Investment Chess

Investing is like playing chess – you have to think about the move you are making right then, while simultaneously planning future moves. This strategy can be difficult, but Mark Tier has found one man who has it mastered…

"First of all, you have to protect yourself from yourself" – Bernhard Mast

I first met Bernhard in Hong Kong when I was testing my "Investor Personality Profile," which pinpoints your weaknesses – and strengths – as an investor. From his answers to the questionnaire I could clearly see that he was following all the Winning Investment Habits – except one. Which puzzled me. He didn’t appear to be following Habit #11 – which is to act instantly once you have made up your mind to buy or sell something.

So I queried him about this, wondering if there was some flaw in the format of my questions.

He told me that he reviews his portfolio and makes his investment decisions in the morning…but he places all his orders through a bank in Switzerland. Due to the time difference, Bernhard can’t phone his orders in until afternoon in Hong Kong, when Zurich opens for business.

As I got to know him and understand his strategy, it became clear that he was, indeed, following all 23 Habits.

Bernhard is living proof that you don’t need to be a high-profile investor with hundreds of millions of dollars, or even an investment professional, to successfully apply the Winning Habits.

Winning Investment Habits: The Greatest Threat to Financial Security

What’s more, he has no ambition to have his name up in lights like Buffett or Soros. He doesn’t want to manage other people’s money, and prefers to remain anonymous. His goal is very simple: "When I’m 75, I don’t want to be stacking shelves at a supermarket to earn money to put food on my table. I’ve seen it happen to others, and it’s not going to happen to me," he told me.

What he sees as the greatest threat to his future financial security is the loss, over time, in the purchasing power of paper currencies. As he points out, a dollar today buys less than 5% of what a dollar bought 100 years ago. In contrast, the purchasing power of an ounce of gold has remained relatively constant.

This is a topic Bernhard has studied in detail. He even wrote his PhD thesis at the University of St. Gallen on central banks and their gold reserves (though as he got an exciting job offer in Asia he never actually handed in his thesis). He’s fascinated by the history and theory of money. And today, his knowledge in this field forms the basis of his investment philosophy.

His first investment was in silver in 1985. He recalls going on holiday and not even reading a newspaper for 10 days. In a taxi on the way to the airport to catch his flight home, he noticed in the newspaper that silver had gone up 20%. He took his profits right away.

Bernhard was, at that time, just dabbling in the markets: his main focus was on building his business. He told me he didn’t make another significant investment until 1992. A friend of his worked on the trading desk of one of the big Swiss banks. Together, they went heavily into silver call options, buying $60,000 worth. Soon after they’d gone into the market, the price of silver soared. They made 10 times their money!

"We felt like geniuses," Bernhard recalled.

So what happened next, I wanted to know. They tried to repeat their success by shorting the S&P index. But American stocks didn’t fall; they began to creep up. Being "geniuses," Bernhard and his friend added to their short position, only to see the market go through the roof. "I was wiped out," Bernhard told me." "I gave back all my profits on the silver options, plus my original investment – and then some."

Winning Investment Habits: "Protect Myself from Myself"

It was then Bernhard realized that, to invest successfully, the first thing he had to do was "protect myself from myself."

Bernhard sat down and did something very few people ever do. He spent several months building a detailed investment strategy, and spent some more time testing it, so he could achieve his primary aim: ensuring he would have financial security and independence for the rest of his life.

He defined his overriding investment objective as preserving the purchasing power of his capital. He believes the safest way to achieve this goal is with investments in precious metals, chiefly gold.

Bernhard divided his assets into four parts: life insurance, real estate, fully owned gold bullion, and a trading portfolio consisting of mining stocks and forward positions in precious metals. He keeps them all separate, even to the extent of using different banks for the mortgage on his property and for storing his gold bullion.

The first three asset classes are the bedrock of his financial security. His aim in his trading portfolio is to make profits he can use to increase his ownership of gold. Bernhard thinks that commodities, including gold, are currently undervalued. And this is the basic premise of the investment system he has devised.

Bernhard owns gold, but as gold pays no interest his holdings don’t increase over time. To achieve that objective, he seeks to use the leverage of gold mining stocks, which he says "typically rise by a factor some two or three times the corresponding rise in the gold price."

