Volatility Just Might Be the New Normal

Sometimes you get an unexpected wake up call, a call to action if you will. If it happened in your hotel room, the famous errant alarm clock going off, well in that case you just push the snooze button, grumble a bit and go back to sleep at 2:45 a.m. Then, there is the other kind of wake up call, not just the annoyance version. This kind of call to action comes based on something truly significant and it can be so very important to evaluate or re-evaluate something of considerable importance such as your health, a family matter, or financial situation. It’s the latter mention that I will be focusing on in this article.

Let’s first consider the financial sequence that closed out the third quarter of 2015. Most financial assets were in a normal sequential, ebb and flow, the usual risk and reward sequencing made the process challenging as always, but rational in terms of expected give and take. Then, almost without warning, a series of contagion events hit and even for many well diversified portfolios, all hell broke loose.

What happened so suddenly? The cast of characters included imploding oil prices, China's economic slowdown, the yuan's revaluation, mega concerns that at any moment the Fed would alter their policy from a near zero percent interest base rate, and that the dollar was therefore EITHER due to implode or explode with tremendous flows of money, (a lot of it foreign), seeking or leaving safe harbor and the comfort of U.S. treasuries. Precious metals were also pushed significantly lower, but some market predictors affirmed this HAD to explode in value, even though it had been in a severe decline for years, as many other areas were suspect, this just had to be the outcome for precious metals.

In this vicious cycle, the stock market went through a severe retracement that started as a correction, (a decline of 10% from recent highs), but then went further and fell to or exceeded bear market percentage declines, by definition a drop of over 20% from recent highs. That occurred in many sectors and close to that amount and even more in certain major averages. Some were convinced that a deeper leg down was imminent despite what had already transpired.

The decline hit even mundane sectors that were considered safe by many including blue chip, conservative good dividend paying stocks, and even utilities, a major place for conservative income seekers. In a lot of cases the severe declines occurred in just a matter of weeks which had many attempting an exit for safety and asking questions about what just happened and why?

Many panicked with the losses at hand, and a substantial amount of money was both lost and made. As an inconvenient truth mention, if one were nimble enough to have profited from this, and some did of course, were they simply lucky or more strategic in how things prevailed? If one had focused exposure in many equity sectors, and had money in energy and/or were on margin, the losses might have been very consequential with the outcome resulting in many questioning whether their previously assumed to be rational portfolios were indeed just that. Even utilities and REITs suffered large losses as concerns about interest rate policy dogged the market and those aforementioned areas were considered to be among the safest places to have exposure.

An inconvenient truth "ah ha" gut check again. That punch to the gut for many (not all of course), begged the question whether the U.S. and even the worldwide bull market had abruptly ended with cause/effect, and the fear was pervasive that it could get a whole lot worse. Losses of 20% or more were just the START of the unwinding, and that this late summer tsunami was indeed approaching crisis proportions. Yes, this time brought a different set of prevailing circumstances than the bank and financial crisis of 2007/2008.

That is a truncated version of what DID occur and the question is did you learn anything about your true risk exposure and how volatile even the most balanced of portfolios can be? If you concluded that nothing warranted attention, and no risk mitigation was needed, even after out-sized losses were absorbed, then you may be in the minority. Are your personal comfort levels just as good as before? For many this was a painful reminder that some change should be taken given the extraordinary volatility that just might be the new normal.

This recognition for many, even in effect some "veterans" who have spent a lifetime as professional investment counselors/brokers, and even some named billionaire investors said they had really never seen anything quite like this. That made me realize just how profoundly different, and concerning the message of this cycle was and continues to be. For many very astute investors, this was a true game changer. Having just turned 60 it reminds me of that old TV game show Truth or Consequences and this was one of those moments that the term takes to task, quite literally.

The question that I want to pose to you, is with this cycle coming on with such sudden and unexpected velocity and acknowledging that this may have caused some real pain and anguish, would it not have been better to have prepared WELL IN ADVANCE and already have a reduced allocation of conventional assets already in place?  In effect, the question is and remains, why subject your entire portfolio to such volatile and unforeseen circumstances? Why not consider a reasonable allocation to an asset class that is largely UNAFFECTED by this aforementioned market risk and volatility, and in weather terms, would have hardly felt anything other than a passing Spring shower?

It’s for these very reasons of market volatility that I allocated a proportional amount of my personal portfolio to the rare U.S. coin market. I got my wake-up call almost 10 years ago, when I first invested, in earnest in this space while still allocating portfolio interests to the conventional areas. My background in the investment area included leading positions in major Wall Street investment firms, almost since getting my MBA in 1978. I think I understand the general investment marketplace pretty well, and again, vis a vis the Q3 2015 shakeout I received the important reminder that a strategic allocation, in proportion to conventional exposure, can reduce stress and volatility experienced by the portfolio and individual.

The U.S. rare coin market has withstood volatility crises and economic downturns, and most anything else you could have thrown at this investment category because the market is so well supported by already wealthy investors who support values and pricing. These aforementioned investors and specialists did their homework years and even generations ago. They may have previously entered this space and allocated for quite possibly the exact reasons that you are now considering.

You may just be hearing about this asset class for the first time or maybe you are now recognizing that it's finally time to move some of your existing portfolio away from so much market volatility. By the way, you may assume, based on the history of rare coins, that there will be more money coming into this space, thus supporting YOUR existent exposure. In that way the investors who followed you also possibly came in because they too saw the advantages of the exposure and the asset class.

