The Daily Reckoning November 13th
“If I had a world of my own,” declared Alice, Lewis Carroll’s red pill-popping protagonist while wandering around her author’s Wonderland, “everything would be nonsense. Nothing would be what it is, because everything would be what it isn’t. And contrary wise, what is, it wouldn’t be. And what it wouldn’t be, it would. You see?”
What’s going on, Fellow Reckoner? What’s happening…now that we’re through the looking glass? Stocks dawdle. Gold drags its chain. And the whole economy — to the extent that such a thing even exists — marches headlong off a cliff. That’s what we’re told. Welcome to post-election 2012…where nothing is quite as it seems.
Here’s Bloomberg News, describing “how a game of fiscal chicken could turn into a cliff dive.”
“The subtext of the fiscal cliff battle between Democrats and Republicans is a dispute between going fast and going slow.
“Democrats want to capitalize on the political momentum from President Barack Obama’s Nov. 6 re-election and reach an agreement that moves policy in their direction with higher taxes on top earners. Republicans want to avert the $607 billion cliff while extending the current lower tax rates, yet they have a good reason for waiting to endorse a deal. Every day puts the 2012 election farther away and brings the country closer to reaching the $16.4 trillion debt limit, an action-forcing event that can give Republicans a political edge.”
We’re all seeing and hearing a lot about the impending “fiscal cliff moment,” when a combination of tax break expirations and government spending cuts will combine to knock the US economy back into recession…or worse. Where will the cuts come from? Social programs and…gulp!…the nation’s euphemistically named “defence” budget.
Of course, the country could do without these cancerous growths anyway. They feed on the labors of the productive class at home and foment distrust and hatred for the US in countries around the world. “Deep cuts,” they say? Ha! What’s really needed is something closer to a bilateral amputation.
In any case, the papers assure us the lawmakers in the nation’s Capitol are hard at work, hammering out deals of vital national importance, racing against the clock like a foaming warren of Ritalin-fed White Rabbits.
And all the while… Tick tock… Tick tock… Tick tock…
For how long can this go on? Just how much track is left before we’re over the “fiscal cliff”?
In truth, the government does have a debt limit…but it’s not the self-imposed “ceiling” that inspires in politicking Washington stiffs no ends of affected indignation. According to the Congressional Research Service, the debt ceiling has been raised 74 times since March of 1962. And it will, after much posturing and hawing and hemming, no doubt, be raised once again.
The entire discussion of whether or not to extend the limit of one’s own credit card is, in and of itself, absurd. A distraction at best. “Gee…will we vote to allow ourselves to spend more…or not?”
There is only one vote that really counts in the debt ceiling debate: the vote of foreign creditors. The debt will ultimately come due, in other words, when the kindness of strangers expires.
“The only thing we know for certain about our looming fate,” observed Eric Fry in this space during the furor of the Obamney-Robama distraction, “is that we cannot afford it.”
The destiny of the US economy rests “not in the hands of a Barack Obama or a Mitt Romney,” continued Fry, “it rests in the hands of our creditors — guys like Zhou Xiaochuan, Governor of the People’s Bank of China, Masaaki Shirakawa, Governor of the Bank of Japan and Abdullah bin Fahd al-Mubarak, Governor of the Saudi Arabian Monetary Authority.”
Americans can’t count on their own politicians to do the right thing. That’s certainly true. But in the end, they won’t have to. Eventually, their government’s hand will be forced, the blue pills will suddenly wear off…and what is, won’t be any longer.
We begin today with an abject lesson in the “law of unintended consequences” — the bane of bureaucrats and world improvers the world over.
“We’re finding it in our systems, and so are other companies,” says Mark Koelmel. “So now we have to deal with this.” Mr. Koelmel runs the earth sciences unit at Chevron, the oil giant.
“This” refers to a computer virus created by the U.S. government.
The computer virus in question is Stuxnet — developed by the U.S. to cripple Iran’s nuclear capacity. Not that the U.S. government ever fessed up to that. Not officially, anyway:
“We’re glad they [the Iranians] are having trouble with their centrifuge machine,” White House arms control czar Gary Samore commented last year. “The U.S. and its allies are doing everything we can to try to make sure that we complicate matters for them.”
