Nathan Lewis

An introduction to the principle of compound interest shows that, an investment that returns a 5% or even 3% rate, over centuries, eventually attains a colossal sum. A million dollars – a decent house these days – invested at a mere 3%, becomes $136 billion in four hundred years. At 5%, it would be $299 trillion.

This doesn’t mean that it is easy to make money. Rather, it demonstrates that it is hard. I don’t know a single example of significant success with this simple strategy. Why not? Many things can happen in four centuries. One thing that seems to happen, with regularity, is currency devaluation, possibly to the point of worthlessness.

In 1935, a stockbroker named Gerald Loeb wrote a book called The Battle for Investment Survival. It is considered a classic today, and is still in print. The dramatic title might be ascribed to the dramatic period in which it was first published. Disaster-mongering books were popular in the late 1970s as well. However, in the book (which was revised in the 1950s and 1960s), Loeb makes clear that the "battle" he had in mind was with inflation. "The greatest threat to successful preservation of capital [is] the varying purchasing power of money," Loeb wrote. People who held their cash at a "safe" 2% or 3% were sure losers in the long-term Battle for Investment Survival, Loeb argued.

Sometimes, cash was a good option. But in the long term, even just to stay even, it was necessary to speculate. The best defense is a strong offense. "Because I am personally completely convinced of the inevitability of loss when attempting to secure a safe income of small return, that I constantly suggest speculation rather than investment [investment-grade bonds] as the policy less apt to show a loss and more apt to show a profit."

The funny thing is, Loeb lived almost his entire life under a gold standard. There was a devaluation in 1933, but that was the only one of consequence for most of his adult life. Oddly enough, money did keep its value in those days. It wasn’t until the floating currency period started in 1971 that Loeb’s worst fears began to be realized. He died in 1974. Maybe his last words were: "I told you so."

Loeb wasn’t the only one worrying about keeping up in the Battle for Investment Survival. It is no surprise that government bonds were popular in the 1930s and 1940s, what with Depressions and World Wars and all. In 1949, the 10-year U.S. government bond traded for about 2.0%! That was the peak of the great bond boom. You might even call it a bubble, to the extent that there can be a bubble in government bonds.

People then began to come to their senses. At first, they noticed that stocks were yielding five or six percent in dividends. But, later, they listened to what was being said by their leaders in Washington, and decided that they didn’t like the way things were going. Ten-year Treasury yields ended 1967 at 5.7%. They ended 1968 at 6.03%. They ended 1969 at 7.65%. Bondholders were intensely aware of the risk that inflation – currency devaluation – posed to their capital. Their fears came true in 1971, when, after 182 years on the gold standard, the U.S. dollar’s link with gold was severed. The dollar was floated and devalued. It eventually lost about 90% of its worth during the decade.

After a twenty-six year bull market in bonds, since 1982, we now have 10-year Treasury bond yields again under 4%. This might have made sense when the dollar was "as good as gold," as it was in 1949. However, the dollar has spent the last seven years declining against every possible benchmark: gold, foreign currencies, a basket of consumer goods, and commodities. The situation that people feared in the 1960s – currency devaluation – has been going on for years now.

It will probably continue until a Paul Volcker-like character appears to put an end to it.

Yet, there is little concern. The government’s CPI statistics are widely regarded, by big-name bond gurus like Pimco’s Bill Gross for example, as something between an honest mistake and a dishonest one. However, the entire Treasury yield curve is now trading below even this artificially low hurdle. The latest CPI readings show an increase of 5.6% from a year earlier.

Government bondholders today think they are "safe" from market turmoil, but, I argue, they are likely to be certain losers in the Battle for Investment Survival. The only safety today, as Loeb argued, is in speculation. Loeb recommended equities. That might not be such a good idea at the present juncture.

Does Loeb offer an alternative to both bonds and stocks? "In the history of the world we find the record of savings really saved through buying gold, hoarding precious stones, and other forms of ‘hard wealth’ privately secreted. In the future history of America most of us will, in my opinion, learn this lesson too late," he wrote.

Gold, silver, and other commodities have had a tough couple months. They seem exceedingly risky, compared to the apparent safety of T-bills. For an inexperienced speculator, these wild moves can lead to catastrophic losses. For the experienced speculator, these hard assets are merely tools in the Battle for Investment Survival – perhaps the best tools for the present situation.

Regards,

Nathan Lewis
for The Daily Reckoning
Los Angeles, California
September 3, 2008

Bill is somewhere over the Atlantic today, traveling from London to Maryland for a publishers ‘jamboree’. Alas, we will power on…

Crude oil extends its price decline today. The black goo is down considerably from its July 11th record high of $147.27 a barrel. At market open today, the price of crude for October delivery was down $2.23 to $107.48 a barrel.

The oil companies in the Gulf shut down 100% of oil production on Monday while bracing for Gustav, but the markets hardly even registered the disruption. CNNMoney.com reports: "Late Tuesday, the Department of Energy decided to loan 250,000 barrels of oil from the Strategic Petroleum Reserve to Citgo’s Lake Charles, La., refinery, according to a statement from the government. The reserve is an emergency repository of 700 million barrels of oil that the government controls.

