Class Warfare, the Productive Class and Gold and Silver

* A reader writes in:


“Hi Rick – I have enjoyed your blog.  Thank you for writing it.  I have missed some days, but appreciate you taking the time.  So, can you give me just a quick general down and dirty where I should put my money? What percentage gold? Thanks”


It has been a while since I have put forth a comprehensive review of how I would position ones portfolio, which I will just refer to as “savings”. I practice what I preach, so these views also reflect my strategies. Here is a basic snapshot:


33-40% Gold and Precious Metals

10% 10 year US Treasury Notes

13% Japanese Yen (in the form of a bank deposit)

5% Bearish Equity ETFs

35% Cash and short duration dollar investments


Here is further elaboration on each component and why I am positioned this way.


* Gold and Precious Metals - 


I have 1/3 of my savings in precious metals, via a combination of a hedge fund which owns gold, silver and mining and resource stocks while being short US stocks, some in overseas bank vaults, in a separate acct, and some physical gold and silver, in the form of coins. If you have no gold or precious metals at all, I would move to 10%, no matter what the price. Here is why I think it is so important to have such a significant weighting in precious metals:


For millennium, precious metals was how man kept his wealth, and precious metals transcend political regimes and all else. Precious metals cannot be printed like currencies can, nor can it created at will, as credit can. While the dominant concern in my playbook is deflation, governments around the world are doing everything they can to prevent deflation, and the way they do that is by increasing the amount of currency in circulation, and through the active support and promotion of credit instruments. The credit in turn is central to the support of the economy, yet it requires, at some point in time, that those who owe the credit will have to pay it back and make good on interest payments along the way. There is a balance between how much credit a system can support, and when we exceed prudent levels, you witness events such as the housing debacle, which is still ongoing, and sovereign debt defaults as we have seen this year with Dubai and Greece. As in all cases, rescues so far have come at the expense of those who have saved, or in the case of the US, the government, which has transferred private debts onto the government’s balance sheet. While the destruction of credit is deflationary, and quite prevalent, governments around the world are doing what they can to keep deflation at bay.


The US government is the main character in what will become the greatest credit bust of all time. So far we are half way through a $4+ trillion spending binge, a $1.4 trillion increase in the Fed’s balance sheet (or 150%), and the economy is barely limping along, with 8 million more folks collecting unemployment than in 2007. In other words, despite these heroic efforts, there is very little to show for it. This exemplifies how intense the deflationary forces are beneath the surface. The risk is that over the course of time, the US will issue, or guarantee credit which it will not be able to make good on. The tricky balance is the $2.6 trillion of FX reserves (mostly US) which China has on the PBC’s (their Central Bank) balance sheet. China’s persistent trade surplus has moved much of the world’s excess currency onto their balance sheet, which in turn is fueling their local economy. Consider that oil has been rising over the last few years because of demand from China and the other BRIC countries who have been the beneficiary of easy monetary policy in the US and in the Developed world. The developing countries will eventually cash in these markers, and when they do, there will be little the US can give them, except more currency.


I am not saying this is happening today, or even next year. From what I can tell, it is impossible to forecast the timing of a debt crises, but usually these things sneak up on us unexpectedly. It is for this reason that I own so much of my savings in gold and precious metals. When currencies and credit fails, the one currency which will do well is the one which governments cannot create out of thin air. I do not look at gold as an inflation hedge, although I will admit that Gold should do well with inflation. It is a hedge against our government and those of the developed world printing too much money and supporting credit which cannot be repaid.


