Putting the pieces together...

Some Reasonable Income Portfolio Currency Hedges

My intent at this site is to stress retirement income generation, although I do and will look at other asset types, if only to keep up on them. I am retired and ~90% of my holdings are income orientated. The rule is that nothing goes into the total portfolio without generating at least 4% cash annually, unless it is an excellent hedge of that 90%. In some cases--preferably all--the hedges themselvesare income generators. An example is Pimco's Commodity Real Return Fund (PCRIX/PCRDX) which is generating about 5% cash because it's underlying  collateral is invested in US TIPs.

 

Before I get back to basics on the income generating funds, I'm looking again at some of the readily available currency funds. (By the way, you can go back and look at articles under Portfolio Ideas for income generators.)

 

The chart shows annualized total returns (with all dividends reinvested) for six funds for the past nine to ten months. I started it from when my total return data base for UDN started. HSTRX and PRPFX are not generally thought of these days as currency plays, but they are. HSTRX trades up to about 20% of its assets either in gold stocks or in currencies, and PRPFX holds a large gold bullion and a Swiss franc position. I own HSTRX for several reasons: it is managed rather adroitly by John Hussman, and it is less volatile than the others. The cash dividend is, alas, only about 2% but it has fairly consistently returned about 4-5% also in trading profits per year. PRPFX has been in operation since the early 1980's and holds fixed amounts of US T bills, Swiss Franc T bills, gold, and growth stocks. It doesn't pay a cash dividend, so I don't own it, but it could be an excellent fund for a taxable account. Morningstar gives it a very high "tax efficiency" rating. BWX holds foreign sovereign T Bonds and pays a dividend, but I don't care much for it because it has too many variables: currency, interest rate, and bond duration.

 

FXY and FXF are Rydex currency funds which pay little or no cash dividends and are simple proxies for the yen and franc respectively. Rydex has similar funds for British pound, Swedish krona, Australian and Canadian dollars, etc. which do pay some dividends UDN is a Deutsche Bank mixed currency play which roughly simulates an inverse or short US dollar index. These may fit into niches, but unless one owns a lot of it, it won't make a whole lot of difference in dollar hedging a total portfolio. These work better for people who don't need the income currently. PCRIX and HSTRX work better for those who do need or want current income.

 

Gold, of course, makes an excellent hedge. During the same time period used for the chart, the gold ETF GLD was up  39.9% annualized, nearly double the nearest contender FXF (Swiss franc). I have ~10% of my total portfolio in gold bullion which I have owned since before 2002. Of course it pays no dividend and can require storage and/or insurance. For younger people I would recommend putting a fixed dollar amount into gold each and every month. I started doing that in the 1970's. I set up a savings account back then and put $500 per month in it. When I had enough for one or more  one ounce gold coin(s), I bought them. That approach is a lot safer than buying a big stash all at once and then seeing it go down....whooosh! You could do the same thing with small lots of GLD if you use a deep discount broker. Even if you only bought $500 a month of GLD (about ten shares), if you do it over time it will make a big difference. But you have to do it every month! If you know you can afford it and will do it, you could set aside more. When gold goes down you will be happy because you can buy more with the same amount of money. It sounds stupid, but that's how you will feel.

 

If you are older and have a large enough portfolio to live on, or are younger and have hit some sort of lottery, maybe it's wise to buy 10-15% into gold in a fairly short period of time. You could do it all at once, but I'd probably do it over six or twelve months. I like dollar cost averaging.

 

These are the basics for hedging a US dollar income portfolio: some vehicles which themselves pay a meaningful dividend, and 10-15% in gold. I wouldn't recommend putting a huge percent of assets into gold "all at once" as it can and does go down for long periods of time too. Ditto for PCRIX or other commodity or currency funds.

 

In a free market, the best cure for high prices is high prices

For some years I have been reading George Slezak's analysis of the weekly Commodity Futures Trading  Commission's (CFTC) Committments of Traders  (COT) Report. George does the hard work I did myself for years. He was the first to do futures category summaries and total CRB summaries in addition to each individual futures contract analysis, with and without its own futures options volume. When CFTC started gettng data on commodity index fund activity, George was right on that long before that issue became "news". This is a guy who was a floor trader in Chicago. He knows his stuff.

 

George's release at the close yesterday is extremely important not only for the current state of physical commodities futures but also for the stock index futures.

