The One Way Bet

Dr. Steve Sjuggerud debunks "the common wisdom" in favor of a (still) contrarian investment…

"The way to make money in Wall Street is to calculate on what the common people are going to do, and then go and do just the opposite."

– Legendary speculator Daniel Drew

"I like China," a broker told me at a neighborhood Christmas party, "and nanotech…What do you think, Steve?"

Oh boy. Here is "the common wisdom" Daniel Drew was talking about in the quote above, all wrapped up in a nice blazer and khakis. My companion then went on to tell me that he focuses on "safe stocks like Microsoft and Wal-Mart."

This guy is in trouble. How do I know? It’s because you never make and keep extraordinary profits by doing what "the common people" are doing. You’ve got to do something extraordinary…and different. In particular, you’ve got to be willing to buy what nobody else wants.

I gave the broker my honest answers…that China is a bubble like the Nasdaq in 1998, and that nanotech is a long way off. Both could double from here, of course. But both will likely end badly.

Specifically, about China, the common people are now buying China without thinking, just as they did in late 1993. The story today is exactly the same story I heard in 1993. China stocks peaked in early 1994, and then the MSCI China Index fell 90% from 1994 to early this year. Now it’s taken off again. The easy money has already been made…

As for nanotech, I told him that it feels like the great boom in power stocks after the power crisis in California a couple of years ago…All the alternative-power stocks [like Ballard, Plug and Active] soared. Of course, none of them had any hope of making profits for many years. And all of them subsequently crashed hard. Nanotech looks the same to me…there is promise, but no profits, and it could be many years before they see any.

Invest in Gold: "Safe" Stocks

As for "safe stocks like Microsoft and Wal-Mart"…all I could think of in my head was the maxim, "things appear the safest when they are the most risky." In particular, I thought of the awful bear market of 1973-1974, when the "safe stocks" all lost over 50% of their values. Take a look at three of the prime suspects, for example:

P/E Jan ’73 P/E Dec ’74 Stock Fall

Coca-Cola: 44 16 -64%

Gilette: 25 9 -60%

General Electric 25 10 -54%

I find the comparison useful for two reasons…First, Microsoft and Wal-Mart are trading at similar P/Es to the "safe" stocks of 1973 (Microsoft is at a P/E of 30 and Wal- Mart is at a P/E of 27). Second, the "safe" stocks were thought to be the place to hide after the tech-stock boom of the late 1960s.

The situation is similar today, where we’re four years after the peak in super-speculative stocks, and the common wisdom is that the "safe" blue chips are the right place to be. We’ve seen this movie before. It’s called Bear Market 1973-1974. And it doesn’t have a happy ending.

With "the common people" chattering about nanotech, China, and safe stocks, it gives me the willies about the stock market. People are buying without thinking. Sure the stock market could rise from here. But I’m not putting too many eggs in that basket.

Invest in Gold: What Works in Investing

What really works when it comes to investing? For me, I like to look for 1) a situation that nobody likes, and then 2) look for a good value, and finally 3) I wait for the start of an uptrend.

Sounds simple. But people can’t bring themselves to buy what nobody else likes – people feel comfortable doing what the common man is doing. You’ll never get extraordinary returns doing the common thing. People also have a hard time buying good, boring, value – as they prefer to chase the latest hot fad. Not me! And finally, people are afraid of uptrends – thinking they’ve already missed it.

What I’m doing isn’t new. It is exactly what Daniel Drew was doing 150 years ago. "He who controls the money market controls the stock market," Daniel Drew said in the 1800s (the "money market" as Drew refers to it, is interest rates). Drew should know…he was the most successful speculator of the time and influenced the markets more than Alan Greenspan and Warren Buffett combined in his day.

Drew is absolutely correct. Like it or not, changes in interest rates by the Federal Reserve have a dramatic effect on stock prices. When the Fed is hiking rates, you don’t make money in stocks.

Fortunately, the Fed is not hiking rates, and with the recent (reported) inflation numbers at 40-year lows, it doesn’t appear that Greenspan will raise rates for a while. Stocks could rise in that environment, where people feel like they have to take their money out of the bank.

The only alternative the common man has known for the last 20 years is stocks. He is not buying gold, or commodities. Are you kidding? The common guy wants stocks. That makes me not want stocks.

Invest in Gold: Gold Competing with Paper

Instead, I’m looking where mainstream investors still aren’t (though perhaps not for much longer): gold.

With interest rates close to zero, gold actually poses competition to paper money…

When given a choice between government-printed paper money paying 5% interest, and gold paying no interest, most folks take the paper money – they figure it’s a risk worth taking. But when the government-printed paper money pays no interest, and the government behind the money is in debt somewhere between $80,000 and $400,000 per household in America, then gold looks more attractive.