Because history is littered with periods of fiscal crises in which the government undergoing the crisis demanded its citizens divest itself of any gold which they own, I favor owning gold in a variety of forms, other than in a brokerage account via an ETF, which is easily tracked and subject to a forced sale to the government, if they so desire. That is why I favor off-shore, and off the grid vehicles to hold gold and precious metals. I am not saying that the government will not be able to get their hands on your metals if they really want to, just that it makes it much less likely that they will. Even if you take physical delivery of gold coins, it is possible to insure them on your home-owners policies. There are two other reasons why I do not like the GLD ETF: one is the fact that there is no insurance in case of theft, or the ETF’s gold is mis-allocated amongst the other folks who have their gold in the HSBC’s depository in London, and secondly, people tend to trade the ETF and this insures that you will not have the metals when all heck is breaking lose and Gold doubles or triples in price in the matter of a week or two. I was with a reader over the weekend, and he thanked me for my advice on Silver, which he bought at $13 an ounce and sold at $16 an ounce. It is now $18.50 and he does not have any. If you own precious metals in non-tradable formats, it insures that you will have it when it is skyrocketing and all else is going down. I have discovered that my brokers all sell gold coins which they can either hold for me in my account or deliver to my home.


* Interest Rates – I have stated over the past month that I was bullish on US Treasuries and thought rates will go down through mid-June. This optimism flies in the face of my long term bearish view on the US currency and interest rates. As with Greece, whose interest rates were as high as 18% last week, in the heat of their crisis, rising interest rates will occur when the world loses faith in the ability of the US government to repay its debts. Last week’s Barron’s Big Money Poll, cited only 1% of their respondents as bullish on US Treasuries. If that is not an excellent contrary indicator, then I do not know what is. I previously cited an overwhelming consensus that rates were going to go up as one reason to get long some rate duration, but I never thought it would be as dramatic as the 1% bullish reading in the Barron’s survey. Seasonal forces are typically bullish for US rates (dropping) from early May into Mid June, so I am keenly paying attention to this time period to see what happens. 


I have a modest position in longer term treasuries, which are quite liquid and can be sold in a phone call with little transaction costs. I would look to trade out of these by the middle of June. If you are thinking of refinancing mortgage debt, the period leading into June should be a good time as well.


* Japanese Yen – everyone loves to bash the Yen, and have been doing so for quite some time. Yet the Yen keeps improving, up 25% over the past 4 years. Japan has been in a deflationary cycle for the last 20 years, and to that end, they are 15 years ahead of us when it comes to working through their problems. The main negative which people cite about Japan is the government debt, which is approximately two times its GDP. The difference between Japan and the rest of the world is that various domestic pensions and GSE’s which hold the nation’s savings, own Japanese Government Bonds (JGB). And because Japan has run a persistent trade surplus for the last 25 years, they are not beholden to anyone other than themselves. Folks have lost a lot of money betting against the JGB’s as long ago as the mid 1990s, and they continue to do so today.


Because Japan is so un-leveraged as a country in the context of the global financial system, when the world was going through its credit contraction in 2008-2009, the Japanese currency did well. The Yen seems to be a safe haven when the rest of the world is imploding. Due to my negative views on the US economy going forward, I like the Yen now. Additionally, long time readers will recall the very bullish chart of the Yen, which shows the Yen in the final stages of a 40 year bull market which has the Yen targeted to a price objective of 55.


The interesting conundrum about the Yen pertains to what to do with the Yen, once you own it. I could recommend JGBs, yet long term rates are below 2%, and I do remain concerned that the fiscal situation over there will not improve, and eventually, the pensions which hold the bulk of the JGBs will need to sell them in order to meet the demands of its aging society. As it pertains to the Japanese stocks, analysts suggest that a weak Yen supports the fortunes of the mostly export driven economy, and if I am bullish on the Yen, then I am by definition, bearish on the economy. This leaves me owning Yen deposits with a yield of 0.0%.


* US Stocks – I maintain a modest short position via un-leverage ETFs in US Stocks, and a small short in a CRE (Commercial Real Estate) REIT. I have spent a considerable amount of energy trying to catch the next wave down in stocks in my trading account, and unfortunately, it has also cost me some money over the last 6 months. Nonetheless, with the bullish seasonal time period past us (Nov-April), my expectations are that a resumption of the bear market in stocks will resume. In fact, it has been my expectations that the stocks will start lower, which has kept me away from resource stocks, which I am anxious to purchase. In its simplest form, Oil and Gas partnerships which pay the owner a dividend based on the production and sale of oil/gas at market prices, yield between 6 and 9% dividends, are an easy way to invest in this sector. Yet, since I remain bearish on equities in general, so I am going to delay investing in these instruments, probably until the fall.