 

I have no financial connection in any way with George or his websites or his business. I just think he's the best at an important type of analysis. His main site is here: http://www.cot1.com/

With his permission I am replicating most of yesterday's release. This is not an ad nor a recommendation. I simply like his work.

 

Tom Drake

 

 

WEEKLY COMMENTARY: 7-18-2008

 

In a free market, the best cure for high prices is high prices. 

 

What happens when there are high prices in a market that isn't free?

 

US oil production went from near 10 million barrels per day in 1970 to 5 million barrels per day in 2007. Obviously higher prices have no impact on US PRODUCTION because the US is NOT a free market. 

 

There are 36 million acres of land leased by the USDA farm program to control excess crop production. Now that prices are high and inventory is needed the land in the CRP is NOT available to meet the current needs because the USDA will NOT release the crop land back into production. (The birds want to keep it.)

 

So, does that mean higher prices DO NOT act as a cure for high prices.

 

But, some argue that we are better off with less pollution and more birds and caribou. Is that true?

 

If we don't produce more oil, won't other countries rip into their exploration and be far worse on the environment of the world in their production? Are the caribou in Siberia treated the way the caribou in Alaska would be treated if we increased our drilling? Aren't we forcing horrible treatment of the caribou in other parts of the world?

 

If Cuba drills for oil and pollutes the Gulf of Mexico, is that better than our drilling in an environmentally controlled way? Aren't we causing increased pollution of the Gulf of Mexico by letting others outside our control do what we would do more responsibly?

 

South America is cutting down the rain forest for farmland. Is that worth our planting grass in our fields for the birds to nest along our creeks?

 

See, free markets SOMEWHERE will find incentive in higher prices. 

 

AND THEN HIGHER PRICES WILL CURE HIGH PRICES. 

 

If $50 oil and $4 corn "should" have brought on more production to bring prices back down to $20 oil and $2 corn, will $140 oil and $7 corn only bring on a little production from other places in the world, or, will there be MASSIVE new production brought on stream in other parts of the world?

 

These higher prices are incentives for massive new finds of oil, for massive clearing of land for farming. Once new oil fields are found, like in Brazil and in India - both have gone from oil importers to oil exporters, will they turn off the pipeline if prices come down? Once land is cleared will they stop growing crops if prices come back down?

 

I believe these high prices will result in MASSIVE GLUT of new world production that will drive prices all the way back down to oil under $20 and corn under $2, and the environmental damage some will cause will be catastrophic relative to the minor disruption we might have caused by allowing responsible production in the US. 

 

Not only will our narrowly defined domestic environmental concerns result in far greater global environmental damage, but  the export of our capital to pay others for production we could have done ourselves has weakened our country and our future by increasing our debt and flooding the world with our currency.

 

I explained the above because this is the trading environment we live in. With 20 20 hindsight we should have known how this commodity bubble would ignite. The domestic drilling restrictions and the acres set aside set up the bubble over many years. But high prices WILL cure higher prices by increased world production. Bull markets can take many years of basing and foreplay until they eventually light on fire. But bear markets are BORN IN THE FIRE OF THE BULL EXPLOSION. Today we only hear about waiting for demand destruction to bring a pause in the bull, when we should also be focusing on the race to increase world supply and the commodity bear market that will result. The world is not merely bringing supply and demand in balance. This has been the greatest commodity bull market in history and in response the world is bringing the greatest increase in supply in history that will eventually overwhelm demand.

 

Remember the Beverly Hillbillies that found oil by shooting a bullet into the ground. Well, today, in the US you can't shoot at the ground and bubbling oil would cost you pollution fines. But in the rest of the world they are strip mining and shooting eagles and their chicks out of the trees to bring new supply to the markets.

 

Let's not talk about right or wrong! Let's not talk about who wins or who loses. Let's not talk about why or why not. Let's just talk about the markets.

 

So how are we going to know that the commodity bull has peaked and the new bear is on the way?

 

For the last few months I have recommended to be on the sidelines, out of the markets except for a few cheap long term puts. (see recommendations in the column at the right.) As of the July 11 close, however, I recommended going SHORT the commodity indexes in my Commodity Index Timing .com web site and long the stock market in my Stock Index Timing .com web site. The Commitments of Traders data was an important factor in both conclusions.