Right now, the government does not look likely to raise interest rates in the near term. And based on that, gold will continue to be a one-way bet – up!

The "one-way bet" is a simple idea…if inflation is dead, the government will print money to create inflation (really to prevent deflation), causing the price of gold to rise. And if inflation appears, gold will rise even more, as the dollar continues to fall, until the Fed seriously starts hiking interest rates multiple times.

There is plenty of room for gold to move higher, even though it has already moved significantly. Triple-digit gains are still possible.


Steve Sjuggerud
for the Daily Reckoning
January 14, 2004

Editor’s note: 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 October issue of Dr. Sjuggerud’s investment advisory:

True Wealth

We were taking a cab to Waterloo station last night when a thought crossed our mind:

We lead such an agreeable life.

Two days a week we work in London…the rest of the week Paris is our headquarters – going back and forth on the Eurostar. In both cities, we dine in nice restaurants…we enjoy the theater…and we have a ready smile for all that we read in the newspapers. We eat well and drink too much whenever we can.

If nothing comes along to disturb our peace, we may stick with this schedule until life itself adjourns. But that is not likely. If our tranquility is not shaken by external events…we are likely to give it a good jerk ourselves. For that is the way things work.

We were trying to describe our book to an interviewer the other day. "You know," we began, "you have moods…times when you feel you can do anything…and times when you think you can do nothing at all. Highs and lows. Ups and downs. Backs and forths.

"Well, put a lot of people together and you get these sentiments amplified…magnified by the mob. So, whenever you have collections of people, you get these kinds of exaggerated group-think trends. You see these things in all sorts of collective activities – sporting events…politics…and markets."

In the 20th century, particularly, politics went haywire. Huge groups of people came to believe the most absurd things…and markets, too, went through the biggest booms and busts on record. Why the 20th century? Because with the advent of mass communications, all of a sudden, many more people could participate in the prevailing illusions.

No, we know of no mass movement in favor of cannibalism…but communism was almost as mad. People were eaten alive by it.

But mass illusions do not last forever. They are destroyed by reality…often at great cost. As Buffett says, markets are a voting machine in the short run (voters can elect any goofy outcome they want)…but they are a weighing machine in the long run (when the voters get what they have coming.)

The illusion that currently grips America has two parts to it. The first is merely a holdover from the bubble economy of the late ’90s – that there is something special about the American economy that places it beyond the laws of economics. Investors think stock prices only go up…no matter how expensive they already are. And both democrats and republicans seem to think they can spend all they want…with no care for how the money will be paid back.

"All Democratic presidential hopefuls want, to a greater or lesser degree, to repeal Mr. Bush’s tax cuts," explains the Economist magazine. "Yet they aim to use the money not to bring down the deficits, but to expand public programs. Mr. Bush’s own new legislation to pay for prescription drugs under Medicare, the federal health program for the elderly, will cost $400 billion over the next ten years. A bipartisan conspiracy exists; it seems to ignore the risks of a widening deficit."

A paper produced for the American Economic Association goes further:

"…substantial deficits projected far into the future can cause a fundamental shift in market expectations and a related loss of confidence both at home and abroad."

"In other words," adds the Economist, "a full-blown, third- world style financial crisis."

But Americans cannot imagine it. And just as they believe their economy is protected by some special magic, so do they believe a second vast illusion: that their role in the world makes them invulnerable to the type of setbacks that have bothered other peoples. But when a man is on top of the world, the old ball gets slippery. Others lube the surface…or he spreads the grease himself.

In bookstores throughout the nation you will find Mssrs. David Frum and Richard Perle with an oil can in their hands. For there on the shelves is their latest book, "An End to Evil: How to Win the War on Terror."

Frum and Perle are "neo-conservatives." The handle itself is a double lie, for there is nothing neo nor conservative about the pair. And the book title is a double disappointment, too…for it is sure that evil will be with us long after Frum and Perle have cooled…and that terror will still make headlines. But you have to admire the chutzpah of the two. In fewer than 300 pages, they not only tell how to rid the world of evil…which is a pretty tall order itself…but also how to re-organize both the mid- east and the U.S. State Department…and how to put the French in their place!

And now over to Addison with more news:


Addison Wiggin in Paris…

– The man is a puzzle, an enigma…a living contradiction. Let’s begin: "Globalization," Alan Greenspan affirmed the obvious yesterday in opening remarks before the Bundesbank, "has altered the economic frameworks of both developed and developing nations in ways that are difficult to fully comprehend."

