The "Five Years 'Till Tragedy" Rule

How one man turned $30,000 into $80 million outside the stock market…in economic conditions eerily similar to our own…

Michael Marcus turned a small trading stake of $30,000 into $80 million dollars in about 10 years…

Marcus made these profits during the 1970s – one of the worst times in history to be an investor. Yet, "I was making at least 100 percent a year for years and years," Marcus writes in the book, Market Wizards. "I think the markets were so good that…you just couldn’t lose. Fortunes were being made."

Huh? The markets of the ’70s were good? What is he talking about? How did he do it? Today, we are seeing the same "setup" conditions as Marcus saw in the early 1970s. When you understand it, you’ll see that the current opportunity is extraordinary…

Five years after the stock market crashed in 1857, the price of gold and other "commodities" began to skyrocket. Why? To finance the War, Lincoln took us off the gold standard in 1862 and, for the first time, the U.S. government printed paper money that was not backed by anything.

Buying Commodities: Gold and Crude Oil

Speculators knew it was coming. And knew what it meant. Legendary speculator Daniel Drew said, "I never made more money or had four years that were all in all more genuinely prosperous, than those four years of the [Civil] War." After gold soared, crude oil was next, in 1865.

According to Edward Chancellor’s Devil Take the Hindmost, "the price of crude oil increased NINEFOLD within a few months, reaching a level that in real terms has never been equaled."

Five years after the stock market peak in 1857, the government got down to the business of creating inflation…crashing the dollar and causing gold and commodity prices like oil to soar. This was the first of many times this would occur.

In short, after a major stock market peak, there are five years until tragedy…five years until a dollar crisis – and soaring commodity prices. It happens time and again. Let’s consider the three major stock market peaks in the last century…1929, the late 1960s, and 2000.

Four years after the peak of ’29, FDR closed the banks and made it illegal for private citizens to own gold. In January 1934 – five years after the bubble – he devalued the dollar, crushing people’s savings. Commodity prices had triple-digit rises in the mid-1930s and speculators once again made a fortune.

Buying Commodities: Creating Inflation

It was an easy bet. FDR wanted to create inflation. It was a crazy idea. Never before had a country attacked its own currency for the purpose of creating inflation and rescuing debtors.

The same thing happened five years after the market peaked in the late 1960s. Five years later, Nixon took the dollar off the gold standard (this time for good). Commodity prices soared for the next ten years, with the price of gold reaching $850 an ounce by the time it was over.

By coincidence or not, each major stock market peak of the 20th Century was followed by a crash in the U.S. dollar five years later. People who kept their savings in dollars saw the purchasing power of their savings shrink substantially. Yet those who invested in commodities made fortunes…folks like Michael Marcus.

Marcus turned $30,000 into $80 million starting in the early 1970s. He did it not by speculating in stocks (which would have been disastrous), but by buying commodities. Again, it was an easy bet.

Marcus got started in 1972, dumping his whole life savings ($700!) into plywood futures. Nixon had price freezes on, so the prices of commodities like plywood weren’t legally supposed to be able to rise. But the futures contracts soared, and Marcus turned his $700 into $12,000 in plywood.

Buying Commodities: The Same Story

In 1973, Marcus turned $24,000 into $64,000, basically by making the same bet. Marcus said when the price controls "were lifted, there was a tremendous run up in commodities. Just about everything went up. Prices doubled in many markets…"

I tell these stories because the same story is unfolding once again. We had another major stock market peak in late 1999/early 2000 (depending on which index you use). And the "five years until tragedy" rule is striking again…

There is no gold standard for the government to adjust today (as was done in 1934, when FDR revalued gold from $20.67 to $35 an ounce), or to go off of the gold standard as Nixon did in 1971, crushing the value of the dollar. But the government today has clearly stated its intent to create inflation (Fed governor Ben Bernanke has offered to drop dollar bills from helicopters if necessary.) Just as in 1862, and in 1933, it has been explicitly spelled out for us.