He has developed a complete investment system with detailed criteria for selecting mining stocks to buy. His first screen is location. He refuses to invest in any company operating in Russia or China. Or places like Zimbabwe, Mongolia and Indonesia. Why? "I simply don’t trust these markets," he says. "Property rights in these countries just plain aren’t secure. They’re riddled with corruption; and governments do whatever they feel like."

Bernhard is justifiably afraid that he could wake up one morning and learn that the mines of a company he owns have been shut down or confiscated, leaving his shares worthless. For him, investing in any of these countries is simply not worth the potential risk of loss.

Winning Investment Habits: Currencies

Next, Bernhard looks at currencies. When I interviewed him in June 2004, for instance, he owned no mining stocks in Australia or South Africa – two of the world’s major gold producers. The reason: both the Australian dollar and South African rand had risen dramatically against the US dollar.

"I had some South African gold shares until about a year ago," Bernhard told me, "but I got out when I realized they can’t make any money. Even though they’re sitting on tons of gold, since the rand has skyrocketed against the dollar they can’t take it out of the ground at a profit."

His next filter is the management. Like Buffett, he wants to be sure that management treats the shareholders well. He wants to invest with managers who’ve successfully found and developed deposits in the past. He also reviews the company’s current projects to evaluate their prospects.

Bernhard gathers all this information using the Internet. "You couldn’t have done this five years ago," he says. "But now, there’s an enormous amount of information readily available." Company websites provide annual reports, financial data, press releases and the like. Stock price data is readily available, as are charts of past prices, which to him are useful tools.

Forty-seven stocks from a universe of some 350 that he has screened meet all his criteria. Following the typical actuarial approach, he owns them all – but he doesn’t have an equal investment in each. His capital allocation hinges on his assessment of where the company is in the development cycle.

To him, mining stocks fall into three categories:

1. Producing companies that typically pay dividends;
2. Companies which have proven discoveries they’re still in the process of developing, often in partnership with one of the majors like Newmont Mining; and,
3. Pure exploration companies, which are just as likely to burn up all their cash as they are to strike it rich with a big discovery.

Bernhard feels that companies in the second category – those nearing production – offer the best risk/reward trade-off. They’re about to turn from consumers of cash to significant cash generators. So his portfolio is weighted heavily towards this category.

And – at the moment – he gives the smallest weighting to the existing producers, as he feels they offer the least leverage on the price of gold.

He also has detailed rules about timing his purchases and sales of these stocks. He will only buy stocks that meet his criteria when gold is under $350 per ounce.

"Following this rule," he told me, "I’ve bought hardly anything over the past six months." Only if gold dips below $350 would he add to his stock holdings.

Winning Investment Habits: Stocks Double, Sell Half

When one of his stocks doubles, he sells half, getting his initial investment back. As a result, he says, "about a third of my stocks I own for free."

Another exit rule is to begin banking his profits if gold goes over $450 an ounce. If gold rises as he expects, sometime over the next few years he will have sold all his mining stocks, and will be looking for some other investment field.

He spends three hours a day looking at political and economic developments that could affect his assets; searching for new candidates to add to his list of qualified stocks; and monitoring the stocks he already owns to ensure they continue to meet his investment criteria. If they don’t, he dumps them.

Bernhard pays cash for his stocks, and then uses them as collateral to finance forward purchases of gold bullion, which is the second element of his trading strategy.

If gold rises above $450 per ounce, he will begin cashing in his stock profits. He will take that money and use it to take delivery of the gold he has purchased with forward contracts. This bullion he adds to his "nest egg" of precious metals.

To protect himself against a catastrophic drop in the price of gold he has stops set to liquidate his entire trading portfolio to avoid being wiped out. Moreover, he has a large cushion of protection. "I have my gold position at an average price of around $310 an ounce," compared to the current price of $408, "so gold has to drop a long, long way before I have to worry."