Unfortunately, the Iranians are no longer the only ones for whom “matters” have been “complicated.”
“I don’t think the U.S. government even realized how far [Stuxnet] had spread,” Chevron’s Koelmel tells CIO Journal. “I think the downside of what they did is going to be far worse than what they actually accomplished.”
Koelmel says Stuxnet had no adverse effects on his company — except for the man-hours required to zap the virus from the company’s computer hardware. Other companies? They’re not saying. Chevron kept its situation quiet for at least two years until The Wall Street Journal broke the story late last week.
That’s if most corporate IT departments can even recognize their systems are infected. “There are probably only 18-20 people in the country who have those fundamental skills,” says Alan Paller of the IT security research group SANS.
Good work, if you can get it, we suppose. Apart from the irony unleashed by Stuxnet, we bring it up today because it makes a fine addition to the list of 2013 “gray swans” we identified last week.
The preceding article was excerpted from Agora Finacial’s 5 Min. Forecast. To read the entire episode, please feel free to do so here.
Many people complain about government control of currency, but only a few do something about it. I’m not talking about movements to “audit the Fed” and such. I’m talking about real innovation that makes an end run around the government’s iron grip on the monetary system.
A few of us old folks might like to return to the days of slapping a silver dollar on the bar for a shot of whiskey, but the younger techno-savvy generation sees paying for their Negroni cocktail with virtual currency from their hand-held device. To serve this market, a new world of virtual currencies has popped up spontaneously.
In a debate, Mitt Romney said, “You couldn’t have people opening up banks in their garage and making loans.”
Really? Some people are thinking precisely along these lines and even going further to create new units of accounting.
You might think these people are crazy. After all, to be a proper money, a currency must have a nonmonetary value, a high value per unit weight, a fairly stable supply and be divisible, durable, recognizable, and homogeneous. Gold and silver fit the bill perfectly. But does that mean something else (or a variety of things) can’t?
Money develops from being the most marketable good that in turn is used for indirect trade. Historically, that has been gold and silver. However, governments have worked very hard to demonetize gold and silver with taxes on precious metals and legal tender laws. And while a few people swear by storing their wealth in gold and silver, in relation to all other financial assets, the percentage of portfolios invested in precious metals is only 1%.
The idea that government is going to re-shackle its currency to gold anytime soon, when the only way federal governments are staying in business is with an unfettered printing press, is naive. Governments always have driven and will keep driving the value of their currencies to the value of the paper. It may take decades, it may take centuries, but it will happen eventually.
The answer to the currency question may not be to reform government in a way that it can’t reasonably be reformed, but to turn loose entrepreneurial genius to solve the problem and create a quality product. There are plenty of government roadblocks, but every new innovation encounters government resistance. Entrepreneurs persevere. However, this is a particularly risky area. There are currency entrepreneurs sitting in jail for competing with the government.
In 2009, Japanese programmer “Satoshi Nakamoto” (not his real name) was designing and implementing Bitcoin. It’s not for the faint of heart. It’s proven to be highly volatile. But it’s also proven to be very useful in a digital age.
Some people in the free-market community don’t know what to think of Bitcoin and have dismissed it. They say no currency can exist that doesn’t have a prior root in physical commodity.
That is because, as Robert Murphy summarized Ludwig von Mises: “We can trace the purchasing power of money back through time until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained.”
The naysayers contend Bitcoins never had a nonmonetary commodity value. The case for it is then dismissed without thought or argument. However, Mises built his “regression theorem” on the work of Carl Menger, the father of Austrian economics and subjective value.
In Menger’s view, economizing individuals constantly look to make their lives better through trade. These individuals trade less tradable goods for more tradeable goods. What makes goods more tradeable, Menger emphasizes, is custom in a particular locale.
“But the actual performance of exchange operations of this kind presupposes a knowledge of their interest on the part of economizing individuals,” Menger writes. But Menger goes on to explain that not all individuals gain this knowledge all at once. A small number of people recognize the marketability of certain goods before most others.
These might be considered currency entrepreneurs. They anticipate consumer needs and demands, and as is the case with any other good or service, these entrepreneurs recognized more salable goods before the majority of people.