And things are reacting as they should. The U.S. dollar is in freefall. It has hit consecutive all-time lows against the euro for the last week. And commodity prices are taking off after taking a breather for the decades of the 1980s and the 1990s.

This trend will inevitably continue for a few reasons. Just like in 1862, when the nation had a new war to pay for and the government printed money, the equivalent of the same will happen today. Additionally, our government is heavily indebted (the largest figure of government liabilities I’ve seen is $44 trillion, roughly $440,000 per household in America). And it is much easier to print money to pay off your debts than to actually earn it through working. Devaluing our dollar is simply the easiest way out…and as the dollar falls, the price in dollars of "real" things – like a barrel of oil or an ounce of silver – rises.

The message is clear…To save the value of their dollars right now, the smart money is looking to gain exposure to commodities.


Steve Sjuggerud,
for The Daily Reckoning

December 10, 2003

P.S. Do you know anyone who’s opened a sugar plantation in the last 20 years? How about a lead mine? I don’t know anyone either. Yet the world is growing. And it needs raw materials.

Consider the case of silver. Silver has been trading around five bucks for the last five years (give or take 50 cents). It hasn’t gone wild yet. Meanwhile, silver stocks have soared. Pan American Silver (PAAS) for instance is up four- fold since early 2001. This stock is now trading at a forward P/E ratio of over 70, at a price-to-sales ratio of 15, and a price-to-book ratio of 5. And silver has hardly moved yet! I’d rather own the silver than the stock…

Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. An international currency expert, he is also a member of the Oxford Club advisory panel. A version of today’s essay appeared in the December issue of Dr. Sjuggerud’s investment advisory.

Those whom the gods would destroy are granted their first wish…

It must have seemed like a wish come true 32 years ago, when the whole world’s money system came to rest on the dollar…and the dollar alone. With no need to settle up in real money (gold), Americans could buy all they wanted – without ever having to pay for it. Or so it appeared.

And so they began a spending spree that continues to today…and now threatens to destroy them. First, they spent their earnings…then they spent their savings…and then they mortgaged their houses and ran up credit card bills. It looked like such a good deal…the more they spent, the richer they felt. Stocks and real estate prices rose – as the foreigners recycled their own money back into U.S. assets. They did not seem to realize that they were exporting their own jobs…and the titles to their own houses…and getting gee-gaws and gadgets in return.

And now we read in the Wall Street Journal that the Chinese are selling U.S. Treasuries. They do so to avoid the falling dollar…and in anticipation of a revalued yuan.

Once again, Americans who were so desperate to see China let its currency rise against the dollar may get their wish – and live to regret it. (Addison hints at another motive below.)

The Chinese are blockheads. Otherwise, they wouldn’t have gone along with America’s bamboozle for so long. Selling things to people who can’t pay for them is not a reliable way to build an economy. And sooner or later, the blockheads are bound to realize it.

The remarkable thing is that it has taken them so long. But this hustle has been going on for so long…and with such impressive results…that hardly anyone can believe it will ever end.

In the stock market, for example, you might have thought investors would have learned their lesson after the bear market began in 2000. Uh-uh. They were still confident…still hallucinating…and still ready to make a wish and seal a deal. "Please let stock prices come back," they must have prayed, "I promise I’ll sell this time."

The market gods set them up again…

"The truly amazing aspect of the ongoing U.S. financial bubble is how long it has endured," comments Steve Puetz. "Normally, the first crash will burst the bubble, sending the associated country into severe recession or depression. It’s now quite obvious that the bursting of the Nadaq bubble in 2000 did not break the speculative fever. After a period of hesitation that lasted several months, speculators are back buying stocks on margin and bidding prices up to insane levels.