His overall approach is exceptionally conservative. Unlike the average homebuyer, who’ll increase his mortgage for spending money when the price of his house goes up, Bernard doesn’t even count unrealized gains when he values his holdings. The only profits he counts as part of his net worth are the ones he has actually cashed in. And while he doesn’t include paper profits, he does subtract paper losses. In other words, values his portfolio at his cost, or the market price – whichever is lower.

Bernhard’s underlying premise is that commodities are undervalued. Eventually they’ll be fully valued. So he recognizes his current system will stop working someday. Indeed, he fully expects that some time in the next five to ten years he will have sold all his mining stocks, taken delivery of his gold forward contracts – and possibly even sold some of his bullion nest-egg.

"Investing is like playing chess. You have to contemplate the present, but you also have to look ahead to the 4th, 5th, 6th or 7th move." So he’s already looking at expanding his universe into energy stocks, a field where he’s beginning to test a variation of his system.

Like the well-known investors we’ve already talked about, Bernhard has devised a system which has all 12 necessary elements. And like their approach to investing, his is highly personalized and specialized, clearly drawing on his own unique background, his studies, his experience and interests.

"Some of my friends think I’m crazy," Bernhard says. "But I’m very happy with my current strategy, and I sleep very well every night.

"I follow it," he told me, "because it’s the safest way I know of, right now, to preserve the purchasing power of my capital. If I knew a better way, I’d do it. I’d switch today."

While his method is certainly unusual, it works for him. And he follows it religiously. To ensure he doesn’t deviate from it, he keeps a written set of guidelines – which he calls his "rules" – and continually refers to them.

Though he admits that he does occasionally make a mistake. "And if you do," he said, "don’t panic! If you panic, you freeze up you become your own worst enemy.

"I just say to myself, ‘Oops,’ review what I did dispassionately, and take the necessary action."

He told me he reviews his list in detail every six months; evaluates his actions to ensure he’s been following his rules; and to see if he’s learnt or discovered something that could improve them.

Such rigor and dedication is unusual in any field. But it’s what has made Bernhard – like Buffett, Soros, Icahn and Templeton – a highly successful investor.


Mark Tier
for The Daily Reckoning

May 24, 2005

The above essay is taken from Mark Tier’s book, Becoming Rich: The Wealth-Building Secrets of the World’s Master Investors Buffett, Icahn, Soros.

Mark Tier founded and edited (until 1991) the investment newsletter World Money Analyst, and is also the author of Understanding Inflation, The Nature of Market Cycles, and How To Get A Second Passport. His articles have appeared all around the world, in publications varied as Time, Reason and Business Traveler.

Seven years ago he adopted the wealth-building secrets of the world’s master investors, sold all his business interests and now lives solely from the returns on his investments.\

What a wonderful world. The sun is shining neither in London nor in Paris, but it must be shining somewhere this morning. Still, it is springtime in both cities. Birds sing in the trees. Lovers stroll in one another’s arms.

The dollar is up. Stocks are up. Houses are up. Americans still spend more than they can afford. But their friendly suppliers in Asia keep extending credit. As reported here last week, Japan printed up an additional 35 trillion yen between 2003 and the first quarter of 2004, just so it could trade them for dollars…and lend it back to the United States. This dollar-buying/lending spree helped keep interest rates low in the United States…which helped expand a bubble in house prices…which gave Americans something to borrow against in order to continue spending!

In New York, an analyst describes Wall Street’s upbeat mood: "People are beginning to realize, ‘You know what, this economy does have some legs to it,’ and companies continue to benefit…Where in the world do you continue to find good growth these days? Increasingly, it’s here in the U.S."

Meanwhile, the U.S. military keeps a vigilant eye…making sure that no sparrow falls anywhere in the world that might upset the spread of globalized commerce in the Pax Dollarum era.

America’s system of imperial finance may have no flaws, but its perfections are devastating.

The "growth" that investors so admire is not a growth in productivity…or in productive capacity…nor in profit-making capacity…nor in wage-earnings. The growth is a growth in consumer spending; and since there are neither savings, nor earnings, with which to pay for more spending, it is a growth in debt.

No one bothers to explain how a person can "consume" wealth…and end up with more of it than he had before. It is just one of those many mysteries that must be left to the gods. It is the oddest kind of growth, a perverse kind of growth in which the grower gets smaller with each day.

