A Conversation with Larry McDonald of the Globe & Mail

30 May 2009

I recently received an e-mail enquiry from Larry McDonald, co-author of the Globe & Mail's "Me and My Money" column. The following discussion is preliminary only, but I felt that some of the material covered might be of interest to the readers of my blog. My responses to Mr. McDonald's questions follow below:

What investments do you have in your portfolio (name of stocks, mutual funds, etc.)?

Primarily gold and/or silver mining companies, with larger holdings in Goldcorp, Yamana Gold, Minefinders, Northgate Minerals, Pan American Silver and Franco Nevada, and also quite a few smaller cap explorers and miners, such as Rubicon Minerals, Premier Gold, Jaguar Mining, ATAC Resources, etc. I also often invest in warrants in many cases, where they are available, including Goldcorp, Yamana, Minefinders and New Gold, for example.

What is your investment approach?

While I do some active buying and selling depending upon factors of relative valuation and timing, for the most part, I am a long-term buy and hold investor, meaning that my portfolio has varied dramatically in market value over time. For example, the market valuation declined over 65% in the fall of 2008, and now we've gained 130% since the November lows. The market valuation was highest in March 2008, and lowest in November 2008. Also, the majority of my investments are held in registered accounts, meaning that I buy and sell equities rather than physical metal (gold, silver).

Brief history of investing path, e.g. how got started, etc.?

I started out very conservatively, holding bonds through the investment bubble of the late 90s. I was then a late arriver to technology investing, which was of course disastrous, and then began to research why I had become drawn into an investment bubble. I thus missed the real estate bubble, and believe that last year’s commodity blow-out was not a bubble.

In the background, my wife invested primarily in income trusts, and thus I am furious with Carney and Flaherty for blowing up Canadian small investors and forcing the western natural gas trusts in particular onto the international investment market (at depreciated values) at the expense of Canadian small investors. I'm single issue against the Conservative Party on their dismantling of the income trust program, and will never forget the betrayal of trust – as well as stupid and short-sighted policy – on that “single” issue. (Don't get me going!)

What were some of your best and worst investment moves?

Worst – investing in technology companies in the early 2000s. Best – shifting my portfolio to the precious metals sector in 2003.

What advice would you offer to other investors?

Look beneath the surface to secular trends (large trends that span decades). Study history to view these trends in perspective. Be aware that financial markets are undergoing a period of massive manipulation based on misconceived government interventions – almost all of which have been counterproductive. Understand why Federal Reserve policy is now of greater interest to the financial community than analysis of underlying economic fundamentals (the markets have become increasingly distorted by short-sighted and increasingly disastrous government and central bank policies, dating back in particular to the advent of the Greenspan era in 1987). Be wary of efforts at market timing. Invest based on underlying, long-term value against the backdrop of a macro environment of inflation, debt promotion and capital misallocation. For longer-term investors, give greater weight to fundamental value than to market price when making investment decisions. Seek the advice of wise and experienced professionals (I rely on Ed Bugos in Vancouver, Bill Fleckenstein in Seattle, John Doody – the Gold Stock Analyst, in Florida, and the Aden sisters in Costa Rica).

By the way, while I view government policy broadly as unbalanced and disastrous, I'm not a conspiracy theorist. It is simply that government is over-intervening to save the market from itself, which has never once worked in history, and the intervenors operate from a very short-sighted perspective, with no acknowledgement and/or awareness of the consequences of their actions.

I do also buy into the notion of a power shift away from the United States towards Asia, and this is due moreso to the departure of Americans from their long-term commitment to free market policy than to the inherent strength of Asian economies. In brief, Asians have been saving while Americans have been borrowing, and, as Warren Buffett illustrated in his classic “Squanderville” story (published in Fortune and other places), the long-term consequence is to shift wealth from borrowers to savers. This is what is now happening globally.

