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THE BLUE MONEY REPORT.
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The Blue Money Report
"Those skilled in war subdue the enemy's army without battle"
~ Sun Tzu
Welcome to the Blue Money Report
Today's Commentary: 03.13.03 Long time readers will recognize Vince when I mention him. A staple of my weekly update, Week Ahead/Week Behind, Vince is guy who worries about his investments far too much. He loves them and hates them, coddles them and tries to predict their next move. He's cautious and he's a gambler. He is also, for the sake of this explanation, the first real gold investor I've known since I dabbled in the early 80's.
Gold is in the news of late because it has been a historic safe haven. But is it a safe place for your money? Some folks suggest that holding 10% of your assets in gold mutual funds might be a way to diversify. They would have had to have developed that opinion recently though. Precious metals were hardly rolling off of any planners lips three years ago. Vince even admits it was the furthest thing from his mind until a year ago.
Suppose you think that 10% of your assets are worth riding in what could be another good year for gold. It might be worth a few minutes to explore what all of the fuss is about.
Gold has held a prominent place in the world of finance for quite some time. In the growth of the pre-WW I economy, it was absolutely necessary. This lofty status for the metal had to do with the gold standard. The gold standard basically insured that each note of currency, no matter what country's money you held, it was worth something in gold. Having this standard in place insured that the product you sold would be worth the same price in England or Europe as an American might pay for it. In other words, gold eliminated the risk that the currency of another country would be worth less than a manufacturer assumed. Foreign exchange risk is fraught with dangers and is really more important that most of us give consideration. Governments and currency speculators can alter the way trade is done without the gold standard. Gold provided equilibrium.
If each note was attached to a specified amount of gold, then trade deficits would need to be avoided. If these deficits were created, hypothetically, owners of these bank notes could demand payment. nations needed to keep this balance in tact. Lowering of a nation's gold reserves could create falling prices followed by falling production, followed by falling demand for imports.
The odd thing about the standard was it's non-creation. There was no meeting of minds or financial committees. It just sort of happened. Britain defined it's currency with gold beginning in 1717. The German's followed in the 1870's. With the Germans looking for gold to back their currency, the demand for the metal caused prices to rise. Americans increased their production of silver which pushed the price back down again. Clever folks with an eye for a buck found a currency loophole and exploited it. Countries tried to keep both gold and silver coins in circulation. Speculators of the time would buy cheap silver, exchange it for currency, and then turn and demand gold for the currency.
By the end of the decade of 1870, the world had found the gold standard to it's liking.
The basis of this gold standard was it's convertibility. But this did little to help the working class at the time. I fact, the creation of the gold standard kept economies growing from the top up denying any sort of economic freedoms to those who weren't relatively well off. To keep the equilibrium, this group of people would just have to remain politically weak.
But in a pre-WW I economy, nations like France and Britain were investing heavily overseas in the hopes of creating far greater wealth and strategic positions. Most of which backfired. But those mistakes grew such countries as pre-Lenin Russia, the U.S., Canada and Australia. The downsides however where more troubling.
This financial capital supplied from these countries was closely tied to each countries economy. There was a great deal of truth to sayings such as,"When London sneezes, the U.S.(or any other heavily invested country) catches pneumonia."
Without detailing all of the problems associated with the gold standard and how it related to every depression in this country since the railroad boom 1870, it is sufficient to say that the mere ownership of gold was not enough to keep a currency strong. It was credibility. By the early part of the twentieth century, Britain had abandoned the gold standard (1931). The USA followed in 1971.
The question is whether this happened too soon. Alan Greenspan championed the gold standard in 1981 suggesting "that budget deficits and large federal borrowings would be difficult to finance under such a standard. Heavy claims against paper dollars cause few technical problems, for the Treasury can legally borrow as many dollars as Congress authorizes." He pointed out that federal deficits would be difficult to finance under a gold standard and therefore would be unable to exist.
