Where's the Bull

The following is an excerpt from Around the Keg, a monthly newsletter published by Paulson Information Systems, L.P. and MoneyKeg.com. Please click here for subscription information.-July 2006 -I recently discussed with a subscriber, to whom I recommended holding his wealth in precious metals, the current outlook for this strategy. The reasons for said recommendation are too long to mention in their entirety here, but a major reason I made the recommendation was that this particular person was VERY conservative. Since he was simply leaving his funds in a CD at the time, almost 2 years ago, I suggested that an investment in precious metals would protect his accumulated wealth better than any paper asset. Up until now, my advice has been correct. And this person’s financial health is better for having acted upon it.In my opinion, the primary reason for this “success” is the rampant inflation seen in the United States for the past several years. Despite the efforts of the government information chain’s blatant attempts to trick the unsuspecting public, simple logic indicates a major inflationary trend.It is not a stretch to think that rising oil prices will have an effect upon the price of consumables. After all, almost every product must be shipped. Therefore, an increase in the price of fuel increases the cost of shipping. This line item cost must be passed on to the consumer. The result is rising prices across the board.But there is something else at work here, behind the scenes, slowly churning up prices continually for almost a century. That “something else” of course, is the consistent increase in the money supply courtesy of our good friends at the Federal Reserve Board and the Federal Government. Is this the real source of price inflation? Or is it supply and demand; the changing climate; Peak Oil; global imbalances; politics; terrorism; total budget deficits; global warming; over population; weapons of mass destruction? Well, you get the idea.My answer to the above is: who cares? Our goal as investors is to beat the inflation. So let’s take a look at the following:• The actual increase in prices;• The return on investment (ROI) in various asset classes;• Available options in light of the above analysis.The Increase in PricesFor decades, inflation has been measured by the Consumer Price Index (CPI). According to the US Department of Labor’s website, the CPI program “produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.”The following are the eight major groups of items factored into the calculation:FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks)HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)APPAREL (men's shirts and sweaters, women's dresses, jewelry)TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)RECREATION (televisions, pets and pet products, sports equipment, admissions);EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).The “core” CPI-U is the measure mostly used in the media today. This index, however, specifically excludes food and energy in the calculation. As the Monthly Labor Review Online explains (http://www.bls.gov/opub/mlr/2000/04/art1exc.htm)“Economists often exclude food and energy price movements when evaluating the underlying or "core" level of inflation. Food and energy price movements tend to be relatively volatile in the short-to-intermediate terms, making only transitory impacts on the All Items CPI. Large rises in these prices are often followed by large decreases, and vice versa. Volatility in food and energy price movements such as that caused by unusual weather conditions, is generally self-correcting. Inclement weather often leads to temporary food shortages and temporarily increased demand for household fuels. Sustained shifts in food and energy prices, of course, will affect overall inflation.” (Emphasis added)Of course, that last sentence tells the real story. Has there been a “sustained shift” in food and energy prices? Let’s go to the charts. (courtesy of www.tradingcharts.com) Above is the CRB index for the last several years. As is painfully clear, the CRB index completed a “double bottom” in late 2001 and has been on a tear ever since. The current construction of the CRB index can be found here. It specifically included the following:•Metals: Copper scrap*, lead scrap, steel scrap, tin, and zinc*.•Textiles and Fibers: Burlap, cotton, print cloth, and wool tops.•Livestock and Products: Hides, hogs, lard, steers, and tallow.•Fats and Oils: Butter, soybean oil, lard, and tallow.•Raw Industrials: Hides, tallow, copper scrap, lead scrap, steel scrap, zinc, tin, burlap, cotton, print cloth, wool tops, rosin, and rubber (59.1).