– We couldn’t agree more. Briefly marveling at our own globalization project here in The Daily Reckoning HQ, we note that Bill, across the desk, is conducting an interview with the South China Morning Post in Hong Kong…we have instant messaging windows open to London and Chicago…and are trying to connect by fax with a reader in Zürich. We’re planning a small PR campaign in India…and another one here in France, for the French edition of our book hits bookstores in Paris this week. How it got to this…well, it’s difficult to fully comprehend.

– But ours is just one inconsequential e-letter of less- than-penetrating insight. What must it be like to command the rate of interest for the currency in which a majority of the world is now conducting business? (At least for the time being.) We have to admit, we have absolutely no idea. Nor would we want the job.

– In his critiques of socialist economies, the economist/philosopher Friedrick Hayek demonstrated that it was impossible for any one human to collect enough accurate information at any given time to make a command decision about the price of a given product. In determining the price of bread, for example, it’s better to let the market figure out how to factor in the cost of flour, yeast, the baker’s labor etc, than to set it by committee in the Kremlin. Likewise, bureaucrats can’t possible collect enough information to make informed decisions about subsidies and trade tariffs. Better let the market determine them. History has thus far borne Hayek out…

– With messaniac zeal yesterday, Greenspan outlined the benefits of free markets for his listeners in Germany. The current account deficit and the "stately" decline of the dollar are "no problem," suggested Greenspan, so long as the chocolate-making countries in Europe do not ramp up protectionist legislation.

– "At a fundamental level," Greenspan sums up the argument, "Americans have used substantial increases in wealth generated by our market-driven economy to purchase what many would view as greater civility." In other words, credit-goosed consumer capitalism produces a far superior civilization than the historical remnant Europeans lay claim to. So far, so good…hey, Mr. Greenspan?

– And yet, Greenspan and his cronies at the Fed set the price of money – the most liquid and exchangeable of all products now being produced by man. Dave Lewis, at chaos-, sums up the contradiction nicely: "In the sense that humans cannot fully comprehend their own slice of reality, much less the totality, of which the phenomenon called globalization is a part, isn’t this a good reason NOT to have central bankers? To the extent the main money man for the powers that be, who are driving the process of globalization, cannot fully comprehend its effects, why is he setting the time value of money for the whole world?" Well, it’s difficult to fully comprehend.

– "In the end," Greenspan admits, "the restraint on the size of tolerable U.S. imbalances in the global arena will likely be the reluctance of foreign country residents to accumulate additional debt and equity claims against U.S. residents." When will that "end" arrive? Greenspan doesn’t know…nor does he think it’s inevitable.

– Both former Treasury Secretary Robert Rubin and PIMCO founder Bill Gross are in the news today expressing their fears about deficits…both trade and fiscal. Your editors, tapping away daily under the rainy skies of Gaul, think foreigners losing money in dollar-denominated assets might decide to flee quickly, but what the heck do we know?

– "He who controls the money market controls the stock market," Daniel Drew said over 150 years ago. "The ‘money market’ as Drew refers to it," explains colleague Steve Sjuggerud in a guest essay below, "is interest rates. Like it or not, changes in interest rates by the Federal Reserve have a dramatic effect on stock prices. When the Fed is hiking rates, you don’t make money in stocks…the Fed is not hiking rates, and with the recent (reported) inflation numbers at 40-year lows, it doesn’t appear that Greenspan will raise rates for a while. Stocks could rise in that environment, where people feel like they have to take their money out of the bank. " [More below…]

– In support of Greenspan’s remarks, Señor Aznar, the prime minister of Spain, proposed a free trade zone between the U.S. and the EU. A measure that, given the state of childish relations between Washington and Brussels (Paris, rather), will likely be ignored. And très vite, at that. But overall, Greenspan’s speech was, in the words of Everbank’s Chuck Butler, a "non-event" anyway. The dollar stayed within its 1.27 trading range. Gold dropped a couple of bucks. The Dow lost 58 points to close at 10,427. "Fresh earnings warnings are to blame," chimes the consensus. The S&P lost 6 points to close at 1,121. The Nasdaq slid sideways…closing down a point.

– Lots of data coming out today. Trade Balance and PPI numbers come out today…as well as the Fed’s Beige book. We’ll get a good look at what rate foreigners are getting nervous about the dollar decline…how the Fed and Treasury are faring in the battle against declining rates of infation…how the nation’s businesses are reacting to trillions of dollars in government stimuli…all in one day. Titillating…we can’t wait.


Bill Bonner, also in Paris…

*** Gold went down $2.60 yesterday. But it is still far above our latest ‘remorse price,’ the price at which we wished we had bought it. Oh for a nice correction in gold and the euro – so we could ‘back up the truck.’

