Bond Bubbles and Bad Apples

Recently, I participated in the Agora Financial Investment Conference, in Vancouver. It was a pleasure to see and talk with so many folks that attended. It was also useful to get out of the resource-centered world in which I dwell and hear informed, thoughtful discussions of macroeconomic and other investment-related issues.

Several speakers commented on one intriguing theme. Today I want to touch on this important investment theme and give you the inside track on avoiding bond bubbles and bad Apples…

In a strange modern development, people across the world are aggressively buying government bonds. Yet inflation is built into the global monetary system, while bond yields are at historically low levels.

I don’t usually discuss government bonds, so let’s review the basics. A government issues a bond in order to borrow money — usually, money that it can’t raise via taxation because people don’t have it or won’t pay it.

The government promises to pay you back for the bond, with interest. But today’s bonds virtually guarantee that you’ll receive low interest rates while your principal is consumed over time by government-sponsored inflation.

In addition, and in a bizarre irony, people are entrusting funds to governments that are — one by one — going broke everywhere. Apparently, bond investors know this, but don’t really care.

How did this come about? In recent history, after the 2008 market crash, central banks lowered interest rates to near zero and created large supplies of new “money.” These cheap funds have to go somewhere. (Note: remember my recent discussion of the “technology” behind money.)

At the Agora Financial Investment Conference, economist Marc Faber alluded to Federal Reserve Chairman Ben Bernanke’s memorable statement about dropping money from helicopters to stimulate the economy.

Back in 2002, Bernanke said, “The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.” Then Bernanke referred to a comment by the late economist Milton Friedman about using a helicopter to “drop” money into the economy.

However, warned Faber, “When you drop money from helicopters, it doesn’t all fall evenly over the ground. It tends to pile up and form bubbles in different sectors, like in housing or now in bonds.”

So Faber — and many others as well — believes that we’re in a bond bubble. Still, despite the looming future problems for governments across the globe, bonds remain a favored asset class.

Yet if you’re the bond buyer, shouldn’t you at least wonder how governments of the future will ever pay back the bonds? Where will the money come from? Will taxpayers sit idly by while larger and larger percentages of future government budgets go to pay interest? Will governments inflate their currencies so that bond repayments offer less and less of the original value?

I don’t know how this bond mania will play out, or over what time frame. But I can’t see how it ends well. My fallback position is hard assets, like owning physical materials (especially gold and silver) and resource investing, as what we do here. Over the long haul, by owning “real” things, I believe we’ll come out ahead.

Strange Equity Valuations, Too

Equity markets have their own strange story to tell. Frank Holmes, founder and president of U.S. Global Investors Inc., began his talk in Vancouver by discussing Apple Corp. At $572 billion, Apple has the largest market capitalization of any private company in the world. (By comparison, Exxon Mobil’s market cap is a mere $405 billion.)

Yet it’s important to note that the Apple iPhone and iPad, for example, rely entirely on telecommunication companies to move content around. Apple devices also rely on electricity to charge the batteries. Apple devices are made of exotic materials, from the inner electronics to the high-spec aluminum case and glass cover. And of course, Apple products rely on a global logistics chain to fly parts to assembly sites and haul finished products across the world to consumer outlets.

Meanwhile, Apple’s market cap is larger than the cumulative total of all of the companies in the North American telecommunications sector. Its market cap is larger than the cumulative total of all of the companies in the North American electric utility sector as well. Apple’s market cap is larger than the cumulative total of all the companies that supply its components and materials. And Apple’s market cap is larger than the cumulative total of all the airfreight and airline companies in the world — and throw in Boeing and Airbus as well.

Of course, the Apple-centric explanation is that the company’s products are innovative and bristling with advanced technology and added value. That, and, as Holmes noted, most of Apple’s supply and manufacturing chain is located overseas. This spares Apple the burden of heavy regulation and unionization, like the North American telecom companies or electricity utilities.

Now consider that an Apple product is a “want,” versus a true human “need.” That is, you can live without your Apple products — really, try it for a few hours. But try getting along without electricity, or living in a world without telecommunications channels in general, let alone a world of scarce basic materials. You’re back to living in the preindustrial era.

Meanwhile, the life cycle of a modern tech app is 18 months or so, at the outside. So if Apple isn’t working on its next couple of generations of new products — and if one or more of them fail to excite the consumer — then where do things go from here?

The situation with Apple offers quite a commentary on modern investor psychology. For as good as Apple is, why are the markets giving this one company such a large valuation? Indeed, most of Apple’s profits are “stranded” overseas, due to tax laws. How does all of this translate into long-term wealth protection for investors?

Yes, Apple is innovative. But Apple products depend on the backbone of telecoms and electric utilities, along with materials and logistics to put the devices together and ship them in the first place. These sectors in turn rely on basic resource and energy producers.

Looking ahead, how long can Apple stay so large and so far in front? I’m sure that we’ll all live long enough to find out. As I discussed earlier with bonds, my fallback position is hard assets, like physical metals, and resource investing. The idea is to come out ahead over the long haul.

Thanks for reading.

Byron King

Bond Bubbles and Bad Apples was originally featured in The Daily Resource Hunter. Check out the newest Daily Resource Hunter research video “The Price of Gas Explained”.

Article Title originally appeared in the Daily Resource Hunter (www.dailyresourcehunter.com) At the Daily Resource Hunter our approach to research is different. With our boots on the ground, we travel the world looking for the most lucrative resource opportunities and deliver them to you in a daily email newsletter. For more information visit us at www.dailyresourcehunter.com)