“Since there is no better way in which men can become enlightened about their economic interests than by observation of the economic success of those who employ the correct means of achieving their ends, it is evident that nothing favored the rise of money so much as the long-practiced and economically profitable acceptance of eminently saleable commodities in exchange for all others by the most discerning and most capable economizing individuals.”
For example, cattle were, at one time, the most saleable commodity and were thus considered money. Although cattle money sounds unwieldy, the Greeks and the Arabs were both on the cattle standard. This currency had four legs that could move itself, and grass was everywhere, so feeding it was inexpensive.
But then the division of labor led to the formation of cities, and the practicality of cattle money was over. Cattle were no longer marketable enough to be money. Cattle still had value, but, “They ceased to be the most saleable of commodities, the economic form of money, and finally ceased to be money at all,” Menger explains.
Then began the use of metals as money: Copper, brass and iron, and then silver and gold.
But Menger was quick to point out that various goods served as money in different locales.
“Thus money presents itself to us, in its special locally and temporally different forms, not as the result of an agreement, legislative compulsion, or mere chance, but as the natural product of differences in the economic situation of different peoples at the same time, or of the same people in different periods of their history.”
So while people contend that money must be this or must be that, or come from here, or evolve from there, Menger, the father of the Austrian school, seems to leave it up to the market. When a money becomes uneconomic to use, it loses its marketability and ceases to be money. Other marketable goods emerge as money. It’s happened throughout history and likely will continue, despite government wanting to freeze the world in place to its liking.
Which brings us back to Bitcoin, what the European Central Bank (ECB) calls in its latest report “the most successful — and probably most controversial — virtual currency scheme to date.”
Ironically, while some economists are pooh-poohing Bitcoin, the ECB devotes some of their lengthy report to the idea that the Austrian school of economics provides the theoretical roots for the virtual currency. The business cycle theory of Mises, Hayek and Bohm-Bawerk is explained in the report and Hayek’s Denationalisation of Money is mentioned.
The report writers indicate that Bitcoin supporters see the virtual currency as a starting point for ending central bank money monopolies. Like Austrians, they criticize the fractional-reserve banking system and see the scheme as inspired by the classic gold standard.
Bitcoins are already used on a global basis. They can be traded for all sorts of products, both material and virtual. Bitcoins are divisible to eight decimal places and thus can be used for any size or type of transaction.
Bitcoins are not pegged to any government currency and there is no central clearinghouse or monetary authority. Its exchange rate is determined by supply and demand through the several exchange platforms that operate in real time. Bitcoin is based on a decentralized peer-to-peer network. There are no financial institutions involved. Bitcoin’s users take care of these tasks themselves.
Additional Bitcoin supply can only be created by “miners” solving specific mathematical problems. There are somewhere around 10 million Bitcoins currently in existence, and more will be released until a total of 21 million have been created by the year 2140. According to Bitcoin’s creator (whomever he or she is), mining on Bitcoin provides incentives to be honest:
“If a greedy attacker is able to assemble more CPU power than all the honest nodes, he would have to choose between using it to defraud people by stealing back his payments, or by using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth”.
The ECB’s report explains that Bitcoin supply is designed to grow in a predictable fashion. “The algorithms to be solved (i.e., the new blocks to be discovered) in order to receive newly created Bitcoins become more and more complex (more computing resources are needed).”
This steady supply increase is to avoid inflation (decrease in the value of Bitcoins) and business cycles caused when monetary authorities rapidly expand money supplies.
Bitcoin has become the currency of the online black market. For instance, The Silk Road (the Amazon of the illegal drug trade that can only be accessed through private networks using the IP scrambling service called Tor) only accepts payments in Bitcoin. However, as the ECB report points out, there are only about 10,000 Bitcoin users, and the market is illiquid and immature.
So why does the ECB give a damn about Bitcoin and other virtual currencies? The central bankers are worried that they are not regulated or closely supervised, that they could represent a challenge for public authorities and that they could have a negative impact on the reputation of central banks.
At the same time, the report makes the point that “these schemes can have positive aspects in terms of financial innovation and the provision of additional payment alternatives for consumers.”
