Fir securewealth 0

A Publication of Newsmax.com and Moneynews.com

Investment Principles for A Lifetime of Secure Wealth

The Most Valuable Secrets Of the World’s Best Investors Revealed!

Page 2 Financial Intelligence Report Special Report

In This Report

• Page 3: LessonsfromaMasterInvestor

• Page 4:BuildingaSafe,High-IncomePortfolio

• Page 5:SectorInvesting:HowtoBeattheS&P500EveryYear

•Page 7:WhyWillGoldAlwaysHaveValue?

• Page 12:WhattheGovernmentDoesn’tWantYoutoKnowAboutInflation

• Page 14:TheDangerousDollar:ProtectingYourWealthbyInvestingAbroad

• Page 17:UseGlobalSectorInvestingtoProfitFromaSoftU.S.Economy

• Page 18:Bewarethe‘Decoupling’Myth:EmergingMarketStocksCanBeRisky

• Page 20:ChinaHoldstheKeytoU.S.EconomicRevival

• Page 21:ThePensionFundTimeBombIsTicking

• Page 24:ProfitWhentheU.S.BondBubbleBursts

• Page 26:ProfessionalInvestorProfilesofWarrenBuffett,WalterSchloss,GeorgeSoros,JimRogers,DavidSkarica

OnthesecondFridayofeverymonth,at12noonEasterntime,internationalinvestorsdialinonaprivatenumber.Forthenexthour,theywilldivulgesomeoftheirbest-keptinvestingsecrets,bringingclaritytothedirectionofinvestments.Everyonevoiceshisorheropinionsinafreewheelingconversationthatcangetabitheatedattimes.Theirgoal:sharingthebestinvestmentideasfromaroundtheglobe.ThebestoftheseideasbecomethebackboneforarticlesandinvestmentopportunitiesinFinancialIntelligenceReport.

Sohowdidthisgroupofindividualinvestorsfirstform?Afterthe2000-2002marketcollapse,theneedtoprovideindependentguidancetoindividualinvestorswasclear.Afterall,inthatfreefall,brokersdidn’tgettheirclientsoutintime.Moneymanagerspreferredsittingbackandcollectingtheirfees,ominousmarketsignalsbedamned.

NewsmaxfounderChristopherRuddy,beingaLondonSchoolofEconomicsgrad,knewhowthewell-offtrulygetwealthy.It’snotbylisteningtooffice-dwellingbrokersorfollowingloudmouthedmediapundits.Thoseonlyfoganinvestor’svisionandleadhimastray.

Thesecrettoinvestingistohaveawell-connectedteamofinsiderexpertswhothinkindependentlyofWallStreet.AndRuddyhadassembledsuchateamforhimself.Butnotbeingthetypetokeepallthisinformationhiddenorsecret,RuddydecidedtopublishthisinformationonceamonththroughFinancialIntelligenceReport,providingacontrarianviewpointtothemarket-makingnewsofthedayandarecommendedportfolioofstocksandotherinvestmentsapersoncouldusetoprotecthisorherassetsingoodtimesandbad.Thefirstissuecameoutin2003.Theresultssincehavebeentremendous.

ThefollowingreportdivesbackintoourpagestofindsomeofthebestarticlesfeaturedinFinancialIntelligenceReport.TheinvestmentprinciplesillustratedherehaveheldtruefordecadesandhavehelpedguideFIRforthepasteightyears,eventhroughthetumultuoushousingbubbleand2008-2009worldwidefinancialcrisis.

Althoughouropinionatedcollectionofexpertshavebeenknowntodisagreewitheachother,alltold,thereisarunningundercurrentthroughoutFIRofcommoncorebeliefsabouttheoverarchingtrendsoftheworldeconomyandtheproperwaytoinvestforsafetyandgrowth.Atthebottomofeacharticle,we’veprovidedreferencestootherissuesthatalsocoveredthatsameorasimilartopicifyou’reinterestedinreadingfurtheronanysubject.Youcanaccesstheseissuesasasubscriberatthewebsite,www.FinancialIntelligenceReport.com.

FinancialIntelligenceReporthasbeenlabeledbearish,contrarian,insider,outsider,and,well,justabouteverythingunderthesun,byfansanddoubtersalike.Butperhapsthebestwaytoillustratethephilosophyofthenewsletteristhroughastory,whenRuddyvisitedafriendandmentor,SirJohnTempleton.Ruddyrecountstheencounterinthefollowingessay,writtenafterTempleton’spassingin2008.

Introduction: How FIR Came to Be


Lessons From a Master InvestorThe world lost a great man in July 2008 when Sir

John Templeton passed away at age 95. Templeton, most widely known for his investment savvy, founded the Templeton Funds. His reputation for business acumen is well-deserved. Many of the “great” stock gurus — I won’t name names — haven’t even beaten the S&P 500 over the long term.

Meanwhile, it’s estimated that $100,000 invested with Templeton in 1954 would’ve grown to more than $20 million by 1992. Over this period, Templeton returned 14.5 percent annual gains to investors. Money magazine dubbed him “the greatest global stock picker of the century.”

I had the honor of visiting Templeton at his Lyford Cay, Bahamas, enclave twice in his later years. My last visit with him was in 2006. He was 92 at that time, and while his body was beginning to show some frailties, his

mind was remarkably sharp.He clearly enjoyed talking

about investments and the world economy, but he was most animated when talking about spirituality and religion. He had put the bulk of his John Templeton Foundation — more than $1.5 billion in assets — behind his efforts to help mankind understand spiritual forces.

Always the businessman, Templeton made a deal with me each time I met him. He would talk to me about the financial world for our readers — but I had to detail in my reports his views on the importance of a spiritual life. It was a done deal.

It is interesting that a man so identified with Mammon also would be so closely involved with God. In reflection, these associations are not opposites. Templeton understood that great moral foundations underpin our free society and free-enterprise system. Our system of contracts works because contracts are honored by honest people. People honor contracts because of their faith and accountability to a higher power.

As for his legacy in the investment world, Sir John Templeton has left an enduring mark there, as well. If one word could sum up his investment philosophy, it is “contrarian.” Many of us talk about being contrarian, but most people find it difficult to break from convention. Templeton lived his life as a contrarian.

Even as a young man, Templeton was a pioneer contrarian. He told me how after graduating from Yale,

he began investing in foreign stocks. Such an idea seems quite acceptable today but, as Templeton recalled, many Americans viewed it as a betrayal of the country to invest abroad. Templeton didn’t see why in a free-enterprise society an individual should limit oneself to one country’s equities when so many opportunities existed elsewhere.

Because of this lack of interest among many Americans in foreign stocks, he told me, he was able to find tremendous bargains around the world.

For Templeton, one of the cornerstones of his investment philosophy was to ignore conventional wisdom. When he moved full time to the Bahamas in the 1980s, he brought his offices with him from Rockefeller Center. Yet, he revealed, he was quite worried about his future investment performance. Away from the center of things, could he invest wisely?

“I actually performed better here than in New York,” he said with a smile. His explanation was that, in the Bahamas, he saw things more clearly, once he was away from the influence of the New York investment world. Templeton summed up his investment approach this way: “Buy when others are despondently selling, and sell when others are greedily buying.” He had a great ability to sense the moment of “maximum pessimism.”

Back in 2005, for instance, he plainly saw the housing bubble for what it was. He predicted to me then that he had little doubt the market for houses would collapse in the United States. He said home prices would fall as much as 50 percent in some markets.

His prediction about the housing market was uncanny.Though he was a contrarian, he was never a pessimist.

He was a realist. He predicted that the Dow would tank as a result of the housing crisis but that it would not be in a permanent trough. He predicted the Dow hitting 20,000 in the next decade or so.

At 92, when I visited him last, he was full of life. I asked him his secret for longevity and good health. He looked at me and said just two words: “Never retire.” He said he wanted to write a book on the subject. He was apparently too busy to accomplish that.

Another secret was exercise. He liked golf, but it took way too much time, he said. He did some calculations and figured out that if he went into the Atlantic Ocean and walked against the current for 45 minutes, he would burn as many calories as walking on the golf course for four hours. He soon took up the practice of walking in the sea and continued it into his 90s. Indeed, it was the story of his life, always walking against the current.

Sir John Templeton


This story originally ran in our inaugural issue in September 2003. It talks about some core principles of the FIR investing style, including the power of dividend stocks, and gives a very concise playbook for when it’s time to get defensive.

Theeraofdouble-digitannualgainsfromamixedportfolioofstockshasgone,anditwillnotreturnovernight.Accordingtohistoricaldata,therealrateofreturn(returnsadjustedforinflation)fromstocksoverthepast200yearsliesbetween6and7percentannually.

ConsidertheanalysisofRobertPrechter,oneofthemarket’sleadingbears.Prechteranalyzedthestockmarketfrom1966through1994,thebeginningofthelastgreatriseinthebullmarket.Hediscoveredthatbetween1966and1994,aninvestmentintheDowJonesindustrialswouldhaveproducedazerogainforaninvestor.

PrechternotedthattheDowJonesindustrialsrosefrom1,000tocloseto4,000pointsalmostthreedecadeslater.Butheexplainedthatthealmost3,000-pointincreaseby1994wasfornaughtinrealmoneyterms.Wheninflationisfactoredin,theactualcostbasisoftheshareswasaboutthesameas30yearsearlier.

Choosing Equities That Protect — and Pay Off Long Term

Dividend-payingstocksareoftenlifeboatsinastorm.Companiesthatpaydividendsshowasignnotonlyoffinancialstrengthbutalsoofmanagementdisciplineandcommitmenttoshareholders.

Additionally,recentstudiesshowthatdividendpayersgenerallyoutperforminbullandbearmarkets.Inonecase,analystsstudiedthemedianquarterlyreturnsoftwogroupsofstocks,thosethatpaiddividendsandthosethatdidn’torpaidonlysmallones.

Whenmarketsgetchoppy,theaddedlureofincomecanpreventsteeplossesindividend-payingstocks.

Tounderstand,adividendyieldisacompany’sannualdividendratedividedbyitsstock’slatestclosingprice.Forexample,theyieldfora$20stockthatpaid$1individendslastyearis5percent,the

sameasfora$40stockthatpaid$2.Therearetwowaysastock’syieldcangrow:

•Thecompanydecidestoincreaseitsdividendpaymentstoshareholders.

•Thestockpricefalls,meaninginvestorscanbuyintothatdividendforlessmoney.

Expertsoftenusethefive-yearTreasurynoteyieldasacomparisonforsearchingfordividends,buttheysayinvestorsshouldnotlimittheirchoicesbyomittingstocksthathavepotentialshare-priceappreciation.

Investorsshouldmakesurethatthecompanyhasplentyofcashonthebooksandthatthedividendiscomingfromexcesscashflow.Aftershareholdersarepaid,therestillshouldberoomforcapitalspendingandthingslikeacquisitions,researchanddevelopment,andsharebuybacks.

Investorscantellhowmuchcashacompanyisusingtocoveritsdividendsbylookingatthepayoutratio,orthepercentageofearningspaidoutindividendsovertime.Yieldsondividendstocksalsoshouldnotbeastronomical.Whenstockspaysky-highdividends,itcouldbearedflagandthepayoutcouldbeunsustainable,althoughthereareexceptions.

Companiesoftencananddocuttheirdividendstosavecash.Toweedouttheonesmostlikelytopullbacktheirpayments,expertssaypayoutratiosshouldbebelow75percent.Thatmeansacompanyispayinglessthanthree-quartersofitsprofitsoutasdividends.Usingalowerpayoutratioisgoodbecausecompaniescanaffordtokeeppayingthosedividends.

Recessionary Stock Investing: Playing Smart Sectors

Overalldeclinesinthestockmarketandtheeconomydonotmeanthatallsectorswillperformpoorly.Infact,investorsoftenfindsectorsthateitherflourishinbadeconomictimesorareamongthefirstsectorstobenefitfromthereturnofabullmarket.

Hereareseveralsectorsthatseemtoworkwelldespiteeconomicbadtimesandmarketwoes.

Soft drinks.CompanieslikeCoca-Colaandothersoft-drinkbottlersseemtoperformwell,asdomany

Building a Safe, High-Income Portfolio


foodindustriesduringeconomicbadtimes.Duringbullmarkets,theydon’ttendtoriseasquicklyasothersectorsbutaregoodlong-termstableinvestments.

Pharmaceuticals.Drugcompanieshavecontinuallypostedstrongerandstrongerprofits.Unlessthegovernmentgetsintothemixandoffersnewregulationstolimitdrugcompanyprofits,theseshouldcontinuetopaybigdividends.Foronething,therewillbeahugedemographicboomaffectingpharmaceuticalsasthebabyboomersbegintoretireatage65in2010.Pharmaceuticalscouldexplodethen.

Other food suppliers. Wementionedsoft-drinkmakers,butfoodcompaniesingeneralaregoodinvestmentsinbadtimesandgoodtimes.

Oil companies. Oilremainsoneofthemostimportantcommoditiesintheworld.Andthoughpricesmayfallinthenearfutureasproductionincreases,theywillremainasignificantrevenue

streamforinvestors,oftenpayingqualitydividends.Telephone companies.Telephonecompanies—

particularlytheoldAT&Toperatingcompanies,whichpaydividendsandhavetheneteffectofmonopolies—willcontinuetobesolidinvestmentsforinvestorsingoodandbadtimes.

Tobacco.Despitegovernmentregulations,tobaccocontinuestobeanextremelyprofitableinvestment.Also,worldwidetobaccocompaniescontinuetobringrichdividendstoinvestors.

Electric utilities.Notonlyisthereapotentialforupsidewheneconomictimesaregoodandthereiscapitalappreciationonthestock,butthesecompaniesalsopayrichdividendsandofferstableshareprices.

Editor’s Note: For further reading, see articles regarding asset allocation in issues 8, 20, 26, 33, 42, 48, 59, 74, 85, and 92.

Sector Investing: How to Beat The S&P 500 Every Year

In the fourth issue, published in January 2004, we delved into sector investing, which has been a hallmark of our style that has helped the FIR Portfolio consistently beat its S&P 500 benchmark.

Thekeytomakingmoneyinfinancialmarketsisknowingwhentoinvestinwhat.Asthesayinggoes,“Everydoghasitsday.”Similarly,everysectorhasitsheyday.

Inthe1940s,itwasdefenseandnatural-resourcestocks.Inthe1950s,itwasbluechipsandindustrials.Inthe1970s,itwascomputers.Inthe1980s,itwasfinancialservices.Inthe1990s,itwastheInternetandhigh-techstocks.Inbullandbearmarkets,specificsectorsareoftenwinnerswhileothersareclearlosers—hencethewisdomofsectorinvesting.

What Is Sector Investing?Asectorisaportionoftheoverallstockmarket

unitedbycommoncharacteristics,suchashealth-carestocksordefensestocks.Sectorinvestingmeansfocusingyourinvestmentsonaparticularsegmentthatyouexpecttobenefitfromthepresentandnear-termtrends.

Bycorrectlytiminginvestmentsintheboomingsectors,youcanmakespectacularprofits—or,withbadtiming,sufferspectacularlosses.

Oneofthemostdramaticexamplesisthedot-comboomandbust.Towit,duringtheboom,theseonce-highflyerssoared:

•AOLsoared1,538percent.Every$10,000investedgrewtomorethan$163,000.

•JDSUniphasewentup2,683percent.Every$10,000grewto$278,261.

•Yahoogalloped2,512percent.Every$20,000investedgrewtomorethan$520,000.

FundresearchandratingcompanyMorningstarInc.tracks10differentsectors:

•ConsumerDurables•ConsumerStaples•Energy•Financial•HealthCare•IndustrialCyclicals•Retail•Services•Technology•Utilities


Choosing Your SectorsYoucanmakehugeprofitsbyinvestinginsectors

ontheirwayup.Unlikedaytrading,inwhichyouprofitbasedonshort-term(evenhourly)fluctuationsinstockprices,sectorinvestingislong-terminvesting(oneyearormore)basedonunderstandingandpredictingmarkettrends.

Forinstance,whentheBerlinWallandSovietUnionfell,thatwasobviouslythetimetobailoutofdefensestocks.Conversely,rightafter9/11wasthetimetojumpbackin.

Herearesomeotherexamplesinwhichsectoranalysishasprovedinvaluable:

•BetweenMay2000andJune2003,theFederalReserveSystemdiscountrate—theratetheFedchargedmemberbanksforborrowingmoney—fellfrom6percenttolessthan2percent.Anobviousbeneficiary:realestate.Duringthesameperiod,housingpricesinsomecitiessuchasSanFranciscohaveincreased40percenttomorethan100percent.

•Fromthe1950stothepresent,computerpriceshaveplummetedmorethanamillionfold.Duringthesameperiod,computerstockslikeAppleandMicrosofthavesoared,resultinginhugeprofitsforinvestorsinthesesectors.

•Duringthelast16months,theeurohasrisennearly50percentagainstthedollar.BybuyingeurosorotherhardcurrencieslikeSwissfrancs,youwouldhavereceivedsimilarreturnsonyourinvestment.

Onegoodruleofthumbisnevertoinvestinsomethingyoudon’tunderstand.Thus,super-investorWarrenBuffettgenerallyavoidstechnologystocksandinsteadinvestsininsurancecompanies,consumerstocks,andhealthcare.Thesamethinkingappliestosectorinvesting.Usecommonsenseandsticktosectorsyouunderstand.

Sector Investing Made Easier: Index Funds

Howwouldyouliketoownaninvestmentthatrequireslittleactivemanagementonyourpartyetproducesuptosixtimesthereturnyouarelikelytoreceivebypickingyourownstocks?Ifthatsoundsattractive,youmightwanttoconsiderindexfunds.