Understanding the difficulties in reverting back to a system once referred to by another economist, John Maynard Keynes as a "barbarous relic", Greenspan suggested that the best solution would be for the U.S. to "create a fiscal and monetary environment which in effect makes the dollar as good as gold."
Greenspan believed at the time, the standard would keep inflation I check as well as fiscal discipline. Any sign, he wrote, that politicians were straying from their course would generate an atmosphere of redemption, dollars for gold.
Greenspan suggested that this disciple would be the reverse of Gresham's Law. Sir Thomas Gresham suggested the if one currency was better than another nations legal tender, the effect would be simple: "Bad money would drive out good." Greenspan suggested that if the gold standard was adopted, with the elimination of federal debt, the effect would be "good money driving out bad."
Is investing in gold still a worthwhile idea? Today is has little use except in dental, ornamental and industrial applications. Mention an impending calamity, and investors rush to the metal as if the safety of the metal provided some hedge against the disaster. Even Greenpsan admits that the metal used as a standard was forced from possibility by the force of law. Gold is now priced in dollars, not the other way around as the standard would suggest. It's premium is simply symbolic.
Folks looking to get involved in this market should consider this. Gold production is not nearly what it could be. Demand is currently outpacing supply. Should demand accelerate suddenly, it would take little time for production to bring it down to reasonable levels again.
These are factors beyond the average investors control. Allocating 10% of your portfolio to such a risk depends on the amount of risk you can tolerate and whether you can judge the upside while it remains up.
There was once a time in the course of world economics, when the production of silver by the United States forced the gold standard to be adopted as the basis of almost every currency. But this metal has a history of wearing many hats, few of which are understood.
It is widely believed that silver will benefit for the steep price gains that gold has and could continue to experience. Although not priced at the same high cost per ounce (at the close on 03.07.03, it was $4.68 per ounce), it's price does have some historic moves usually based in tandem with gold.
As with most commodities, it is the demand met by supply that keeps the price of the metal in check. It uses are rather mundane compared to some of the other metals. Mostly widely used in photography, jewelry, silverware, electronics and some other types of manufacturing, the typical increase in price because of this recent run in gold hasn't materialized.
Interest in the metal is still there. Warren Buffet bought over 100 million ounces in the late nineties. Inventory numbers are sketchy at best. And as with gold, there is a much larger, more unpredictable pool of cash floating around in the market with no real place to go. Inventories haven't grown at 2% of this demand. Should investors think better of their previous strategies and start looking at gold and less expensive brethren, prices in this metal could get as high as $7.00 by the end of the year. That would amount to about a 33% gain over Friday's close.
Platinum on the other hand may have some future potential based on more than it's application in jewelry. It shows a good deal of upside possibility in the metal's application i fuel cell production and in it's use in catalytic converters. The later will get a boost as the world finds itself pressured to clean up the air. Friday's (03.07.03) close of $684 on the Platinum Merc could rise to well over $900 an ounce.
Copper is dirt cheap and because of it's attractive price is as widely used as you might expect. Once again, the price will be effected by pressure on inventories which could, emphasis on "could", increase over the next three to four years. Although there is a very large above ground inventory, it wouldn't take much demand for the price to spike. I can't remember where I read that Chile, a large producer, is planning to get production up to meet any possible demand increases from the likes of China. Copper is a popular conductor metal.
I don't however suggest you attempt to purchase these metals as commodities though. If you want to buy into the possibility that demand will outpace inventories, the markets will flock toward the generally assumed safe haven of precious metals, and you don't want very much in the way of risk. A look at these top performers over the last year might help narrow your search. Just remember, that these are not recommendations to buy and I don't own these funds, although they meet quite a few of the criteria prefer in a fund. Both are no-load, lw expense, and have a low intial entry cost.
U.S. Global Investors World Precious Mineral Fund UNWPX , + 41.86%.