The report says big players in the financial services arena are purchasing companies in the virtual payments space. VISA acquired PlaySpan Inc., a company with a payment platform that handles transactions for digital goods.
American Express (Amex) purchased Sometrics, a company “that helps video game makers establish virtual currencies and… plans to build a virtual currency platform in other industries, taking advantage of its merchant relationships.”
This would dovetail with American Express’ entry into the prepaid credit card business. Banking industry insiders are upset with Amex and Wal-Mart, that also is offering prepaid cards, because these prepaid accounts would amount to uninsured deposits, according to Andrew Kahr, who wrote a scathing piece on the issue for American Banker.
Kahr rips into the idea with this analogy:
“To provide even lower ‘discount prices,’ should Wal-Mart rent decaying buildings that don’t satisfy local fire laws and building codes — and offer still better deals to consumers? And why should Walmart have to honor the national minimum wage law, any more than Amex honors state banking statutes? With Bluebird, Amex can already violate both the Bank Holding Company Act and many state banking statues.”
Kahr is implying that regulated fractionalized banking is safe and sound, while prepaid cards provided by huge companies like Amex and Wal-Mart is a shady scheme set up to rip off consumers. The fact is, in the case of IndyMac, panicked customers forced regulators to close the S&L by withdrawing only 7% of the huge S&L’s deposits. It was about the same for WaMu and Wachovia when regulators engineered sales of those banks being run on. Bitcoin supporters, unlike the general public, are well aware of fractionalized banking’s fragility.
Maybe what the banking industry is really afraid of is the Amexes and Wal-Marts of the world creating their own currencies and banking systems. Wal-Mart has tried to get approval to open a bank for years, and bankers have successfully stopped the retail giant for competing with them.
However, prepaid credit cards might be just the first step toward Wal-Mart issuing their own currency — Marts — that might initially be used only for purchases in Wal-Mart stores. But over time, it’s not hard to imagine Marts being traded all over town and easily converted to dollars, pesos, Yuan, or other currencies traded where Wal-Mart has stores.
Governments are destroying their currencies, and businesses know it. Entrepreneurs won’t just stand by and theorize. They’re doing something. They recognize a market opportunity. The banking industry realizes it. As Mr. Kahr concluded his article that calls for an end to all uninsured deposits: “Otherwise, we might have an unregulated Facebook or Google of payments, even PayPal, quickly becoming both highly vulnerable and TBTF. (It could actually be run by someone wearing a hoodie, without tie or even white shirt!)”
Here at LFB, we don’t know what tomorrow’s money will be. Digits and computer algorithms? Silver and gold coins engraved with someone wearing a hoodie, perhaps? What we know for sure is that we’re rooting for enterprising entrepreneurs to give the government a run for their money in the money business. Watch this space.
Original article posted on Laissez-Faire Today
In the late 1950s, John Bogle changed the investing world.
Bogle became the chief advocate for index investing, a strategy based around the idea that investors should stop trying to pick individual stocks, quit buying mutual funds, and just buy the big stock indexes.
Why would an investor take such a hands-off approach? Bogle cited research that proved that most actively managed mutual funds don’t beat the market — and on top of that, they charged hefty management fees for their mediocre performance. The data was damning, and Bogle’s fund, the Vanguard 500 Fund, became one of the most popular investment funds in history, today worth more than $26 billion.
The Vanguard 500 fund doesn’t pick stocks. Its managers don’t have opinions on which indexes are best. It just tries to mirror the S&P 500 Index as closely as possible. And it does it for a tiny management fee.
Today, there are scores of index funds and ETFs that mirror all sorts of different market indices. If you want to buy “the market” or “stocks in general,” just plow some cash into one of the funds. Passive, hands-off investing has become the norm for scores of investors in the last five decades, becoming the “buy and hold” strategy that most people know about.
So, if passive index investing is so great, why would you ever want to pick a stock again? Well, it’s because the hands-off, buy and hold approach isn’t so great after all.
Today, I want to bust some myths about everyone’s favorite way to invest…
For starters, there’s no such thing as a “buy and hold forever” approach (no matter what certain octogenarian billionaires in Omaha may claim). That’s because everyone who’s ever tried it is broke.