Asthenameimplies,anindexfundinvestsinagroupofstocksselectedtocloselytracktheperformanceofastockindex,suchastheDow,theS&P500,oramorespecificgroupofstocks—such

asAMEXmidcapitalizedstocksorNASDAQenergystocksonly.Likemutualfunds,indexfundscanonlybetradedafterthecloseofbusinessonastockexchange.

Since1991,theS&P500Indexhasincreasedfivefold.Justthinkofwhatthatcouldhavemeanttoyourinvestments.WhiletheaverageS&P500stockheldbytheindividualinvestorhasincreasedbyajuicy148percent,accordingtoIndexFundAdvisors,anS&P500indexfundhasreturnedanastounding840percentatthesametime.Inotherwords,ifyouhadpickedyourownstocksduringthelast14years,youmostlikelywouldhavemadeabout10percentayear.However,ifyouhadinvestedthesamemoneyinanS&P500indexfund,yourreturnswouldbenearly60percent.

Exchange-Traded Funds: A PrimerExchange-tradedfunds—orETFs—area

variationonindexfundsandhavedefinitelybecomeanincreasinglypopularinvestment.In2004,ETFassetsincreasedby47percentto$222billion,accordingtotheinvestorserviceMorningstar.

Themaindifferencebetweenindexfundsandexchange-tradedfundsisthatwithETFs,youcanbuyorsellshareswheneveranexchangeisopen.Inaddition,investorsareabletotradeoptionsonETFsjustliketheycanwithcommonstocks,addingaggressiveanddefensivetradingtoolstotheirarmory.

Investorsalsocanshort-sellETFsjustliketheycanwithmanycommonstocks.ThatalsomeansyoucanbailoutofanETFmorequicklyintheeventofadramaticmarketcorrection.

ETFsdon’tsellsharesdirectlytotheinvestor.Instead,theyissuetheminlargeblocks,called“creationunits.”Thesearetypicallymadeupof50,000ormoresharesandaregenerallypurchasedbylargeinstitutions,whichinturnsplituptheselargeinitialblocksofsharesandsellthemtosmallerinvestors.

TheperformanceofindexfundsandETFscloselyfollowsthebasketofstockstheytrack.Forinstance,whentheS&P500goesup10percentinayear,anindexfundthattrackstheS&P500(suchasBarclays’IVV:AMEX)alsowilltendtogoup10percent.Thatmakesexchange-tradedfundsaparticularlyeasyandhassle-freemethodofinvestingduringabullmarket.

However,thepriceofETFsisnotthesameas


thatoftheunderlyingstocks.Rather,itreflectssupplyanddemandfortheETFitself.Ofcourse,arbitrageopportunitiesmeanthatthetwodon’tgetoutoflineoftenorforlong.

TherearemanydifferentETFsandindexfundstochoosefrom,includingfundsthattracktheDow,theS&P500,energystocks,emergingmarketstocks,Chinesestocks,andLatinAmericanstocks.Thelistgoesonandon—anditgetslargereverymonth.

Onemajoradvantageofexchange-tradedfundsisthatmanagementfeesaregenerallyverylow—aslittleas0.9percentofassetscomparedtoaveragemutual-fundfeesof1.4percent.ThatmeanswhenyouinvestinETFs,youcansaveasmuchas12percentayearinmanagementfees.

ThegovernmentalsostrictlyregulatesETFs,soyoucaninvestwithreasonablepeaceofmind.FinancialfirmsareonlyallowedtoofferanETFafterthefundiscloselyexaminedbytheSecuritiesandExchangeCommissiontoensurethatitmeetsalonglistoffinancialrequirements.Effectively,thatmeansETFsaresoldbylargeinstitutionalfirmsratherthansmall,fly-by-nightcompanies.

AllETFcertificatesalsomustbeclearedthroughtheDepositoryTrust&ClearingCorporation—thesamegovernmentagencythatrecordsindividualstocksales.ThismakesETFtransactionstransparentandhighlyliquid.IfyouareconsideringanETF,

besuretocheckouttheprospectusor“productdescription.”Bylaw,thefundmanagermustgiveyouthisonrequest.

WhileyouownETFshares,thecompositionofunderlyingstockscouldchangeandtheirvaluemightriseorfall.However,youowenotaxesonthemuntilyousellyourshares.

ThatisbecauseofaregulatoryloopholethatassertsthatETFsarecreatedthroughthetradingof“equivalentcertificates.”Thisisanin-kindtradeandisthereforenontaxable.Whilethereisnowayofavoidingcapitalgainsentirely,bydelayingthistax,youcanaccumulatewealthinanETFuntilyousellyourshares.

Likeotherinvestments,exchange-tradedfundshavetheirownuniquenomenclature—andthecreatorsofmanyofthesefundsseemtohavegottenabitcarriedawaywithcutenames.Forexample,SPDRs(pronounced“spiders”)arefundsthattracktheS&P500(SPY:AMEX).“SPDR”isanabbreviationfor“Standard&Poor’sDepositoryReceipt.”VIPERsarefundsissuedbyVanguard(www.vanguard.com).VIPERisanacronymfor“VanguardIndexParticipationEquityReceipt.”AndDiamonds(DIA:AMEX)isanETFthattracksallthestocksontheDow.

Editor’s Note: For further reading, see articles regarding sector investing in issues 20, 23, and 83.

Why Will Gold Always Have Value?In Issue 25, November 2005, we wrote about

a topic just as hot then as it is these days: the gold bullion investment market. As gold itself, the advice stands the test of time.

Therearemanyreasonstoowngold.Foronething,itistheultimateinsuranceforyourassets.

Goldprovidesyouwithavarietyofwaystoprotectyourself.Youcaneitherkeeppossessionofitorreapthelustrousmetal’scountlessbenefitsinthewakeofdisaster.

Forcenturies,goldhasbeenacceptedinlieuofmoneythroughouttheworld,andthiswilllikelycontinuelongaftertoday’spapercurrenciesaregoneandforgotten.

Here’swhygoldwillalwaysremainaformofmoney:

•Unlikepapercurrency,peopledesiregoldforitsaestheticvalue—becauseitisbeautifulandhasimmeasurablevalue,beingusedinmetallurgy,art,jewelry,decoration,andelectronics.

•Typically,tonsoforemustbeminedtoextractasingleounceofgold.Allthegoldeverunearthedinthehistoryofthehumanracewouldprobablyfitinsidealargehome.Thatscarcitypreservesgold’shighvaluethroughtheages.Goldisrare.

•Goldisvirtuallythesamepriceanywhereinthe


world.Anddividinggoldintosmallamountsdoesnotchangeitsvalue.Comparethistoadiamond,forexample.Twoone-caratdiamondsaren’tworthnearlyasmuchasonetwo-caratdiamond.Goldiseasilydivisible.

InChicagoin1930,afew1-ouncegoldcoinswouldbuythefinestsuitintown.Today,inanylargeAmericancity,thosesamecoinswouldstillbuyyouthebestsuitinamajorclothingstore.Goldhashelditsownagainstinflation.

•Golddoesn’ttarnish,andit’sextremelydurable.Evenifthegoldbullioncoinsinyourhomesafeweretomeltduringahousefire,theresultinglumpofgoldwouldbealmostasvaluableastheoriginalcoins.

•Notonlycanyoucountongoldbeingworthasmuchormore20yearsfromnow,butyoualsocanconvertitalmostinstantlyintocash.Goldisconvertible.

Everyinvestor,fromasinglemomwith$10,000toinvesttothejet-settingmultimillionaire,shouldownsomegold.Generally,werecommendkeepingabout5percentofyournetworthingoldandgold-relatedinvestments.Ifyouarearealgoldbullandareespeciallyworriedabouteconomicproblemsandterrorism,then10percentmaybemoreappropriateforyourportfolio.Inadditiontothe“insurance”factor,youalsomayhaveagreatopportunitytopotentiallyearnveryhighreturnswithgold.

Seven Forces Push Gold UpwardForthefirsttimesince1975—whenprivate

ownershipofgoldwasonceagainlegalizedintheUnitedStates—powerfuleconomicforcesareconvergingtocreatewhatshouldsoonbecomeamajorgoldbullmarket.

Understandingtheseforcescouldmakeorbreakyourinvestmentportfolioandliterallymeanthedifferencebetweenmakingorlosingasmallfortune.Hereiswhatyouneedtoknowaboutthesesevenpowerfuleconomicforces:

Force No. 1: A collapsing dollar.InvestorshavebeenworriedabouttheUnited

Statesforalongtime.Endlessbudgetdeficits,anagingpopulation,massiveentitlementprograms,andacivillegalsystemgoneberserkwithtrial

actionshavemadetheUnitedStatesloseitsprimestandingwithglobalinvestors.

EvenlongtimeinvestorswhoboughtsolelyintheUnitedStates,likeWarrenBuffett,arenowlookingtodiversifyoffshore.Unfortunately,mostofthesefundsareflowingintotheeurooreurozoneinvestments.Theeurohasseenarallyasthedollardeclines.

Butwedonotseethatcurrencyasalong-termoptionforcapitalpreservation.WhiletheUnitedStatesisfacingmanyproblems,theeurowillexperiencethese,aswell,andwithgreatereffect—suchasthedemographictimebomb.IntheWest,thenumberofseniorsasapercentoftheoverallpopulationissoaring.Bytheyear2050,thatamountisexpectedtoincreaseby35percentinEuropeandby28percentinNorthAmerica.Thiswillcreateseverestrainsonmanygovernmentprograms,suchasNationalHealthServiceinBritainandSocialSecurityintheUnitedStates.AlreadyinmuchofEurope,therealdollarvalueofgovernmentretirementbenefitsfortheelderlyisplummeting,anddeterioratinggovernment-runhospitalshavelongwaitinglists.

TheEuropeanUnion’sresponsetotheseproblemshasbeenmoresocialism—exactlywhathasgottenitintothismess.Evenitscurrencyisintrouble.Thereareseriousquestionsaboutwhethertheeuroisarealcurrencyatall.AtleastAmericanmoneyisbackedbyasovereigncountrywithasinglearmedforce.Theeuro,ontheotherhand,isacontrivedcurrencyformanynationswithdifferentbankingsystems,differentratesofinflation,differentratesofgrowth,andevencontradictorymonetaryandfiscalpolicies.

Historically,wheneverpapercurrencieslikethedollarandeurofall,goldrises.Thishasbeentherealityforcenturies.Essentially,it’snotthatgoldisrisingbutthatpapercurrencyisfalling.However,nomatterhowyoulookatit,asthedollarcontinuestodecline,youcanexpectgoldtokeeprising.Asthedollarfalls,othercommodities—includingsteel,timber,andsilver—arelikelytorisesharply,aswell.

Force No. 2: Soaring worldwide gold demand.Throughouttheworld,moreandmore

individualsandgovernmentsarebuyinggoldasasafehavenfortheirfundsintroubledfinancialtimes.In2004China—theworld’slargestcountry,withmorethan1.3billionpeople—authorized


Chinesebankstomarketgoldbullionandcoins.Asaresult,Chinesedemandforgoldrosebyatleast50percentin2004,andithascontinuedtogrowsince.WhenalargeChinesedepartmentstorestartedsellinggoldlastyear,theysoldoutinhours.

Butit’snotjustChina.“Indianhouseholdsareonarecordgold-buyingspreeasoil-price-driveninflationthreatenstowipeoutsavingsfromrisingincomesinoneoftheworld’sfastest-growingeconomies,”reportsEconomyNews.India,with1.1billioncitizens,istheworld’ssecond-largestcountry,justbehindChina.Indiaisalsotheworld’slargestmarketforgold,andsofar2005salesareatleast80percenthigherthantheywerein2004.

Inaddition,MiddleEasterncountriesarebuyinggoldatarecordpace,particularlyintheformofjewelry.For2005,Arabgoldjewelrypurchasesarerunning50percentaheadof2004purchases.DemandforgoldisalsosoaringinIndonesia,SouthAmerica,andmanypartsoftheworld.Increasingdemandforgoldmeansmuchhigherpricesinthenearfuture.

Force No. 3: Faltering gold supply.In2004,goldproductionfell13.3percent.Many

oftheworld’smostproductivegoldminesarerunningoutofore,andnewfindsaren’tkeepingpacewithrisingdemand.

AlthoughSouthAfricanmineshavebeensomeofthelargestproducersintheworld,goldisbecomingmoredifficultandexpensivetoextractthere.MostSouthAfricangoldisatleasttwomilesbelowthesurface.Asaresult,itcurrentlycosts$380to$480anouncetoextractgoldatAshanti,GoldFields,andHarmony—includingoperatingcosts.

InAustralia,goldproductionfelltoanine-yearlowin2004atminesownedbyAustralia’ssecond-largestgoldproducer.

Worldwide,asminedgoldsuppliesareexhausted,laborcostsriseandenvironmentalconcernsmakeminingmoreexpensive.Theinevitableresultoffallinggoldsuppliesishighergoldprices.

Force No. 4: Much higher inflation.AlthoughtheofficialU.S.inflationrateis

supposedlystilllow,therealityisfardifferent.AswehavepreviouslyexplainedinFinancial

IntelligenceReport,theofficialgovernmentstatisticsaremanipulatedtoreflectfavorablyon

thegovernmentandminimizegovernmentpayouts,suchasSocialSecuritybenefits,militarypensions,andinterestonthenationaldebt.ButthiswouldnotsurpriseaEuropeanorThirdWorldinvestor.Theyjusttakeitforgrantedthattheircountry’sofficialstatisticsarefalse.TheUnitedStateshascometomirrorhowtherestoftheworldbehaves,anditisdemonstratedinalmosteveryaspectoflife.

Here,officialinflationratesgreatlyunderstatetherealrateofinflation.Weestimatethatithasbeenunderestimatedby2to5pointseachyearoverthepast10years.Fudgedinflationnumbersmeanyourrealwealthisdeclining—justlikethevalueofthedollar.Ifyourinvestmentsreturned4percentlastyear,youbelieveyouareslightlyahead,basedon3percentinflation.

Buttherealityisthatinflationwasat5or6percentlastyear,andyousufferednegativewealthof2to3percent.Ifyourwealthdeclinesat3percentayearcompounded,in10years,thevalueofyourportfoliohasdeclinedby37percent.

WearenowseeinghowthefederalgovernmentstickstheAmericanpeoplewiththeconsequencesofthebig“inflationlie”—intheformofanemicsalaryandbenefitincreases,underestimatedpersonalandbusinessexpenses,andridiculouslylowinterestonsavings.

Globally,marketsrecognizethatthedollarisdepreciatingandthatitisvaluedmuchlower.Its35to40percentdeclineinrecentyearspegsittoexactlyhowmuchwebelievethephonyinflationstatisticswouldhavecausedittodepreciate.

Anotherareainwhichthefederalgovernmentgets“caught”lyingaboutinflationiscommodities.Theworldnolongerwantstotradethesameamountofdollarsforoil,cotton,wheat,corn,gold,andothercommodities,sothepricesforU.S.investorsgoup.It’sinterestingtonotethatothercurrencyholdershavenotbeenhitwiththesamecommoditypriceincreasesthattheUnitedStateshasexperiencedwithitswitheringdollar.

Goldisthemostpreciousofallthecommodities.Therefore,itisanexcellentbarometeroftherealvalueofthedollarandothercurrencies.ThereisampleevidencethattheU.S.governmentandotherG-7countrieshavesoughttomanipulatethegoldprice,artificiallyloweringitsvaluebydumpingcentralbanks’reservesontothemarket.Anditworked—forawhile.Butthemarkethasfounditsequilibrium,andgoldisbackupagain.


Butthisshouldn’tbesurprising.Wheninvestmentsandtheeconomyappearturbulent,peoplelookforasafehaveninwhichtheycanpreservethevalueoftheirassets.Goldfitsthebilladmirably—itisoneassetthatpreservesitsvalueyearafteryear,andevencenturyaftercentury.

Force No. 5: Weak stock, bond, and real estate markets.

Bothequitiesandbondmarketshavebeenveryweakthisyear,withstockindexesbarelychangedfromtheirlevelsinJanuary2005.(OnJan.3,2005—thefirsttradingdayoftheyear—theDowclosedat10,630.Bymid-October,theDowclosedat10,281.)

WhiletheDowandS&P500couldendupslightlyhigherattheendofthisyearthantheydidlastyear—ledbytechnologystocks—webelievethattheoutlookforthemarketnextyearisgloomyandarecessionispossible.

Ifthereisarecession,itwillprobablybeledbyacollapseinthehome-financingandrealestatemarkets.Already,realestatenationwideisshowingsignsofweakness,withstagnantorfallinghomeprices,decliningsalesvolumesinhotmarkets,andlongertimesrequiredtosellhouses.

Thinkaboutalltheenterprisesthatdependonrealestatesales,eitherdirectlyorindirectly:Mortgages,refinancing,consumerloans,construction,movingandstorage,furnitureandappliancesales,homerepairs,heatingandairconditioning,andpaintingandplumbing,tonameaswathofthem.

It’seasytoseewhyatleastone-thirdoftheU.S.economyisdependentonrealestate.Asaresult,ifthehousingsector“catchesacold,”theoverallU.S.economycouldcatchdeadlypneumonia.

Withinterestratescontinuingtorise,weexpectweakstock,bond,andrealestatemarketsfortheforeseeablefuture.Insuchanenvironment,preciousmetalsandotherselectcommoditiesareoneofthefewgoodalternativesforprotectingyourassets.

Force No. 6: Artificial manipulation of gold prices.Thekeytounderstandingmajorcentralbanks’

manipulationofthegoldpriceistherealizationthatgoldismoney—andthattheirfiatcurrenciesarenot.From1933until1975,privateownershipofgoldbullionwasprohibitedintheUnitedStates,andtheU.S.government—alongwithothercountries

—maintainedthepriceofgoldat$35bykeepingthe“officialprice”artificiallylow.Then,startingin1975,whentheAmericanpeoplewereonceagainpermittedtoowngoldbullion,thepriceofgoldexplodedto$850anounce.