The differentiation that this non correlated asset class brings may provide you with a much higher level of comfort especially with assets you want to be both productive and stable in value irrespective of other political, economic, or financial cycles and their perceived associated risks and unknowns. This just may be the appropriate time to consider that reasoned and appropriate reallocation and removal of profit and even principal from other correlated investment areas. I remind you the notion is to consider an appropriate and prudent allocation as part of a broader portfolio composition.

With so much market volatility and external factors such as concerns over China, North Korea, Syria, ISIS, Russia and Putin, Iran and its potential nuclear threat, as the prevailing backdrop to a challenging and ever-changing market even external non monetary threats may cause the next cycle of disruption. Be reminded that it's always something different that can be a catalyst for the next extreme market reaction(s).

Consider valuations and volatility risk with stocks and bonds which are typically a large component of a conventional portfolio. Also be cognizant that bonds may possibly be a sector that could experience considerable future price volatility and may entail significant risk in future periods.  Imagine if the Fed really started a series of interest rate hikes and what kind of pressure and even contagion impact such a change of interest rate policy might create. So for all these economic, political, monetary, and related reasons, do consider whether you are positioned in the best way to achieve long term success with the right amount of conventional and non-conventional portfolio exposure. 

The Fed is Positioned to Raise Rates Any Day Now

The Fed’s reasons for not raising rates in September did not make sense as raising short-term rates would strengthen the U.S. dollar which would be advantageous from a trade perspective with foreign economies. With regards to China, the only advantage the Federal Reserve could have for not raising rates in September, was to help U.S. and European international companies that trade with China. But the Fed’s ploy did not work. Within days of the anticipated date that the Fed was supposed to raise rates, China devalued their currency by the largest amount in history, with the result of a positive trade advantage for China. At this point, the Fed must know they do not have the tools to win this specific battle with China or the rest of the world for that matter, as they devalue their currencies.

Some would say the U.S. should enter a currency war and devalue the U.S. dollar by keeping rates low and/or printing more money. This would lead to a downward spiral for everyone in the world with no one winning. The rest of the world has nothing more to lose by following this tactic but the U.S. would.  This leaves only one option at this point for the U.S. and that is for the Federal Reserve to finally raise rates. Yes, this would put the U.S. at a trade disadvantage for a while with U.S. international companies resulting in U.S. consumers paying a little more, but, it will also lead to U.S. banks raising rates and in turn easing lending criteria allowing more people to buy homes and obtain business loans for start-ups and expanding companies resulting in an improved economy.

At this point the Fed does not directly have the tools to fend off foreign currency devaluations but the U.S. private sector does with a booming economy. The U.S. needs to concentrate on doing business in the U.S. and where it makes sense in foreign markets. The Fed needs to move back to normal monetary policies so the private sector can do what it does best, capitalism. We have five years of innovation backed up just looking for investment capital to move forward.

What this means for U.S. markets is volatility. As the Federal Reserve raises rates, investment capital will shift helping some industries and harming others. This will be a great place for short-term risk takers to make money or lose money.

For the person wanting to sit this volatility out, safe recommendations are assets that will not be affected by the interest rates whichever way they go. If you are looking for a long term or generational investment not affected by rate changes, market shifts or commodity fluctuations. You might want to consider rarities. If you want the rarity with the lowest volatility, consider rare U.S. coins for portfolio diversification as an option to explore. 

Extraordinary Value in Alternatives

The concept of relative value never exists in a vacuum. In fact, the term relative value is a method of determining an asset’s value by taking into account the value of similar assets or cohorts. Investors evaluating opportunity in a particular asset class designate assets as either “rich” (expensive to its cohorts) or “cheap” (inexpensive to its cohorts.) Once discovered, value investors then look to purchase those assets within a specific cohort that have been defined as cheap.

This article focuses on the collectable assets of fine art and rare coins, as I believe that rare coins currently represent extraordinary relative value verses fine art.

Firstly, I want to clarify that this article is focused on the enduring value of genuine and certified numismatic rarities from the 1700 and 1800’s and not the “rare coins” that are mass marketed on television. Numismatics 101 – coins (or anything else for that matter) being “mass marketed” on late night television, through cable television personalities or any other mass marketing venue are most assuredly NOT rare coins.

High-Level Data Points 

  • Alberto Giacometti’s “Walking Man” sculpture sold for $104.3 million at an auction in 2010.
  • Edvard Munch’s “The Scream” was sold for $119,922,500 in 2012.
  • The 1794 “Flowing Hair Silver Dollar” is believed to be the First Silver Dollar struck by the United States of America. It was sold in January 2013 for $10 million.

All three collectables rightly possess iconic status! Yet, while the 1794 “Flowing Hair Silver Dollar” clearly benefits from occupying the rarified intersection of coin, art, history and rarity – it is being valued (using the last sales pricing of each) at a 91% discount to Giacometti’s “Walking Man” and a 92% discount to Munch’s “The Scream”.

Using my relative value context and basic logic it seems reasonable to assert that while “The Scream” and “Walking Man” may be rich - if either were sold today – it would likely be at a significantly higher price!  One thing for sure the “Flowing Hair Silver Dollar” is egregiously cheap to the two pieces of fine art!