Finally, I view Canada as uniquely well-positioned due to the balance of our economy towards commodity production. However, I view our national Conservative Party leadership as largely blind to the implications of this reality, with the result that they are attacking small investors (through their anti-small investor income trust policy) and throwing money at declining industries (obviously but not only autos), rather than providing support to small investors and to investment in Canada’s capacity to lead the world in commodity production (I once read that we have more mining and mineral exploration companies in Canada than in the rest of the world combined, though I've never verified that statement by “counting”). That is, Canada has everything we need to be global leaders in the 21st century, but our elected officials are looking backwards rather than forwards.
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Bond Prices: The Seismic Shift That Triggers the Gold Tsunami (IV)

27 May 2009 - Updated 9 August 2009

It is no secret to investors that the US 30-year "long" bond has risen in value for 28 years.

It has certainly also been noticed that this almost one-third century trend has recently reversed - with the reversal confirmed by a break in the long-term-trend-defining 65-week moving average this very week.

The implication is that bond prices could now fall, and interest rates rise, for the next one-third century or so.

The cause, of course, is the massively inflated, bloated, still over-valued US dollar and the floundering US economy.

The rate of change in the bond market is typically glacial, though do remember that even glaciers have periods of rapid movement - when the weather is very cold or very hot.

However, the key point here is that bonds will soon cease to be the outperforming investments that they have been for the past 3 decades. Additionally, it has grown increasingly obvious that general equities are in a long-term bear market.

What then will investors turn to for preservation of the value of their holdings?

You know and I know that gold is a store of value in uncertain times.

The reversal in the long-bond trend is a seismic event in the investment world. The tremors will be felt far and wide for decades to come.

The falling bond price is the seismic shift that will ignite the gold tsunami.

With both bonds and equities in decline, gold remains the only secure vehicle in the investment world. Other investments may rise, but only gold possesses the combined qualities of relative strength (its time is now) and security (gold is no one else's obligation and thus is not subject to possible default).

Tsunamis begin with a deep undersea earthquake. The disruption in the ocean depths is transmitted to the surface, giving force to the giant waves that later crash to shore at the ocean's perimeter.

The collapse of the 30-year bond price is the earthquake.

The price of gold is the tsunami.

There is a tsunami coming in gold.

9 August 2009: My charting site allows me to create a chart of the 30-Year Treasury yield from 1990, so let's have a look at that here.

As you can see, the change in trend is most notable on a short-term basis only. The yield bottomed at an amount of 2.519% on Friday, December 19, 2008. This subtle transition can be observed on the following chart.

Though this may look like yet one more dip on a 3-decade journey downwards, don't be deceived. The long-term trend of the 30-year yield is defined by the 65-week (325-day) moving average, and that is the line that was crossed during the first week of May 2009, and again more decisively (after a retest) during the week of May 25-29, 2009.

The 65-week moving average has been crossed before, in fact, many times since 1990. But in this case, the rate plunged to an atypical low near 2.5% before almost doubling to 5.066% in June 1990. Each time the 65-week moving average has been violated to the upside, it has appeared that a trend reversal was in the offing.

This time, however, the move appears more definite for several reasons. To begin, this is the first time we've seen a doubling of the yield. Further, the dramatic turnaround of the rate in a "double" in a matter of 6 months is also unprecedented. Given macroeconomic factors, it is also difficult to see how the yield can again fall below 2.5% (a retest of this low in a "double bottom" is certainly possible at some point, particularly if another financial crisis akin to that of 2008 should occur), as foreigners are displaying a markedly diminished appetite for US treasuries, and the US government is running a $2 trillion deficit this year which will not be recouped by increased tax receipts at any foreseeable future time.