Thefactthatthis“goldboom”occurrediscommonknowledge.Butwhatfewnowknowisthatbehind-the-scenesmanipulationofthegoldpricewassecretlyreinstatedandhasbeenineffectforatleastadecade.

Uptoathirdofclaimedcentralbankgoldmaybegone.Thebottomline:Onlymassivefinancialmanipulationandconcealmenthasbeenpreventingthepriceofgoldfromexploding,likeitdidbetween1975and1980.

ManyotherfinancialprofessionalsconfirmtheSprottReport’sfindingthatcentralbankmanipulationofgoldpricesisveryreal.Forinstance,theGoldAnti-TrustActionCommitteereportedinJuly2005,“Thegoldpricehasbeencappedat$440perouncesincelastDecemberbyrepeatedsellingofgoldreservesbyEuropeancentralbanksandtheEuropeanCentralBankitself.”

Infact,onasingledayinJuly2005,theEuropeanCentralBanksoldnearly1millionouncesofgold.However,thisgamecouldendsoon,ascentralbanksdepletetheirgoldandmoreandmorepeoplebecomeawareofthemanipulation.

Force No. 7: Gold is again becoming a safe haven.Becauseofsteadygoldpriceincreasesoverthe

pastseveralyearsandthelacklusterperformanceofmanyotherinvestments,goldhasonceagainbecomeattractiveasastoreofvalueandafinancialsafehavenintroubledtimes.

Asaresultofthefactorswehavementionedabove—coupledwithwhatappearstobeanever-endingwarinIraqandAfghanistan,ayawningbabyboomercrisis,andmanyothermajorproblems—thestagehasbeensetforatrulyexplosiveriseingoldpricesduringthecomingyears.AndthenthereistheWaronTerrorismhereathome.Ifandwhensuchacatastrophedoesoccur,goldwouldbeoneofthefewinvestmentsthatwillsoar—afinanciallifepreserverinanageoffearandterrorism.

FIR’srecommendedpreciousmetalinvestmentsconsistofthefollowing:

a) Bullion Coins:Oneofthebestwaystoholdpreciousmetalsisintheformofbullioncoins.


Thesearecoinsthatsellclosetotheactualcostofmetal.Everyfamilyshouldownsome.Forgold,werecommend1-ouncecoinswithlowpremiums.Premiums(theamountyoupayontopofthedaily“spot”priceofthemetal)arelowestfortheCanadianMapleLeaf(4percent),MexicanCorona(2percent),SouthAfricanKrugerrand(2percent),andAustrianandHungarianKorona(2percent).One-ounceU.S.GoldEagleshavesignificantlyhigherpremiums(5percent),butyouusuallycanrecovermostifnotallthatadditionalcostwhenyousellthem.

Forsilver,werecommendpurchasing“junksilver”—pre-1965U.S.dimes,quarters,andhalfdollars—whichare90percentsilverbyweight.

Alwaysgetpricesfromatleastthreedealerstogetthebestbargain.Evenifyouendupbuyinglocally,gettingpricesfromacoupleoflarge,out-of-statedealerswillhelpyounegotiatewithlocalvenderstogetthebestprice.

Youalsoshouldbuyatleast$1,000worthofcoinsatatime.That’sbecausemoststatesdon’tchargesalestaxonapurchaseofthatsize.Thealternativeistoorderfromanout-of-statedealeryoutrust.

b) Gold Savings Accounts, CDs, and Certificates:Youalsocanbuygold-denominatedsavingsaccountsandCDsfrombanksintheUnitedStates,Canada,Switzerland,andothercountries.InAmerica,werecommendEverBankinFlorida,888-882-EVER(3837),www.everbank.com.

Aswetoldyouinoneofourpreviousreports,“Switzerland:StilltheUltimateInvestment”(May2005),Swissbanksareanotherexcellentalternativeforstoringlargeamountsofgold.MostpublicandprivateSwissbanksoffergoldstorage.AnotherbenefittokeepinggoldinaSwissbankisthatseveraloffereasycreditagainstyourstoredgoldatratesaslowas1percentorless.

c) Gold Stocks:Unlikepurchasinggoldbullionitself,whenyoubuyagold-miningshare,youarebuyinggoldintheground.Becausethisgoldhasyettobeextractedandrecoveredfromtheore,youbuyitatalowerpriceperouncethanwhenitisabovegroundandrefined.

Consequently,yougetmoregoldforyourmoneythroughminingsharesthanyoudowith

refinedbullion.However,youalsotaketheriskthatthepriceofbullionontheopenmarketcouldfallbelowtheextractioncost—andthatwouldwipeouttheminer’sprofits,causingyourminingsharestoplummetorevenbecomeworthless.Further,notallrawgoldinthegroundisthesame.

Extractionandrecoverycostsvarywidelyfromminetomineandareheavilyinfluencedbyoregrade,depthofdeposits,andwhatothermineralsthegoldismixedwith.Also,themetallurgicalprocessusedtorecovergoldfromorecanberelativelysimpleorextremelycomplicated—itdependsonthenatureoftheore.

Thehigherthecostofextractionandrecovery,themoreoperatingleveragetheminerhas.Thatmeansthemorethepriceofgoldrisesandfalls,thelargertheeffectithasontheminer’scashflow—andthereforestockprice.

Thelowertheminer’sextractioncosts,thelessriskythestockisforinvestorsifthegoldpricegoesdown.Ofcourse,itisalsolessrewardingifthegoldpricegoesup.

Inadditiontooperatingrisk,politicalriskisanextremelyimportantfactorforgoldmines.Agoldmineisacaptiveoperationthatcan’tbemoved,likeafactoryorsoftwarebusinesscanbe.Thegold-mineownerisatthemercyofthegovernmentinthecountrywherehismineissituated.

Asmentionedearlier,someofthebest-knownmines(suchasthoseinSouthAfrica)haveveryhighextractioncosts,sotheirvaluewilltendtogouptheleastasgoldrises.

Attheoppositeendofthespectrumaretheso-called“pennygoldstocks”—low-pricedsharesthatsellforlessthan$1.Suchstocksaresocheapbecausethesecompaniesarenotyetproducinggold—rather,they’restillexploring.Iftheyfindarichstrike,thevalueofthecompany’sstockcouldmultiplyby20,50,oreven100timesinjustweeks.Butmorerealistically,mostarelikelytofindnothing.

Inthemiddleareso-called“juniorminingstocks,”whichhaveatleastsomeprovenreserves.Buttheyarestillinvolvedindevelopingtheirproperties.Thesealsohavehighprofitpotentialbutwithlowerriskthanpennygoldstocks.

Editor’s Note: For further reading, see articles regarding the gold market in issues 1, 3, 5, 15, 28, 32, 33, 64, 71, 73, 83, 84, 85, 87, and 91.


What the Government Doesn’t Want You to Know About Inflation

In this article by John Browne, originally printed in Issue 37, released in November 2006, a topic that has ramifications today was covered: the insidious threat of inflation on people’s pocketbooks and investment portfolios. While it was written years ago, much of what is said may sound eerily similar to problems faced today in 2012.

SohowisitpossiblethatthecoreConsumerPriceIndex,publishedasanofficialgovernmentstatistic,isahistoricallylow2.8percent?Canitbetrue?

No,itcannot.It’sagiganticcontokeepusquiet.Andjudgingbythemoneyflowingfromrealestateandcommoditiesintolongbondsandstocks,itisworkingandworkingverywell.

Thetrickisthatbyexcludingsuchitemsasenergyandhealthcosts,andbyincludingonlytherentalequivalentratherthantheactualassetpriceofhousingfromtheindex,thecoreCPIisuponly2.8percent.

Withlowinflation,governmentincreasesinpaymentstoentitlementprograms—likeSocialSecurityandgovernmentemployeeraises—arekepttoaminimum.Atatimeoflowinterestrates,whocanjustifyabidforhigherwages?

Also,low“official”inflationhasledtolowinterestrates(sincetheFederalReserveSystemsaysitlookstoinflationforsettingitsrates)andarelativelylowcostofgovernmentdebt.

Today,investorsandcertainmediapunditsforecasta“Goldilocks”economy(nottoohot,nottoocold,butjustright)iftheFedlowersratesinNovember.Andofcourse,thelowerourinterestrates,thehigherbondandstockmarketswillroar.

Why Are the Inflation Books Cooked?

Highinflationisbadforbusiness,particularlythebusinessofpolitics.IncreasesinSocialSecuritypaymentsarefixedtoinflationandwouldrisedramatically.Ifthetrueinflationratewere

declared,U.S.interestrateswouldhavetorisesharply.Thecostofgovernmentdebt,includingthehundredsofbillionsofU.S.TreasurydebtheldbyChina,wouldrisedramatically.

IncreasedinterestrateswouldhaveamajordepressingeffectontheU.S.economyandonstockandbondmarkets,riskingareturnofthestagflationthatplaguedWesterneconomiesinthe1970s.Therearethereforepressingeconomic,financial,andelectoralreasonsforthegovernmenttomaintaintheillusionoflowinflation.

Thestronglyadversarialpartypoliticsoftodaymilitateagainsttheacceptanceofrisk,eveninthenationalinterest.Soexpecttheofficialrateofinflationtoremainfalselylow,untilitexplodesonus.Thenwatchout!Inthemeantime,beprepared.

How Are the Inflation Figures Manipulated?

Ourreadersmaywellwonderhowsuchgrossmanipulationofakeypublishedgovernmentstatisticcanbeachieved,letalonebejustified.

AsFinancialIntelligenceReportstatedin2005,thereareseveralwaysinwhichgovernmentscanhideinformationandkeeptheCPIartificiallylow.Theseincludethefollowing:

1. Geometric weighting. Thisallowsforthelowerweightingofanygoodsandservicesconsidered“toovolatile”bythegovernment.Theirpricesareconsideredasonlytemporaryandthereforedisruptivetothestatistics.Thissoundsgreatintheory,butitopensthedoortostatisticalmanipulationatthegovernment’swhim.

2. Hedonic adjustments.Thisinvolvesthereductionofthepriceincreasesofcertainitemsbyanarbitraryamount,reflectinganincreasein“quality.”Forinstance,onecouldclaimthattoday’sFordcarshavescarcelyincreasedinpricesincetheModelTFordssoldfor$300becausetoday’scarsaresomuchmoretechnologicallyadvanced.


3. Ignoring quality decreases and “on-sourcing.” Intheolddays,thepostofficeprovidedfourdeliveriesaday.Gasstationspumpedgas,checkedoil,andcleanedwindshields.Today,theseserviceshavebeenreducedatthepostofficeoratthegasstationand“on-sourced”tothecustomer.ButthehighereffectivecostrelativetothereducedserviceisnotreflectedinthemakeupoftheCPI.

4. Assumption that consumers will turn to cheaper alternatives.Ifthepriceofamealatarestaurantwentup,customerswouldmoveelsewhere,soitisnota“justifiable”increase...orsotheflawedargumentgoes.

5. Exclusion of goods and services subsidized by the government.Inthisconjuringtrick,theretailpriceisincludedbutnottheactualcost,whichcontainsthegovernmentsubsidy.Itemslikeairportsecurity,publicschooling,interstatehighways,andhousingforthepoor,althoughprovidedatgreatlyincreasedprices,arelargelyexcludedfromthemakeupoftheCPI.Statisticalmanipulation?Wethink,definitely!

Consequences of Mass Deception on Inflation

Ofcourse,thegovernmenthastrieddesperatelytoaverttheeconomicdepressionthatloomedafter9/11.Everyfinancialspigotwasopenedatfullforceinanunprecedentedmanner.

Liquidityandcreditweremadeavailableatrecordlowratesofinterest,sometimesevengivenawayatnegativerealratesofinterest.Governmentspendingwasunleashedonamassivescale.

Fiveyearslater,ithasamazedusandmanyotherobserversthatsuchactionsdidnotunleashamajorinflationwave.

Ofcourse,therehavebeensomelegitimatefactorsholdinginflationdown.TheFarEast,particularlyChina,hasexporteddeflationtotheUnitedStatesonavastscale.Until2004,eventhefallincommoditypriceswasdeflationary.

Butthepriceofcommoditiesturnedaroundinamajorwayin2005and2006.Indeed,theywentwildandyetinflationremainedstrangelybenign.Why?Becauseofthe“nowyouseeit,nowyoudon’t”cookedbooks!

Foreignersandcurrencytradershaverecognized

theproblemforsometime—hencethefallofthedollaragainsttheSwissfranc,gold,andotherdepreciatingcurrenciessuchastheeuro,sterling,andeventheyen.WhatistrulyworrisomeisthoughtheFedhasmovedtoraiseinterestratesdramaticallyfromalowof1percenttomorethan5percent,thedollarhasnotstrengthenedbutweakened.

Anymoderngovernmentfacedbyinflationanddepressionwillacceptinflation.Depressioncanbedevastating,botheconomicallyandpolitically,takingmanyyearstocorrect.

Sowecanunderstandagovernmentdecisiontoacceptinflation,especiallyifitcandistorttherealfiguresinordertodisguiseinflationintheshorttomediumterm.ThedownsideofsuchapolicyisthatitcansoeasilyleadtotheonsetofthestagflationthatbedeviledWesterneconomiesinthe1970s.

Iftherealinflationratewastobeexposedpubliclyat,say,just7percent,whatpanicwouldensueasthe10-yearTreasuryfellinpriceuntilityielded9percent,just2percentaboveinflation,withoutanyexpectationoffuturehigherrates?

Stockmarketswouldplummetaslonger-termbondyieldsandthedirectlylinkedmortgageratesroseinevengreaterpanic.Webelieveyouwouldnotwanttobeinlong-terminvestments,otherthangold,duringsuchapanic.

Inshort,asuddenriseininterestrateswouldleadtopanicsellinginthefinancialandrealestatemarketsandpanicbuyingofgoldandcommodities—theexactreverseofwhatishappeningtoday.

However,whenthetrueinflationrateeventuallyleaksout,readersofFIRwillnotbethoseinapanicbecausetheywillhavebeenforewarned.

Editor’s Note: Understanding the role of inflation, and the lengths government goes to understate it, is critical to investment success. Fixed-income investments, in a world where inflation is chronically understated, do not provide the kind of principal protection that most investors need when adjusted for the true numbers.

For further reading, see articles on inflation, bonds, and interest rates in issues 10, 18, 26, 27, 28, 29, 32, 36, 39, 42, 45, 52, 65, 80, 81, 86, and 90.


The Dangerous Dollar: Protecting Your Wealth by Investing Abroad

In June 2004, Issue 8, we published this article, which detailed the U.S. dollar’s continued decline in status and value. As of today, it still stands as the world’s reserve currency, but based on the rampant devaluation of the dollar from excessive money creation by the U.S. government, for how much longer is that status sustainable?

Forthelast100years,theU.S.dollarhasbeenoneofthestrongestandmostuniversallyacceptedcurrenciesintheworld.FromNewYorktoMoscowtoBeijingtoOuterMongolia,peopleeverywheregladlyaccepteddollars.Peopleevenhaveriskedjailtohoardthegreenback.Duringitsheyday,thedollarwas“asgoodasgold,”andindeed,until1971,thedollarwasatleastpartiallybackedbygold.

ThenonAugust15,1971,PresidentRichardNixonclosedthe“goldwindow”andremovedthelastshredofgoldbackingforthedollar.Whathashappenedsinceisamatterofhistory.Between1971andtheendof2003,thedollardeclinedinvaluebymorethan70percentandtheendisnowhereinsight.

Thebittertruthisthatwithoutgoldorsomeotherformofbacking,thereisnothingtopreventthedollarfromfallingmuch,muchfarther—andindeed,manyexpertsthinkthatispreciselywhatwillhappeninthenextfiveyears.Thatwillbeterriblenewsforthevalueofmanyofyourdollar-denominatedassets,particularlyyourcheckingandsavingsaccounts,andevenmanystocks.However,itwillmeananincrediblebonanzaifyouinvestinassetsthatgoupasthedollargoesdown—suchasgoldandstrongforeigncurrencies.

Inthisarticle,welookattheimmediateprospectsforthedollarandhowyoucouldmakeamintfrominvestinginforeigncurrencies.

The Impact of Supply and DemandAswithallgoods,thevalueofthedollarisruled

bysupplyanddemand.Whenthesupplyofdollarsincreases,thevalueofeachdollartendstodecline.Whenthedemandfordollarsdecreases,thevalueof

dollarstendstodecrease,also.Duringthelastdecade,thesupplyofdollars—

alsoknownasthemoneysupply—hasincreasedenormously.TheFederalReserveSystem,whichcontrolsourmoneysupply,iscreatingmoneyatbreakneckspeed—upto$1.5trillionayear.Thisisknownasmonetaryinflation,anditresultsinpriceincreases.

Untilrecently,priceincreaseshavebeenmostevidentinthepricesforhomes,whichhavebeenincreasingatalmost20percentayear.Youalsoseeitnowinrisingpricesforgasolineandheatingoil,higherfoodprices,highercarprices,andevenhigherpricesformovietickets.Rapidmonetaryinflationalsoresultsintheverylowinterestrateswe’veseenthepastfewyears.

AtthesametimethattheU.S.moneysupplyhasbeenincreasing,thedemandfordollarshasbeendecliningbecauseof,amongotherfactors,lowinterestrates.ThisismostevidentinthehistoricallylowrateofsavingsbyAmericans—nowlessthan1percentofincome.Wheninterestratesaresolow,itmakessensenottoputyourmoneyinabank.Whygetjust1or2percentinterestwhenyoucaninvestinrealestateorcommoditiesandget15or20percentappreciationayear?