A significant number of the most valuable coins in the world are classic U.S. coins and many symbolize the birth of our nation’s international economy. U.S. rare coins provide investors with the opportunity to own an asset that is part of the history of our country. Like fine art – the supply of U.S. rare coins is finite! Investors are comforted by the fact that the rare coin market is supported by wealthy collectors and investors – much like themselves – having strong hands and deep pockets.

In addition to being a cheap or currently undervalued asset class, rare coins present an alternative investment strategy for savvy investors looking to diversify their portfolio with an exceptionally “non-correlated” asset class that exhibits superior wealth preservation and capital appreciation characteristics.

Investors are actively seeking intelligent, compelling alternatives to volatile stocks and bonds. The only thing we can be certain of – is uncertainty!  Global economic and political uncertainty, domestic economic and political uncertainty and interest rate uncertainty. Rare coins, as part of a portfolio diversification strategy, can provide investors with alternative assets with a number of unique and compelling attributes! Virtually zero correlation to the market volatility associated with traditional assets; proven strong stable market performance over time; portability; tax advantages and being a self-regulated market – no 1099 reporting is required, which makes the process of buying and selling rare coins fast, private and convenient.  

Collectibles as An Integral Part of Long-Term Portfolio Diversification

It’s ironic. Oftentimes we talk about investing as if there are an infinite number of possible goals and every individual is going to have a unique set of circumstances that govern the construction of their portfolio. And while there may be some truth to that in a short-term context, I’ve found that the majority of investors tend to have similar long-term ideas. That is: work hard, plan for retirement, protect what you have, and provide for your family.

Generally speaking, this is true whether your net worth is $250,000 or $250 million. Lower your risk, increase your returns, protect yourself, and make sure your family is taken care of.  And so by definition investing is a long-term proposition and one’s long-term performance should be the main priority.

Too often though investors lose sight of this endgame and get caught up in the news or sidetracked in some capacity. One way is by chasing returns with abandon and taking on too much risk by ignoring diversification. Over the last few years U.S. stocks have been the dominant asset class in terms of absolute performance. And while taking advantage of such runs is a great thing, overexposing yourself to risk is not. Bubbles and crashes happen. They can ruin you without proper diversification.

Conversely, some investors let fear drive them and they become so afraid of volatility and market corrections that they are unwilling to let their money work at all. They become frozen in a sense – and become content with no return because all they can see is the risk of loss.  This is happening right now as many investors see risk in the U.S. stock market and have let it consume them to the point where they have most of their assets entirely on the sidelines!

Don’t make the mistake of being so caught up in the present that you lose track of your endgame. Do this by keeping a diverse group of assets with investments that are not correlated to each other. Allow your money to work in different directions. Be flexible and open to new ideas. This will allow you to shift money around and maintain positive portfolio performance even when specific assets you own may be performing poorly.

One way to accomplish this is by incorporating collectibles as an alternative investment. The right collectible can make a tremendous amount of sense for diversification as these types of items have strong long-term track records with little correlation to conventional markets. They offer you performance outside of your traditional stock and bond back-and-forth.

Knight Frank Luxury Investment Index

While I cannot speak for all of these collectibles, I do understand investing in rare coins. The rare coin market is based on the concept of having a high and growing demand with a limited supply that cannot increase. The fundamentals of supply and demand make this work as an investment. Furthermore, because the market is driven by wealthy collectors who view this as only part of their estate, there are limited amounts of fire-sales – and the market being flooded is an irregularity. This keeps volatility in prices to a minimum.

Curiously enough, one of the most common objections I hear to investing in rare coins is being resistant to investments that could be longer-term in nature. This seems counterproductive to me as the endgame is about capturing the best long-term results. Very rarely should your portfolio be entirely comprised of short-term positions. Whether you’re planning for retirement or planning your estate to provide for your family, incorporating this type of asset can lower your overall risk level while improving long-term performance. 

Hey Fed, You're Steering the Ship

I was recently sent the latest TIPS spreads, which are downright scary if you believe the Fed should actually try to hit its inflation target:

  • 5 year TIPS spread = 1.34%
  • 10 year TIPS spread = 1.66%
  • 30 year TIPS spread = 1.82%

Keep in mind that even if the Fed were on target for 2% Consumer Price Index inflation, the 30 year spread will usually be a bit over 2%, because long term there is more tail risk of high inflation than deflation.  The 1.82% figure is worse than it looks.

The Fed is actually targeting Personal Consumption Expenditure inflation, which tends to run about 0.3% below CPI inflation, so those spreads actually reflect about 1.04%. 1.36% and 1.52% PCE inflation expectations.  That’s dangerously close to a position where the Fed could lose credibility.

Why then are they planning on raising interest rates?  They seem to be relying on flawed NK models that suggest tight labor markets cause higher inflation and they notice that unemployment has recently fallen to 5.3%, and may decline further.

But these NK models are simply wrong; low unemployment does not cause inflation.  Rather unexpectedly high inflation (when caused by demand shocks) causes low unemployment and monetary policy drives inflation.   The NK models have causation reversed.  The Fed is acting like a bystander waiting for the economy to bring inflation on line, whereas actually the Fed determines inflation.  But to do so they need to ease monetary policy when they are likely to fall short of their target.

