Wednesday, September 23, 2009

Wednesday FOMC Day

I got a sense there was more attention than usual to the FOMC announcement today. I have no idea why that would have been. I will try and make some sense of it all tonight.

Reason Number 1,245,678 to Vote Against Every Incumbent Everywhere: Hypocrisy
Back in time around late 2003 Massachusetts had a Republican Governor. There was a huge fear by the 92% democrat held state government that if John Kerry should beat George Bush for the Presidency, the governor would appoint a Republican senator to replace him. The state legislature immediately went out and over the course of 2 weeks changes the longstanding rule to allow for a special election to fill the seat.

The argument was that the will of of the people must be followed, not the whim of a partisan governor. Ok, I'll play. While I think changing an almost universal rule was an over reaction, I allowed that the argument that lack of representation until a special election better fits a state like ours. Fair enough.

Fast forward to today, 2009. Senator Kennedy has recently passed, and the special election is set for this late fall. But now of course, the ability of a democrat governor is impaired by the very rule the 92% majority forced through as law an this of course cannot stand. Again, in the space of two weeks the law has been changed to allow the governor to appoint a replacement on temporary basis, until the special election. And what happens should another republican win the top office? I think you can figure that out.

I point this out to highlight hypocrisy. I am sure the same games go on in heavily republican states with the same kind of intellectual dishonesty. What can you do? Easy, vote against every single incumbent come next election. That way at least you are sure to get new hypocrites.

The Bubble in Gold Debate
I really wanted to leave this one alone, but of course "Just when I thought I was out, they pull me back in". My good friend over at Illusion of Prosperity wonders in last nights offering "Is There a Gold Bubble?" The author writes:
In my opinion, in order to justify gold's current price then inflation better show up at some point. Further, if inflation does show up there are probably better things to hoard than something that has already risen by a factor of four. Toilet paper continues to come to mind. Just a thought.

I know this isn't going to be popular with the gold bugs, but I just call it like I see it. I'm not saying gold is in a bubble, but I certainly have no interest in buying it (again) at these prices. There is serious risk at these levels and that is not something I look for in a "safe" store of value. Maybe that's just me.
My first thought is "it is far too hard to identify bubbles as they are forming, but better to try and mop up the mess after they have burst"...I am kidding! That was the FED's answer to the DotCom bust!

Because I know the author well I can guarantee he is not a gold hater by any means, he just sees better opportunities right now. Given the current market mess, I think anyone espousing putting all your eggs in one basket is asking for trouble as well.

My answer about a golden bubble was written on March 27th of this year. In a post titled "Will the Next Asset Bubble Please Stand Up?" I laid out the following criteria for a bubble to happen ( I hate to quote myself!):
To find that next great chance at a lottery winner, we must first describe some criteria that have to be met for the next bubble to really take off. Here are some qualities I think would be needed:
- Exciting (E): to foster attention and participation said bubble has to have an element of excitement. Junk bonds are so boring, you know?
- Leverage Access (L): for a bubble to really get going you need access to leverage to expand buying power above and beyond that which is directly available to the buyers.
- Believability (B): the next bubble needs a believable storyline, well at least a good story. We all know beanie babies are not going to cost 1 million dollars, but a condo in North Dakota? Maybe!
- Low Entry Threshold (T): the next bubble will not be in some kind of hedge fund that requires 100 million in assets to qualify for participation.
- Displayable Results (R): like YHOO stock rolling up 30% every month or a home going up in price 20% every 3 months, there has to be some way for the masses to show their awesome investment skills off to the world.

With an eye on this criteria, lets look at some possible candidates and score (1 lowest, 10 highest) them on each category.

I looked at Oil, Real Estate (again!)and Gold. On gold, here was my scoring:
Candidate 3: Gold
E score: 9
Gold is about as exciting as it gets. Shiny and never changing, gold gets the blood pumping
L score: 4
While ETF's can be bought on margin, real bullion sellers will not play loose with the leveraged buying only by all but the big boys.
B score: 9
If you think paper money the world over is backed by mostly nothing, gold sells itself. That gold has been money since the dawn of man is a solid tale.
T score: 3
A little gold is easy and cheap. Any real amount gets expensive, fast.
R score: 9
Gold prices run on most market tickers and eBay can always get you excited about how much you could auction your gold off at.
Total score: 34

In reference, Gold scored higher than Oil, but below a replay of Real Estate.

I think the leverage issue is a major one. The main point to take home is still how small an investment gold is for almost the entire US market.

Can gold be overpriced right now? Yes, it can. Can gold have much further to go to the upside? Of course. If gold is indeed a bubble, it was the slowest expanding bubble in history. We have yet to have the blow off top where taxi drivers are telling you to buy gold!