Even though everyone in the industry calls index investing “passive,” there’s really nothing passive about it. The Dow, the S&P, the Russell — they’re all active investment strategies. Don’t follow?
Of all of the stocks that were part of the original Dow Jones Industrial Average, only General Electric is still a part of the index. All told, the index has changed 48 times since it was created — all of those changes being picked by the editors of The Wall Street Journal. That means that the Dow is, in fact, an active stock-picking index.
It’s how they unloaded garbage names like Kodak, Chrysler, and Woolworth when they hit the skids…
The S&P 500 is no different. S&P components are picked by a committee at Standard & Poor’s, who try to make the index mirror the 500 biggest stocks on the market. Since the rules on who makes it into the S&P 500 are largely based on who’s the biggest, stocks that fall get tossed out, and stocks that increase in value get added. So, in other words, the S&P committee is selling the losers and buying the winners. It’s the very reason why Apple (NASDAQ:AAPL) is a bigger chunk of the S&P 500 now, and Enron isn’t. We’ll get back to that in a minute.
The bottom line is this: passive investing doesn’t spare investors from the risks of stock picking. It just takes the stock picking off of portfolio managers’ plates and leaves it up to Dow and S&P. Clearly, that hasn’t worked very well lately. In the last 12 years, for example, the S&P 500 has actually lost just over 2%. So much for “buy and hold” always working out in the long-term.
A Different Way to Invest
But there is a different way to invest — a better way…
The key is in that phrase I mentioned from the S&P: selling losers and buying winners. It’s ironic, but the most successful long-term strategy any fundamental investor can point out is in essence a technical approach known as “trend following”.
The main idea behind trend following is simple: the market moves in big, long-term trends, and if you can identify them, you can ride them. It’s an approach that some of the most successful investors in history have used — and one you can use too.
Trend following can also avoid the pitfalls that index investors have struggled with over the past few years. You see, the S&P’s approach to trend following is crude at best. Since correlations between stocks in the S&P are very high, it’s not as effective at reducing risk as it could be. That’s why a purpose-built trend following approach makes so much more sense than all of this buy-and-hold brouhaha.
So, what would it look like?
For trend followers, there are basically two steps to figuring out what to buy: identifying when a trend begins and identifying when a trend ends. To do that, we don’t rely on emotion or opinion — instead, it’s critical to base any investment decisions on a set-in-stone system.
Today, we’ll construct a quick one.
Spotting a Trend Using Math
If you’re familiar with “technical analysis” at all, you’ve probably heard of a moving average. In short, it’s the average price of a stock over a set number of days. A moving average is a stellar indicator of trend — if it’s moving steadily higher, then we know that a stock is generally moving higher over the time period that we’ve set. More importantly, we can define moving averages mathematically, so, we’ll go ahead and use a moving average as our “trend indicator”.
For simplicity’s sake, we’ll apply it to just one investment: the SPDR S&P 500 ETF (NYSE:SPY).
So let’s create a quick rule. If SPY moves above the 300-day moving average (a long-term average that approximates a year’s worth of price data), we’ll buy. If it falls below the 300-day, we’ll sell. In real terms, that rule says that if SPY moves above the 300-day moving average, Mr. Market is entering an uptrend, and if it moves below, it’s entering a downtrend.
So, how would that simple strategy have fared over the last fifteen years? The chart below shows the hypothetical profit and loss of sitting back and letting that simple system trade for you:
All told, you’d end up with gains of 74.3% — nearly double the 40% and change that a buy and hold approach would have earned you. But there’s an even more exciting story there…
See the handful of flat lines (with red arrows pointing to them) over that period? Those are the times you’re out of the market because the system said “sell”. So you didn’t touch stocks for almost 2 years while the tech bubble was bursting, and you were out of the market for all of 2008! I think you can see just how dramatically this system reduced the risks of being an investor.
Because despite that “hands off” approach to investing, you still beat the market by a wide margin.
Remember, the rules we just made up are crude. By adding some extra simple short selling rules to the approach, our trend following system could have upped its total profits to 80.8%, and actually made substantial profits when the floor was falling out for everyone else in 2008.
Our crude trend following system produced a chart that’s hard to believe, especially when you consider the fact that it includes two of the biggest market crashes in most investors’ memories.
