Save, Invest, Speculate, Trade or Gamble?

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By Doug Casey, The Casey Report

For some time I’ve been saying that the economy is in the “eye of the storm” and that when it emerged, the weather would be far rougher than in 2008. The trillions of currency units created since the Greater Depression began in 2007 have papered over the situation, but only temporarily.

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In some ways, the immediate and direct effects of this money creation appear beneficial. For instance, by averting a sharp and complete collapse of financial markets and the banking system – or by allowing a return to some approximation of normalcy in the daily lives of most people.

However, a competent economist (as distinguished from a political apologist, many of whom masquerade as economists) will correctly assess the current prosperity as an illusion. They’ll recognize it as a natural cyclical upturn – a “dead cat bounce.” The Greater Depression hasn’t been chased away by Quantitative Easing – it’s developing and about to get much more severe.

What we’re really interested in, however, are not the immediate and direct effects of “Quantitative Easing” (I love the way they fabricate these euphemisms…) but the indirect and delayed effects. In particular, how do we profit from them? What is likely to happen next in the economy? Which markets are likely to go up, and which are likely to go down?

What Now?

I’ve been looking for bargains, all over the world and in every type of market. And, yes, you can definitely find a stock here or a piece of real estate there that qualifies. But when it comes to any particular asset class, absolutely nothing – anywhere – is cheap at the moment.

You may ask, how that can possibly be? It’s almost metaphysically impossible for “everything” to be expensive, if for no other reason than that it raises the question: “Relative to what?” Nonetheless, we’re in a genuine economic and financial twilight zone, where nothing is cheap and everything is high risk. This is most unusual because there’s usually something on the other end of the seesaw.

The reason for this anomaly is worldwide “QE” on a completely unprecedented scale and by practically every government. So much money has been created in the past couple of years that it’s flowed into every sector of every market – stocks, bonds, commodities and property. Even money itself is actually overpriced – the conundrum is that it’s maintaining as much value as it is, despite many trillions having been recently created around the world and much more to come.

Many people, and most corporations, are staying in cash simply because it allows you to move quickly (which is important when you’re sitting on a financial volcano), and it seems better to suffer a sure loss of perhaps 5% per year than an unexpected loss of 50% in some volatile market. Neither is a good alternative, of course. But I’ve thought about it and feel I can offer some guidance.

Again, an economist learns to see the indirect and delayed effects of actions. But this isn’t an academic exercise. So although we want to think like economists, we want to act like speculators. A speculator is one who sometimes profits from the immediate and direct effects of actions, but that’s not his real forte; almost everyone can predict those, so it tends to be a crowded playing field. Running with the crowd limits your profit potential – the whole crowd is unlikely to make a million dollars. And it’s dangerous, because crowds can change direction quickly and trample the less fleet of foot.

Rather, the thoughtful speculator prefers to look for the indirect and delayed effects of politically caused distortions in the markets. Because the effects are delayed, we have more time to get positioned. And because far fewer people pay attention to what’s likely to occur over the horizon, versus what’s tucked up under their noses, the potential tends to be much bigger.

The fact that few tend to share his viewpoint, and that he’s not often with the crowd, makes a speculator a natural contrarian. He’s always looking for something similar to silver in 1965, when the U.S. was controlling it at $1.29, or gold in 1971, when it was controlled at $35. Although politically guaranteed distortions are best, any kind will do – especially those caused by manias, when things rise way too high, or panics, when things fall way too low.

Rothschild’s famous dictum “Buy when blood is running in the streets” is the speculator’s motto.

This concept is especially critical at the moment. You have to decide – basically right now – how you’re going to play your cards over the next few years. If you don’t, you’re going to find yourself acting in an ad hoc way in what will be a chaotic situation. If that’s the case, you’re likely to wind up as financial road kill.

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There are basically three realistic actions available to you: saving, investing, and speculating. I urge you to burn the distinctions into your consciousness. When people don’t fully understand the words they use, they can’t understand the concepts they convey; the result is confusion.

Saving

Saving means taking the excess of what you produce over what you consume and setting it aside. It’s basic and essential, because it creates capital. It is capital, in turn, that allows you to advance to the next level. An individual or a society that doesn’t save will soon find itself in trouble. A major problem is looming, however, that transcends the fact that many, or most, people don’t save. It’s that those who do almost always save in the form of some currency – dollars, euros, yen, etc. If those currencies disappear, so do the savings, devastating exactly the most productive and prudent people. That is exactly what I believe is going to happen all over the world in the years to come. With predictably catastrophic consequences.

Investing

Investing is the process of allocating capital to a productive business, in the anticipation of creating more wealth. You can’t invest, however, unless you have capital, which usually only comes from saving. Investing necessarily becomes harder, more unpredictable, and less likely to succeed as government interventions – in the forms of currency inflation, taxation, and regulation – increase. And all three are going to increase vastly in the years to come. In addition, as society reorders itself to different and lower patterns of consumption, most businesses will suffer serious declines in earnings, and many will go bust. Investing, which thrives in a stable, business-friendly atmosphere, is going to be a tough row to hoe.