In fact, the labor market will eventually adjust to any inflation rate, at least within reason.  If the Fed steers the economy towards 1.4% long run inflation, wages will adjust and unemployment will naturally fall to the natural rate.  There is nothing that will automatically move inflation up to 2%, unless the Fed does something to make it happen and raising interest rates in September or December is not the “something” that will get those TIPS spreads up where they need to be.  It won’t just happen; the Fed must make it happen.  They should cut the interest rate on bank reserves from 0.25% to zero, tomorrow. There’s your “normalization”, Interest on Reserves was 0.00% for the first 95 years of the Fed, until October 2008.  How’s that positive IOR working out for you?

Is 1.3% or 1.5% inflation actually that bad?  Not necessarily, but what is bad is a monetary policy that is not steering nominal GDP in a direction consistent with the Fed’s announced goals.  If they can’t get this right, how will their policy have any credibility in the next recession?  Won’t we go back to the old failed policy of procyclical inflation during the next recession?  I hope not, but I’m seeing nothing out of the Fed that gives me any assurance they’ve learned their lessons from the past recession.

The Fed’s apparent willingness to raise rates in the next few months proves that market monetarists were right in the 2009-13 period.  It wasn’t that the Fed was out of ammo; they simply had an excessively conservative policy target.  If the critics were right (that the Fed wanted to do more, but was out of ammo), then the Fed would not be contemplating a rate increase with these appalling TIP spreads, which are similar to the bad old days of the Great Recession.

Slowing down a boom in house prices is likely to require a considerable increase in interest rates, probably by an amount that would be widely at odds with the dual mandate of full employment and price stability. Moreover, the Fed would need a crystal ball to foretell house price booms. In restraining asset prices, while the power of interest rate policy is uncontestable, its wisdom is debatable.

The Fed tried popping the stock bubble in 1929.  It “worked.”  Once is enough. Please, no more bubble popping.

To read additional blogs from Dr. Sumner, and learn more about his insights on monetary policy, click here

Risk and Uncertainty – Making the Case for Alternatives

Perhaps at no other time in modern history has there been so much confusion and uncertainty for the typical investor. In just the last 10 years there have been bubbles, crashes, recoveries, and run-ups in a number of markets. We have created billions of dollars via Quantitative Easing, kept interest rates at all-time lows, and managed to stave off inflation.


Make no mistake, we are in an all-new economic and investing environment where the stakes are high and there are no sure paths to victory. There is a clear abundance of risk across almost all conventional assets right now with very little room for maneuvering. Even the so-called experts can't seem to make sense of it. So if there's ever been a time to seriously explore new assets and non-correlated alternatives… this is it.


Let's explore some of the risks and uncertainties facing traditional investments. Take a look at the Fed Funds rate:



Rates are at all time lows. Putting your money in a CD or savings account may be low risk in the sense that your principal is protected, but your gains are minimal at best assuming inflation stays around 1.5%. If inflation runs higher than expected, or is actually higher than the CPI-based data suggests, you are guaranteeing yourself a small loss with zero upside opportunity.


Rates this low also present a significant risk to owning precious metals and bonds. As we all know, an increase in rates spells trouble for bonds. When yields (interest rates) go up, prices go down. Assuming The Fed begins to raise rates later this year as Janet Yellen indicated in last week's Congressional testimony, you can expect to take a hit on bonds. Granted, you can minimize your losses by moving from longer to shorter dated bonds, but they are still losses. The only way to avoid this would be to hold the bonds to maturity, but does that make the most sense with the returns being offered?


Less obvious is the risk to owning metals. However, the risk is very real, real enough that I do not feel comfortable recommending gold or silver to any of my clients as an investment right now. I broke this process down in my previous entry: Gold and Interest Rates ... What's the Big Deal?


Whether you believe Janet Yellen and The Fed or not, is irrelevant. There is only one direction rates can go from here – and that is up. Do not buy into the argument that the United States government will not be able to service the national debt at an increased rate. One of the key stipulations of The Fed raising rates will be continued GDP growth. Growing the size of the economy increases the government's tax revenue and will offset any increased debt payments.


This happened once before as the United States had massive debt after World War II, over 100% of GPD, not too different from today. Rates were around 1% in 1945 and gradually rose over time. Because the economy was growing right alongside rising interest rates, (and interest payments on debt), those increased costs were easily managed.



So we see the dangers with owning bonds and precious metals because of the low-rate environment we're in. We also see the lack of performance in CDs, savings, etc. What about equities though?


The answer isn't so straightforward. One of the main arguments right now is that monetary policy was designed from the ground up to support the market. It has been the only game in town as returns in other traditional assets were simply not strong enough to warrant investment. This money has flowed to the stock market – and what goes up must come down.


On the other hand, we see the debt problems in Greece – and basically the entirety of southern Europe. China has massive debt issues and a troubled market. There are good reasons for investment capital to leave other currencies and come running to the U.S. markets – but with how interconnected economies are and the prevalence of multinational companies there may be more risk in the U.S. markets than history would suggest.


Furthermore, investors are panic-prone. Take the Ebola crisis for example. Was it really that big of a deal? No, but we can see how it affected the market!



What will happen if Greece defaults and leaves the Euro? What if Spain, Cypress, Portugal, and Ireland want the next round of handouts? What if Germany bails on the Eurozone and currency collapses? Sure these are “ifs” – but really, how unlikely is it that any of those can't happen? What about the impact to the U.S. markets? Would the reaction be positive or negative?