 

My "July 11 sell signal" on the commodity markets

 

To get to my sell signal on the commodity markets I have been saying in this commentary for months that the totals of the Commodity Index Trader (CITs) positions in the Supplemental Report covering the Ag markets could be used as an indicator of a change from accumulation of commodity index positions to distribution of the commodity indexes.  

 

(Click http://www.futuresemail.com/cot/cotp2.htm to view an explamation of the Supplemental Report.)

 

In the following chart the Commodity Index Trader totals are plotted as the BLUE line over the CRB. The Commodity Index Trader positions have been declining since last May. (The following chart, along with charts of 40 other markets, is updated for subscribers in the chart section of this web page each Friday evening after the issuance of the new COT reports.) 

 

 

You could have drawn a similar conclusion that the CIT's were reducing positions from the 12 week summary of CIT positions linked in one of the yellow buttons in the navigation bar at the top of the page. Following is a portion of the 12 week summary showing that the largest position of the last 12 months was on May 3rd at 1,781k contracts (bottom line in table below) and has reduced 5% to 1,689 in the report for July 1. 

 

 

 

My view of the totals as an indicator is that the positions of the Commodity Index Traders had dropped over 10% in most major commodities and that suggested I take a short on the indexes when I saw a technical reason for a short. The new highs in crude Oil not confirmed by the indexes was my primary technical reason for moving to a sell on the Commodity Indexes.

 

Further, I have been saying we should look for a $20 to $25 drop in crude in the first 3 to 5 days after the high to call a top. On July 11 the high in August Crude was 146.65. Today the low was 128.54. Do you think?

 

My "buy signal" on the stock market 

 

In my July 11 "buy signal" on the stock market, I also used information from this web site in making my decision. 

 

Since the beginning of the year I have often explained in this commentary that the commodity index trader positions in the supplemental reports are tied to structured investment notes issued to the commodity index funds. The firms issue the notes to the funds to contract for the return of the index. This way, the funds do not make actual futures trades, it is all covered by the note. But the issuing firm will buy futures to hedge their contract obligation. These are the positions represented by the Commodity Index Trader totals in the supplemental report. 

 

The supplemental report only covers the Ag markets. To try to gain a similar perspective of other markets like, Crude and Gold, I began publishing separate 12 week summaries with the one year, three year, and five year range of the data of the Commercial LONGS separate from the Commercial SHORTS. Each week I post those summaries on this web site for subscribers.

 

Based on these summaries, in past commentaries I explained that the gross commercial short position in Gold and in Crude were at the largest short position in history. Contrary to the mindless idea that the gold mines should be unhedged, the gold mines actually have increased production and increased their production hedging greater than any time in history.  

 

I used similar information in my stock index timing .com commentary to recommend a "sell signal" on the stock market. The table shows the commercial short positions in the stock index futures were near the smallest short position in the last three years.

 

 

 

In the past we would view the net commercial position in the stock index futures as an expression of value by the portfolio managers that use futures to hedge risk. When the net commercial position was at the smallest net hedge in the last year, I viewed that as a statement that the portfolio mangers viewed the stock market as cheap. When the net commercial position was at the largest net hedge in the last year I viewed that as a statement that the portfolio mangers viewed the stock market as overpriced.

 

The mutual funds use of structured notes to contract for the returns of the Commodity Indexes has obviously also spread to contracting for the returns of the stock indexes. The effect has been the firms issuing the notes are buying stock index futures to hedge the contract risk and those totals are included in the commercial category in the COT Report. The effect is as the stock market goes higher and retail adds to their fund investments and the funds have more structured notes, the firms buy more futures to hedge that obligation. As the stock market goes down and retail investors reduce their investment in mutual funds the redemptions result in less structured notes, and the firms reduce their contract hedges.  The structured note hedge has grown so much that it is far greater than the portfolio hedging by portfolio managers that use futures to hedge risk, so the effect is the stock index futures net commercial position in the cot report now increases as the market goes up and decreases as the market goes down.

 

I used the separate tables of commercial long positions and commercial short positions to view the commercial short position in the stock index futures as representative of the positions of the portfolio hedgers that use stock index futures to hedge risk and saw the the gross short position was near the smallest gross short position in the last three years! So even though the net position was declining because the structured note hedgers were reducing LONGS as the market declined, the gross short position was declining suggest the short hedgers that were hedging portfolio risk were reducing hedges to the point that it suggested they viewed the stock market as very cheap!