There’s a lot an investor can do to improve performance beyond what I’ve shown you here — adding individual stocks, more complex rules, or introducing statistical optimization are all things that can easily improve returns under a trend following system.
But the key here is the fact that following trends (and not trying to predict them) can fuel some incredible returns while smashing risks much lower than you’d see from a “buy and hold” approach.
Turns out our infrastructure problems in Baltimore just keep getting worse.
Yesterday, another water main break occurred right near our DRH headquarters. Water pressure was reduced to a drip on higher floors and our faucets were spewing out delicious brown-colored water.
If this micro-trend is any indication of what’s to come, which I believe is the case, the U.S. is set for infrastructure overhaul. And today we’ll cover a few ways to play it…
If you remember from our discussion yesterday, America’s coming infrastructure boom is a two-part phenomenon.
First is the need to fix ailing infrastructure that’s simply too old. Much like the 1913 water main in Baltimore or the bridge in Minnesota, much of America’s infrastructure has paid its due and now needs to be replaced.
The second part of the story is that we’ll actually have a way to facilitate this infrastructure boom with a bountiful supply of oil and gas. With more domestic energy flowing in the pipes, not only is the private sector enjoying a cost advantage over the rest of the world – but the local/state/federal government is benefiting from oil and gas taxes and fees.
The need for infrastructure AND the means to pay for it, I love it when a plan comes together!
That’s the backstory. Today let’s take a look at three ways to play it.
Fluor Corp. (FLR) is a 100-year veteran in the American infrastructure industry. This multi-billion dollar company is a huge player in the energy and mining sectors along with regular infrastructure and government projects.
The great part about Fluor is its primary focus on the energy sector. So while America’s energy boom continues to grow the demand for gas-fired power plants, ethane separation plants, petro-chemical plants and other energy-related industries will blossom. Fluor is a go-to contractor for these large-scale projects.
Fluor is also a major player when it comes to global infrastructure for the mining industry. You may remember a few write-ups that we’ve posted here about the enormous resource potential of Mongolia. Well, it just so happens that Fluor is the contractor for what could be the world’s largest copper mine, the Oyu Tolgoi copper mine in Mongolia.
Getting back to the point, Fluor also handles major domestic infrastructure projects, including its current work on the San Francisco Bay Bridge. Add it all up and you’ll see that Fluor has a bright future here at home and abroad.
Another company that should be on your radar is Mueller Water Products Inc (MWA.)
Mueller is a direct play on domestic water infrastructure – in fact, the company is the leading North American provider of water infrastructure, flow control products and services.
By the looks of their share price year to date, things are booming! Mueller is up over 104% since January. Although the company has shown a substantial run-up, its current price is still 70% below its 2007 highs. So there’s still plenty of room for growth, as the infrastructure biz picks up.
A third way to play the coming infrastructure boom focuses less on regular infrastructure and more on what we’ll call “energy infrastructure.”
After all, America’s infrastructure overhaul isn’t going to emerge without “cheap” energy. Without oil and gas flowing plentifully through our pipes we’d be hard-pressed to find the resources to establish the 2013 version of the New Deal.
But with cheap energy, say $80 oil and $3 natural gas, there will be plenty of wealth floating around the country. Tax revenue from oil and gas operations will fill the coffers and fuel some loose-money infrastructure projects.
This money flow will also fill the pockets of private companies – specifically ones that control the energy infrastructure.
A great way to play energy infrastructure in one fell swoop is through the SPDR Macquarie Global Infrastructure 100 ETF (GII). Out of all the major energy/infrastructure plays this ETF offers a solid list of holdings all in one easy to own share.
As I type, holdings include large utilities (Duke Energy, Southern Co and Dominion) along with pipeline and infrastructure plays like National Grid, Transcanada and Enbridge. It’s a one stop shop for the best energy-infrastructure plays – plus, it gives you a solid 4% dividend.
Looking ahead, our country’s infrastructure needs more than just a band-aid.
Today, with revenue bursting from America’s energy patch, we’re sure to see nothing shy of an infrastructure overhaul.
America’s infrastructure boom is coming, now’s the time to buy in.
Keep your boots muddy,
Original article posted on Daily Resource Hunter