"’Demand for oil is 1.2 million barrels a day less than it was a year ago, so a release from the SPR can very easily make up for the lost supply,’ said Phil Flynn, senior market analyst at Alaron Trading."

A strengthening dollar has something to do with this trend as well. Since crude is priced in dollars around the world, a strong dollar puts downward pressure on the price of oil. In addition, when the dollar is weak, investors rush to commodities as a hedge against inflation. Now that the U.S. currency is flexing its muscles, investors are looking for more profitable avenues for their money.

The greenback is on quite a tear, reaching an 11-month high against major currencies today. Forbes reports that "investors increasingly put faith in the U.S. amid a deteriorating global economic backdrop."

Yikes…when everyone else is looking so bad that the United States is looking good…you know the world at large is in trouble.

Take the Eurozone for instance. Investors are dumping the euro left and right on data that retail sales slumped more than expected in July. In addition, second quarter domestic product growth dipped to its slowest year-on-year pace in close to 5 years, according to the Wall Street Journal. Today, the euro sits at a low not seen since January.

Our intrepid correspondent, Byron King, offers his two cents on the situation:

This gain in the dollar versus the euro "is evidence of a powerful wave out in the world marketplace.

"What kind of wave? Call it sentiment. Call it perception. Or as Groucho Marx once said, ‘Call it a banana.’

"But the bottom line is that people are buying dollars and selling euros. This is based on their beliefs about the future, and not much else. Really, it’s not as if just one month is enough time for anything major to occur within the structure of either the U.S. or the European economic spaces.

"For example, new industries and labor markets don’t rise and fall in just one month. Tax codes don’t revise within a matter of weeks. Demographic shifts don’t occur in a month. But a month is plenty of time for peoples’ attitudes to change from ‘sell’ to ‘buy,’ and vice versa.

"In Outstanding Investments and Energy & Scarcity Investor, we worry about energy and resources. And in the space of one month, it’s not as if the underlying values of energy and resources are falling. People still need and want oil, corn, copper, etc. (At $107 per barrel of oil, they want less of it, to be sure.)

"But in this summer’s monetary phase – driven by sentiment – the dollar is strengthening. So pricing is weakening for energy and resources and their stocks.

"But really, how strong is the dollar over the medium to long term? Will the U.S. somehow magically balance its budget? Is there any hint that Congress will change the U.S. tax code to make American industry more competitive?

"The dollar is looking good because the alternatives are looking less good. That’s hardly a ringing endorsement for the future. So again, the evidence points to us experiencing a short-term correction."

*** Our favorite precious metal fell for the fourth straight day – another side effect of a strong dollar. Gold is now sitting below $800 – but is this low price a bad thing? GoldMoney.com’s James Turk weighs in on the discussion:

"Years ago Warren Buffett asked an amusing question in one of his annual letters to the shareholders of Berkshire Hathaway. He noted that he was perplexed by people’s mood swings in relation to stock prices. He wondered why people were happy when the stock market was high and somber when it was low because he believes it should be the other way around.

"To explain his point he asked the following question: If you ate only hamburgers your entire life, would you want the price of hamburgers to be high or low? Clearly, you would want the price to be low because in that way you would obviously maximize the purchasing power of your dollars. So too with stocks. When their price is low, you get more stocks for your dollars.

"I believe that this insight also applies to gold and silver. When their price is low, you are able to exchange more overvalued dollars for undervalued gold and silver. Consequently, my approach to the precious metal markets over the past several years has been based on one simple premise. Namely, continue to accumulate the precious metals month after month after month. Some months the price will be high; some months the price will be low. But consistently take that portion of your income you save every month and save sound money. Don’t save dollars; save gold and silver instead.

"Then by the time this bull market finally ends, you will have accumulated a meaningful amount of physical metal because gold bull markets span decades. Importantly, with this simple strategy you will have avoided the emotional roller-coaster ride that can come from looking at the market day-to-day and from reading newspaper headlines. Leave the daily, weekly and monthly price swings for the professional traders to worry about, and instead be a wealth accumulator, buying the precious metals month-in and month-out."

*** Just because the oil prices are on the decline and the dollar is on the rise, don’t be lulled into thinking the U.S. consumer is out of the woods just yet.

Even though relief is being felt at the pumps, prices of most consumer products that were raised when the oil price surged have not yet come down. The New York Times reports:

"Procter & Gamble, for example, has raised by 7 percent to 10 percent the prices it charges retailers for items made with ingredients derived from oil. The company is planning to maintain the increase ‘to recover costs already incurred,’ Paul Fox, a spokesman, said."

And most companies are following suit, and waiting it out to see if oil prices are going to stay low, or if recent pricing is a fluke.

As winter looms in the not-so distant future, worries of high home heating bills are mounting. Although oil and natural gas prices have fallen from their previous highs, they are still well above last year’s level.

The Energy Information Administration estimates that heating oil prices are expected to reach $4.34 a gallon across the nation this year.

Get ready for a long winter…

Until tomorrow,

Short Fuse
The Daily Reckoning

Nathan Lewis

Nathan Lewis was formerly the chief international economist of a leading economic forecasting firm. He now works for an asset management company based in New York. Lewis has written for the Financial Times, the Wall Street Journal Asia, the Japan Times, Pravda, and authored Gold: The Once and Future Money.

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