Speculating

This is the process of capitalizing on government-caused distortions in the markets. In a free-market society, speculators would have few opportunities. But that’s not the kind of world we live in, so speculators will have many opportunities to choose from.

Sadly, speculators have an unsavory reputation among the unwashed. That’s true for several reasons. Their returns are often outsized, inciting envy. Their returns are often realized in times of crisis, which prompts the thoughtless to presume they caused the crisis. And since speculators usually act counter to the wishes of governments and counter to their propaganda, they’re made to appear anti-social.

In point of fact, I wish we lived in a world where speculation was redundant and unnecessary – but that would be a world where the state had no involvement in the economy. As it stands, the speculator is a hero, and something of an unloved good Samaritan. When everyone wants to buy, he stands ready to provide what others want. And when everyone wants to sell, he stands ready with cash in their hour of need. He’s a bit like a fire fighter – his services aren’t usually needed, but when they are, it’s typically a time of danger.

One mistake that novices make is to confuse a speculator with a trader, or worse, with a gambler. Again, let’s define our terms.

A trader is generally one who’s in the market for a living, a short-term player who tries to buy low and sell high, often scalping for fractions, typically relying on technical analysis or a read of the market’s mood at the moment. There are some extremely successful traders, but it’s a real specialty. I’m disinclined to trade for two reasons. First, it’s necessarily very time and attention intensive, and therefore psychologically draining. Second, you’re always swimming upstream against lots of commissions and bid/ask spreads. A trader and a speculator are two very different things.

A gambler relies on the odds, or sometimes just luck, in an attempt to turn a buck. While luck and statistical probabilities are elements in most parts of life, they shouldn’t play a big part in your financial activities. People who think so are either ignorant or losers who want to attribute their lack of success to the will of the gods.

The years to come are going to be tough on everybody, but the speculator has by far the best chance of coming out ahead.

The Markets

As noted above, with everything expensive and overvalued, we’ve arrived at a strange place, almost a unique place.

Real Estate

Real estate has been the worst market, of course. The leveraged markets of the U.S. and Europe still have a long way to fall, partly because unemployment rates are still rising. But even with interest rates at historic lows, property is still unaffordable for most, one of many indicators of a falling standard of living.

And property is becoming unaffordable in other ways, even as prices drop. For instance, the problems of local governments assure that real estate taxes will rise. And much higher interest rates are eventually going to put the final nail in this market’s coffin.

I think those who are bargain hunting are way too early. The markets that are still in a bubble – like China, Canada, and Australia, all of which have a lot of debt leverage – won’t be immune. Agricultural property is no longer a bargain anywhere. But many people are buying property, regardless, to get out of currency and into a real asset.

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Bonds

Bonds are so overvalued, they will turn into the next great graveyard of capital, after the ongoing real estate debacle. Prices are artificially high because central banks have been buying them, partly to keep long-term rates down and partly to increase the money supply – although these two intentions are ultimately completely at odds with each other.

The public has apparently been buying a lot of bonds, idiotically thinking that the 4-6% they can get as they go way out on the yield and quality curves is a great deal relative to the ½ to 1% they can get in cash accounts and CDs. But they’re going to be hit with a triple whammy, starting with the inverse relationship of bond prices to rates. As rates go up – and rates are headed higher – bonds will fall. Likewise, as the creditworthiness of borrowers continues to drop, so will bond prices. And as paper currencies descend to their intrinsic values, so will the purchasing power of the bonds. Many will be defaulted on outright. All bonds today are overpriced.

Stocks

Common stocks have been holding their own, in dollar terms. But not because they’re good value. Many people are buying because of the dividends (1.85% on average). And they see stocks as a better place for money than earning essentially zero interest from shaky banks.

That said, I’m not interested. The earnings of many companies will collapse at some point as the public’s patterns of consumption change radically in the years to come. Even companies with huge cash hoards could be hurt badly when the dollar starts to plummet. Where will they put all that cash? It may evaporate before their very eyes.

The stock market will likely go higher, just in response to all the new dollars being created. But it’s not a place that should make an investor comfortable.

Commodities

Commodities have been in a huge bull market, with many making at least nominal new highs. I’m not going to discuss them in detail here, except to note that the higher they go, the more will be produced, and the less will be used. Of them, I’m most friendly towards crude oil since I buy, albeit reluctantly, the Hubbert Peak Oil scenario.

Gold and silver are special situations, because their prices aren’t determined so much by new production and consumption (although they look very good from both angles) but by people’s desire to hold them. And by the fact that they’re actually money. Neither is cheap anymore, but both are going a lot higher.

Where Does That Leave Us?

Those trillions of new currency units are going to go somewhere. It took far less in the way of currency and credit than we have today to create the bubbles in stocks in the late ‘90s and in property in the ‘00s. There will unquestionably be other bubbles. But what are the most likely places for the bubbles to appear? That is a critical question a speculator must answer.