 

This was an important additional piece of information, combined with my technical analysis of the stock market, in bringing myself to go the a buy signal on the stock market as of the close on July 11.

 

Following is a portion of my table of "short" only commercial positions. Just a few weeks ago we had the SMALLEST "GROSS SHORT" STOCK INDEX FUTURES POSITION IN THE LAST THREE YEARS!

 

 

 

-------------

 

I explained the above information I used from this web site in my market timing decisions on the Commodity Indexes and the stock Market Indexes to try to illustrate ways to use the information I provide to subscribers in my web sites. 

 

I have always found reviewing the COT tables and charts that I present in this web site as a great stimulant of market ideas that I just don't find in other data sources. More often than not, the ideas I gain from reviewing the data tend to be contrary opinion type ideas. ie everyone is bearish stocks and the portfolio hedger positions suggest the market is cheap so it is time to buy. or, ie, the commercial gross shorts in gold are the greatest in history so it is obvious the story that the producers are unhedged is probably false. Maybe some are, but the majority are aggressive hedgers and that suggests gold is grossly over priced.

 

I hope you subscribe and use the information provided in this web site in making your trading decisions. 
  Charts of Supplemental Report data         

 

NEW SHORTCUT TO THIS WEB PAGE www.cot1.com    

 

CURRENT OPEN TRADE RECOMMENDATIONS:

 

Following are the open trade recommendations in this free weekly commentary. Subscribers should see Commodity Index Timing .com (shortcut www.cit1.com ) for further commodity recommendations.

 

Hold the Long December 2008 $3.00 Corn PUT option bought for 3 cents or $150. If you followed the recommendation in this report, on 11/28/07, you purchased the December 2008 $3.00 Corn PUT for 3 cents or $150. Hold the position. Risk is the net premium paid plus commission. December 2008 corn option prices

 

Hold the Long May 2009 $4.00 Corn PUT option bought for 7 cents or $350. If you followed the recommendation in this report, on 3/31/08, you purchased the May 2009 $4.00 Corn PUT on a 12 cent or better recommendation for 7 cents or $350. Hold the position. Risk is the net premium paid plus commission. May 2009 corn option prices

 

HOLD the Long SEPT 90.00 Swiss Franc PUT for 40 ($500) or better.    If you followed the recommendation in this report, on 3/14/08 you purchased the Swiss Franc September 90 put for 40 or better (about $500.)  Risk is the net premium paid plus commission. Sept 2008 Swiss option prices

 

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Good luck and good trading!

 

George

 

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PSS Would you like me to consult with your firm on these or other matters? Call me at 239-947-9131, or email me at [email protected]

 

Email [email protected] for more information.

 

 

 

The $35 per month subscription to Commitments of Traders .com includes access to Stock Index Timing .com  Commodity Index Timing .com ,  The Gold Bull .com , and Beans in the Teens .com, where recommendations in those markets are made each week end based on the data in the COT Report.
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Bonds Galore and More

About six weeks ago in one my blog posts on income investing I wrote:

http://twocents.blogs.com/weblog/2008/06/recognition-wave.html

"Unless we have a deflationary collapse starting soon, bonds have nowhere to go but down. There is still a small group who believe that the deflation of 1996-98/99 will recommence after this inflationary interlude of 8-10 years. I myself have felt that a timeout or rest period in inflation was due, especially if a deeper recession occurred. In that case one would expect a decent bond rally. However, barring amazing collapses of multiple financial institutions and a permanent contraction of credit in its wake this year, there will be no long term bond rally until rates are much, much higher in a decade or more."

Much sooner than I would have thought possible we have had "amazing collapses of multiple financial institutions" and evidence of credit contraction not just in the markets but also at the bank loan officer's desk, according to the FED's loan officer survey. And the new (and long due) rules for rational credit rating of mortgage applicants, proposed this week, will constrict it more. Bonds are still bouncing around, but we are seeing a fracture in the bond market. Treasuries and GNMA's ("full faith and credit....") and municipals are holding up and rising slowly, but corporate bonds, especially high yield or junk bonds, are not.(Incidentally, there is now a good way for those of us without a Bloomberg terminal to get a feel for what junk bonds and munis are doing. HYG is the symbol for a junk bond index ETF and MUB is the symbol for a muni bond index ETF.) This parting of ways or "widening of the spread" between junk and treasuries has been taking place while crude oil and gold have been re-exploding upwards and a commodity mania has become acceptable on Main Street. It bespeaks an approaching recession.

