows at about 182 in 1999 and 2001 and rose to 615.05 this year, a 236% increase, and an all-time high nearly double the 1980 CRB high of 337.60. Since the July 3, 2008 CRB high the CRB lost 63.2% to the recent low. That's nearly as great a retracement as the first deflationary smash off the 1980 high to the 1982 low which was 69% of the 1975 to 1980 rise. The "Vacation From Inflation" looks like a whole lot more like a "career change" or a "regime change".
The recent CRB low at 341.55 was quite close to the 1980 high of 337.60, and this is providing support at this time.
Oddly, in the same year that CRB has made an all-time high and then collapsed, US Treasury 30 year Bond futures are making new highs and their interest rate has collapsed under 4% to 3.34% (or lower) today. This is the lowest rate since the 30 year bond started trading (being regularly issued) in 1977. The ten year bond which has a very much longer history has dropped to the lowest rate since 1955!
Looking just at prices of commodities and interest rates and ignoring anything else one has to conclude that the markets see deflation ahead. The news headlines always have a reason and it varies with the news of the day. Today the "reason" is that the FED is bloating up its balance sheet. In my last post I made the case that this is just neutralizing or "reverse sterilizing" the increasing Treasury issuances which removes cash from the markets worldwide to pay for the bonds. Thus the FED is primarily buying Treasury bonds from the market and putting the cash back into the markets that the Treasury removed.
The FED's and Treasury's goal is to force people and institutions out of Treasuries with these very low rates. Thus they will "have to" buy stocks or real estate or other higher paying bonds: investment grade corporates and government-owned mortgage bond issuers' debt (GNMA, FNMA, etc). But what happened in the 1930's was that this backfired, and people flocked into long term Treasuries which doubled from a fairly low interest origin. Money was sucked out of the market for anything else but Treasuries.
Falling rates across the yield curve do NOT guarantee reflation of the economy or markets, and may do just the opposite as people and institutions stampede into the only remaining non-callable, guaranteed, long term interest-bearing instrument. Thus in fighting deflation, the FED and Treasury may be hastening it.