Stocks will continue to be popular, up to a point. Precious metals will be very popular. Mining stocks, however, are a double play. I suspect, therefore, at some point the public and institutions alike are going to start a real mania in mining stocks. I’ve seen several fantastic ones over the last 40 years, where the junior stocks – as a group – move 10-1, with favorites going 50 or 100-1. Or more. The odds of it happening again are extremely high, and when it does, the returns will be extraordinary. I expect something similar from energy juniors.

This is nothing new to longtime subscribers to the International Speculator, BIG GOLD, and Casey’s Energy Report. But we really haven’t had anything wild in the resource sector since the last bull market came to a sorry end with the Bre-X disaster in 1996. The new bull market started in 2000 and has long since finished the Stealth stage and is now ending its climb of the Wall of Worry. There’s every reason to believe it will end in a Mania, as classic bull markets do.

And it is a classic bull market we’re in, with a long gradual ramp-up (10 years and counting), slowly getting more recognition from a starting point of zero and based entirely on fundamentals (significantly higher metals prices). But still almost no one is involved. And the juniors, as a group, are far from being even micro-caps, they’re nano-caps.

I would be very bullish on them, even if we were only talking about the solid fundamentals, the long base building process, the low market caps, and the low level of interest in them. But what’s going to supercharge them is the tidal wave of currency units now saturating the financial landscape and the psychological reaction of millions of investors to the continuing deluge. Many more bubbles are inevitably, and predictably, going to be created. And junior resource stocks are not only the most likely bubble-to-come but also very likely the biggest.

The majors will also do extremely well, but the juniors offer the maximum leverage. When Mrs. Buggins in East Nowhere, Iowa, decides she has to get in, she’ll probably tell her broker to buy $10,000 of Barrick and another $10,000 of some highly promoted penny stock. Her purchase will have no effect on Barrick, but it alone could noticeably move the penny stock. Multiply that by billions of dollars and hundreds of thousands of buyers.

As I’ve said before and will say again before this is over, the effect on the market will be like trying to squeeze the contents of Hoover Dam through a garden hose. Having been in this most volatile and cyclical of markets for almost 40 years, I feel the dam getting ready not to just overflow but to burst.

Other bubbles? Definitely shorting distant-maturity government bonds – whose demise we’ve discussed in the past as inevitable, but which is now also becoming imminent. Beyond that, I’m not sure at the moment. But resource stocks impress me as a first-class speculative opportunity.

A good speculation, you’ll recall, is one that offers – in your subjective opinion – not only a very high chance of success but a significant multiple on capital. Resource stocks, and the juniors in particular, definitely fit the bill. They’re not cheap anymore, true, but that’s not an issue if I’m right about the coming mania.

A time will come to sell, of course. I don’t know how high they may go, or how low stocks, bonds, or property may go. What’s important is relative value, not picking absolute tops and bottoms.

I’ve often said that a signal of the top will be when Slime or Newspeak (should either still exist at the time) runs a cover showing a golden bull tearing apart the New York Stock Exchange. At that point, you’d want to sell anything to do with gold and buy common stocks.

I’ve also said that when you can buy common stocks for an average dividend of 6% to 10%, it’s time to start moving back into them; that’s also a turning point to watch for.

For real estate, I don’t expect a bottom until properties being sold for back taxes go begging or you can get about a 10% net rental return. Will they get that low, in view of the trillions of currency units chasing after them? I don’t know. But I believe it’s very unwise to get an idée fixe in your mind as to what anything “should” be worth.

Right now there are still millions of players out there looking for bargains in stocks and property; they believe this is just another post-WW2 recession, soon to be followed by renewed prosperity. I believe this isn’t just another cyclical downturn, it’s the end of a super-cycle. When the bottom actually comes, not only won’t there be anyone looking, but the very thought of looking will be hateful and ridiculous.

As for gold, the market is much better than we’ve seen for many years, but it’s still full of skeptics, and almost nobody actually owns the metals or the companies that mine them. In the next few years, everyone from Mrs. Buggins to New York traders will be piling in.

I remain of the opinion that the world is in the early stages of really massive change, bigger even than what we saw in the ‘30s and ‘40s. Your savings should be in gold and silver, in safe, neutral jurisdictions. Your investments should be limited. You should orient your psychology and portfolio toward speculations.

Someday we will look back fondly on today’s period of relative calm as the “good old days,” at least compared to what’s coming. The time to get positioned is now, well ahead of the crowd.

 

[Every month, Doug and his co-editors of The Casey Report provide razor-sharp analysis of the economy and markets, so readers can make truly informed investment decisions. “Making the trend your friend,” as Doug says, can indeed be very lucrative. Get in on the editors’ recommendations right now, and give  The Casey Report a risk-free 3-month trial with full money-back guarantee.]

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avatarDoug Casey - Casey Research posted Thursday, March 10th, 2011.

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