Blogs on How to Invest, Gold & Silver, and Economics 101

Not Your Father’s Annual Letter to Shareholders

Welcome, WealthCycles readers.  As many of you already know, Warren Buffet released his annual letter to shareholders for 2012 over the weekend. His letter is lengthy, so we cut it down to a fun report on the most important subject, gold, and let our readers reply.

The insights posited by our readers, such as this gem, “You will have to produce more and more at an increasing velocity,” do much to illustrate the central fallacy in Buffet’s argument.

Buffet deliberately treats gold as an investment, not as money, keeping stride with the big lie: gold is not money, but merely an inedible commodity.

Yet in the pile A and pile B exercise Warren postulates, he sees both piles as speculative investments--Investments “which will have to produce more and more, at an increasing velocity” to increase in real value, measured in purchasing power.

A good or asset's ability to be exchangeable or replaceable in whole or in part with a good or asset of the same type. 

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Buffet's Letter

Here are Warren Buffet's comments in his letter to shareholders from the Berkshire Hathaway's annual report. We will release our comments tomorrow but we want to hear what you think first. 

A dividend is an annual payment made to stockholders from the company’s profits. The dividend yield is calculated by dividing the annual dividend by the price paid for the stock, to determine the percentage dividend yield. For example, if you pay $10 per share for a stock and receive $0.60 in dividend payments annually, then your dividend yield is 6%.  

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Don’t Cry For the Elevator Operator

As the U.S. economy continues limping along, and unemployment numbers show small, if misleading, improvements, a recent piece in Bloomberg Businessweek makes a point similar to one WealthCycles.com made a few months back: some jobs go away not because the economy is broken, but simply because their time has come.

The Businessweek article takes off on Wal-Mart’s announcement that it is doing away with its entranceway greeters on the night shift at its 3,800 U.S. stores and “repurposing” its daytime greeters. Visions of white-haired, polo-shirted seniors sadly streaming out of automatic doors and across a vast parking lot come to mind. The reality is Wal-Mart is taking a job it deemed to bring insufficient value to its business and transforming it into a job with more varied responsibilities, higher value, and probably more inherent satisfaction to the employee.

As the article points out:

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The Plan to Cut Tax on Businesses

The U.S. administration is considering a reduction in the corporate tax rate from 35% to 28%. As a general rule, a reduction in taxes collected, increases the amount of productivity in the economy. Here is how it works:


Back in the 1970s economist Art Laffer developed the Laffer curve—a theoretical diagram that illustrates the relationship between tax rates and tax revenues to the government. Basically, it shows that if we paid 0% taxes, the government would collect zero tax revenues, and if we paid 100% taxes, the government would also collect zero taxes because we would have no incentive to work, and therefore, we would pay no taxes. Laffer theorized that there was a sweet spot (t in the diagram) where governments would collect the maximum amount of taxes without stifling the economy.

A dividend is an annual payment made to stockholders from the company’s profits. The dividend yield is calculated by dividing the annual dividend by the price paid for the stock, to determine the percentage dividend yield. For example, if you pay $10 per share for a stock and receive $0.60 in dividend payments annually, then your dividend yield is 6%.  

 

The amount or difference between the initial purchase price of your investment and what you received after selling your investment sometime in the future. 

 

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Overt Currency Printing - Round 3

The Federal Reserve holds eight regularly scheduled meetings annually, and other emergency meetings as needed. These meetings are where the carefully crafted Fedspeak message is painstakingly explained for us rubes. There is a clear difference between overt printing of currency and the stealth printing (inflation) we have seen in the interim.

In the January meeting, we learned that the Federal Reserve wanted to set expectations for interest rates to remain near zero for at least another year beyond the earlier projection, to 2014. Setting this expectation encourages further misallocation of resources that would have otherwise been invested in more productive development of our economy. WealthCycles previously wrote about the zero interest rate policy (ZIRP) in this feature. Moreover, the policy allows the precarious currency system to remain functional. Imagine if the United States actually had to pay real rates of interest on its massive national debt.

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Key Players Buying More Gold Now

Investor appetite for gold is heating up, in part because of signals from hedge fund guru John Paulson, the guy who saw the real estate meltdown coming in 2007 and became a billionaire as a result.