The Dark Side: Our National Debt Binge

Lowinterestratesencouragedmassiveindebtednessbyindividuals,companies,andlocalandstategovernments.WhynotbuythatnewSUVorsportscarwhenyoucangetzero-interest-rateloans?Whynotbuyabiggerhousewhenyournewpaymentislessthanwhatyoupreviouslypaidforamuchsmallerhouse?Whynottakethatdreamvacationwhenanyonecangetfiveorsixcreditcards,eachwith$20,000“limits”?

Theresulthasbeenthehighestdebtever.AccordingtoBusinessWeek,theaverageU.S.citizenhaspersonaldebt(mortgage,carloan,creditcard,etc.)andfixedcosts(food,medicalcare,taxes,etc.)thatconsumemorethan100percentofhisorherdisposableincome.TotalU.S.consumerdebtismore


than$2trillion,or$18,700perhousehold.Andthisisontopof$6.2trillioninrealestatemortgagedebt.ThedisturbingrealityisthatmostU.S.familiesarefinanciallyoverextendedandextremelyfinanciallyvulnerableintheeventofarecessionoranothereconomiccrisis.

Sowhathappenswheninterestratesincrease?Overnight,peoplewithadjustable-ratemortgagescouldfindthemselvesunabletomaketheirnew,highermonthlypaymentsandcouldbeforcedtoselltheirhomesatfire-saleprices.

Underthisworst-casescenario,thehigherinterestratesoncreditcardswouldmeanthatmillionsoffamilies—whoarealreadystretchedtothelimitfinancially—wouldbeunabletomaketheircredit-cardpayments.Highergas,food,andenergypricescouldpushmanyovertheedgeintobankruptcy,takingmanyhighlyleveragedbusinessesalongwiththem.

Governmentitselfisalsoatrisk.UncleSamhasalsobeenonaspendingbinge.

Therearejusttwowaystopayoffthesehugegovernmentdebts:1)Vastlyincreasetaxesto80percentormoreofincome;or2)inflatethecurrency—causingthevalueofthedollartoplummet.

Foreign Financial SaviorsManyanalystsbelievethatourfinancialhouse

ofcardswouldhavecomecrashingdownlongagobutforonebigfactor:massiveforeignpurchasesofU.S.debt.Inessence,Japan,China,andEuropehavebeenfinancingourdecades-longfinancialbinge.

InadditiontobuyingTreasurybillsandothergovernmentpaper,European,Japanese,andChinesebankshavebeenabsorbingtrillionsinU.S.mortgagepaperandotherdebt.WithU.S.realestatepricessoaringat15to20percent,buyingmortgagepaperfromU.S.banksseemedlikeagreatinvestment.

Foreigncentralbanksalsogetasafeplacetoparktheirmoneyandaneasywaytokeepthevalueoftheircurrenciesdown,enablingthemtoexportevenmoregoodsandservicestotheUnitedStates.Andwegettocontinueourdebtbinge.Soeveryonewins,right?Unfortunatelynot,becauseasthedollarfalls,sodoesthereturnoninvestmentfortheseforeigncentralbanks.

Thebeginningoffallingrealestateprices,decliningoffshoreinvestments,risinginterestrates,andrampantpriceinflationinoil,food,andmanycommoditiesindicatesthatAmerica’sspending

bingeiscomingtoanendandthatthedeclineofthedollarcouldaccelerateevenfaster.

The Trade DeficitAnotherwaytounderstandwhythedollarhas

beendecliningistolookattheU.S.tradedeficit.Increasingly,theUnitedStateshasbeenspending

moreandmoreandimportingevermoreforeigngoods,withoutaproportionateincreaseinexports.SanFranciscofinancialanalystRobertsonMorrowsummarizesthesituation:

“Therearetwowaysforanationtohaveastrongcurrency:exportgoodsorexportdebt.Forthepastsixyears,America’sgreatexporthasbeennotgoodsbutdebt.Foreignerssellusoil,cars,computercomponents,andothergoods.Inreturn,wesellthemdebtandotherfinancialinstruments—governmentbonds,corporatebonds,andsecuritiesbackedbythemortgagesofAmericanhomeowners—forwhichforeignershaveseemedtohaveanalmostinsatiableappetite.From1997to2002,importsofgoodsandservicesincreasedbyathird,whileexportsofgoodsandserviceswereflat.

“Themeasureeconomistsusetoquantifythisexportofdebtisthe‘currentaccount.’Priorto1983,America’scurrentaccountdeficitneverexceeded1percentofGDP.In2003,thecurrentaccountdeficit[was]morethanhalfatrilliondollars—over5percentofGDP.”

However,asthedollarhasweakened,sotoohasthewillingnessofforeignerstobuyandholdU.S.debt,causingthedollartofalleverfaster.AddtothisvolatilesituationrisingoilpricesandmassiveincreasesintheU.S.monetarysupplybytheFed,andyouhavearecipeforroaringpriceinflationandacollapsingdollar.

How Low Can the Dollar Go?Toreducethecurrentaccountdeficitfromits

presentlevelof5percenttoitshistorichighof1percent,thedollarwouldhavetofallbyatleastanother50percent.Buteventhatmightnotbeenough.TocompeteintheglobalmarketplaceagainstinexpensiveJapanesecomputersandlowIndianandChineselaborcosts,thedollarmayhavetodeclineby80percent.

ItisalsolikelythatasthecostsoftheWaronTerrorismmount,theU.S.governmentwill


increasinglydowhatgovernmentsalwaysdotofinancewar:turntomonetaryinflationratherthantohuge,unpopulartaxincreases.Allthisaddsuptoasharplydecliningdollarfortheforeseeablefuture.

Firstandforemost,foreigngoodsandimportswillgetmuchmoreexpensive—prohibitivelysoformanyAmericans.SolookformuchlowerpurchasesofGermancars,Italianshoes,andFrenchcheese.

Second,commodities,particularlythoseweheavilyimport—includingoil,selenium,rareearths,copper,lumber,gold,silver,andplatinum—willsoar.Infact,theyalreadyhaverisen.

Third,interestrateswillgomuchhigher.Fourth,asharpdollardeclinewillcurtailthe

consumptionbubble.Notonlywillforeigngoodsbemoreexpensivebutsowillthepriceofvirtuallyeverythingyoubuybecausenearlyallgoods,includingthosestamped“MadeinAmerica,”useimportedcommoditiesandpartswhosepricesarestronglyaffectedbyafallingdollarandrisingoilprices.

Betweenrisingprices,highertaxes,andfallingincomesinadecliningeconomy,householdswillfaceaseriousincomesqueeze.

Fifth,theUnitedStatesmaybeforcedtocutbackonforeignmilitaryoperations,whicharealreadyprovingmuchmoreexpensivethananticipated.

Finally,forsavvyinvestors,thefallingdollarwillcreatehugeprofitsforinvestorsincommodities,preciousmetals,foreigndebt,equities,andcurrencies.

Investing Recommendations to Protect Against a Falling Dollar

Asweregularlynote,itiscriticallyimportantforinvestorstodiversifytheirholdings.ThisincludesinvestingoutsidetheUnitedStates.Wearenotsuggestingthatyoumovemostofyourportfoliooffshore.ThereareandwillcontinuetobestronginvestmentopportunitiesintheUnitedStates.

Still,youmustcontinuetohedgeyourportfolio.Wehavesuggestedthat5to10percentofyourportfoliobeplacedinamixofgoldinvestments:goldcoins,bullion,miningshares,andperhapsoptions.

Thesameadviceappliestointernationalinvesting.Wesuggestthat10to20percentofyourportfoliobeplacedinarangeofforeigninvestments,includingcurrencies,foreignbonds,

equities,andsomeoptions.

• Currencies: Foravarietyofreasons,wedonotrecommendinvestingintheeuroorJapaneseyen.EuropeandJapancontinuetoexperiencemajorstructuraleconomicproblemsandgovernmentbudgetaryproblems,aswellastheirowncorporatescandalsandcurrencyandbankingproblems.Furthermore,EuropeandJapanimportvirtuallyalltheiroil,alsoputtingtheireconomiesandcurrenciesatrisk.

Asthedollardeclines,thebestforeigncurrenciestoinvestinarethosethatareeitherbackedbygoldorstronglylinkedtocommodityprices,henceretainingtheirvalueovertime.Thefollowingthreecurrenciesareourtoppicks:theSwissfranc,theNewZealanddollar,andtheAustraliandollar.

Indeed,allthreehavehadtremendousappreciationandwilllikelycontinuetorise.Therewill,ofcourse,beshort-termcorrectionsandlosses,butthelong-termoutlookisgreat.(TheBritishpoundwillremainaqualitystoreofvalue,too,aslongasBritaindoesnotfullyengagetheEuropeanUnionandaccepttheeuroasitssinglecurrency.)

CurrenciesofSwitzerland,NewZealand,andAustraliaareattractivebecausethecountriesthatissuethemarepeaceful,free,prosperous,andstable.TheyarealsonottargetedbyterroristsandhavenotexperiencedanythingcomparabletotheU.S.corporatescandalsanddot-comcrash.SwitzerlandalsohasthemoststablebanksintheworldandmuchbetterbanksecrecylawsthantheUnitedStatesandmostofEurope.

There are four main ways to invest in foreign currencies:

1.Buyforeigncurrency.Youcanexchangeyourdollarsatacurrencyexchangeorbankforforeigncurrencyandthenkeepyourcurrencyinasafe-depositbox.Wedonotadvisethatyoutakethisroute,butmostlargeU.S.banksprovidecurrencyexchangeandsafe-depositboxes.

2.Openasavingsaccountdenominatedinaforeigncurrency.

3.BuyaforeigncurrencydenominatedCD.4.Investinforeigncurrencyoptions.While

risky,thismethodalsohastheadvantageofgivingyoutremendousleverage—asmuchas50to1.Forcomparison,ifyoubuy$5,000worthofSwissfrancsandtheygoup10percent,youwillmake$500,lessyourtransactionfees.However,with


thesame$5,000,youcouldcontrolasmuchas$250,000worthofSwissfrancs.Ifthefrancgoesup10percent,yourprofitwillnotbe$500but$25,000(lesstransactionfees),or50timesasmuch.Onthedownside,youcouldloseyourentireinvestment.

• International Funds:Itisoftendifficulttotracktheactivitiesofforeignequitiesanddebtinstruments.Anexcellentapproachistoinvestininvestmentfundsthathaveproventrackrecords.As

ofthiswriting,thesefundshadsuchtrackrecords:MutualEuropeanFund(TEMIX),TempletonGlobalIncomeFund(GIM),TempletonGlobalOpportunitiesFund(TEGOX),andtheTempletonGlobalSmallerCompaniesFund(TEMGX).

Editor’s Note: For further reading, see articles regarding the U.S. dollar in issues 3, 15, 18, 22, 24, 26, 27, 28, 32, 36, 39, 42, 43, 51, 68, 77, 78, and 86.

Use Global Sector Investing to Profit From a Soft U.S. Economy

In June 2007, Issue 44 of the newsletter, author John Browne tackled a familiar but important topic for regular readers of Financial Intelligence Report, as he detailed the factors that strongly support having a global reach in your portfolio.

Forseveralyears,thebuzzwordofbusinesshasbeen“globalization.”EconomistswilltellyouthatglobalizationleadstoimprovementsinthestandardoflivingforconsumersintheUnitedStatesandabroad.However,myfriendLouDobbsatCNNandmany,manyothershaverecentlybeendecryingtheeffectsglobalizationishavingonAmerica.Andtheymayhavesomeverylegitimatepoints.

Butwhethertheeffectsofglobalizationshouldbeconsideredasapositivedevelopmentornot,onepointisclear—globalizationistakingplaceonagrandscaleandyouwillneedtoridethiswavetogrowyourwealthinthemonthsandyearsahead.

Forsomepeople,especiallyintheUnitedStates,thinkinggloballyisanewprocess.

SirJohnTempleton,thefatherofmodernglobalinvesting,relatesthatwhenhefirsttoldinvestorsinthe1930sand’40stoinvestglobally,hewasviewedasatraitortoAmerica.

InvestorshereandabroadhavelongviewedAmericaas“thelandofopportunity.”Upuntilthepastfewyears,thisperspectivehasnotbeenterriblysurprising,givenAmerica’svasteconomicresourcesanditstechnologicaladvances,superioreducationalsystem,andoverallwealth.

Itwasalsotruethatbusinesshadbeenableto“keepcorruptionatbay”andthatinvestorshave

beenabletorelyonAmerica’ssolidcorporatefinancialreporting,legalsystem,andaccountingregulations.Asaresult,Americahashistoricallyledtheworldintermsofconsumerdemandandwealthgeneration.

Forsure,mostAmericanssawthebiggesteconomicandfinancialopportunitiesrighthereathome.AndinvestorsaroundtheglobesawtheUnitedStatesasthebestplacetoputtheircapital.

The World Is ChangingOverthepasttwodecades,numerousfactors

havechangedthefundamentalsoftheAmericanandworldeconomies.OnedramaticchangewasthecollapseofcommunisminRussiaandtheendoftheColdWarduringthe1990s.

Asyoumayknow,IwasthefirstrepresentativeofaNATOcountrytodealsignificantlywithMikhailGorbachevwhenhewasanagriculturesecretaryfortheSovietUnion.WhenhecametoBritainonavisit,PrimeMinisterMargaretThatcheraskedmetobehisguide.AfterspendingafewdayswithGorbachev,ItoldtheprimeministerthathewasamanwhowouldfundamentallychangeRussia.IbelievemycommentshadaneffectonherwhenshelatersaidGorbachevwasaman“wecoulddobusinesswith.”

SincethefalloftheBerlinWall,theworldwastrulyopenedforfreetrade.Asaresult,moreandmorecountrieshaveimplementedfree-marketpoliciesoverthepast15years.Manyofthesecountrieshaveonlyjustbeguntobuilduptheirbasiceconomicinfrastructures,andAmericanow


facesaworldwideeconomic“build-out”manyhundredsoftimeslargerthanthegreatbuild-outoftheUnitedStatesfollowingtheendofWorldWarII.

Thismassiveinfrastructurebuildingistakingplaceprimarilyinemergingmarkets,anditlikelywillfollowthesamecourseAmericadidoverthepast100years.Alreadywehaveseencommoditypricesspikeinrecentyearsbecauseofthedemandfromemergingnations.

Demandforsuchcommoditiesmayslow,butitwillstillbeonanupwardtrendasthesenationsseekmorefinancialcapital,food,rawmaterials,industrialmetals,infrastructure(roads,factories,etc.),andconsumerproducts.Thisdemandwillresultinamajorworldwidereallocationofresourcesandpoliticalpower.

Fortunes Will Be Made and LostWecanalreadyseetheeffectsofthesechangesin

theworld’scapitalmarkets.Economicgrowthandfinancialmarketsinmanyoftheworld’semergingeconomieshavebeengrowingatarapidrateoverthepastseveralyears.

Youmightask,“HowcanItakeadvantageofglobalizationandthemajorshiftsineconomicgrowthandfinancialreturns?”Theanswerissimple.Youmustbecomeaglobalinvestor.

Throughtheyears,FinancialIntelligenceReporthasbeendevotedtotwomainthemes.

First,wethinkAmericanscannolongerignorethevastfinancialopportunitiesofferedbyinvestingabroad.Second,weadvocate“sectorinvesting”inthosesectorsofthemarketthatareexpectedtobenefitthemostfromunderlyingeconomicandgeopoliticaldevelopments,aswellasfromchangesindemographicfactors.

Asaresult,werecommendthatoursubscribersinvestthemajorityoftheirfinancialassetsinaselectgroupofinvestmentsthatwillbenefitbecauseoftheirlinkswithakeysectororanemergingeconomy.

Sectorinvestingiscriticalforsuccess.Studieshaveshownthat75to80percentofastock’smovementisgenerallytheresultofmajorfactorsaffectingthesector(orspecificindustry)inwhichtheunderlyingcompanyoperates.

Wethinkoneofthebetterwaystoimplementasuccessfulsectorinvestingstrategyistoinvestinexchange-tradedfunds.

Wehavelongpositedthatthekeytomakingmoneywithsectorinvestingistounderstandkeytrends.Understandthesetrendsandinvestinthesectorsthattrackthosetrends,andyoualmostalwayswillprofit.

Editor’s Note: For more information on international investing, please see issues 8,16, 19, 31, 43, 51, 67, 79, 83, and 92.

Beware the ‘Decoupling’ Myth: Emerging Market Stocks Can Be Risky

Bob Wiedemer, the in-demand co-author of the best-selling financial tome Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown, joined the Financial Intelligence Report Brain Trust team in 2010. He penned this article for Issue 89, published in April 2011.

Isittimetogoabroad?Manypeopleseemtothinkso.Internationalstockfundshavebeenthedarlingsofinvestors.Flowsofcashintosuchfundsnearlydoubledto$58.9billionin2010from$30.6billionin2009.

Someoverseasstockmarkets,suchasIndia’s,as

shownbytheSensexIndex,havemorethandoubledsincethestartof2009.

ManyinvestorshopethatsuchgoodreturnswillcontinueandgetevenbetterandthatthegrowthinemergingmarketswillbethenextbigboomthatpushestheU.S.economyforward.

However,allthisassumesthatgrowthinemergingcountriesisnottiedtogrowthintheU.S.economy.Duringthepastcoupleofyears,itcertainlyappearedthatwaybecausetheUnitedStateshadslowgrowthwhileemergingmarketsgrewrapidly.