As a former commodity futures trader before I got old and gray, my gut feeling, based on the history I know, has been that we would have a significant pull back or at least leveling out in commodity prices, including gold. We've had several periods like that since the lows of 1999-2003, and it is common in commodity bull markets. Whether it really started today or not is foolish to speculate about, but I have been cutting back on commodity exposure in recent weeks just as I cut back on "generic" stocks last year and early this year. As mentioned I sold one-half of my high yield oils and gas trusts. I did buy TYG the infrastructure closed end fund, but did not buy KYN and MGU. Not did I add on to ETO or buy DRP. I still like them at some point, but I'm going to wait. I cut back to minimal positions in VGENX and VGPMX the Vanguard managed petro and the managed mining funds. PCRIX has also been pruned and the rest hedged by the long/short commodity/currency fund from Rydex--RYMFX. Gold is untouched. This is the lowest exposure to inflation/commodity vehicles that I have had since 1998. I may be wrong but if so I can buy them back. But I do think the long bull market for commodities, which I see lasting into the 2020's, is going to take another breather.

Recently I saw another of Kate Welling's dynamic interviews, this one with Albert Edwards and James Montier of Societe Generale. Read it. It's a bit of a circuitous route to get to it: go here first:

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/07/14/inflation-is-not-the-problem.aspx

Then click through to the Investment Postcards site, and finally to Welling@Weeden. Edwards and Montier are bearish not only on the world stock markets, including emerging markets, but also on commodities. This interview is over a month old, and some of what they foresaw has occurred. I'm already basically out of stocks except for the minuscule position in ETO and residuals in the trusts, so it's easier for me to relate to this forecast. In fact I'm mainly interested in Edwards and Montier because of the implications for bonds which is "where I live" these days.They  don't talk much about bonds or the dollar except to mention that both could go up, but I think that is the big news for dollar-based income investors.

I had cut back duration or maturities both in municipals and in taxable bonds, thinking that increasing rates would take a big bite out of total assets. Also I can make nearly as much interest on 4 year GNMA's (VFIIX/VFIJX), which are as safe as Treasuries, as I could on 20-30 year Treasuries. So I figured why go out long term? In fact I also bought Vanguard's short term federal fund VSGDX which is essentially two year GNMA's.

Hildy and Stan Richelson wrote a fine book "Bonds: the Unbeaten Path to Secure Investment Growth", 2007. I bought it this weekend at Amazon and it is also available form Bloomberg Books who had a hand in publishing it. This is the Gospel of 100% bond investing. I think it was $16 at Amazon with almost as much for one day delivery. Even you are a bond dealer or trader there is much to learn here. To make this short, I learned that my approach hasn't been all that bad, since their main goal is to produce income to live on while being safe from the ravages of stock volatility in a retirement portfolio. I had been feeling my way there, but I think I'm nearly home. I plan to keep my bond duration/maturities fairly short since I do not know for sure (who does?) which way rates are going. I had been toying with the idea of small positions in either long-dated TIPS or long-dated strips (zero coupon) treasuries. When I read the Michelson's "bar-bell" duration strategy I knew I was onto a good idea. The concept is to have short duration for safety but some long duration exposure to extend the average duration out to the intermediate term, say 5-7 years. The Michelsons like long duration individual bonds, but I do not work with an adviser and want to keep accounting simple and under one roof, namely at Vanguard where I can buy almost anything through their clearing house arrangement for client brokerage with Pershing. Almost all my taxable bonds and high yield investments are in tax-deferred accounts, and the municipals (also fairly short duration--2-3 years) in taxable accounts. Taxes are surely going up next year no matter who gets elected, and the best we can hope for is that it is only Bush tax cuts which are allowed to expire and not new increases on top of that.