I can't answer that question, but I can say that it has me nervous. I don't even know many people that aren't nervous about their positions in the market and when you take that and combine it with the risks in precious metals and bonds… it doesn't leave you with a lot of options. When you're in a position of uncertainty about where and how you can avoid these risks to find a positive return.


Wise investors understand these risks and uncertainties, and they can make adjustments based on that understanding to best position their family for the future. Right now is the perfect time to begin incorporating alternative strategies and non-correlated assets into your mix of investments as the outlook for so many traditional markets is very murky.


And while I am not an expert in every alternative, I do have a deep understanding in how many of these markets work – and I am a strong believer in being creative and coloring outside the lines, so-to-speak, with your portfolio. I am happy to share any thoughts or insight I may have on using various alternatives as a means of diversification. Please feel free to reach out to me with your questions.

Greece, China, Oil, and US Short Term Rates

This is the time to be proactive and not reactive


Don't buy into the fear in the news! Many of these fears are being misconstrued and may actually result in a positive impact on the U.S. economy over the upcoming months. Anxiety about Greece's debt is causing many investors to make quick decisions based on fear. However, this Euro zone crisis could actually have a positive effect on the U.S. dollar. The fear that oil prices could plummet like they did at the end of 2014 is causing many investors to panic. The reality is that a repeat of last year's oil price drops in September would be more devastating to Russia, the Middle East, and the South American countries. This would ultimately provide further support for the U.S. economy. Investors need to wake up! The Federal Reserve is looking to possibly raise Short Term Interest Rates this fall which means they believe the economy is improving. You can wait, watch, and hope you can react fast enough to these changes to cut your losses – or you can do something beforehand. Do your research and get out ahead of what is coming. Let me provide some perspective on these two current crises to give you a direction so you can do further research to protect yourself.


Let's start with Greece. Everyone looks at a Greece default/exit and thinks this will crush European economies and by extension the U.S. economy. Let's break this down a little further to understand what could happen. If Greece defaults and exits the Euro Zone what can we expect? Remember Greece would only exit the Euro Zone not the European Union. This means that the 17 countries in the Euro Zone would take the largest initial hit to the markets. The other 10 countries in the European Union would take a smaller hit. However, in the long run Europe needs to move toward fiscal responsibility to have a chance for a solid recovery. The U.S. markets could experience some short term volatility but ultimately should not be affected in the long run because of the low exposure the U.S. economy has on these markets. The big short and long term loser will probably be China. We are already seeing some signs in the Chinese markets. China exports over 30% of its GDP and half of that goes to Europe. Greece's exit could be the straw that brings down a heavily debt ridden Chinese economy. In contrast the U.S. economy is growing and is only 1/6th of China's exports. The economic debt problems in Greece, Europe, and China, far exceed that of the U.S. While U.S. markets will see some short term volatility, the entire U.S. economy will keep recovering with the big winner of course being the U.S. dollar.


Will a repeat of last fall's oil price drop, greatly affect the U.S. economy? Here is what you need to look for. Winter oil blends, politics, market share and innovation are setting a déjà vu moment for oil. The biggest global profit time for oil is when the U.S. is on its summer oil blends. If anyone is going to drop oil prices it would be when the U.S. moves to its winter oil blends on September 1st. Watch for a high level government official like Secretary of State Kerry to visit Saudi Arabia like he did last year on September 7, 2014. Three days after this meeting, oil started dropping until it went to the low $40's by January which had multiple effects. Russia's incursions into the Ukraine and its supply of weapons to ISIS took a serious hit as Russia had enough U.S. cash reserves to get through 2014, as 50% of Russia's economy is oil based.


Graph of World Liquid Fuels Production and Consumption Balance, 2009-2014


Other middle-east countries except Saudi Arabia would also take major hits along with several Central and South American countries such as Mexico, Venezuela, Brazil, Argentina, etc. Saudi Arabia can go lower in price as they have more U.S. cash reserves than anyone else. Saudi Arabia can grab other countries oil market shares, cut off funds and weapons to ISIS and slow U.S. oil production. The U.S., Europe, and China take small market hits but basically they are all getting oil cheaper which is a benefit to their economies. Again, like the Greece crisis this crisis has a greater effect on other countries which ultimately provides positive results for the U.S.


The Elephant in the world economy is the Federal Reserve and its pending short-term interest rate hikes. The question is when. There are two things holding back the U.S. economy; shortage of investment capital liquidity to U.S. private sector and Government anti-business regulations. The majority of U.S. states are busting anti-business state regulations but don't expect much from the Federal Government until January 2017. The big thing now is U.S. banks are sitting on 11 trillion in cash. With short term interest rates at basically zero, banks have no incentive to lend money for housing, start-up companies, or expanding companies. The question is whether the U.S. economy and Federal Government can take the lag in time between raising rates and the benefits that will follow. If they go too fast, too soon, or too much, the Fed could do more harm than good.


Graph of Historical Federal Funds Rate


September 17, 2015 could be a defining moment in the U.S. economy. This is the date that the Federal Reserve may change its zero interest-rate policy that it has had since December 2008. This would be a major shift in the economic recovery policy and would signify that the FED believes the U.S. economy is strong enough to handle such a change. When they raise the interest rate, expect market hits around the world and short term volatility in the U.S. market. The big loser is everyone who does not jump on the U.S. economy coat tails and ride it up as the U.S. moves from a slow to a medium recovery. This is the time to be proactive and not reactive.