"In particular, with the technology fever behind them, this time speculators have turned their attention to any stock that’s low-priced. Speculators now favor low-priced, thinly capitalized, financially troubled stocks. These are companies where the stock’s price can be pushed significantly higher with relatively small purchases of shares. That’s great during an uptrend. However, when the subsequent downturn finally does arrive, relatively small amounts of selling of thinly capitalized shares can also cause a stock’s price to collapse. And that’s what will surely happen when the current low-priced stock mania goes the way of all manias – with a bursting bubble leading to a market crash.

"The most alarming increase in speculation has been in financial derivatives. The explosion in derivative open- interest began during the last half of 1999. The market panic during 2000 only halted the rise in open-interest for one year. Then during early 2001, the derivative market speculation resumed…

"The derivative market speculation this year is the greatest ever. With still one month to go, the open- interest in financial derivatives has increased by over 200 million contracts – to 733 million. The last serious liquidation in derivative open-interest was after the 1987 stock market crash. Right before the 1987 crash, derivative open-interest stood at 20 million contracts. By early 1988, half of that open-interest was liquidated. Furthermore, derivative open-interest didn’t exceed the 20 million contracts again until June of 1992 – five years after the 1987 crash.

"Right now, derivative open-interest is 36 times greater than it was before the 1987 crash. So there really isn’t any reasonable comparison between the two speculations. The amount of leverage used in the current bubble market is many times greater than the leverage used during 1987. That’s also true when the leverage is adjusted for money- supply growth, income growth, or market capitalization increases. As the bubble bursts, and all of this margin- debt and open-interest is finally liquidated, the selling pressure will overwhelm the marketplace and cause the greatest stock market crash ever."

When that will happen, we don’t know. That it will happen at all, we can’t be sure. But readers are advised not to bet too heavily against it.

Meanwhile, Addison Wiggin, holding down the fort in Paris, brings more news:

Addison Wiggin at the DR HQ…

– "I hate to be the bearer of bad tidings," the economist Gary Shilling said in Forbes yesterday. "But if you expect the economy and the market to keep climbing next year, you will be sorely disappointed." Shilling’s beef with the ‘recovery’ is a familiar one: jobs.

– "The sober truth is," Shilling explains, "that cutting costs is the only route to profit salvation these days. Most costs, directly, or indirectly, are labor. And that means more layoffs." On Monday, we took a look at the Bureau of much be-Labored Statistics website and discovered – right there in liquid crystals – that if you count all the discouraged, disparaged and disgusted workers, the rate of unemployment actually rose to 9.7% in November…rather than falling to 5.9% as the financial media has been so keen to report. Shilling adds that the average time someone spends hot-footing it in the unemployment line has increased to 19.4 weeks in the May-October period, up from 17 in same period the year before.

– "Optimists," warns Mr. Shilling, "seize upon any shred of evidence that employment [the missing link in the evolution of a full-blown recovery] is coming back." That’s what all the hubbub over the 5.9% figure…and the fervor over accounting for the ‘self-employed’ is about. Floyd Norris, crunching the numbers for the NY Times, concludes that "without [the increase of 156,000 self-employed in November], it would be far harder to put a rosy tint on the employment. But with [it], it is possible to point to one government survey that indicates more people are working now than at any time before."

– Shilling’s not buying it. "Sorry, the party cannot continue," he concludes. "Cost-cutting layoffs will squeeze consumer incomes. Fiscal and monetary stimuli [the likes of which the world has rarely seen] have masked the devastating effects of layoffs, and are fading, too."

– Without consumer incomes rising, retailers are likely to suffer droopy sales during the holidays. They now have a big snowstorm to blame, too. "I think we pretty much lost the weekend," Bill Cheney, chief economist at John Hancock First Boston told Reuters. Following the deluge, retail sales fell below a "five year average pattern" and threaten weak numbers for the entire holiday-spiked consumption binge.