Inthepast,however,that’snothowpeople

Special Report Financial Intelligence Report Page 19

lookedattheworld.Emergingmarketgrowthwasdrivenbytheengineofworldeconomicgrowth,theU.S.economy.Remembertheoldsaying:IftheU.S.economycatchesacold,theworldcomesdownwithpneumonia.

Ofcourse,thatisbecauseemergingmarketeconomiesareheavilydependentonexportstousandtoEuropeforgrowth.Somepeoplebelievethathaschangedandthatemergingmarketcountries,especiallyChina,havedevelopeddomesticeconomiesthatcanpowertheirowngrowthwithoutexports.

Theargumentiscalled“decoupling”ineconomiccircles.ThesustainingbeliefisthattherestoftheworldneedsAmericalessandless,thattheyhave“decoupled”theirgrowthstoryfromourown.

Therealityisthatmostemergingmarketeconomiesarestillhighlydependentonexports.Andthoseexportsareevenmoreimportantbecauseoftheexportjobsmultiplier.Themultipliermeansthatforeveryjobexportsdirectlycreate,onetotwomoreadditionaljobsarealsocreatedasaresult.

It’ssimilartotheruleeconomistsuseforlocaleconomies,suchasacity.Everyjobinacityforwhichtheresultingproducts’demandresidesoutsidethecity,suchaswhenDetroitsendsitscarstootherU.S.cities,createsonetotwoadditionalsupportjobs—sales,marketing,carparts,finance—inDetroit.

IthinkalargepartofthereasonpeoplebelievethatexportsarenotasimportanttoemergingmarketsistheenormousgrowthChinahasseeninthepastcoupleofyears.ItgrewdespiteadeclineinexportsresultingfromU.S.andEuropeaneconomicrecessionsandsubsequentslowrecoveries.

Play Emerging Markets With CareSomuchexcitementsurroundsemergingmarket

fundsthatit’snotsurprisingthatthecrowdwantsin.Inabubblemood,that’snotabadplacetobe.Thekeyisgettingoutbeforethebubblepops.Andthat’sthebigproblemwithnearlyallforeignequities:Theyarenotlong-termplays.

EvencountriessuchasTurkeywillhaveproblemswithMiddleEastexportsiftheChineseconstructionbubblepopsandthepricesofoilandothercommoditiesdeclineontheworldmarkets.

Indiahasthebesteconomicfundamentalsintermsofthecost-savingnatureofitsservices,buttherearelimitstojusthowmuchservicescanbe

exportedandhowfasttheycangrow.Also,Indiastillretainssomeoftheeconomic

instabilityandinfrastructureproblemsthathaveplagueditfordecades.FundamentallystrongcountriessuchasCanadaandGermanyarebenefitinggreatlyfromtheChineseconstructionbubble.Whenthatpops,therewillbeproblems.Then,whentheU.S.economypopsbecauseofitsmoneyprintingandmassivegovernmentborrowing,consumerspendingwilldeclineagain,multiplyingthemaladies.

Dangerous Bubbles AfootAlotofthemoveupforemergingmarketstocks

canbetraceddirectlybacktotheU.S.FederalReserveSystemanditsmoney-printingoperation.Stocksrosesharplyaftertheannouncementofnew“quantitativeeasing”inAugust2010,thenleveledoffonceitwasclearthatsucheasingalsomeantstrongerinflationinthosecountries.

Asweknow,stockmarketscandeclinemuchfasterthaneconomieswhenthingsturnsouth.Agreatreminderofthatisthe15percentlossontheShanghaiIndexduringayearofexplosiveChineseeconomicgrowthin2010.Thedeclinewasduesimplytothefearthatgrowthmightslowsomewhatfollowinginterestrateincreases.

Manyofthesemarkets,includingtheChinesestockmarket,haveexperiencedrapidgrowthoverthepastfiveyears,makingthemripeforapullback.Higheconomicgrowthoftendoesn’ttranslateintoextremelyhighstockmarketgrowth,evenintheshortrun.

So,theruleissimple—playingwithbubblesisdangerousstuff.Properlytimed,bubblescanpumpupyourinvestmentportfolio,butyouhavetobewillingtotaketheriskofasuddenandunwelcomepop.

Editor’s Note: In the few months after this article came out, China’s stock market corrected by nearly 20 percent (quite normal for a developing country’s stock market). Over a longer 10-year time frame, however, the overall gains in the markets of emerging economies have trounced stock market returns in mature, market-established countries. Which emerging markets are bubbles? Time will tell. As noted with the previous article, international-related investment articles can be found in issues 8, 16, 19, 31, 43, 51, 67, 79, 83, and 92.


China Holds the Key to U.S. Economic Revival

This article, written for FIR by respected economist John F. Sheehan for the May 2005 issue (Issue 19), still resonates with its critical analysis of the U.S.’s precarious position caused by its unbalanced financial relationship with China.

AmericansshouldnotunderestimatetheenormousleveragetheyhaveontheglobaleconomyingeneralandonChinainparticular.ButtheyshouldnotunderestimateAmerica’svulnerabilitytoacrashfromthisrelationship,either.

AmericahasbecomesodependentonChineseandgloballendingtofinanceitsimportsfromChinathattheresultingdistortionstotheinternationalfinancialmarketsarebecomingunmanageable.WhateveryouhearaboutthehealthoftheAmericaneconomy,Americaislivinginafool’sparadisebecauseitisallonborrowedmoney.Indeed,thewholerealestateassetbubble(whichalsohasfinancedconsumerdemand)hasbeenfinancedbyChineseandotherAsianpurchasesofGinnieMae,FannieMae,andFreddieMacpaper,whichkeepstheAmericanrealestatemarketliquidandisbiggerthanthemarketforU.S.Treasurysecurities.

ChinaandotherAsiancountriesownmorethanhalfofallthispaper,meaningtheycontroltheliquidityoftheAmericanrealestateandconsumercreditmarketasmuchastheFederalReserveBank.

ByfinancingourpurchasesofChinesemanufacturedgoods,theChinesehavebeenturningAmericaintoaneconomiccolonyofChina.Thisisbankruptingournationalfinances,destroyingourcurrency,andhollowingoutourindustry.Indeed,weareengagedinaself-destructiveco-dependencywithChinathatisunsustainableandhasturnedglobalizationintoaChinese-Americanaffair.MostoftheThirdWorlddevelopmentforeigndirectinvestmenthasbeendivertedtoChina,andmostallofChina’smanufacturedexportsgotoAmerica.

AlltheseexportsarefinancedbyloansmadetoAmericansfromChineseandotherAsiancentralbanks.Thisco-dependencywillcollapsebecausetheglobaleconomyhasbecomeoverdependentonthecreditandtradingrelationshipbetweentwo

countries—andthenatureofthatrelationshipisnotfriendlybutpredatory,threateningtodestroyAmerica’seconomicposition.Thestatisticalweightofthisrelationshiponglobaltradeandcapitalflowsisawesome.

Since1995,60percentoftheworld’scumulativeoutputdemandhascomefromAmerica,whichistwiceAmerica’sshareofglobalgrossdomesticproduct(demand).Americanspendinghasbeenup3.5percentperyearsince1995,whichistwicetheincreaseoftherestofG-7countriescombined.And75percentofChina’seconomyisdedicatedtoforeigntrade,64percentoftheentirePacificRim’sis(upfrom55percentintheearly1990s),andprettymuchallofEastAsia’s“intra-Asiantrade”isdedicatedtosupplyingmanufacturersthatexporttotheU.S.market.ThatmeansAsia’sdevelopmentiscertainlynotself-sustaining,andwithoutAmericanimports,intra-Asiantradewillcertainlycollapse.

ThisisespeciallytrueforChina,whichonlyhasacurrentaccountsurpluswiththeUnitedStateswhileitisprobablyinadeficitwiththerestoftheworld.WhileChinamustimportcapitalgoodsandrawmaterialsforwhatitmanufacturesforAmerica,itsdependenceonothercountriesforitsso-calledinevitableriseistotal.Moreover,Asia’sovercapacityissomassive,sooverdependentonAmericandemand,andsogearedtoAmericanpricesthatAsiacouldnotabsorbitsownproductionevenifitwantedto.

Keeping China AfloatTheinevitabilityoftheriseofAsiaandChina,

therefore,isamyth.ItisaphenomenondependentonAmericanindulgence.Bywithholdingtradeandinvestment,itcanbestopped…likeotherAsiancountriesbeforeit,China’scapital-intensivemanufacturingexportstrategyishittingalineofdiminishingreturns.China’sadvantageisthatunlikemostotherAsiancountries,ithasanunlimitedsupplyofcheaplabor.LikeotherAsiancountries,however,itisstilloverdependentonAmerica.

TheonlythingthatkeepsChinesebanksfromcollapsingfrombadloansistheamazingChinese


penchantforthrift—citizensoftensavemorethan50percentoftheirincomes.Thisdepositgrowthaverages30percenteverysixmonths,allowingdomesticcredittogrowatasimilarrate.TheChinesepeople’sperceptionoftheirbanks’solvencyishighlydependentontheimpliedandinferredguaranteeofdepositsbythePeople’sBankofChina,whichhasaccumulated$500billioninforeigncurrencyreserves.

EverytimethesolvencyofChinesebankslooksshaky,thePeople’sBankofChinainjectshardcurrencyintoitsbigfourstatebanksandenticesAmericaninvestorsintobuyingminoritystakesinthemandinothersmallerChineseinstitutions.

Eitherway,China’sbankingsystemisdependentonforeignhardcurrency—theAmericandollarinparticular—becauseAmericaisChina’sbiggestcustomer.Withoutthese“forex”reserves,China’sbankingstructurecollapsesintothenightmaresofbankruns,disappearingcapital,andachoicebetweenhyperinflationandhyper-deflation.

Forthelast15years,atleast85centsofeverynewdollarsavedbyeverypersononEarth,fromAntarcticatoCanadatoChinatoIndia,hasgoneintoU.S.-dollar-denominatedinstruments.ThisiswhathasbeenfinancingAmerica’sgreatconsumercreditmachine,ourassetbubbles,andourfederaldeficits.

Andeachyear,aswedevalueourcurrency(andconsequentlythevalueofforeigninvestmentsinU.S.paper),wedefaultonthesedebtsbytheexactpercentageofthedollar’sdecline.

Credit-Card EconomicsUntilnow,Asiancentralbankshavebeenwilling

togoalongwiththisbecausetheirpurchasesof

AmericangovernmentsecuritieskeptAmericanconsumerdemandforAsian(andparticularlyChinese)productsstrong—meaningAsianinvestmentsinAmericanpaperhadnothingatalltodowith“Americabeingagreatinvestment.”

Rather,Americahasbeenagreatcustomer—oncredit.Asiansrationalizedthattheycouldtakethelossifithelpedthemaccumulateacriticalmassofindustrialpowerthatmightbecomeself-sustaining.ThisindicatesthattheirloanstoAmericahavehadapredatorymotive—notoneofconfidenceintheAmericaneconomy.Itwasanactofplunderingandusingdebttokeepitgoing.

ChinesecentralbankersunderstandthattheworldeconomywillcrashifthisprocessoflendingAmericamoneytobuyChineseproductsisinterruptedbecause60percentoftheworld’s“growth”isfinancedbyChineseexportstoAmericaandChineseloanstofinancetheseexports.

ButitalsomeansthatthisstabilityispredicatedonagradualtransferofAmerica’srealwealthtoChina.Thismeansthattheendpointofthis“stable”transfusioniseconomicdeathfortheUnitedStates.Isthis“stability”worthit?

Editor’s Note: While China holds significant foreign exchange reserves, lending by the central governments to regional and local governments is a problem that some economists are comparing to the early years of the housing bubble. Many of these loans are going into infrastructure projects, leading some to think that a slowdown in lending may lead to a substantial correction in commodities. For further reading on the role of China in the investing world, see issues 32, 40, 55, 69, 70, 75, 87, and 88.

The Pension Fund Time Bomb Is TickingIn this story from Issue 65, printed in April 2009,

authors Julie Crawshaw and Dave Eberhart sound the alarm on a still-lurking problem facing the United States, the damaged pension system.

Despitehugegovernmentbailouts—nowestimatedtobemorethan$10trillionbetweenfederalpayoutsandFederalReserveSystemcashinjections—another800-poundgorillastillisstandinginthecorner:thecomingimplosionofthe

U.S.pensionsystem.Thisdominohasyettofall,butitcouldbe

themostdevastatingofall.Closelylinkedtothisconceptofapensiontimebombisthebabyboomerphenomenon.Anestimated77millionAmericans(theoldestofthemisnow64)arethelargestdemographicwaveinU.S.history.

AsFinancialIntelligenceReporthaspositedinpreviouseditions,thebabyboomerswhocameofprofessionalageinthe1980sandalsobecamenet


saversandinvestorshelpedtocreatethebiggestandlongestbullmarketinhistory.Now,theseboomerssoonwillturnintonetsellersofstockandotherassets,helpingkeepnow-depressedU.S.equitymarketsinalong-termbear.

Addingtothedownwardpressurewillbeseveralfactors:First,retireeswillneedtosellassetstopaytomaintaintheirlifestyleandhealthcare.

Second,diminishingassetvalueswillfurtherundermineretirees’confidenceinthemarkets,causingaviciousdownwardspiralinvalues.Third,privatepensionsystemsarewoefullyunderfunded.Fourth,publicpensionshavebeenthesubjectofaccountinggimmickryforyears,andtheywillnotbeabletojustifypromisedpayouts.

Fifth,byrejectingformerPresidentGeorgeW.Bush’sproposaltotakeindividualtaxpayersawayfromSocialSecuritytoprivateinvestmentaccounts,Congressrejectedthebestfree-marketwaytohavepreservedtheideaofmarketandpensionstability.

America’s100largestcompaniesalonewerebehindby$217billionthrough2008,withjust79percentofthemoneytheyneededfortheirpensions,areportshows.Those100hadan$86billionsurplusattheendof2007,reportedconsultingfirmWatsonWyatt.Investmentlosseslastyearcausedpensionassetstoposta26percentloss.

Aseparatestudyshowstheplanslostanother$54billionjustinFebruary.Thelosses,plusnewfederalregulations,“willrequireemployerstomakestaggeringpensioncontributionsoverthenextcoupleofyears,atatimewhentheycanleastaffordthem,”DavidSpeier,aseniorretirementconsultantatWatsonWyatt,toldUSA Today.

Deep Pockets, Big GainsWhenthatfallouthits,theObamaadministration

hadbetterbereadyforataxpayerrevoltunlikeanythingthiscountryhasseenbefore.Hereareafewfiguresthatwillmakeyoureyeshurtjustreadingthem:

•Thereisroughly$3.5trillionscatteredacrossmorethan2,600publicpensionfundsandfederalretirementaccounts.

•Another$1trillionorsocoversunionworkersatcorporatejobsinwhichtheunionhasmanagementcontrolofthefund.

•Thesepublicandunion-baseddefinedbenefitplanscover27millionpeople.

•Intotal,theplansrepresentmorethan30

percentofthe$15trilliondollarsheldinU.S.retirementaccounts.

Unfortunately,thelikelihoodthatwe’llhavetobailoutmanyofthesepensionfundsishigh,unlessCongressauthorizessomequickrelief.AlthoughthePensionProtectionActof2006requirescorporationstokeep80percentofrequiredpensionfundsinpensionaccounts,about200ofthecountry’sbiggest500companiesrecentlytoldCongresstheylackthecashtodothat.

Ifaplanislessthan80percentfunded,certainrestrictionscomeintoplay,suchascompaniesnotbeingabletopayoutlump-sumdistributionsuntilthepensionfundreachesthe80percentbenchmarkagain.

Building in a BankruptcyOrdinarily,thiswouldn’tbeaproblem.But

companieswhosepensionplanswere100percentfundedayearagonowfindthatbecausetheirassetshavedroppedinvalueby30percentamidthemarketcrash,thoseplansaresuddenlyunderfunded.Beingforcedtocontributeenoughmoneytobringtheirpensionplansbackuptothe80percentfundingbenchmarkcoulddraincashthatcompaniesdesperatelyneedtosurvive.Thebankruptcyfaitaccompliiscomplete.

EverythingthatcanbedonebyCongresstoprotectthePensionBenefitGuarantyCorporationhasbeendone,saysMartyZiglerofactuarialfirmTowersPerrin.

Butwhathashappenedinthemarketshasputsuchstrainonpensionfundingthatcontinuingtopressfor80percentfundingcouldeasilycausemanyplanstoterminatebecausecompaniesaren’tgoingtobearoundtofundthem.

It’sthebiggestCatch-22inyears,maybeever.Ultimately,Ziglerpointsout,thestrengthofapensionplandependsontheabilityofthecompanytoremaininbusiness.ThisiswhytheAmericanBusinessCouncilandnumerousotherbusinessgroupshavelobbiedCongressforrelief.Legislatorsrespondedbyreducingtheamountcorporationsmustsupplyby$16billion,butitwasn’tenough.

AccordingtopensionexpertsatWatsonWyatt,U.S.employerswillberequiredtocontributemorethan$108billionintotheirdefinedbenefitplansin2008—and,theyestimate,therequiredcontributionlevelsin2009and2010willbesignificantlyhigherthantheywerelastyear.


Public Pensions No Better OffForthepublicpensioncommunitiesasawhole,

thelosseshavebeeninthehundredsofbillions.AstudybytheCenterforRetirementResearchatBostonCollegeestimatesthetotaldeclineinequityvaluebetweenthemarkethighpointinOctober2007andOctober2008forstateandlocalgovernmentbenefitplansat$1trillion.

Justthreeexamples:•CaliforniaPublicEmployees’Retirement

SecuritySystem,thelargestU.S.publicpensionplan,lostastaggering20percentofitsvalueinjustthreemonthslastyear.