Scudder Gold & Precious Metals AARP SGLDX +35.65%
Today's Commentary: 03.10.03 n. 1. A lively dance consisting of various two step patterns embellished with twirls and acrobatic manuevers.
The economy is not growing at a rapid enough pace as reported by the latest jobless numbers. Pushing 5.8%, the unemployment numbers had 308,000 new folks in line. The surprise in this number came from the service sector, a group that has been known to add low paying jobs at a faster clip than the rest of the economy.
Somewhere in the fifties, before numbers were kept about interest rates for mortgages, rates were lower. With thirty year fixed rate interest rates at 5.67% (15 year fixed at 5.01%, some even lower), this lower than historic low could be with us for awhile. More a symbol of continued weakness than strength, this has caught the attention of those Fed governors. Short term yield on the Two Year Treasury note hit the lowest mark in 44 years at 1.40%. In case you didn't know already, contracts are sold based on the probability that the Fed will cut rates again. Those contracts predict a 38% chance of another cut soon. At the beginning of the year, there wasn't even that much of a chance.
Warren Buffet's recent pronouncement that he was in junk bonds came as a surprise, but his terse words for derivatives as financial weapons of mass destruction caught Mr. Greenspan's attention. Derivatives, which are a financial instrument that does not constitute ownership, but a promise to convey ownership, are based on a cash product such as the Spot Foreign Exchange, Commodities, Equities, Bonds, Short term ("money market") negotiable debt securities such as T-Bills, or Over the Counter ("OTC") money market products such as loans or deposits. This has worried regulators in the past because of the chance that one of those promises will be tied to a bankrupt business. Big banks swap all kinds of promises all the time in the form of interest rate swaps, forward currency swaps and options on futures. This balancing act, while done off the books, can leave many folks holding worthless promises. Enron was a good example of exactly this type of financing.
But the Fed chairman suggested as a way of rebuttal that these instruments were not as bad as they seem. In Mr. Greenspan's opinion, these financial instruments have kept economies flexible and because of that has prevented what he referred to as a dramatic decline in stock prices had they not been used. The concerns voiced recently by Buffet were overdone, Greenpsan said. Without the use of these tools, the markets would have collapsed completely in the face of current conditions, both at home and on a global basis.
Another poorly received comment came from the President's team. This one, reminiscent of former Treasury Secretary Paul O'Neill, came from his replacement, John Snow. His comment that he was "not particularly concerned' about the dollar's recent (and continued) weakness brought his aides to the forefront explaining what he meant and what the Treasury policy really is. What they said does not really seem like a policy at all. And this is unfortunate. It comes at a time when foreign investment in the United States has dropped significantly in the past three years. Becoming borrowers of foreign money, as we have become in a big way, is far worse than receiving money from investments. I suspect that Mr. Snow has something to say but has been recently reminded of his place and responsibilites on the team.
The nervousness of the markets was further fed by the President's mid-week press conference where he declared, in the only economic question asked, that the cost of doing nothing would be far greater than the cost of the current military campaign. A campaign whose price, I might add, that has no ceiling. These costs threaten to run on for decades to come.
So we have war, Warren, and now weather to blame for poor retail sales numbers. That may be, but who is expecting the consumer to respond with enthusiasm and act much differently than their counterpart, the investor. Especially when these two are the same person. Could it be that these folks are more concerned at the continued rise in unemployment? With 308,000 new faces out of work, prediction of a slow but steady growth are on the line. Factories say that orders are up. Productivity numbers also climbed reminding me of the cartoon I saw recently. In it, the man applying for employment and standing before the personnel manager is given good news. There are two jobs open, he is told, and he has just been hired both of them. Productivity shows that manufacturing is replacing more workers with machinery or better, using what few employees are left to do more.
Monday is the anniversary of the high water mark in the NASDAQ three years ago. Most of us know where we were at that point in time. Most of us have become jitterbugs since.
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