Personally I think the Federal Reserve should have started raising rates a year ago to help the average person in the U.S. and the private sector. Instead they kept rates low and helped the rich, the markets, Europe, and the rest of the world. There is however, a point of diminishing returns to low rates. Europe hit that point in January and went into negative rates. The Federal Reserve does not want to get to that point because it leads to stagflation which Japan has experienced since the 1990's, Europe now, and China about to enter into it. It could be late in Q3 or Q4 of 2015, or in Q1 of 2016, but it is coming.


I hope that you have gained some other perspectives on these issues. Remember, don't buy into the doom and gloom articles and critics. Instead, take the time to do your research. To filter through the propaganda, misinformation, and agendas, research the author of the article on Wikipedia and look at the last paragraph which normally lists who the author's associations are. This will help you see if they have a bias or agenda. Red Flag articles have dozens of unsubstantiated facts that no one has time to verify. They are trying to overwhelm you with data. Completely ignore opinion articles that give no facts. This will leave you articles with only a couple of facts to verify. If you have any specific questions feel free to give me a call.

One final thought... Most of the doom and gloom authors and speakers have made millions of dollars doing this for over 20 years. So when coming across an article, it's always important to trust but verify.

Gold and Interest Rates ... What’s the Big Deal?

The buzz right now among most investors and virtually every economic commentator is on interest rates. It seems that at this point it's not a matter of if – but when – the Fed will begin raising rates with the majority sensing it may happen sometime between September, 2015 and Q1 2016. The last time the Fed raised rates was nearly 10 years ago in June of 2006. So needless to say, it's been a while since we've seen this shift in policy, and at this point there are a lot of guesses on how the economy and various markets will react.


Focusing in on the gold market specifically though, there are some very real risks that gold owners need to be aware of. Simply put, there are a number of indicators for gold, but one of the most compelling is the very strong negative relationship between the price of gold and real interest rates. It is widely recognized that rising real interest rates create a poor environment for gold, whereas falling real interest rates tend to push the price of gold up… let's look at why that is.


Gold is an expensive asset to hold. It offers no dividend and does not produce any interest. As such, in a higher real rate environment there is a high opportunity cost to holding the metal versus interest bearing assets such as CDs, bonds, etc. Conversely, when real interest rates are low (or even negative) investors see very limited returns (or real losses) on interest bearing assets giving a higher incentive to hold gold.


This impact is exacerbated as supply-demand shifts cause billions of dollars of both individual and institutional money to move in and out of metals as real rates change. Think about this logically. How likely are you to own a CD (or other interest bearing investment) when real interest rates are for example -2%? What about 1% or 6%? Obviously, you are more likely to own that CD performing at 6% and you would look to protect your capital another way if that CD was offering a real return of -2%.


Most investors view gold as a store of value, not too dissimilar from the idea of holding treasury bonds, CDs, etc as low-risk assets. Thus when real rates are rising we see money flow from gold into interest-bearing assets. When real rates are falling we see money flow from interest-bearing assets into gold.


This is a very strong indicator as to the direction in the price of gold. Understanding where real rates are going can aid you in buying gold at the right time – or protecting yourself by selling before a sharp decline in prices.


World Gold Council Chart


Source: Thomson Reuters Datastream, World Gold Council


Oftentimes people will say “But wait, gold was spiking in the late 1970s when interest rates were high and gold was falling in the 1980s when interest rates were low!” This is why we need to make the distinction between real and nominal interest rates. The nominal interest rate is the percentage of increase in money the borrower pays the lender. Suppose the bank lends you $100 at a 10% interest rate. When you pay back the $100 you're paying an additional $10 in interest. Simple, right? But this does not take into account the impact inflation has on the bank's return.


The real interest rate is adjusted for inflation. It measures the percentage increase in purchasing power the lender receives when the borrower repays the loan with interest after accounting for inflation. So continuing on with our example, let's suppose inflation is running at 7%, which essentially is a 7% loss in purchasing power. The bank is gaining a 10% increase in purchasing power from the interest it's being paid on the loan, but it is losing 7% purchasing power due to the cost of inflation. Therefore, creating the real interest rate, the bank is seeing a 3% (or $3) gain in real purchasing power on this $100 loan.




So yes, in the late 1970s nominal interest rates were high… but inflation was almost as high, and at times even higher! So if you have a nominal interest rate of 13% and inflation is running 14%, you have a negative real rate of 1%. With low (or negative) real rates gold tends to perform better, thus in the late 1970s we saw gold spike heavily.


During the 1980s nominal interest rates were falling, but the rate of inflation was falling even faster. This meant that even though nominal rates were coming down, real interest rates were actually rising. What happened to gold in the 1980s? Well, gold was $850/oz in January, 1980, and it dropped to $300/oz by 1985.


Indeed, one can make the argument that it was the low real interest rates of the mid-late 2000s that led to the price increase of gold, especially during 2009-2011. Economists like Paul Krugman have reiterated numerous times that gold was responding to changes in real interest rates – and not inflation alone.