Since TIPS are long term inflation-adjusted US Treasuries and Strips are long term zero coupons, and hence leveraged, which should do better in a disinflationary environment, it seems to me that switching between TIPS and Strips is the way to go at the long end of the "bar-bell". There several mutual funds for doing this but there are also several ETFs now. TIP and EDV. TIP trades in decent volume, EDV the Strips ETF from Vanguard is pretty new and trades very little. Vanguard has not wanted to publicize it at all  for fear that small investors might load up on it and lose a lot if rates went up. But as a "duration kicker" if rates are going down, you effectively get double the leverage of a regular Treasury bond fund like TLT. the advantage is that I can leave most of my bonds at the short end and use TIP and EDV alternately in bond price excursions due to inflation or disinflation. If this isn't clear to you, just forget about it or read the Michelson's book. They don't talk about this strategy specifically  but do explain all about these two bond types. It's not necessary to do this at all, but it will give me something to do  to add value with TIP or EDV. Be sure you use strict and realistic limit orders if you deal with these two, especially EDV. I bought a tiny, tiny first position of EDV today, just to focus my attention. By the way, both TIP and EDV pay monthly dividends. I've been thinking about and writing some about inflation-hedging an income portfolio, but one can also disinflation-hedge it with EDV.

If you are into this at all, do get the Michelson's book for $20-$35 including shipping, and read the Kate Welling interview. Bear in mind always that I am just talking about what I am doing, and I am not making investment recommendations for anyone except myself and family. Based on what I've been doing this year my total investment accounts--not including checking account, home, personal items, etc.--are up 4.72% year to date. Not fabulous by any means, but I'm thankful when I hear horror stories of some friends who are also retired and have taken big hits in stocks. If you are a chicken like I am, read the Michelson's book.

High Yield Energy Stocks

High Yield Energy Stocks

The US and Canadian natural gas and oil trusts have had a magnificent run up of 30-50% in price over the past six to twelve months while paying about 8% dividends annually in monthly installments. I have had Mesa Royalty (MTR), Hugoton Royalty (HGT), Cross Timbers Royalty (CTR), San Juan Royalty (SJT) and Canadian Oil Sands (COSWF/COS.UN-TO) for a wonderful ride. I recently sold MTR on a gap up, and have been thinking I ought to take profits on some of the rest. These were being held in my tax-deferred accounts where capital gain and income are not taxed until withdrawn some day, and where the intricacies of tax law, such as depreciation or depletion, type of dividend, etc. need not be an immediate nor a continuing concern.

I have felt that these stocks were due for a correction by themselves after such a run, but also because of the tremendous run up in commodities generally and the possibility, widely believed, that a recession was due. I'd hate to give it all back. Nevertheless I'd hate to give up those nice increasing dividends in the retirement funds. Of course if natural gas and crude oil prices were to fall, the dividends would fall as well. I took a long look at US and global utilities for replacement yield, and there are a few utes with decent yields abroad. I happen to live in Arizona where regulators have been very restrictive with rate increase for utilities, despite their enormous cost increases for peak load purchased power and just normal operating costs. I have heard that New York State and Maryland have been even worse with their own captive utilities. So the easy period for regulated utilities in the US may be past. With US democrat party majorities looming seemingly everywhere for 2009, utilities may have seen their best days. It may be time when the regulators let the utilities run down, even though we'll need a lot more power, and much cleaner, going forward. A run down utility faces higher interest rates and has less capital, or incentive, to upgrade, but politics is politics. Then too, utility dividend rates aren't all that great now anyway. The Vanguard Utility Index Fund pays just about 3.5%. Scratch retail utilities.

There is another class of utilities in the US which is regulated at the federal level instead of at the state level, and it does not bill retail tax payers monthly like the local electric utility does. Therefore it doesn't have quite the same pressure from politicians to keep rates (electric, gas, and water rates) down at all "cost". I am talking about the energy delivery utilities, also known as gatherers, pipelines, and shippers. Most crude oil, natural and LPG gas (eventually, we hope), and distilled products (gasoline, diesel fuel, heating oil, jet fuel, ethanol) are transported by pipelines from major producing areas to major user areas. Most pipelines used to be owned by the very big oil and gas companies, but as their sources for fuel went overseas and their plans to build new refineries in the US were put on indefinite hold by the NIMBY crowd ("not in my back yard"), they either spun off or sold off these pipeline facilities. Without going into political and tax history (redundant?), the pipeline (long distance) and gatherers (from individual US wells) became organized as master limited partnerships many of whom became listed on the US stock exchanges. They have many of the same advantages as do REITs in that their dividends are taxed only once instead of once at the corporate level and then again at the dividend receiver level. In effect they pay little or no corporate tax for the good reason that they aren't corporations. However, for arcane reasons they may not be held in tax-deferred IRAs and 401Ks etc. REITs can be held in those accounts, but not MLPs. So they were not terribly interesting except to people who paid very little income tax and who were also excellent bookkeepers and accountants to keep track of the depreciation and other tax factors forever.