•Foodstuffs: Hogs, steers, lard, butter, soybean oil, cocoa, corn, Kansas City wheat, Minneapolis wheat, and sugar (40.9).This is only one piece of the story because fuel costs are not included in this index. For that analysis we need only look at the following: (courtesy of www.barchart.com ) We can see the price of crude start at around $20.00 US to over $70.00 per barrel as of the first of July, 2006. It becomes clear then; the core inflation numbers do not accurately measure the inflationary trend. The increase in food and energy prices has been steady for five years running. So much for these “core” numbers.The Return on Investment (ROI) in Various Asset ClassesStocksLiquidity certainly helps the stock market as new money comes into the markets in various forms, not the least of which are pension funds and increased investor activity. After all, the extra money must go somewhere.The problem is that a continuous influx of money must be present in order for this, Ponzi scheme gone crazy, to continue. In other words, if the world central banks, including the FED, continue to tweak up rates, that will stifle the easy money policy that has allowed the DOW to creep up towards its all time high since 2003. See below the Chart of the DJIA as charted by my Tradestation software.Not much going on in the above chart – a large consolidation maybe - waiting for its next big push in a few years. This could very well be. But this fact is of little help to us, as we are trying to make our dollars work in the face of oppressive inflationary trends. When will I be convinced of a new bull trend in the equity markets? When the historical high is surpassed and that level maintained for some time. I just do not think that broad equity positions will help us reach our goals in the current economic climate.BondsFor the current yields visit here (courtesy of Bloomberg.com). Notice that none of the bonds quoted yield anywhere close to the actual rise in prices that is inflation. Let’s take a look at the yields on the 10 Year Note. (courtesy of yahoo.com) Of course, the yields are nowhere near what we need as inflation fighters. To beat inflation, bonds do not make the grade.Real EstateSince Real Estate investing is unlike many of the other potential destinations for your investment capital, in that the market is generally illiquid and not uniform, any charting based upon mortgage rates, home sales, rental increases, etc. will be of little use to us. Real estate investing is evaluated on a case by case basis.However, what one should be aware of, and something that I will share with you since I practiced a fair amount of residential real estate law in my day, is that there are more costs that meet the eye when buying/selling property. I will not go into detail about these here. (perhaps in another edition) Let’s have a brief look at only some of these, since they, as will all costs, will affect your bottom line.•Marketing;•Closing Costs;•Recording fees;•Title insurance;•Tax escrows.Be aware that these costs exist and range from $5,000 to $10,000 per transaction. Sure, the bank will often offer to roll it into the loan, but it is still a debt. I talk about mortgages later in this edition, but just be cognizant of the fact that transaction costs in the real estate market dwarf those in the other traditional investment markets.The Available OptionGold/SilverThe following charts sum it up nicely. Gold has been in an uptrend for several years now. So has silver. See for yourself below: The markets do not lie. An uptrend in these markets began over 5 years ago. In my opinion, they have a long way to go. The reasons for this are plentiful. A partial list includes:•Fiscal irresponsibility on behalf of politicians and citizens, continuously spending debt instead of production;•The reckless printing of money as enabled by the Federal Reserve Board;•Declining production out of the United States;•Exporting of jobs to emerging countries to take advantage of wage arbitrage;•The War on Terror spending;•Increased demand for oil, costing more for families to live, causing them to borrow more to sustain their lifestyle;•The voracious appetite of foreign countries to consume federal debt;•And more.Why sweat it though? We cannot control these things. We can only control ourselves. As I stated before, we need to beat inflation. If we cannot accomplish this, without exposing ourselves to large risks, then we must protect what we have. This is important because an individual’s wealth is determined not only by what he possesses, but also what everyone else has. That is, your wealth is relative to everyone else’s.For example, if every citizen was given a $1,000,000 bonus this year for being a good citizen, it would have little effect on your wealth, since everyone was given that bonus.All of this to say that you can become wealthy just by protecting what you have while others are losing what they have. This, in my opinion, is the current scenario.•Bonds cannot beat inflation at the present time.•Stocks are languishing in a trading range.•Money Markets and CD's currently yield far less than the inflation rate.•TIPS (Inflation Protected Securities) fail because each is usually linked to the government reported inflation rates which we have seen are less than accurate.•Real Estate is evaluated on a case by case basis. Even if a good deal is found, it may be cost prohibitive in terms of time and effort.Gold however, is the historic hedge against inflation. Silver too. But monetary metals are much more than that, because they are monetary metals. They serve as the watch dog over the financial world. And their story of the past several years tells the story of financial recklessness. Place your money in these vehicles and protect what you have until such a time as conditions change. Then, perhaps, inflation exceeding gains will be possible in stocks, bonds, and/or real estate.Thanks for listening.Paul PaulsonDISCLAIMER: This writing is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever. Trading and investing involves high levels of risk. The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The authors may or may not have positions in the financial instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future performance.

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