Fred Chart

In fact, gold prices are down a lot. But it's also important to understand why they were high in the first place. Gold is not, in fact, a hedge against inflation. It's something people buy when real returns on alternative assets are low. The figure shows the price of gold versus the interest rate on inflation-protected bonds inverted, so that a falling real rate of interest is a rise on the chart. Gold went up as real interest rates turned negative, thanks to a depressed economy — an economy, by the way, that was deflation, rather than inflation-prone.


And as recovery has gathered strength, real rates have gone up and gold has gone down.”


So where do we go from here? The last few years have seen gold trend down as nominal rates have stayed flat while inflation has fallen – meaning real rates have risen. The Fed has been telling us for over a year now that they are going to be raising interest rates soon. Assuming rates do increase and inflation stays steady, or raises at a level slower than the increase in nominal rates, real interest rates will continue to rise. This would suggest a continued decline in the price of gold.


I'm not saying owning gold right now is good or bad. Everyone has their own reasons for owning the metals, and what makes sense for me may not make sense for you. And there are certainly other contributing factors that influence the price; it is a volatile commodity after all. But for me, I am hesitant to invest in gold as a performing asset given the current economic environment and outlook on interest rates.

Gold ... a Solution to a Non-existent Problem

The Internet is full of apocalyptic stories about the US economy. If you believed everything you read you would think that the US dollar is about to be dethroned, our debt situation will get out of control, and hyperinflation will ensue. But as Adam Smith once said, "there is a great deal of ruin in a nation." What Smith meant is that economies can absorb quite a bit of punishment and keep on ticking. Here I'll explain how despite America's very real and serious problems, investors should be skeptical of get-rich-quick schemes suggesting that gold is a good hedge for the turmoil ahead.


Let's start with the national debt, which by one measure is as large as our GDP. If you look at the part of the debt actually held by the public, however, it's a bit over 70% of GDP, which is not unusual for a developed country. The budget deficit, which is the net increase in the debt over one year, has fallen to about 3% of GDP, also similar to many other countries. Even better for the Treasury, interest rates are relatively low and likely to rise only modestly. This means the cost of financing the national debt is not too burdensome, and long term rates will stay fairly low (about 2% to 4%) even as short term rates rise.


So we don't currently face a public debt crisis. On the other hand, the retirement of baby boomers will soon lead to large increases in spending on programs like Medicare and Social Security. So there are some long-term issues that need to be addressed, but in my view we will be able to adapt to the changing demographics through a combination of a higher retirement age, cost controls in healthcare, and slightly higher taxes.


I've emphasized the public debt issue because many of the other concerns are linked to this one key problem. For instance, those who claim that hyperinflation is on the way often suggest that the government will be forced to "monetize the debt" which means printing money to pay off government bonds. In the past, countries that have done this have often suffered from extremely high inflation. Printing money to pay for deficit spending largely explains the very high inflation suffered by places like Brazil and Argentina during the 1980s and the more recent hyperinflation in Zimbabwe.


There are lots of good reasons to doubt whether this scenario will play out in the US. First of all, investors in 30-year Treasury bonds obviously don't fear hyperinflation, or they wouldn't be willing to lend money for such a long time period at 3% interest rates. Even better, those low interest rates make a debt crisis much less likely as it means the national debt can be financed at an interest cost of roughly 2% of GDP.


Second, there are other developed countries that have dramatically worse public debt problems, measured as a share of GDP. In Japan public debt is about 240% GDP, or 140% in net terms, double the US level. Yet the Japanese continue to borrow money at very low interest rates, despite this large public debt. It would take many decades for the US to reach the debt situation of Japan today, and not only does Japan not have hyperinflation, they're even falling short of their 2% inflation target. China’s official public debt is not too large, but the Chinese government is widely seen as being responsible for a dramatic increase in debt issued by state-owned banks and local governments. Total debt in China is higher than in the US as a share of GDP.


What about Greece? This is the example that people cite who are concerned about excess debt. Greece actually has three problems that are interrelated: excess debt, no ability to control their own currency, and a deep depression that led to roughly 25% unemployment. This is nothing like the situation faced by the US, where unemployment is only 5.5% and trending downwards, and which has a Federal Reserve that can print money if we are in recession. Borrowers understand this distinction, which is why countries with their own central bank have not suffered from the sort of debt crises that hit the southern European countries.


Some people claim that the US is only able to borrow so much because the dollar is internationally recognized as a reserve currency. The fact that Treasury bonds are a preferred international reserve might allow Uncle Sam to borrow at slightly lower interest rates, but it’s only a slight advantage at best. For example, many other developed countries, such as Japan, Germany, and France, have large amounts of public debt outstanding and pay even lower interest rates than the United States. The Australian dollar is not widely used as an international reserve, and yet Australia has run trade deficits comparable to the US for many, many decades.


And even if the US dollar’s reserve status does lower borrowing costs, there is no plausible alternative out there for the foreseeable future. The euro is a mess and likely to be plagued by periodic crises due to the decision to impose a single currency on many vastly different countries. In the first decade of the euro’s existence there was a modest shift out of dollars, and the US dollar share of international reserves fell from the low 70s to just over 60%. But in recent years the euro has slipped back, and now comprises only 22% of international reserves, while the dollars share has leveled off at over 60%. No other currency is even close.


China is growing rapidly, but its currency is still heavily regulated through capital controls. Because foreigners cannot freely move Chinese yuan in and out of China, it is not a very attractive option as an international reserve currency. While China’s economic influence will gradually increase over time, the US dollar will remain the dominant reserve currency for many more decades. In some respects the US is like Britain in the late 1800s; it will still have the world’s most sophisticated financial markets even if China’s total GDP is larger.