The Paulson & Co. founder “told investors it’s time to buy the metal as protection against inflation caused by government spending,” Bloomberg reported today.

“By the time inflation becomes evident, gold will probably have moved, which implies that now is the time to build a position in gold,” New-York based Paulson said in a letter to investors obtained by Bloomberg. Armel Leslie, a spokesman for Paulson, declined to comment.

Bloomberg reported that 12 of 22 companies surveyed had a buy on gold, with five surveyed neutral.

Paulson & Co., the largest owner of the SPDR Gold Trust Exchange Traded Fund, which trades in gold futures, cut its position in 2011, Bloomberg reported earlier, probably to cover losses in securities.

Inflation is simply an increase in the supply of currency and credit. The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling is defined by the term "price inflation." Central Banks attempt to stop deflation, a natural phenomenon which occurs in order to correct the prior inflation.

Futures are really nothing more than IOUs. Futures contracts are just standardized agreements to deliver a specific commodity, in an agreed quantity, at an agreed price, on an agreed date, someday in the future. They are traded like stocks on numerous commodities exchanges around the world. They differ from buying stocks in that you agree to a transaction at some point in the future.

Quantitative easing is central banker speak for creating currency to buy debt or other assets.

The process of quantitative easing is fairly simple—it involves printing currency and buying assets from banks—but it can take many different forms. Central banks can use Q.E. to buy relatively safe treasury securities, pumping cash into their vaults to stimulate lending; or they can buy assets that have lost value (think mortgage-backed securities) in order to make banks whole and attempt to shore up their balance sheets. Central banks can also target certain maturities of the assets they purchase, to push down the cost of short-term, medium-term, or long-term borrowing. 

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NYSE Volume Signals Investor Disinterest

Fewer and fewer investors are participating in the stock market after $395 billion more dollars have left equity mutual funds than have gone in (below) since the summer of 2008 to the present (data source: ICI).

NY stock exchange volume hit a new low on Monday, the least amount of shares traded on any day in over 10 years, excluding holidays. Trade volume beginning the week was almost 16.9% below the 2012 average, which is dismal in and of itself. Trading activity denotes interest: if no one is interested there ceases to be a market.

Below shows a long-term decline in volume (millions of shares) from 2005 onward to the beginning of this week, which is marked in red. This trend of withdrawals has continued, despite the equity market rising in nominal value for over 2-½ years.

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Economic contraction; AA double dip

Earlier in February, President Barack Obama came to the podium to announce that “The economy is growing stronger…the recovery is speeding up. We’ve got to do everything in our power to keep it going.” Yesterday we profiled the recent jobless rate in a blog titled Election Year Employment Deception—a clear and present sign that administration has touted a false increase in employment—and thus, a false picture of an improving economy. Combine this with the proclamation from every official source that we are in a recovery, and not a depression, as described by WealthCycles here, using both Kondratiev long wave and confirmed below, using simple current fact.

There is no better term than depression when accurately describing the plummeting employment and the economic contraction in developed economies. Bloomberg:

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Election Year Employment Deception

During July of last year we went though the details about the manipulation of the rate of unemployment. We showed how the decrease in the quantity of the people considered “in the labor force” leads to a lower rate of unemployed than is in fact the case. The N.Y. Times subtly gives this fact away in an article from the beginning of February (our emphasis):

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U.S. Foreclosure Deal Just Another Stall Tactic

After long months of wrangling, the U.S government and 49 states announced yesterday a settlement agreement in the bank foreclosure scandal. But despite the tough negotiating stances taken by some states attorneys general, the end result represents only a drop of relief in the bucket of bad U.S. mortgage debt, and an executive of the world’s largest bond investment fund says the deal punishes pension funds and bond investors more harshly than it does the errant banks.

The $25 billion settlement with the nation’s five major mortgage lenders includes $10 billion in direct principle reduction on underwater mortgages and another $10 billion for “other forms of mortgage relief,” according to National Mortgage News: refinancing underwater borrowers, forgiveness of deficiencies after short sales, and principal forbearance for unemployed borrowers. The remaining $5 billion will be paid directly to state and federal government.

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Understanding the Uptrend in Wealth Cycles

Two men, Jim Chanos (left) and Jim Rogers (right), are both famous for being very right throughout their careers managing money. So how can they be diametrically opposed when considering the long-term prospects of Chinese growth?