•LastMay,Vallejo,Calif.,becamethelargestcityinthestateevertofileforChapter9bankruptcy,largelybecauseofunmanageablepensionobligations.

•Pittsburgh’spensionfundhasonlyalittlemorethanathirdofwhatitshould.

AccordingtoNorthernTrustInvestmentRiskandAnalyticalServices,definedbenefitfundslostanaverageof26percentduringthefirst10monthsof2008.NovemberwasterribleandDecemberonlyslightlybetter,making2008theworstyearonrecordforcorporateandpublicpensionfunds.

Manypublicpensionfunds,too,decidedtooffsettheshortfallbysellingbonds.Ratherthangettingthemoneydirectlyfromcontributors,theypusheditoffintothefuture—$50billionworthoverthepast25years,accordingtoBloomberg Marketsmagazine.

“Whatappearstobearisklessstrategyisactuallyveryrisky,”saidDavidZion,accountingresearchdirectoratCreditSuisse,inaninterviewwiththemagazine.“Ifthereturnsonbond-financedassetsdon’texpectthecostofservingthedebt,thetaxpayersbearthebrunt.”

Thesituationcouldbecomedramaticallyworseunlessfundmanagerschangetheirinvestmentstrategiesfast.

Assomeexpertsnote,traditionally,publicinvestmentsandunioncorporatepensionfundscontainedprimarilylow-riskgovernmentsecuritieslikeU.S.Treasurybillsandbonds.Managersadheredtostrictfiduciaryprinciplesdesignedtoprotectworkersandtaxpayers.

However,duringthelast30years,statepensionfundmanagersbeganplayingthemarket,puttingtheirmoneyintoriskierandriskiersecurities—firststocks,corporatebonds,andforeigninvestments,

thenrealestate,privateequityfirms,andhedgefunds.

Today,mostpensionplanshaveactiveratherthanpassivemanagers.

Andbecauseactivemanagershavehighercoststhanpassivefunds,asagroup,theyoftendoworsethanpassivefunds.Historically,30percentofactivemanagerswilldobetterthantheirbenchmark,regardlessofwhetherthemarketisgoodorbad.Theremaining70percentwilldoworse.

Withoutatleastsomeadditionalshort-termlegislativerelief,andpresumingthestockmarketremainsdownforevenafewmoremonths,pensionfundmanagersalsowillfacedifficultchoices,suchaspostponingcost-of-livingincreasesandreducinghealth-carecoverageforretirees.Longterm,benefitsfornewemployeeswillbeloweredandpersonalpayrollcontributionswillhavetorise.

Moreover,becausethePensionBenefitGuarantyCorporationdoesnotguaranteehealthandwelfarebenefits,vacationpay,orseverancepay—allbenefitspresentinmanycompanyplans—thereareboundtobeadditionaldrainsontheoveralleconomythatstemfromtheagencyhavingtoassumeresponsibilityforfailingcorporateplans.

Forinstance,beneficiarieswhoordinarilywouldusehealthbenefitsthattheircorporateplanprovidedwillhavetofindotherwaystomeethealthcosts,mostlikelybyturningtoanalreadyoverburdenedMedicareprogram.

Lessdiscretionaryincomemeanslessspendingandfewervacations,somethingsuretohittheeconomyhardonmanylevels.

Important Considerations for Investors

Evenifthevariousfederalrescueplans“work”andtheimmediatefiscalcrisisweretoberesolved—ahighlydoubtfulscenario—theU.S.economyisheadingforatrainwreckwiththebabyboomersandthemassiveentitlementprogramstheyexpect.

Inadditiontopublicandprivatepensions,health-caredemandsalsowillbemassiveandcreatenewproblemsforbeneficiaries,taxpayers,andthegovernment.Someimportantconsiderationsforinvestors:

•Nooneshouldrelysolelyonpublicorprivatepensionforretirement.

•Governmentswill“resolve”theirfinancial


obligationstoretireesbytheuseofinflation.Currently,thegovernmenthasmassivelyincreasedthemonetarybasetorescueourailingfinancialinstitutions.Moreinflationiscoming.

•InvestorsneedtobewaryofinvestinginU.S.equitiesandbondsasawaytohedgetheirinvestments.SomeemergingmarketswilldoexceedinglywelldespitearecoveryinU.S.markets.

•Typicallyduringinflationaryperiods,realestate,bothresidentialandcommercial,doeswellbecausethecostofnewconstructionrisesasinflationarypressuresdriveupthepricesofcommodities.Buttherecentresidentialoverbuildandeconomicwoesareputtingdownwardpressureonproperty.

Ifyouownrealestateinhigh-taxstateslikeNewYork,Massachusetts,andIllinoiswithagingpopulationsandnegativepopulationgrowth,youshouldconsidersellingyourrealestateandmovingtoareasofthecountrythathavelowertaxes,betterclimates,andwhereboomersandimmigrantsaremoving.StateslikeSouthCarolina,Florida,andTexas,amongothers,willbenetwinnersintheloomingbabyboomereconomicstorm.

ManyAmericansarelivingabroad,takingupresidencesinThirdWorldcountries.Withmodestincomes,Americanscanliveaqualitylifestylewithspaciousrealestate,inexpensivequalityrestaurants,andlowercostsacrosstheboard.Still,therearetrade-offs,suchaspoorqualityhealthcare,crime,corruption,andotherissues.

Considerallyouroptionscarefully.Someveteransoflivingabroadtalkoftheruleofthree:KeepyourU.S.citizenshipandliveinanothercountry,suchasCostaRica,butalwayskeepyourmoneyandinvestmentsinathirdcountry,likeSwitzerland.

ThetimesaheadfortheUnitedStatesandWesterneconomieswillbechallenging—evenmoresobecauseboththeUnitedStatesunderBarackObamaandEuropeappeartobesteamingtowardastatistcoursetosolveourproblems.Suchacoursenotonlywilllimiteconomicgrowth,worseningtheseproblems,butalsowillundermineindividualfreedoms.

Investorsneedtobeagileandcageyinthemonthsandyearsahead.WehopeFIRwillbealighthousethatwarnsyouofshoalsamidthefog.

Editor’s Note: More than two years after this article came out, most pension fund managers are investing in risky assets to earn substantial returns.

The reason is twofold: First, the bigger the gains, the faster these funds can make up for the market crash of 2008. Second, these gains mitigate the need to cut benefits, increase contributions from employees, and institute other measures that tend to irk retirees. As of early 2012, this strategy seems to be working … for now.

For further reading on the topic of pension problems, see issues 11, 12, 38, 40, 49, and 65.

Profit When the U.S. Bond Bubble BurstsIn Issue 67, published in June 2009, gold stock

expert and professional investor David Skarica, who has been carefully studying the U.S. markets because of their inherent links to the gold trade, outlined the dangerous risks facing the U.S. bond market and the country’s currency.

WehaveheardalotoftalkaboutgovernmentTreasurysbeinginabubble.However,thequestionarises:Howdoyouknowwhenabubbleexists?Afterall,thereareplentyofbullmarketsfollowedbybearmarkets.

Bubbles,todefinethem,areonce-in-a-generationeventsthatrarelyarerecognizableuntilaftertheyhaveburst.Infact,therehavebeenjustfivemajor

bubblesinassetpricesintheUnitedStatessinceWorldWarII:

•Thecommoditiesbubbleofthe1970s.•Theinterestratebubbleofthesameperiod.•TheInternetbubbleofthe1990s.•Thehousingbubbleofthe2000s.•ThepresentU.S.governmentbondbubbleStockspeakedin1966,1987,and1990andthen

enteredbearmarkets,butthosewerenotbubbles.Thekeyisinknowingthedifferencebetweenanormalbullmarketpeakandamajorbubble.

Afewaspectsaresimilarineverybubble.Bubbleshappenneartheendofabullmarket.Theyarenotcreatedinaday,andtheydonotoccurearlyinbullmarkets.Bubblestakeyearstocreate.Abullmarket


isverymaturewhenabubblestarts.Usuallyabullmarkethasbeengoingonforsevento20yearswhenabubblestarts.

Whathappensisthatprosperityreignsinthespecificsectororeconomythatisinabullmarket.Peoplebelieveinitandthenbecomeenthusiasticaboutthatsectororeconomy.Youbegintoseeinvestorstalkingabout“neweras”andclaimingthattheeconomyorsectorwillgoupinpriceforever.

“Irrationalexuberance”eventuallytransformsthebullmarketintoatruebubble:Priceincreasesacceleraterapidly,withpricesevendoublingandtriplingoverthecourseofayear.Butyoushouldbecautiouswhenyoubegintoseesuchunbridledenthusiasm.Italmostalwaysguaranteesthatthebubbleisabouttoburst.

Bubblesignorefundamentalsandspeculationtakesoff.Inabubble,stocks,commodities,whatevertheassetclassmaybe,tradetolevelsthatareoutofwhackwithhistoricalvaluations.Duringthe1929peakinstocks,theDowgotuptonearly27timesearnings,nearlydoubleitshistoricalaverageof15.TheNASDAQtradedupto100timesearningsin1999,andtheS&P500reachedmorethan30timesearnings.

Housingpricestradedatnearly40percentabovetheirhistorical,inflation-adjustedaveragesduringthehousingtopin2006.Inallbubbles,speculationrunsrampantasinvestorslooktoselltothenextsucker.(ThinkdaytradingofInternetstocks,homeflippers,andthelike.)

Thenthemarketgoesparabolic.Thelastmoveofabubbleisextreme.Forexample,theDowwentto360from200justbeforetheCrashof’29.DuringtheInternetboom,theNASDAQwentto5,000pointsfromjust1,400inlessthantwoyears.

Attheendofthe1970s,inaveryshortperiod,goldwentto$800anouncefrom$270.Similarly,from2004to2005,theDowJonesU.S.HomeConstructionIndexnearlydoubledto1,100.

Inthelastyearofthebubble,theretypicallyisonehugeblowoff.Thismarksthetopofthebubble.Thebubblethencollapsesduringthetwotothreeyearsfollowingthetop.Afterthebubblehascompleteditsrise,itfallsjustasfast,ifnotfaster,thanitrose.Theaircomesoutofthebubblelikeapinprickflattensaballoon.

Forsomereason,abubbleusuallytakesafewyearstoimplodefully,andthatimplosiontakesbetween60and90percentoffthepeak.The

NASDAQ,forinstance,peakedat5,100inMarch2000andtradeddownto1,100byOctobertwo-and-a-halfyearslater,adeclineof78percent.

Goldcollapsedby1982,fallingfrom$850anounceto$280inlessthanthreeyears.AfterthecrashthatsetofftheGreatDepression,theDowtooknearlythreeyearstodeclinefromitsheightof380tojust48.

Government Bonds: Serious BubbleThebondmarkettodayfitsalloftheabove

criteria.Thegovernmentbondmarkethasbeeninalong-termbullmarket,anditturnedintoabubblefrom2007to2008.Since1981,bondshaveriseninprice.Weare27yearsintothebondbullmarket,sothetimingisrightforabondbubble.

Asinvestorsrushedtogovernmentbondsoutoffearin2008,theyignoredfundamentals.IgnoredwasthefactthattheFederalReserveSystemwasprintingmassiveamountsofmoneytobailoutnumerouscrises.Historically,suchprintingisinflationarydownthelineandweakenstheunderlyingvalueofgovernmentbonds.

Disregardedwasanyrecognitionthatthefederalgovernmentisundertakinghugeamountsofdebttobailoutfinancialandotherfirms.Alsoneglectedwasthehistoricalprecedent:Governmentsthattrytospendtheirwayoutofcrisesfindthatthistacticalmostalwaysendsupinfailureandleavesthemfacinghigherdebts.

RecentFeddecisionswillincreasethesupplyofdebtexponentiallyandleadtohigherratesincomingyears.Speculationhasrunrampantinthebondmarket.Nooneisbuying10-yearbondswitha2.50percentyieldthinkingtheyaregoodinvestmentstoholdforadecade.Theyarebuyingthemthinkingtheywillflipthemtothenextdupealsospeculatinginbonds.ChinarecentlyexpressedconcernsabouttheU.S.debtincomingyears.

PresidentBarackObama’spresssecretaryrespondedwiththesimple-mindedstatementthatthereisnosaferinvestmentthanU.S.Treasurys.Wewillsee.Whenyouissue$1.5trillionto$2trillionofdebt(morethan12percentofU.S.grossdomesticproduct)ayear,you’regoingtoseethatforeignerswantmorereturnontheirmoneyasthedebtmarketbecomesover-saturated.Itisjustbasiccommonsensethat,assupplyincreasesfasterthandemand,rateswillmovehighersoon.

Thereareindicationsthat,lackingbuyers,theFed


isbuyingTreasurysdirectlybycreatingnewmoney.Thisisadesperateaction.UnfortunatelyfortheU.S.Treasury,theFedcan’tdothisforlongwithoutacollapseofthedollar.

ItalsoisimportanttorememberthattheU.S.governmentisnottheonlygameintown.Globally,itsdebtofferingshavetocompetewithothergovernmentsthataresounderandsomeofwhichofferhigherrates.

Still,theUnitedStatesmaygotoextraordinary

meanstokeepmedium-andlong-termdebtinstrumentsindemand,thuskeepinginterestratesforthemlowforthenextyearortwo.Forexample,itcouldpersuadeChinaandothercountriestobeginbuyingU.S.debtagain.Italsocouldencourageothercentralbankstostepupandbuyourdebt,howeverdistastefulitmaybeforthem.

Editor’s Note: For more on the U.S. bond bubble, see issue 75.

Professional Investor Profile: Warren BuffettHere and in the following stories wrapping

up this report, we’ve compiled some of our more popular “investor profiles” of past years. These are meant to serve as part guidance, part inspiration as you pursue your investing goals. In this first article, published in Issue 22, August 2005, writer Brian O’Connell profiles one of the greatest investors of all time, Warren Buffett.

Thesecret,accordingtothe“OracleofOmaha,”isthatthereisnosecret.“Allthereistoinvesting,”hesays,“ispickinggoodstocksatgoodtimesandstayingwiththemaslongastheyremaingoodcompanies.”

WarrenBuffetthasdonethatinspadesoverthepast40years—

atthehelmofBerkshireHathaway,oneofthemostsuccessfulinvestmentcompaniesinthehistoryofWallStreet.The$44billionbehemothislikeablockofgraniteinanotherwisefragileinvestmentenvironment.

Astuteinvestmentsinbrand-namevalueplayslikeCoca-Cola,H&RBlock,AmericanExpress,andComcasthavefueledBerkshireHathaway’srisetoelitestatus.Berkshireinvestsonlyinsolid,no-nonsensecompaniesthatofferinvestorsthethreethingsBuffettprizesmostinhisselections:steadygrowth,goodmanagement,andnosurprises.

Buffett’sresultsspeakforthemselves.A$10,000investmentinBerkshireHathawayin

1965wouldhavebeenworthnearly$30millionby2005.Incontrast,$10,000intheS&P500wouldhaverisentoroughly$500,000.

Consequently,BuffettisaZen-likefigureonWallStreetandMainStreet.Businesswritersandstockmarketanalystsjotdownhiseveryutterance.BerkshireHathawayannualmeetingsarealmostmythicalevents,withasmallarmyofBerkshireinvestors—andBuffettzealots—hangingonhiseveryword.

ItpaystoexaminetheinvestmentphilosophythatearnedBuffettsome$40billion.Manycallit“theBuffettWay.”

The Buffett WayInthisdayandage,whentraditional

investmentslikestocksandbondsebbandflowwiththeeconomictides,seeminglytetheredtonothing,battedabouthelplesslyinglobalfinancialmarketsalmostdaily,thereiscomfortinknowingthatavisionarylikeWarrenBuffettexists.HisBerkshireHathawayisoneofthemostsuccessfulbusinessesinAmericanhistory—ifnotthemostsuccessful.

Buffetthimselfhasamassedapersonalnetwealthofmorethan$40billion,makinghimthesecondwealthiestindividualinAmerica,behindMicrosoftfounderBillGates.

Butitwasn’tsolongagothattheso-called“experts”onWallStreetwerelaughingatBuffett,mockinghiscautiousandcarefullymeasuredmethodologyofinvestinginthefinancialmarkets.Totheself-proclaimedgurus,Buffett’stakeonthingsseemedoutoftune.Therulesofthegamehadchanged,andhejustdidn’tgetit.

“WarrenBuffettshouldsay,‘I’msorry,’’’fumedHarryNewton,publisherofTechnologyInvestorMagazine,inearly2000.“Howdidhemissthesilicon,

Buffet


wireless,DSL,cable,andbiotechrevolutions?”ThatwasayearwhenAOL’sstockrosesixfold

andAmazon.comstockskyrocketedby1,000percent.Meanwhile,sharesinBerkshireHathaway—theinvestmentcompanyBuffetthadvirtuallybuiltfromscratch—climbedameager11percentduringthesameperiod.

ButofcoursehistoryhasprovedthattheBuffettWaywonoutintheendbecausethedot-combubbleexploded,leavingmillionsofAmericanswithhugeholesintheirinvestmentportfolios,andmorethanafew“experts”witheggontheirfaces.Yes,wiseoldBuffett(“alifelongtechnophobe”asheconfessesontheBerkshireHathawaywebsite)stuckwithboringbluechipslikeGillette,Coca-Cola,andAmericanExpress,sayinghecouldn’tunderstandthoseothernewfangledcompanies.

SowhatdidBuffettknowthatthetechnologygeniusesdidn’t?Heknewhowtolookforgoodvalueplays.BuffettandhispartnerCharlesMungerbeganlookingcloselyatdot-comcompanyvaluationsheetsandcameawayconvincedtherewasmorefollythanfortuneinallthosecelebratednew-economycompanies.Instead,Berkshirereturnedtothegroundstheyhadtilledbeforeandknewsowell—valuestocks.