Many of the individual MLPs pay 6-9% currently. Many of them also use some leverage through preferred shares or lines of credit. What has occurred over the past three to five years that they have all been in existence is that they tend to trade in cycles opposite to the oil and gas royalty trusts. When the royalty trusts are going up, the MLPs are going down, and vice versa. The market economics for this are not all that complicated, but I had never seen an analysis of it. Royalty trusts are tied directly to the price of oil or natural gas, and the trusts have no debt. Pipeline MLPs have long term contracts to move the products based largely on volume, not on price of oil and gas, although there are some minor PPI or price adjustments. But the pipes have a lot of debt, typically 25-50%. So they do well when interest rates are low and credit is easy and not so well when credit tightens and credit spreads go up. Even if oil and natural gas and gasoline prices go way down (we hope!), the volume (gallons, barrels, cubic feet) of the product moved is not going to collapse. So the MLPs are a better bet in a recession or other event of price declines. Plus interest rates tend to go down in recessions.

In the past two to five years several investment firms, primarily Kayne Anderson and Tortoise Capital, have developed public traded funds holding MLPs within a structure which made it possible for them to be owned by US tax deferred accounts without the tax difficulties of native MLP pipelines. And since those stocks have gone down during the credit crisis of the past year, they are yielding almost as much as the royalty trusts. Two of the earliest, and therefore most seasoned, stocks are KYN, yielding 7.3% annually, and TYG, yielding 8.2%. Regrettably they pay quarterly rather than monthly dividends, unlike the royalty trusts. But the fact that royalty trusts "may be" topping out and MLP aggregators may be bottoming out and are paying similar dividend rates, I am switching a part of my investments in royalty trusts to KYN and TYG. Not all by any means, because I could be wrong or I could be early, but probably 50-66% to start with. Also I am phasing in with dividend schedules in both classes.

A Perspective on Total Outstanding US Government Debt

http://welkerswikinomics.com/blog/2008/06/13/the-us-national-debt-level-is-the-sky-really-falling/

Until 2007 I was always geared toward capital gains by speculation and by investing. That's normal, I think, for people who are professionals or are employed and have a source of continuing income to live on and save "from". I had never thought of asset allocation in any real or thorough sense, only asset accumulation. When I started to think about it I reluctantly accepted the traditional concept of progressive reductions in US stock exposure and increase in US bond exposure as one got older. After all I would need dollar income to spend.

Actually I had never been a stock investor in the usual sense. I had been more intested in commodity futures speculation, having lived through the inflationary era of the 1960;s and 70's as a young adult, a time much like the present. From the 1960's to early 80's, US stocks and bonds went nowhere but down, or sideways at best. Metals, grains, and foreign currencies went up. In the 1980's and 90's that all changed, and I had to learn to short futures and buy stocks and bonds. That was a great time for our elders to retire on 14% 20-30 year old US Treasury bonds and rising stocks. But now that I have retired we are back in the inflationary patterns of the 60's and 70's, and it's becoming less clear that relying on US stocks and especially on US bonds is going to work out as it did from 1980 to 2000.

Fortunately I retained my interest in gold and commodities and currencies, although I really do need steady income as well. When I see what has happened to highly regarded balanced US stock and bond funds this year, such as Dodge and Cox's DODBX, which I had owned, and many others, now down over 15% already this year, I'm happy I got suspicious last year. I felt like a wimp for cutting stock funds and growing negative or at least cautious in my posts here while stocks were going up last year. I got down to mainly bond funds and Vanguard's Wellesley Income (balanced) Fund VWINX/VWIAX and First Eagle Global SGENX and a gaggle of inflation beneficiary funds. Late last year and early this year I even cut out SGENX and VWIAX as they lost strength. I had expected to own them forever, but they suddenly faltered in a way I had not observed historically. I have the service of Investors FastTrack http://www.fasttrack.net/ which has a data base of the total returns of mutual and closed end and ETF funds back to 1988, so I knew what all US funds had done under all sorts of conditions since 1987. It costs about $300 per year but is well worth the cost if you are choosing your own funds. They don't tell me what to buy or sell, they just give me the data and graphs of their fund records and an ability to analyze it and them.