* Cash and Short duration investments -  Bank deposits and short dated CDs yield very little, but if you look hard enough you can find some institutions offering rates on short term deposits between 1 and 2%. I have mentioned this in the past, that you could also purchase FNMA and FHLMC MBS, which final maturities between 2018 and 2020. These typically are seasoned 15 year MBS issued between 2003 and 2005. With 8 to 10 year to go before maturity, these instruments spit out a lot of cash and have a 2 to 3 year average life with a yield in the mid 2′s. These are not great, and less liquid, but better than a bank CD. These are self-liquidating securities, and the amortization on the underlying loans insures that the LTV of the underlying properties will drop quite fast as the maturity date approaches. I like this because you should get your money back even if the FNMA or FHLMC does not survive. The non-agency alternatives yield about 1 to 2 % more, and unless you know what you are doing, and are able to monitor the portfolio, it is not worth the effort.


* Where you keep your money will be important going forward. In early 2008, I established overseas bank accounts, at institutions which have 20 to 25% capital bases, and little in the way of corporate loans or mortgage debt. This was due to my concern that domestic US banks were going to be in for some tough sledding. I did not anticipate how heroic the US was going to be to keep these institutions afloat, and to what extent they would be there for their depositors. With TBTF legislation in the wings, and Timmy Geithner promising that equity and debt holders will be on the hook for losses at failing institutions, I am not sure that you can count of these institutions unless you keep your deposits with them to below the $250,000 FDIC insurance limits. 


Given the growing back-lash against the well to do, I am also concerned that the government might eventually launch confiscatory taxes against the savings of those with assets to tax. I am not saying that having overseas bank accounts is the end all for wealth preservation, but it would go a long way to making it more difficult for the US government to get their hands on your money in the heat of a crisis. To conclude, and re-inforce my concerns about keeping all your eggs in US banking institutions, I will leave you with one comment from a reader, in response to my class warfare piece on Friday:


I wrote: “Nonetheless, we are approaching a cross-road which will include more polarization between those who do well and those who have gotten used to riding on the golden entitlement system. With half of the US not paying taxes, this type of polarization will likely get worse, not better.”  


The reader writes: “Absolutely, and this plays into something I’ve been thinking about of late: the inherent tension between the Productive Class and the Political Class in a democracy.


The most insidious risk over time to a well-functioning democracy is the Political Class using the power of the state to take money from the Productive Class to give to their clients  – the private and public sector unions, government employees (a.k.a. bureaucrats), and favored minorities – in exchange for political power.  


The Progressive Political Class has made it crystal clear that this is their agenda.  They have also made it plain they will tell any lies and break any rules in order to achieve their objectives.


The big, big question to my mind is: “Will the Productive Class act to protect its own interests?”  Can It?  Upon reflection, the Productive Class has historically been remarkably passive in protecting its rights, probably because most members of the Productive Class want to get on with their lives and have little or no interest in directing others how to live theirs.  Of particular interest is that the most successful and productive citizens have meekly paid confiscatory tax rates with hardly a whimper.  Time to stand up and say: “Enough.” (end of readers comments)


It is mildly inconvenient to establish overseas bank accounts, but in the end, this could be the difference between keeping some of your savings and not. It reminds me of the folks who bought A4 CMBS tranches with 30% credit support,  versus those who bought the AJs (13% C/E) or AM’s (20% CE). To go from an A4 to an AM, you picked up 3-4 basis points at the height of the market, and another 3-4 basis points to go to the AJ’s. That is the difference, in some cases between bonds worth 100 and 60 today.