TheyinvestedincompanieslikeProcter&Gamble,whichmadeproductsthatpeopleactuallyused.Itishardlynecessarytopointoutthatthiswasduringtheeraof“irrationalexuberance,”whentheNASDAQwasflyingandBerkshire’sstockwasflopping.WhiletheexpertsconsideredBuffett’sfixationonvaluetobeoldhat,thesageprovedthemallwrong.

Buffett’s Keys to Profitable Investing

WhatstrategiesdoesBuffettemploywhenpickingstocks?Forstarters,helooksforcompaniesthatexhibitsolidfinancialperformanceandaremanagedbyseasonedandsavvyexecutives.Buffettalsofavorscompaniesthathavehistoricallydemonstratedabove-averageearningsgrowth.HisholdingsinAmericanExpressandCoca-Colaaregoodexamplesofthat.

Here’salistofadditionalattributesBuffettlooksforwhenbuyingstocks:

1. Simple businesses. Buffettlikestokeepthingssimple—andhelikeshiscompaniestodothesame.Againandagain,Buffetthasrailedagainstthekinds

ofcompaniesthatseemeithertoocomplicatedordifficulttovaluate.HisavoidanceofInternetandtechnologybusinessesduringthedot-combubbleisthemostfamousmanifestationofBuffett’s“keepitsimple”dictum.

Buffettjokinglycallshimselfatechnophobe,butheactuallydoesshyawayfromtechnologyandtelecomstocks.Helikestobasehisstockpickson,amongotherthings,whatacompanywilllooklike10yearsdowntheroad.Technologycompanies,hesays,aremuchtoovolatileandriskyforthatkindofanalysis.The10-yearappraisalalsoappliesinabackwardsense—Buffettwillonlyconsidercompanieswithagood10-yeartrackrecord.Mosttechnologycompanieshaven’tbeenaroundthatlongand,fortheirlackofseasoningandearningshistory,tendtofalloffhisradar.

2. Return on equity. AnotherofthekeycriteriaforBuffettisacompany’sreturnonequity.Again,hefavorsa10-yearplaninwhichhecanpredictreturnonequity10yearsout.Companiesthatcan’tbeaccuratelygaugeddon’tmakeitintotheBuffettportfolio.Healsofavorscompaniesthatdon’tneedmuchcapital.Suchcompanies,hehassaid,generatesignificantlyhigherreturnsonequity.

3. Cash on the barrel.TheBuffettWayislongoncompaniesthathavedeeppockets.BusinessesthathavewhatBuffettreferstoasamplecashflowarethosethathaveplentyoffinancialresourcestopaytheirbillsandkeepgrowing.

4. Low debt.CompaniesthatcanlimitandmanagetheirdebtarehighonBuffett’sprioritylist.Insurancecompanies(heownsGeicoandGeneralRe)areparticularfavoritesinthisregard.WiththeBuffettWay,lowdebtequalssignificantroomforgrowth.Buffett’semphasisonlowdebtisgroundedinreality.Withlimiteddebt,earningsgrowthisbasedonshareholders’equityasopposedtoborrowedmoney.

5. Emphasis on value. Historically,Buffetthastargetedinvestmentsinundervaluedcompanieswithgoodlong-termgrowthpotential.Identifyingsuchcompaniesisn’teasy,butBuffetthasmasteredthetechnique.Inanutshell,hefavorsstocksthatareunjustifiablylowbasedontheirintrinsicworth.Hecalculatesintrinsicworthbyanalyzingacompany’sfundamentals.

Aswithmostbargainhunters,Buffettfocusesoncompaniesthataregoodrevenueproducersandarecapablymanaged,thoughunderpriced.TheOracle


ofOmahaisalsofamousforhisaversiontoreadingstockmarkettealeaves.That’snotwhatheisabout.Quitesimply,heselectsstockssolelyonthebasisoftheiroverallpotentialasacompany.Onceaddedtohisportfolio,Buffettwillhangontosuchstocksforyears—evendecades.

Themancouldn’tcarelesswhetherornototherinvestorsevergetaroundtorecognizingthestock’smarketvalue.Hisonlyconcernisthathiscompaniesearnmoney,andlotsofit.

A Role Model for InvestorsTheydon’tmakeAmericanslikeWarrenBuffett

anymore.Toughandplain-spoken,he’sgenuinelyconcernedaboutaverageinvestors—thelittleguys—gettingafairshotonthestockmarket.Buffettisarealmanofthepeople,andmoresoonMainStreetthanWallStreet.

He’sfamousforberatingWallStreetforitsemphasisonthechurn-and-burnbrokeragemindset,andhehassaidpubliclythateveryAmericaninvestorwouldbebetteroffifheorsheexecutedonly20stocktradesintheirentirelives.HehasalsopoundedthetableatimeortworegardingthesubjectsofpersonallibertyandtheimportanceofAmericanstakingresponsibilityfortheirownlives.

WarrenBuffettistheultimateAmericansuccessstory.WhatmakeshimtrulyuniqueisthathegenuinelybelievesthatsuchasuccessstoryexistswithineveryAmerican,justwaitingtoblossom.

ButprospectiveinvestorswillhavetospendalotoftimedoingwhatBuffettdoes—diggingforthoseoverlookedcompaniesthatactuallyoffervalue.ToBuffett,it’svaluethatcounts—andhe’sspentthepast40yearsprovingjustthat.

Professional Investor Profile: Walter SchlossIn this article, published in Issue 7, May 2004,

we profile Walter Schloss, an old friend of Warren Buffett’s with some sage advice of his own.

MeettheotherWarrenBuffett.HisnameisWalterSchloss,oneofBuffett’soldestfriends.LikeBuffett,heisoneofthegreateststockinvestorsofourtimes.

Youdon’thearmuchaboutSchloss.Hehasflownundertheradarandhaslittleinterestinpublicity.Ofcourse,therehas

beentheoccasionalarticleabouthim,suchasthe1995Fortune magazinearticleabouthowheandBuffettconsistentlybeatthemarketingoodyearsandbad.

Oneofhisgoldenrulesisadvicethathereceivedfromthefatherofvalueinvesting,BenjaminGraham,whotoldhimthat“anintelligentinvestorshouldbuystockslikeyoubuygroceries,notlikeyoubuyperfume.”

Schloss’approachhasbeenmuchlikeBuffett’sinitssimplicity.Itmightbesummedupthisway:

1. Buy companies as their stock prices are falling, and sell them as their prices increase.

2. Buy secondary companies,i.e.,“thestruggling

firmsthatmostinvestorsoverlook.”AsSchlossnotes,greatcompaniesaregenerally“notcheapenough.”Hethinksittakesa“strongstomach”tobuyacompanythat’shavingproblems.Butthatisthebestwaytofindavalue.

3. Once you sell a stock, forget about it.4. Never disclose to your partners what you

own. Buffettnotedinalettertohisfriendswho

hadbeenBenGrahamanalysts:“OfWalter’spartnership,however,thereismuchtobesaid.Overitslifetime,ithadagrossreturnof21percentcompoundedannually(beforethegeneralpartnershare)andachievedthisreturnusingonlyminorleverageandwithouteverrunninganyriskofpermanentlossofcapital.TheS&Pdelivered11.2percent.It’sanastoundingrecord.”

Attheendofsuchasuccessfulstockcareer,Schlosshasonelessonthathewantstosharewithhischildren,grandchildren,andgreat-grandchildren:“Knowthattheonlythingharderthanmakingmoneyismakingitbackonceit’slost.”

AnotherimportantlessonthathelearnedfromGrahamwastokeepfocusonacompany’sfinancialsandavoiddiscussingthecompanywithitsmanagement.Schlosswarnsnottoletemotioncloudyourinvestmentjudgment.

Schloss


Schloss’advicesometimesdiffersfromBuffett’sstrategy.

Forinstance,Buffetttendstobeabuy-and-holdinvestor.Schlossdoesnotagreewiththatphilosophy,notingthatstockpricescanriseandthenstagnateforalongtime.

Meanwhile,theinvestmentmoneycouldhavebeenusedmoreprofitablyinfindingbetter-valuedstockswithmoreroomforgrowth.

Second,Buffetttookanactiveroleinpurchasingandmanagingcompanies,somethingthatGraham

andSchlosswouldhavedetested.Graham’sideaofvalueanalysiswassimple:“to

findcompaniesthatweresellingbelowtheirnetworkingcapital.”

AsSchlossexplains,thismeantfindingcompanies“whosemarketvalueswerelessthanitscurrentassets:cash,inventory,andreceivables.”

“Tocalculatethis,Schlosssays,“wewoulddeterminethecompany’sliabilitiesandsubtractthemfromitscurrentassets,thendividewhatwasleftbythenumberofsharesoutstanding.”

Professional Investor Profile: George SorosIn September 2006, Issue 35, we featured a piece

by Brian O’Connell, who detailed investor George Soros’ six most important investment strategies.

“Survive first and make money afterward.”—George Soros

HemaybeapolarizingpoliticalfigureintheUnitedStatesandEurope,butGeorgeSorosisalsooneoftheworld’sgreatinvestors.

WhenSorosshortedtheBritishpoundsterlingwith$10billionworthofleverage(ashedidin1992),hewouldbecomefamously

knownas“theManWhoBroketheBankofEngland”—andhesenttheworldamessageonjustexactlyhowworld-classriskmanagersoperate.

Soros,whoisfondofsayingthatriskcomesfrom“notknowingwhatyouaredoing,”knewgoinginthatthemosthecouldlosewasabout4percentofhisportfolio.“Therewasreallyverylittleriskinvolved,”hesaidafterwalkingawaywith$2billioninprofits.

Sorosismoreinterestedinanideathatshouldserveasvitalinvestmentadvicetotherestofus:It’snottheamountofriskyoutake.Moreimportant,itishowmuchmoneyyoumakewhenyou’rerightaboutastockandhowmuchyoulosewhenyou’rewrong.

ThekeytoSoros’investmentlegendisembeddedinthatsimplephilosophyofinvestinginahandfulofpositionsthatgeneratebigprofitsthatcanoffset

lossesonotherinvestments.Butthat’snotdiversification,oneofthetop

commandmentsfollowedbyWallStreettypes.Sorosdoesn’tbelieveindiversification.Hebelievesingettingafewbigpicksrightandstickingwiththem.

Still,hiscriticshaveaccusedhimofbeingpersonallyresponsibleformanyfinancialdebacles,includingtheBritishcollapse.ButSorosremainsnonchalant.Hecontinuesworkingtofurtherhiseconomicself-interests,simultaneouslylobbyingforanoverhauloftheglobalfinancialsystem.“Asamarketparticipant,”hehassaid,“Idon’tneedtobeconcernedwiththeconsequencesofmyfinancialactions.”

Soros’ Six Investment PrinciplesWhileSorosdoesn’tworryaboutthe

consequencesofhisactions,therearemanywhodo.Theywatchhimwithakeeneye,hopingtoemulatehimandthecharacteristicsthathavemadehimsuccessful.Amonghisinvestmentstrategies,sixprinciplesareclear.

1. Financial markets are highly dependent on the human beings who buy and sell in them. Thetheoriesofanopensociety,fallibility,andrelativityhavegivenSorosasolidsystemforselecting,buying,andsellinginvestments.Andhefollowsitreligiously.Expertssaythat’sobviouswhenyouobservethecoolnesswithwhichhemonitorsstock,bond,andcurrencyprices.Putsimply,heleaveshisemotionsoutoftheequationbutrealizesthatthecrowddoesact—oftenimproperly—outofemotion.

AsSoroshasnoted,toomanytraders“react”

Soros


insteadofsimplycoollyactingonlogicalcalculations.Hebelievesthebestopportunitiescanbegainedbydetachingfromemotions.Instead,hebelievesinvestorsshouldsimplyfocusonmarketpricesandthevalueofunderlyingassets.

2. Preserve capital. Previously, Soros has said he likes to avoid pure chance. Whilehehaslearnedthatsurvivingrequiressomeelementofrisk,hehassaidthatitissmartriskthatmakesthedifference.Soheonlyinvestsinsomethingifheunderstandsitanditmeetshiscriteria.Hehasnoproblemsayingno.Andhe’swillingtowaitfortherightbet.

“Iliketohaveabetterunderstandingofthesituationthanthemarket,andthenIbetonmyjudgmentsoIknowIcananticipatethefuture,”hehassaid.“Sothat’snotgambling.Now,youcan’tavoidtakingrisks.ButIonly[doit]whenIthinkIhaveabetteranddifferentperspective.”

Putanotherway,Sorosdoesnotbelieveheneedstoplacehisbetsonthetableforeveryspinofthewheel.Hewillsitonthesidelines—keepinghiscapitalsecure—andwaitforanopportunity.Thenhepounces.

IntheforewordofSoros’2003book,The Alchemy of Finance,formerFederalReserveSystemChairmanPaulVolckerwrote:“GeorgeSoroshasmadehismarkasanenormouslysuccessfulspeculator...wiseenoughtolargelywithdrawwhenstillwayaheadofthegame.”

3. Diversification is not what you think it is. MostWallStreetadvisersgenerallydefinediversificationasacquiringmanysmallerholdings,thusensuringthatallyourinvestmentnesteggsarenotinonebasket—astrategythatismeanttoprotectyoufromlargelossessinceyourmoneyisspreadout.

ButSorosbelievesthatjusttheoppositehappenswhenyoudiversifytoomuch.Hebelievesthatevenifyouamassatidyprofitinonearea,itwillhavelittleimpactonthevalueofyouroverallportfolio.Instead,hebelievesitisbettertoinvestinahandfulofstrongcompaniesthathavethecapacitytoproducehugeprofits,thusoffsettinganylossesonotherinvestments.Forexample,comparetwoportfolios—thefirstisdiversifiedamong100differentstocks,whilethesecondisspreadamongonlyfivestocks.

Ifoneofthestocksinthefirstportfoliodoublesinprice,thevalueoftheentireportfoliorisesjust1percent.However,thesamedoublinginthesecond

portfoliopushesthatportfolio’sperformanceup20percent.Fortheinvestorwiththefirstportfoliotoachievethesameresult,20stocksmustdoubleoroneofthemhastojump2,000percent—anunlikelyscenario.

InSoros’view,it’smucheasiertoidentifyonestockthat’slikelytodoubleinpricethanitistopick20thatarelikelytodouble.That’sthedifferencebetweenaverageinvestorsandGeorgeSoros.

Becausehisportfolioisconcentrated,hefocuseshisenergiesfarmoreintensely—andmoreeffectively—onidentifyingtherightinvestments.Sorosspendshistimelookingforhigh-probabilitystocksthatmeethiscriteria.Whenhefindsone,heknowsthereislittleriskoflosingmoney.SowhenSorosbuys,hebuysbig.

4. Fortune favors the brave. WhileSorosisarisktakerwhoalsoreliesonreservesandintelligence(andnotjustverve),healsoknowsthatluckisnottheoperativetermforinvesting.Courageis.

Hisactivitiesin1992areaperfectexample.TheamountofmoneyheinvestedinspeculationthattheBritishpoundwouldbedevaluedrepresentedastaggeringproportionofhisassets.Andtheresultwasfameandfortune.Still,Soroshimselfcallsthatrisk,inparticular,anexaggeration,claimingthatthe“oddswereverymuchinhisfavorwhenhetookthatbet.”Otherwise,hewouldn’thaveboldlygambledit.

5. Keep quiet about your investments.Whatothersthinkismeaningless.Youneedonlylistentohiscriticsandwatchhimworktwosidesofanissue(i.e.,reformglobalfinancesandcreatehisownwealth)tounderstandthedichotomythatmakesuphischaracter.Heisaninvestorforthetimes,arolemodel,andstillamanwhokeepshisinterestsandactivitiesclosetothevest.Hedoesn’tletthecourtofpublicopinionswayhim.

Infact,inJune1981,whenSoroswasfeaturedonthecoverofInstitutional Investor,hewasdepictedas“somethingofamysteryman,alonerwhonevertelegraphshisviews,whoevenkeepshisassociatesatadistance.”Whysuchsecrecy?Sorosbelievesthatifothersfindoutwhathe’sdoing,they’llpileintothemarketandthepricewillrunawayfromhim.

ThatactuallyhappenedinOctober1995whenaburstofspeculationthatSoroswasshortingtheFrenchfranchelpeddrivethatcurrencydownagainsttheGermanmark.ForaheavyhitterlikeSoros,whooftenhashugeshortpositions,it’snotagoodideatotrumpetyourmarketmovesand


thusrisksqueezingyourself.Sorosisalsoamanwhodoesn’tadvertisehis

losses,ifhecanhelpit.Andwhenhecan’t,itdoesn’tseemtotarnishhisreputation.Thiswasthecasewhenthepressleakedwordofhismultibillion-dollarlossesinRussiaafterthecollapseoftheSovietUnion.Still,heremainedaguru.

6. Take advantage of chaotic markets.Soros’theoryofreflexivitydriveshisinvestingdecisions.Hebelievesthatfinancialmarketsarechaotic.Thepricesofstocks,bonds,andcurrenciesdependonthehumanbeingswhobuyandsellthem,andthosetradersoftenactoutofhighlyemotionalreactionsratherthancoollylogicalcalculations.Opportunitiescanbefoundbycarefullystudyingthevalueandthemarketpricesofassets.TraditionalglobalboursesanddevelopingeconomiesaretwoofSoros’favoritetargets.

Forexample,Sorosandotherbig-nameinvestorshaverecentlybeenpouringmoneyintoGermany’sbanksandfinancialinstitutionsonthecheap,believingthatGermanyisinlineasthenextbigglobaleconomicsuccessstory.WithordersforgoodsandsuppliesflowinginfromEasternEuropeandthePacificRim,GermanyhassurpassedtheUnitedStatesastheworld’slargestexporter.SorosisbettingthatGermanbankswillsoonbecrammedwithcashafterseveralleanyears.