– The Dow bumped its head on the 10,000 ceiling yesterday. But then the gray old lady of Wall Street tumbled back on her rump, falling 41 to 9923. Her younger, more sprightly compatriot, the tech-savvy Nasdaq also slipped on New York’s icy sidewalks, sliding 40 points to 1,908. From where we sit, the psychological barriers at $400 for gold and $1.20 euro – both confidently surpassed last week – are far more telling trends than a weakening rally in equities.

– The financial media blamed the selling of shares on the Fed. At their meeting yesterday, the FOMC decided not only to leave rates unchanged at 1%, but also to leave the phrase "for a considerable period" in their statement following the meeting. Analysts presume this will mean they won’t raise rates through March 2004.

– Much as we like heaping ire on the world’s most profligate central bank, we’re inclined to go along with our friend John Mauldin on this one. Even if they wanted to raise rates, the Fed has its hands tied in the election year. Any change in the wording…heck, any indication that the battle against ‘disinflation’ has come to an end…would shut down the speculative rally on Wall Street and cause homeowners to cringe. Not exactly the ideal conditions for an eager incumbent hitting the campaign trail.

– Which leaves them where? "Central banks have made the riskiest bets in modern history," writes Stephen Roach in Morgan Stanley’s forecast report for 2004-2005. "Policy rates [are at] ‘zero’ in Japan, 1% in America, and 2% in Europe. At the same time, fiscal authorities have upped the ante as never before, with government budget deficits of 7% in Japan, 4% in America, and 3% in Europe. And the authorities have colluded in currency management in a period of unprecedented external imbalances."

– Following such stimulus, "Most [central bankers and financial analysts] believe that the long nightmare that began in early 2000 is now over. I don’t," Roach concludes. "In my view, there was never an easy way out, especially as the authorities reacted to the popping of one bubble by creating other bubbles. The bill for speculative excesses and global imbalances has yet to be paid. As we peer into 2005, that’s the biggest risk of all."

– Meanwhile, the pao mo bubble stretched a little thinner yesterday. The Financial Times reports that in the best first day performance of an IPO on the NYSE in three years, a Chinese Internet company called jumped 88% from $16 to nearly $34. The fact that the offer began in the $16 – $18 range reflects keen investor interest in the stock in advance of the offering. Next up? China Life, the mainland’s largest insurance company. "That offering," says the FT, "the world’s biggest this year, is oversubscribed 10 times."

– Chinese stocks have soared in popularity, even since this past summer. "After such a huge run up," says Richard Gao, co-manager at the Matthews China Fund, "we are cautious in the short term that valuations are running ahead of fundamentals. But in absolute terms, these companies are still not that expensive." Even after big gains, many Chinese stocks are still trading in the 12-14 P/E range.

– Still, sino-sceptics abound. Roach is one of them. "Asia has become the hope of those who believe a U.S.-centric world has found a new growth engine," he writes. "I don’t buy it. Today’s Asia is basically a story of China and Japan, with increased emphasis on the former. Our operative view on China is that the authorities are engineering a soft landing after an unsustainable growth surge in 2003.

– "On the back of a credit bubble, excess is evident in coastal-region property markets – especially Shanghai – and in infrastructure spending. China’s central bank has moved to tighten monetary policy, and bank lending is slowing in response. We expect this reduction in the supply of credit to temper property and infrastructure investment in 2004, leading to a significant reduction in Chinese import demand, from 40% growth in 2003 to 20% in 2004."

– And what’s this? Doug Noland points out that central bank of China was a net seller of U.S. government debt in September. What are they doing with all the dollars they’ve been hoarding? They could even be following Wang Jian’s recommendation to stockpile oil in long-term preparations for a war between the U.S. and Europe.

– Whatever the case, "If pursued, China’s diversification away from U.S. government bonds will be bad news for Washington," says Noland, "which has relied heavily on China’s debt purchases to fund its [twin] fiscal and current-account deficits." We Daily Reckoneers often wonder when the kindness of strangers will give way to apathy. Perhaps it has already begun.