*** We are getting a surprising number of letters. Some hate us. Some love us. And some just don’t know what to think.

The critics can be divided into two camps…those that hate us because they think we are leftists who support Howard Dean…and those that hate us because they think we are rightists who support Louis 16th.

Many cannot bear our impertinent attitude to everything they hold dear. And some seem to hate us for no apparent reason.

But it is our headquarters in France that seems to attract lightning. "Traitors!" thunders the mob. No matter that Jefferson and Franklin spent many years in Paris…the current generation of numbskulls seems to take a French passport stamp as tantamount to treason.

As we mention above, we are rather fond of our European lifestyle. It gives us a 6-hour headstart each morning – to write the Daily Reckoning…and enough distance from the great mass of lumpen-americanoes to avoid getting caught up in their collective hallucinations. That must be what really galls our critics.

*** "France is a socialist country…with high taxes and crushing regulations," say the critics. We offer no defense of France. Instead, we counter-attack: For after nearly a decade in Europe, we have found many differences…but the residue of human liberty in both America and Europe is similarly small…and current trendlines are converging, not going their separate ways.

The Economist: "Americans will soon have to accept that federal spending is rising to a permanently higher level, one closer to European levels of government spending…"

*** But here’s a view we didn’t expect. We criticize Bush because he is an FDR-style activist. Here, a reader complains that he is not FDR enough:

"In the January 8th Daily Reckoning I couldn’t believe your comparison of what Bush is doing to the economy with FDR’s New Deal. The New Deal never gave huge tax breaks to the super wealthy, thus accelerating the trend to extreme difference between the rich and the poor that has been going on for decades. The New Deal provided for assistance to those in need…its major effort was not to find excuses to remove many from eligibility, as the current administration is doing. The New Deal fought to protect workers from inhumane treatment and to protect the environment from pollution, not just the opposite as Bush is doing.

"The New Deal never made it easy for wealthy individuals and corporations to completely avoid paying any taxes, as Bush has done. The New Deal made and enforced laws that made it hard for corrupt management to cheat the public, whereas both Bushes completely de-regulate everything they can, resulting in disasters like Enron, and the old Lincoln Savings fiasco, thanks to daddy Bush. Under FDR, government assistance went to those who needed it, not to those who could give massive financial assistance to the party in the White House, as a quid pro quo."

*** "It’s strange how you never know what you’re going to get with a President," writes our friend Doug Casey on the same subject. "Few people remember that Franklin Roosevelt ran on what was almost a radical free-market platform in 1932, decrying the tax, spend, and regulate policies of Hoover. One might have thought you’d have gotten a fiscal conservative with Reagan (‘If not us, who? If not now, when?’), but his policies sent the deficit through the roof. It was reasonable to anticipate a socialist disaster with Clinton, but government spending grew slower than the overall economy. Baby Bush, few now recall, made noises about personal freedom, and no more ‘nation building’ in foreign hellholes.

"I’m not sure what conclusion one can draw from all this, apart from the fact the kind of people who survive in the game of politics long enough to become President are, almost necessarily, pathological liars. It would appear that Boobus americanus doesn’t much care. Certainly not if the domestic economy is good. In which case who cares who’s lying? Or if there’s a war or emergency going on? In which case they believe that almost anything is justified in the interest of ‘national security.’" [For more on the lies that leaders must tell, see Doug’s article on the DR website:

Politics, Lies and Really Big Government ]

*** And here is an old pen-pal, Virginia Abernethy, still trying to tighten up America’s borders:

"Conservatives and some Democrats are resisting Pres. Bush’s open borders policy.

"He cynically left his announcement on amnesty for the 8 to 14 million illegal aliens in the United States until it was too late for any other candidate to file for the Republicans primaries.

"But in Tennessee, we are organizing a campaign for a write-in ballot.

"The decision to support Congressman Tom Tancredo [R-CO] for the Republican presidential nomination, challenging incumbent President George W. Bush, stems from President Bush’s recently announced proposals for the 8 to 14 million illegal aliens now living in the United States.

"President Bush’s plan to offer 3-year work permits, renewable without limit, amounts to amnesty – or worse still, an open borders policy. That seems like the best interpretation of Bush’s assurance that the plan ‘will offer legal status as temporary workers to the millions of undocumented men and women now employed in the United States and to those in foreign countries who seek to participate in the program and have been offered employment here.

"According to Harvard economist George Borjas, immigration costs American workers close to $200 billion annually through displacing them from jobs and depressing wages. Other economists estimate that as many as 15 million Americans are unemployed, discouraged, or involuntarily part-time workers."

The Daily Reckoning