If none of these apocalyptic theories of dollar collapse are true, then what does drive the international gold market? Gold tends to do well during periods of extreme economic stress, such as very high inflation or depression, and also during periods of very low real interest rates. (Real rates are the actual market interest rate (nominal) minus the rate of inflation.) This needs a bit of explanation, because some people might recall that gold did very well during the late 1970s when interest rates were high. Yes, but that was due to high inflation; real rates were not high. Investors bought gold as a hedge against risk of high inflation. When inflation is 13%/year, even a 15% nominal interest rate means only a 2% real interest rate. Even though nominal interest rates fell in the 1980s, inflation fell even faster, so real interest rates actually increased. That’s why gold prices fell after 1980. With the Fed now targeting inflation at 2%, it's unlikely that we'll see a repeat of the highly inflationary late 1970s.


A better argument is that low real interest rates help the gold market because they make other alternative investments such as bonds look less attractive. However, the US is gradually moving out of the depressed period of the early 2010s, and the Fed is expected to raise interest rates sometime in the second half of this year. In my view, the Fed rate increase might come a little bit later than some people expect, but I do think interest rates will gradually rise over the next few years, probably beginning in late 2015 or early 2016 at the latest. Higher interest rates take away one of the factors that underpinned the bull market in gold a few years ago. Indeed gold prices declined in 2013 on just a mention of the Fed’s intention to “taper” its purchases of bonds, aka “QE.”


Some commentators had falsely hyped a risk of high inflation due to quantitative easing and near-zero interest rates. In fact, there was never much risk that QE would lead to high inflation, because unlike previous hyperinflationary episodes, most of the new money went right into interest-bearing bank reserve accounts at the Fed. The Fed was not dumping trillions of dollars of paper money directly into circulation. Economic recovery and higher interest rates in the US will also diminish any latent fears of inflation. As interest rates rise the Fed will remove some of the excess reserves from circulation and immobilize the rest by paying a higher rate of interest on reserves. That policy did not even exist in the 1970s.


There might be some international factors pushing gold up in the short run, such as "Grexit”, which means Greece leaving the euro. Even if that occurs, and it's not at all clear that it will, any effects are likely to be short-lived. Greece is less than 2% of the Eurozone economy. Back at home there is a deadlock between the two political parties, which some believe is actually good for growth as it stops Congress and the President from greatly expanding the size of government. The world’s key central banks (Fed, ECB, Bank of Japan, People’s Bank of China) are all focused on maintaining steady growth with low inflation. As I indicated, the low interest rates have been a positive for gold, but that factor is already priced in. From this point forward rates are more likely to rise than fall.


Over the long run, stocks have done far better than gold. That doesn't mean gold is a bad investment; people care about more than just the average rate of return. Some people cite gold as a hedge against risk. But gold is itself a very risky asset, with a price that is highly volatile over time. To make an argument in favor of gold you need to show that gold does well when other assets are doing poorly. Someone worried about another Great Depression or double-digit inflation might be tempted to invest in gold as a hedge.


In my view, however, the problems of the 21st century will look different from those of the 20th century. Instead of depression or hyperinflation, the risk is economic stagnation—especially in countries with falling populations. And in that environment gold is not a particular good hedge. Stagnation will be less of a problem in the US due to factors like a growing population (immigration) and new technologies such as fracking which remove the previous fear that “peak oil” would inhibit economic growth. Again, gold does not do particularly well when there is low inflation and steady growth.


This is not to say that gold prices won't go higher over time; the long-term trend has obviously been positive, and there is growing demand in Asia. But don't forget that much of this merely reflects the effects of inflation. Gold prices are about 60 times higher than in 1900, but the cost of living has increased roughly 30-fold. So the increase in purchasing power of someone who invested in gold is about 2-fold, but that’s over 115 years! This is a much lower return than you would've seen in alternative investments.

Best collectible investment in 2014?

Best collectible investment in 2014? Written By Robert Frank | CNBC (*Excerpt from article) Full Article: Investing in high-end collectibles has been more lucrative than investing in stocks. Over the past 10 years, the Knight Frank Luxury Index (which tracks collectibles from cars and art to stamps, wine, coins and furniture) is up 182 percent while Dow Jones is up 62 percent. According to the report, art has been far more volatile over the past 10 years than gold, equities or real estate. Among collectibles, coins and furniture were the least volatile. Coins, in fact, have had a strong, if under appreciated, run recently. They returned 10 percent over the past 12 months and 90 percent over the past five years, ranking second as investments just behind cars. Best collectible investment in 2014? Written By Robert Frank | CNBC (*Excerpt from article) Full Article: Investing in high-end collectibles has been more lucrative than investing in stocks. Over the past 10 years, the Knight Frank Luxury Index (which tracks collectibles from cars and art to stamps, wine, coins and furniture) is up 182 percent while Dow Jones is up 62 percent. According to the report, art has been far more volatile over the past 10 years than gold, equities or real estate. Among collectibles, coins and furniture were the least volatile. Coins, in fact, have had a strong, if underappreciated, run recently. They returned 10 percent over the past 12 months and 90 percent over the past five years, ranking second as investments just behind cars.