 

Presently it appears that Chanos is winning the long-term growth bet.  The Shanghai composite has dropped 50% from its 2008 high. It is important to know that Chanos runs a $6 billion dollar short fund, which successfully shorted Enron. He states that his fund starts with a top-down approach. He starts with a macro analysis and drills down into individual assets. Here is his slightly sarcastic take on our present state:

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What's The Debt Ceiling Got To Do With It?

Imagine if, as a household, you went into debt deeper and deeper every year. You announced your intentions to do so periodically, and as you went along, you consistently spent around 2 times more than your income. Would you be viewed as less reliable over time?

When considering wealth management, the best financial information comes to us (and everyone else) courtesy of the U.S. debt numbers.

With a debt to GDP ratio now at 105%, the U.S. crossed the significant 100% threshold around the beginning of the year. The deeper into debt the U.S. and other countries around the world go, the less valuable the dollar and all paper currencies become—and the higher the value for gold.

 

In the chart above, we can see that the correlation between debt and gold is unmistakable. It will soon take more than $2,000 dollars to buy a single ounce of gold.

Euro teetering on edge of dramatic devaluation

As investors consider the precarious situation in Europe throughout the beginning of 2012, the hottest issue remaining on the minds of investors is that European taxpayers have finally reached a point where they will not be able to refinance all of their outstanding debt.

With over $8 trillion in G-7 developed nations needing to be refinanced this year alone, it has become clear that there is not the level of savings anywhere in the world available to loan to these nations, who are apparently quite desperate to get even further in debt.

Courtesy of ZeroHedge.com:

Leaving two options: default—or—increase the amount of currency in supply; in other words, to inflate their currency until the value of their debts are reduced to nothing.

Default is not desirable for lenders, as they would lose far more wealth than if the status quo were prolonged through inflation. In the latter scenario, the bond payments continue, albeit in a newly inflated currency with a lower real value.

Inflation is simply an increase in the supply of currency and credit. The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling is defined by the term "price inflation." Central Banks attempt to stop deflation, a natural phenomenon which occurs in order to correct the prior inflation.

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Why Are Economists Allergic To Gold?

As the old saying goes, the more things change, the more they stay the same.

Some 32 years ago, Ronald Reagan ran for U.S. President, in part, on a promise to appoint a “gold commission” to study the issue of whether and how the United States should return to some variation of the gold standard.

The nation had just come through a couple of tough decades during which, at times, it seemed as if the whole fabric of American society was being ripped apart. Devastating inflation and a lagging economy only made worse the social and emotional turmoil created by changing mores and standards surrounding civil rights, gender roles and military intervention. President Richard Nixon’s shocking act of severing the U.S. dollar’s ties to gold had failed to bring economic prosperity to the nation, and the Republican Party was feeling a bit of buyers’ remorse. The idea of a return to a gold-based monetary system gained steam.

Inflation is simply an increase in the supply of currency and credit. The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling is defined by the term "price inflation." Central Banks attempt to stop deflation, a natural phenomenon which occurs in order to correct the prior inflation.

The tangible things that we eat, use and/or buy. Commodities that are traded include Cattle, Cocoa, Coffee, Copper, Corn, Cotton, and Crude Oil, just to cover the Cs. Gold, silver and platinum also are traded on the commodities exchanges as futures contracts.

A fiat currency is created by a government decree. The Latin word fiat means “let it be done.” And with the stroke of a pen, or the crank of a printing press, “money” is created. Fiat currency has no inherent value—the paper that a $100 dollar bill is printed on is surely not worth $100. It might have been worth a few cents before the government ruined its utility as scrap paper by printing green words and numbers all over it! Compare this with gold, which is a precious, rare metal that is, in many cases, the only substance on earth that can be used for certain human purposes, including science, medicine, and of course—adornment.

A fiat currency is created by a government decree. The Latin word fiat means “let it be done.” And with the stroke of a pen, or the crank of a printing press, “money” is created. Fiat currency has no inherent value—the paper that a $100 dollar bill is printed on is surely not worth $100. It might have been worth a few cents before the government ruined its utility as scrap paper by printing green words and numbers all over it! Compare this with gold, which is a precious, rare metal that is, in many cases, the only substance on earth that can be used for certain human purposes, including science, medicine, and of course—adornment.

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