The debate is always fun, but as always a balanced portfolio with out all bets on one sector has always been my position. If you are of the end of the world bent, items other than gold will be far more useful. Scope out Survival Blog to understand just what the minimum would require.

Wednesday FOMC Day
The FED announced nothing earth shattering today. The only change was some language about some pick up in economic activity. The FED said they will extend MBS purchases out longer, but in smaller amounts. That was about it.

The market I think was front running some kind of expansion of both the treasury buying and MBS buying. The sell off after the news would back this up. I would caution the bears about getting excited here, by tomorrow the bulls will have a new story to rally around.

As far as the FED, they in no way hinted at any exit strategy, no matter what you will read across the media today. They all but bold typed the "we reserve the right" to expand these programs. In light of the dollar beating that has been going on, the FED should play for time before rolling out more market support, and that is all they did today. The end of October (treasury purchases) is still far off, and March of next year (MBS buys) may well be 2020 for how long that will seem in economic terms.

For all the economists out there that can summon cool charts and make awesome graphs I would offer you a homework assignment. Figure out how far "below capacity" the US economy would run at even historically "normal" interest rates. Try out a FED rate of even 2%, 3%, and all the way up to 5%. Still think a rate hike is coming before 2012? Run those numbers again.

Have a good night.


Stagflationary Mark said...

"Because I know the author well I can guarantee he is not a gold hater by any means, he just sees better opportunities right now."

I certainly don't hate gold. I was the type of guy who liked the heavier audio equipment (assuming the specifications were good) just because it felt worth the money, lol.

So how do you think I felt when I compared the 1964 "junk" silver quarter to the 2009 "collector" state quarter? My biggest risk is actually the feel of a gold or silver coin in my hand. It's hypnotic.

That said, I don't try to make investments based on emotion. There are a lot of things I may someday want in my hand even more. Like... um.... well... you can probably see this coming...

A roll of toilet paper! Hahaha!

We take so much for granted in this country. There may come a time when we shouldn't.

Lisa said...

Hey G! Glad the patient is doing better. Hugs to you!

GawainsGhost said...

Yes, GYC, glad to hear you mom is doing better and out of danger. Here's to hoping she makes a full recovery and enjoys a long life.

As to the whole gold vs. real estate thing, I'm not a gold hater, but I'm not a gold lover either. It's a sound investment as part of a diversified portfolio, however I wouldn't put all of my money into it, nor would I put all of my money in real estate either.

The thing is that I just happen to know more about real estate than most people, because I grew up in it. You don't start at the age of eight and watch your mother become a prominent broker and build a very successful company without learning a thing or two.

I'm on a first name basis with multi-millionaires who made their fortunes in real estate. And I noticed how they did it. I'm also on a first name basis with many more zeronaires who went flat broke in real estate. And I noticed how they did it too. I'd much rather emulate the former than the latter, but that's a no brainer.

Anyway, the deal with real estate is that it is, more often than not, a higly leveraged investment. So it's extremely important that you do your research and make intelligent decisions on where and when to purchase. This is what most people don't understand. They fall in love with a house or piece of property, and then rush in. That's stupid.

All old cliches are true. It's location, location, location. This is why McDonald's is such a successful franchise. Because they spend a lot of time researching, particularly looking for corner lots in high traffic areas, before they make a purchase and open a new restaurant.

Most of the people I know who made millions in real estate all did it the same way. They bought up large tracts of land on the outskirts of towns, zoned them agricultural to minimize the taxes, then sat on them for twenty or thirty years, waiting for the growth and development to come. When it did and the value of their land was ten times or more than the paid for it, they sold and walked away with a whole lot of money.

It's the same with us. About 20 years ago, we had two large offices in two different cities. Then my mother realized that she had twice the office expenses, but she wasn't selling twice as much real estate. So we bought an old ranch home on seven acres centrally located between the two cities and converted it into an office. At the time there was nothing around it, just a lot of vacant land, so it only cost about $250,000.

Well, about five years ago, the growth and development came. The cities started to expand, streets were widened, businesses began to spring up, and now there's whole new subdivisions with new homes right across the street. That old ranch home probably isn't worth much these days, but the seven acres of undeveloped real estate it sits on, give the location, is probably worth at least $2.5 million.

In fact, that land is worth so much money, you'd have to be a fool to sell it today, because in ten years or so, it will be worth four or five times that much.

The difference between gold and real estate is the difference between real estate and real property. Real estate is the land and its improvements. Real property is the rights associated with it--the right to sell, tranfer, build on, do nothing, etc. Gold is like real estate, it's the physical substance itself. And there is real property associated with it, albeit somewhat limited. You do have the right to sell or transfer, but there's not much you can do to improve it, other than convert it into jewelry. Owning a gold mine, however, now that's a different story.