Anotherexampleisinanotherhigh-growthsuccessstory.SoroshasbeeninvestinginrealestatecompaniesinIndiaoflate,includingAnantRajIndustries,Unitech,andGMRInfrastructure,accordingtoarecentarticleintheonlineeditionofIndia Times.InacountrywherelanddevelopmentisakintotheUnitedStatesinthe1950s,SorosisrightonthemoneyingettingintoIndianrealestateearly.

Professional Investor Profile: Jim Rogers The founder of Financial Intelligence Report,

Christopher Ruddy, took the helm for this article on famed investor Jim Rogers, published in Issue 79, June 2010.

JimRogers,inmybook,isaremarkableinvestor.Hedoesn’tplaythemarketforshort-termswings.

Instead,hegraspsthemarket’sgreatcurrentsandactsonthem.WehaveinterviewedhimseveraltimesforFinancialIntelligenceReportandforMoneynews.com.

Hisviewsonthemarketusuallyhavebeenspoton.Clearly,hedoesn’tpaintarosypicturetoday.Somepeoplemightsaythathisviewisnegative.Icallitrealistic.

Arealisticinvestorisonewhoseesthenegativesandpositivesofglobalmarkets.Therearemanyinvestors,forinstance,whoarecompletelyfixatedoninvestinginU.S.marketsalone.TheyhaveanunbridledfaithinthefutureoftheU.S.economy.

Whenitcomestoinvesting,however,pastisnotalwaysprologue.JustbecausethelastcenturywastheAmericancenturyandsawtremendousgrowthinoureconomicstandingintheworld,thatisnot

necessarilygoingtobetruethiscentury.Foronething,demographicsareworkingagainst

theUnitedStates.Wehaveanagingpopulationandfarfewerpeopleonthelowerendofthepyramid.

TheU.S.populationisexpectedtogrowby8percentoverthenextdecade,butthenumberofAmericansolderthan60willgrowby50percent.

Thatisaremarkablenumber,anditshowshowtheagingbabyboomerswilldominateoureconomicandpoliticallandscapefordecadestocome.Asmartinvestorwillpayheedtothattrend.

AtFIR,ourportfoliohasdoneremarkablywellbecausewehavefollowedtheadviceofpeoplelikeJimRogersandbecausewehavebeenrealisticabouttheeconomiclandscape.

ManyofourlongtimereaderswillrememberthatwhenwelaunchedFIRmorethansixyearsago,wewarnedinvestorsthenthatinflationwasmuchhigherthanwhatthegovernmentclaimed—lessthan3percentperannum.

Oilpricesandothercommoditieswereskyrocketingandthedollarwascrashing.Itwashardtobelievethatinflationwasn’tatleastdoubletheofficialrate.Ourreadersmadesignificantprofitsoncommodities,gold,evenonoil.RogerswasamongthefewwhounderstoodthattheU.S.government’sofficialinflationstatisticsweresimply

Rogers


alie.Whenitcomestoinvestments,knowledgeis

power.Today,anhonestappraisalofthesituationshowsthatthereareseveralmajorthreatstoyourwealthandyoumustbecognizantofthem.

Herearethethreemajorones:

Taxation.ThenonpartisanTaxPolicyCenterestimatesthattheU.S.governmentwillhaveashortfallof$500billionperyearforthenextseveralyears.Toclosethatgapbysimplyincreasingtaxesonthewealthiest—therhetoricaltacktakenbyPresidentBarackObamasofar—meansthehighesttaxrateswouldhavetoincreaseto77percentfrom39percent,accordingtothecenter’sfigures.

Obamawillnotraiseincometaxestothatlevel.Instead,Ithinkhewillscroungeforrevenueseverywhere.Investorsneedtobeawarethattax-advantagedinvestmentswillconferagreatbenefitinthelongtermoverinvestmentsthatarenottaxadvantaged.

Inflation.Rogerstellsourreadersthismonththatinflationhasalreadyarrived.Ibelievewewillseeitwithrisingcommoditypricesandafallingdollar.Forthemoment,thedollarhasbeenstrengtheningbecausetheEuropeanUnionhasbeeninsuchdifficultshape.

But,overall,wemustrecognizethatthedollarhasweakenedtremendouslyoverthepasttwodecades.Here’sananecdotalbitofevidence:IvisitedSwitzerlandthispastmonthandsawfirsthandhowthedollarhasstoodagainsttheSwissfranc.

WhenIwasinSwitzerlandinthemid-1990s,thedollarwasstrong.Sincethen,thedollarhasdramaticallydepreciatedagainstthefranc.Everythingisquiteexpensive.The10-minutetaxifrommyhoteltotheZurichAirport,forinstance,cost100Swissfrancs—about$100.

Wehearthatthedollarisholdingupagainstothercurrencies,butthatismostusuallycomparedtotheeuro.Weconvenientlyforgetthatwearecomparingitagainstanothercurrencythatisbeinginflatedanddepreciated.TheSwissfrancmayproveamorerealisticbenchmarkforthetruevalueofthedollar.

National security.Anotherintegralpartofoureconomicsecurityisnationalsecurity,although

Americansoftenignoreit.ThoughObamahaskeptmanyofBush’sWaronTerrorismpolicies,hehasalsobeensendingdangeroussignalstoouradversariesaroundtheworld.

Recently,healteredthenationalnuclearposture,radicallychangingitfromtheBushadministration’spolicy.UnderBush,theUnitedStateswouldretaliateagainstanynationthatusedchemical,nuclear,orbiologicalweaponsagainstit.UnderObama’sdoctrine,theUnitedStateswillnotusenuclearweaponsagainstacountrythatuseschemicalorbiologicalweaponsagainstit.

ThisisarathersurprisingandunusualpolicystatementforanAmericanpresident!Suchpoliciesareworrisomeconsideringthegrowingthreats,suchastheonefromIran.

Defensive MeasuresConsideringtheseseriousthreatstoyourwealth,

itiswisetodothefollowingwithyourinvestments:

•Continue to buy gold.Goldisnotreallyaninvestment;itisinsurance.Inmyview,goldisoverpricedrightnow.Butitisonlyoverpricedinthesensethatithasnorealvalueasacommodityotherthanasastoreofperceivedvalue.Therecouldbearushtogoldifthereismoreeconomicmayhemorawar.Goldalsodoeswellduringperiodsofhighinflation.

•Global investing.ItisveryclearthatinvestorstodaycannolongerinvestinjusttheUnitedStates.EvenDr.JeremySiegel,theWhartonprofessorwhohaslongstudiedandpromotedtheU.S.equitymarkets,advisesthatinvestorsnowputabouthalfoftheirequityportfoliointoglobalstocks.

WeatFinancialIntelligenceReportparticularlylikedividendstocksofglobalbluechips.Forexample,wehavelonginvestedinNestle,theSwissconsumerproductgiant.

Keepyourstoporderscurrent.Continuetoplacereasonablytightstopordersonyourequities.Thelikelihoodofamajorcorrectionissmallbutpossible,especiallywhenoneconsidersthetaxhitthatwillhammertheeconomywhentheBushtaxcutsexpire.

Themarketisupsignificantlysinceits2009low.Investorswouldbesmarttolockinprofitsifthemarketcrashes.


Professional Investor Profile: David Skarica David Skarica, who was the author on an earlier

article in this Special Report, gets his own “profile” treatment from Christopher Ruddy in this piece, which ran in Issue 85, December 2010.

Likeyou,Iusuallygivecredencetoexpertswhohavebeenrightaboutthingsbefore.

OnesuchexpertisDavidSkarica.ImetSkaricaatthememorialserviceformyfriend,thelateSirJohnTempleton.TheservicetookplaceinTempleton’sadoptedhomeofNassau,intheBahamas.

Basedonourconversations,itwasclearearlyonthatSkaricaofferedbrilliantinsightsintothemarket.

IresearchedSkarica’spublishedrecordanddiscoveredapowerfultrailofuncannypredictionsaboutthefutureofthemarkets.

Idiscoveredthat,inthelate’90s,Skaricahadself-publishedabook,Stock Market Panic! How to Prosper in the Coming Bear Market,inwhichhepredictedthehousingbubble,anensuingbearmarket,andthedeclineofthedollar.Backin1999,hesaidwewouldseeariseinthepriceofgold.HeevenpredictedacomingU.S.warintheMiddleEasttoprotectouroilinterests.

Allthathascometopass.Thereare,ofcourse,“perma-bears”outtheretellingthesamethe-bust-is-herestorytoanyonewhowilllisten.Likeabrokenclock,theyarerightatleasttwiceaday.ButSkarica’smindisfarmoreagile.

Unlikethegloom-and-doomgoldbugs,whoholdtheirpositionswithareligiousfervor—ignoringkeyfactsandpowerfultrendsagainstthem—Skaricaisafact-basedanalyst.

Theaforementionedgoldbugsmaybeconsidered“contrarians”inasense,butlikeSirJohnTempletononcesaidtome,beingacontrariandoesnotmeanonesimplygoescountertoallconventionalwisdomandmarketmovements.Inthatlight,Skarica’spragmaticapproachtogoldisvaluable.

Instead,acontrarianstudiesandactsonthehardfactswithoutregardtotheconventionalwisdom.Becausesometimesconventionalwisdomisright—andsometimesit’sjustwrong.

Templetononcetoldmethat,whenhemovedfromRockefellerCenterinNewYorktothetinyenclaveofLyfordCay,hewasworriedabouthisinvestmentperformance.Yearslater,herealizeditwasthesmartestmoveheevermade.UnshackledbytheconventionalwisdomsopervasiveinNewYork,hecouldseethemarketsandtrendsmoreclearly.

Skaricafollowshisfootsteps,employingsimilarlyunconventional,yethighlyprescient,analysis.Forinstance,themarkethititsmostrecentintradaylowof6,469inearlyMarch2009.ManywarnedthattheDowhadroomtofall.YetSkaricahadamuchclearervisionofwhatwasahead.

Infact,onlyamonthbefore,writingintheFebruaryissueofFinancialIntelligenceReport(“MarketRallyAhead,BearWillRemain”),Skaricatoldinvestorstoexpecta50to100percentmarketbounceupfromthatbottom,retracingagoodportionofitsprevioushighabove14,000.

Stocksjustdidthat,puttingbackonmorethan62percentbeforepeakinginthepastfewweeks.FIRinvestorswhoignoredallthegloom-and-doomfolksandfollowedSkaricamadesignificantprofitsasstocksroaredoffthebottom.

HowdidSkaricaknowthis?Hehadanalyzedeverymajormarketsell-offgoingbackoverthepastcentury.Everyoneofthem,hearguedinFIR,wasfollowedbyarapid50to100percentrebound.

Withsuchatrackrecord,itwasnowonderthat,whenIrecommendedSkaricatoamajorNewYorkbookpublisher,JohnWiley&Sons,itsnatchedhimupwithacontracttoproducehisfirstmajorbook.

Well,thatnewbookhasjustbeenreleased.It’scalledThe Great Super Cycle: Profit From the Coming Inflation Tidal Wave and Dollar Devaluation.

ThebasicthrustofSkarica’sbookisthattheU.S.economyisgoingthroughamajorcyclicaltrend,inthiscasealong-termbearmarket.Atthesametime,theUnitedStatesislivingthroughatectonicparadigmshiftasitlosesitslong-heldglobaleconomicsuperpowerstatus.

Skaricaarguesthatthesetandemtrendsarenotunusual.GreatBritainunderwentthesameparadigmshiftafterWorldWarII.Livingunderstaggeringdebts(soundfamiliar?),thegreatestempiretheworldhaseverknownquicklydissolved.

Economicpowershiftedtoaformercolony,the

Skarica


UnitedStates.Incidentally,thepoundsterling,onceaglobalreservecurrency,collapsedinvalueby80percentovertheensuingdecades.

SkaricaseesthistrendrepeatingasAsiansuperpowersandemergingcountriessuchasBrazilbecometheeconomicenginesoftheworld.Thiswillopenuntoldopportunitiesforinvestors,butitwillbebadforU.S.equitiesholdersandthosewhomaintaintheirwealthindollars.Skaricamakesacompellingcasethatthedollarwilldevalueby50percentinthenextfiveyears.

Inflationisinevitable,heargues.Thisphenomenonwillpushstockpriceshigher,butthemarketwillactuallygonowhereasdollarsdevalue.The Great Super Cyclesuggeststhatthebearequitymarketcanlastanotherfiveto10years.Thosewhodon’tthinkmarketscanstagnateforthatlongshouldjustlookbackatthelast10years!

ButThe Great Super Cycleoffersmanywaystomakemoney.Chiefamongthemisgold.

Byanyreasonablemeasure,goldhashadanamazingrun,upfromthedoldrumsofunder$300anounceduringthestockmarketboomofthelate1990stomorethan$1,300now.Ifyouhadthenervetoignorestocksandnearlyinfinitepatience,goldturnedouttobeagreattrade.

Soit’sdone,right?Everyhotassetrevertstoitsmean,onemightconclude,andthegoldbugsoftodayarelookingtogetkilledtalkingthemetalupaftersuchastrenuousclimb.

Notevenclose,Skaricasays.Infact,Skaricafiguresgoldwilldoublefromherewithoutbreakingasweat.

Asheexplainsinthebook,thereisa“new”roleforgold.Or,rather,

itisreturningtoits“old”rolebeforetheriseofmoderncurrencies,asthemoneyoflastresort.

Inthebook,hedetailshowtheappallinglackofspendingrestraintintheUnitedStatesmeansthedollarwillcraterandhowthateventinevitablypushesgoldmuch,muchhigher.“Ithinkintermsofgoldandcommoditiesandactualpurchasingpower,thedollarwillfall50percentorgreaterincomingyears,whichmeansthatgoldwillprobablyatleastdoublefromhere,”hewarns.

Skaricaseesnewworriesahead.InFebruary2010,hewroteinFIRthatU.S.federalgovernmentdebthadmovedintobubbleterritory.The10-yearTreasurynoteyieldmovedtoaslowas2.59percentinearlyNovember.WiththeFederalReserveSystembacktoeasing,U.S.debtshouldgetafewmoremomentsinthesun.Butevenmainstreammoneymanagersarestartingtogrumbleaboutthe“bondpricebubble”wesawearly,andnowtheyarequietlymovingclientsoutoffixedincome.

Canthepoliticians,eventhenewlyelectedGOPleadership,domuchtostopthebondmassacre?Skaricahashisdoubts.Morelikely,theleaderswilldelay,andmarketrealitywillsetinfast,hesays.“Ipersonallythinkthatthemarketisgoingtohavetoforcetheirhand.IfyoulookatGreece,forexample,interestrateswentfrom4percentto14percentinninemonths,”henotes.

Editor’s Note: For more articles on the strategies of the world’s top investment experts, see issues 7, 9, 14, 16, 22, 27, 29, 35, 46, 51, 54, 57, 64, 76, 78, and 79.

Stay up to date on the latest financial news — and benefit from insightful contrarian analysis you won’t get anywhere else — by making Moneynews.com your home page on the web. You’ll get breaking updates,

daily blogs from economic experts, and everything you need to make exceptional investing decisions.

The Financial Intelligence Reportisamonthlypublication of Newsmax Media, Inc., andNewsmax.com. It is published for $199 peryear and is offered online and in print throughNewsmax.comandMoneynews.com.

Oureditorialofficesarelocatedat560VillageBoulevard, Ste. 120, West Palm Beach, Florida33409.

Periodicals postage pending at West PalmBeach, FL, and additional mailing offices.POSTMASTER: Send address changes toFinancial Intelligence Report, PO Box 20989,WestPalmBeach,FL33416.

For rights and permissions, contact thepublisheratP.O.Box20989,WestPalmBeach,Florida33416.

Chief Executive OfficerChristopherRuddy

FIR Brain Trust LordWilliamRees-Mogg,ArnauddeBorchgrave

JamesDaleDavidson,AxelMerk,HansParisis,RobertWiedemer

Financial Publisher AaronDeHoog

Editor MichaelBerg

Art/Production DirectorElizabethDole

TocontactFinancial Intelligence Report,sende-mailto:[email protected]

Subscription/CustomerServicecontact1-800-485-4350or

[email protected]@newsmax.com

©2012NewsmaxMedia,allrightsreserved.

DISclAIMeR: Theowner,publisher,andeditorarenot responsible for errors and omissions. Thispublication is intended solely for informationpurposes and is not to be construed, under anycircumstances,byimplicationorotherwise,asanoffertosellorasolicitationtobuyorsellortradein any commodities or securities herein named.Information is obtained from sources believedto be reliable, but is in noway guaranteed.Noguaranteeofanykindisimpliedorpossiblewhereprojectionsoffutureconditionsareattempted.Innoeventshouldthecontentofthismarketletterbe construed as an express or implied promise,guarantee or implication by or from FinancialIntelligenceReport,oranyofitsofficers,directors,employees, affiliates or other agents that youwill profit or that losses can or will be limitedin any manner whatsoever. Some recommendedtrades may involve securities held by ourofficers, affiliates, editors, writers or employees,and investment decisions may be inconsistentwith or even contradictory to the discussionor recommendation in Financial IntelligenceReport. Past results are no indication of futureperformance.All investments are subject to risk,which should be considered prior to makingany investment decisions.Consult your personalinvestmentadvisorsbeforemakinganinvestmentdecision. Please view our Terms of Use for fulldisclosure at www.newsmax.com/terms.html.Copyright©2012FinancialIntelligenceReport.

Fir securewealth 0

Documents

templeton funds

templeton didnt

report introduction

report dives

market stocks

best investment ideas

best way

worlds best investors