– "The policy of massive deficit spending can go on for [only] as long as investors are willing to buy government debt at interest rates of 5% or less," writes Gary North. "Why would foreigners buy T-bills at under 1.5%? The fall in the dollar more than wipes out that rate of return."

– In London, to much fanfare, the World Gold Council launched its Gold Bullion Security yesterday. The new security effectively allows investors to "buy and sell gold on the London Stock Exchange for the very first time." The launch follows a similar success in Australia…and bodes well for an upcoming issue in the United States of America.

Bill Bonner back in Baltimore….

*** The dollar hit another low against the euro yesterday – the 8th in a row. Gold rose, briefly, over $410. Both gold and the euro have had nice runs against the dollar; do not be surprised by a pullback.

Still, there are two reasons why these trends are not likely to come to an end anytime soon: the U.S. trade deficit…and the U.S. federal deficit. The trade deficit now requires about $1.5 billion in new lending from overseas – every day. With not enough money coming forward, the dollar is falling. As it falls, fewer and fewer foreigners see the benefit of holding U.S. dollar assets. On the contrary, they will sell…pushing the dollar farther, and perhaps faster, that people expect. So far, the dollar has fallen more than 25% against the euro – with no improvement whatsoever in the trade deficit. This suggests that it will have to fall much, much further.

"The bill for speculative excesses and global imbalances has yet to be paid," warns Stephen Roach.

Adding to the bill are appalling spending increases and deficits of the Federal government. No democrat could have dug a deeper debt hole than the one hollowed out by the George II administration. Spending is rising twice as fast as under Clinton…and more than twice as fast as GDP. This year, federal spending per household will top $20,000.

Everybody wants something for nothing. Yesterday’s paper brought a picture of a pack of feeble scoundrels gathered around George Bush while he signed a bill to provide pills for old people. Again, it must have seemed like a wish come true for the drug companies and graybeard mooches. "Keeping our commitment to seniors," was the caption. "Pandering for votes," would have been a better one. "To hell with the young, who will have to pay the bill for this nonsense," the story might have explained. "These geriatric drug addicts vote!"

Americans must think they will never have to pay the federal bills…or the personal ones. Somehow, it will all work out…they must say to themselves. And it will, somehow. But not without regrets.

Short-term interest rates will remain at Eisenhower era lows, said the Fed yesterday. But it is a very different world we live in today, Kurt Richebächer points out in his December letter. In 1959, non-financial borrowing rose 1.4 times the increase in GDP for the year. In 2002, non- financial borrowing totaled $1.34 trillion – 7 times the increase in GDP. It was also true that in 1959, Americans were borrowing the money "from themselves." Net national savings totaled 12% of GDP. Now, with almost no national savings of their own, they rely on the kindness of strangers. Net national savings in 2002 were 0.6% of GDP.

Before too long, we predict, the dollar will barely buy 60% of a euro. Foreigners will hold it in contempt and be reluctant to take it. Each dollar will be an emblem of recklessness, a scarlet letter of financial sin. Traveling abroad, Americans will be embarrassed to open their wallets.

*** With contempt for the dollar will come a growing contempt for all things American. After marveling at the miraculous U.S. economy for so many years…foreigners will wonder how they could have been duped by it. "It was all smoke and mirrors," they will say to themselves. They will wonder how Americans could have been so stupid as to think they could have spent their way to prosperity. Foreigners will also wonder why they once lent Americans so much money…especially when they knew all along that the whole thing would end badly! (If there’s a bright side, our colleague Steve Sjuggerud thinks he has found it…in today’s Daily Reckoning PRESENTS, below…)

*** We found ourselves wondering yesterday. We were permitting ourselves a little euro snobbism. Why is it that even fairly low-wage workers in Europe – such as tollbooth attendants, cab drivers, or airline employees – seem capable and presentable…while in America, these jobs seem to be held by people who, at best, could be described as friendly slobs?

The Daily Reckoning