If there is an argument against higher long-term rates, it is a weak one based on quantitative easing. This is the practice of the Federal Reserve Bank under Chairman Bernanke to "print money." That is, the Federal Reserve is now creating money "out of thin air" to purchase the 30-year Treasury Bonds that literally no one else wants. While Fed purchases keep the rate artificially low, this is also the same policy followed by such governments as that of Zimbabwe. It is no secret that while the practice may temporarily restrain bond yields, wary investors will be more circumspect about purchasing bonds whose value is being artificially supported by money creation "ex nihilo."

Wikipedia describes the following as the primary risk of quantitative easing:

"Quantitative easing runs the risk of going too far. An increase in money supply to a system has an inflationary effect by diluting the value of a unit of currency. People who have saved money will find it is devalued by inflation; this combined with the associated low interest rates will put people who rely on their savings in difficulty. If devaluation of a currency is seen externally to the country it can affect the international credit rating of the country which in turn can lower the likelihood of foreign investment. Like old-fashioned money printing, Zimbabwe suffered an extreme case of a process that has the same risks as quantitative easing, printing money, making its currency virtually worthless. ^[13]"

So, yes, quantitative easing may temporarily sustain the market for the now-unloved 30-year US Treasury, but the greater risk is that the US will follow in the footsteps of Weimar Germany, Japan, Argentina (in the past), and most recently Zimbabwe, by "shredding" its currency in the court of international public opinion.

For more information on how the Fed carries out quantitative easing, click here, here or here.

So, will quantitative easing support the long-term value of the US 30-Year Treasury Bond?

Unlikely.

The greater chance is that such central bank recklessness will drive international investors to more secure alternatives. For example, the Chinese are now using their stores of foreign capital (mostly US dollars) to stock up on such real-world necessities as copper, as well as to purchase productive assets (mostly commodity-producing investments) around the world.

As you have heard me say before, when paper money is devalued, gold is the historically-favoured alternative place to go to avoid devaluation of your savings. That has not changed in the third millennium.

My gold tsunami posts are as follows:

There Is a Tsunami Coming in Gold

Gold Tsunami II: Anthropomorphizing Gold

Gold: Safe Haven in the Approaching Perfect Storm

Gold Tsunami III: James Kunstler's Use of the Analogy

Bond Prices: The Seismic Shift That Triggers the Gold Tsunami (IV)

Gold Tsunami V: The $23 Trillion Bailout... and Counting

Gold Tsunami VI: Looking for Patterns in Gold Price Advances

Gold Tsunami VII: This Is It

Gold Tsunami VIII: Gold Mining Stocks Now Participating
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The Bailouts Are Above All a Moral Problem

27 May 2009

John Hussman, President of Hussman Investment Trust, has stated in simple terms what is wrong with the bailout process.

It has diverted funds from hopeful and productive enterprises to wasteful and inefficient activities. The cost? Our future wealth, health, productivity and morality.

Mr. Hussman states:

"The bailout is not something "neutral" that cancels itself out, but instead amounts to a transfer of trillions of dollars of purchasing power directly and indirectly from those who didn't finance reckless mortgage loans to those who did. Farewell to the projects, innovation, research, investment, and growth that might have been financed by the savings and retained earnings of good stewards of capital. Those funds are being diverted to the careless stewards who now stand to be made whole.

"In short, these bailouts are emphatically not neutral to society as a whole, because they damage incentives and divert productive resources into hands that have proven themselves to be reckless and incapable. To believe that the bailouts are just money we owe to ourselves is to overlook serious ethical implications, as well as distributional and incentive effects."

What else is there to say?

Well, perhaps I do have one point to add....

Now that we are funding vice rather than virtue, what becomes of the bigger issues at stake in the world? How does waste on this scale impact the chances of war versus peace? International cooperation versus conflict? Responsible government versus cronyism and promotion of special interests? Opportunity for all versus inequality? Hope versus cynicism? Moral progress versus moral dissolution?

We have not yet begun to count the costs, both financial and non-financial, of the greatest bailout of the reckless by the responsible in world history. The costs will inevitably be greater than those that are presently being reckoned.
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