Nor is there any explanation for how the entire American economy could owe its Asian suppliers more and more money and yet still be a model of "good growth." But it was not good growth at all, but bad growth. It is the kind of growth you achieve just before you go bankrupt…or the fun you have just before you go to Hell. Imagine a church treasurer who runs off with the choir mistress and the new steeple fund; he sends back a postcard from Las Vegas: "Enjoying much personal growth. Have taken up smoking…drinking is fun too. Gotta run…gotta hit the slots while I still have some money left."

Spending money you don’t have is not disagreeable. The disagreeable part comes later.

For the moment, Americans salute their imperial standards. They gratefully paste the flag to their car windows, their jackets, their hats, their beer mugs, their shirts and even their underwear. Americans are proud of their empire – and should be. Without it, they could never have gotten so far in debt. What central banker would fill his vault with Argentine pesos or Zimbabwe dollars? What drug dealer or arms seller would want Polish zlotys in payment? What insurance company would want to buy Bolivian or Kyrgistan bonds to cover its long-dated liabilities?

The dollar has not been convertible into gold for 34 years. Yet, people still take it as though it were as good as the yellow metal – only better. Ultimately, lending money to a foreign government is a bet that the government will put the squeeze on its own citizens to make sure you get paid. The United States doesn’t even have to squeeze. When one foreign loan comes due…other foreigners practically line up to refinance it; it is as if they were bringing pastries to an extremely fat man…just to gawk and wonder when he might explode.

More news, from our team at The Rude Awakening…


Eric Fry, reporting from Manhattan:

"Hedge fund managers hate tech stocks…Is there any better reason to love them? We dispatched our colleague, Hilaire Atlee, to a hedge fund manager’s investment conference in Manhattan to gather intelligence…"


Bill Bonner, back in London…

*** Chris Mayer, reporting from Gaithersburg, Maryland:

"I’ve been on a variety of radio shows over the past few weeks talking about China. One of the interesting points I raised in these discussions was the apparent divergence between China’s economic performance and its stock market – a point brought up by only one radio host that I talked to, but one that demonstrates an important if unoriginal principle, namely that economic performance has little to do with stock market returns.

"To wit: Between 2000 and 2004, China’s economy grew by more than 50%…while the Shanghai and Shenzhen benchmark indices fell by more than a third. Chinese shares have been among the worst performers in the world recently.

"Why such a divergence? One reason is that in 2000, the average price of a listed company was nearly 60 times earnings. Much ink has been spent on China’s poor stock market performance. Yet, the simple and uninspiring truth only reinforces the old wisdom that price matters. What you pay for an investment has a great deal to do with what you end up with later. China’s explosive macro story once again proves the point."

*** Charlie Munger: "The present era has no comparable reference in the past history of capitalism. We have a higher percentage of the intelligensia engaged in buying and selling pieces of paper and promoting trading activity than in any past era. A lot of what I see now reminds me of Sodom and Gomorrah."

We didn’t know Charlie was that old.

*** Liberation, the French leftist newspaper, is worked up this morning by "The Specter of Social Dumping." What it means is that workers from Eastern Europe are coming to France and taking jobs from French people at lower rates of pay. Polish plumbers, Portuguese masons, Czech truck drivers…"foreign" workers are all over France. And no wonder. Wage rates are lower in the East. So companies from Eastern Europe are able to underbid their French competitors for the same jobs.

We have some personal experience of this. We can’t resist a money pit of old stones, and we found a deep one in Normandy; we bought the old house in January. Now, we are fixing it up. We were prepared for over-runs…we thought the renovation might cost twice as much as we estimated. Instead, it is turning out to be nearly four times as much. Naturally, we look for the artisans and contractors who can give us the best prices. In one instance, we found a company from the Czech Republic that would replace the windows at half the price of the French company.

All over the world, dear reader, globalized competition is driving down labor rates. No doubt, this very minute, there is some poor sod in Mumbai or Calcutta preparing to write The Daily Reckoning for a quarter of our own measly stipend.

The Daily Reckoning