Thanks to FastTrack and my commodity background I was able to unload the faltering stock funds gradually, keep the income producing funds and hedge away the inflationary and currency devastation. I am still only up about 5% this year, but I could have been down 15% very easily. For a retired person early in retirement a 15% down year is a killer. I mainly did this all by feel and by hunch, although my bias toward the economic long wave helped me greatly as well. "Generic" or index stocks do not do well during inflation, nor do bonds. Actually, bonds have done pretty well and much longer than have stocks. So much so that I had many doubts about the primary economic direction, although looking at gold and oil and the rest of the commodity spectrum told me the tale.

Gradually I have been shortening the duration or spectrum of the bonds funds since I do believe that interest rates will be going up in the US as they are in Europe and elsewhere. This is painful if one is retired since  short term rates have been devastated by the US Fed action. In 2007 we could make 5.2% in the Vanguard money market fund with no hazard of capital loss. In July 2008 it is paying 2.2%! Nevertheless I have cut back from 5-7 year bonds to 1-2 years in both tax-free municipals and in taxables. I still own my favorite LSBDX, Loomis Sayles Bond Fund, but I have greatly increased the shorter term Vanguard Federal VSGDX and the Ginnie Mae VFIJX with stock fund sales proceeds. Gold, metals funds and energy funds and PIMCO's PCRIX and Hussman's HSTRX have provided the inflation hedging and some income as well as the natural gas and oil trusts I have written about.This is my blog and my story, and I'm not an investment professional, for better or worse. I have felt my way and explained how. And I may just have been rather lucky.

I have developed a healthy appreciation for PIMCO management over the past few years, and this week I read an interview http://www.allianzinvestors.com/commentary/frm_PIMCO_sec06012008.jsp with Mohamed el Erian who is now PIMCO's joint chief of operations with Bill Gross after coming back to PIMCO from two years running Harvard University's endowment fund. This interview is necessarily subtle and not a barn burner or Bible thumper, but if you read it thoughtfully you will get a much better picture of where and how we need to be investing over the next three to five years. It's a logical and concise layout of why and how and where to invest given current and expected conditions. Given that PIMCO is primarily a fixed income shop, the advice is particularly acute and meaningful for retired investors. One needn't even use PIMCO funds to accomplish what they see. But I think they are correct.

I have absolutely no connection with PIMCO, or any other financial enterprise, except that I own several of their funds. Read el Erian's interview. Print it out and read it until you understand it completely. I'll talk about it more another time and don't want to prejudice your views further until you have read it yourself.

Independence Day

To my American readers I wish us all a wonderful national Independence Day. I just finished an interesting book by Jeffrey Manber and Neil Dahlstrom, "Lincoln's Wrath", Sourcebooks, Inc, 2005, ISBN-13: 978-1-4022-0398-5. For the past seven years I have thought that George Bush's experience and character were a lot like Abraham Lincoln's. Since most people today regard Lincoln as a saint, in the Gandhi or Mandela model, and as a national hero, I was always greeted with rude shock and/or laughter at the comparison to Bush. Lincoln's achievements were not regarded highly at all in his time except by the radical abolitionist minority. He was deeply hated by the northern and southern democrats of his day and by most civil libertarians and haters of big government. It was only much later that his achievement in saving the union and freeing the slaves was recognized for what it was. Lincoln was regarded as a rube and an ignorant tool of his advisers, like Bush.

Lincoln had as much to do with the development of the centralized modern nation state in North America as did the Roosevelt's I and II. And his relations with the press during the Civil War were similar to and even rougher and nastier than those of Bush. If you see a copy of "Lincoln's Wrath", buy it. It's an eye opener to history and how myth-making shapes it.

It's ironic that we will have a person of color, although not African-American in the usual sense, running for president this year as a democrat, since the democrats of south and north in 1861 were all pro-slavery and anti-Lincoln. They feared the competition of the possibly freed slaves for jobs and economic position and resented the Federal Government and Lincoln for forcing the issue on the states. The republicans were thereafter considered the party of progress and freedom until the democrats turned the tables by adopting the socialist rhetoric of victimization while also adopting the republican strong government policies.

The ebb and flow of political movements is crucial to history and economics. Since we are now in an inflationary era which has one or two more decades to run, it's quite probable the democrats will be chosen to lead and to soothe the soreness of the public who now hate the off-shore (Asian/Latin American) economically competitive "slaves" as they hated the southern slaves in the 1860's. It may be a bumpy road, but it's the way we do things, and I wouldn't want to be anywhere else. Enjoy the fireworks.