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Updated @ 9:00 p.m. EDT, Sunday, July 8, 2007.


WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint roughly once per week [sorry that it has been less frequent recently]. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.

Finance is the art of passing currency from hand to hand until it finally disappears. --Robert W. Sarnoff

IF SOMETHING RETURNS 1% PER YEAR, IS IT A GOOD INVESTMENT? (July 8, 2007): The answer to the above question is obvious, especially since there are many U.S. money market funds and U.S. time deposits which are currently paying 5.25% per year, completely risk free. Of course you're thinking, what a dumb question; obviously no one would accept a 1% rate of return on any investment. And yet that is exactly what most residential real estate is yielding these days, not only in the U.S., but around the world.

In the final analysis, any investment must be fairly measured by the return on that investment. With real estate, after subtracting property taxes, maintenance, interest, and other charges, the average return in most areas is currently only 1%--and that's before considering income taxes.

If your response is, well, Donald Trump never talks about rates of return on real estate, then ask yourself why that it is the case. Obviously it is because once you begin to talk real economic numbers and look at real data, there is no longer any justification for owning real estate. Sure, if you happen to have bought property before the recent bubble, then that's great--but such a bubble will only happen once every one thousand years. So unless you plan to live a really, really long time until the next one, you're going to have to tolerate a 1% annualized profit until then.

This assumes that real estate prices will remain constant around the world for the next decade or so, which is probably the most wildly optimistic estimate that anyone can make. With real-estate prices in most countries having doubled relative to inflation, such as in the U.S., or tripled, as in Ireland or much of the U.K., we have the first-ever instance in which there are severe widespread overvaluations. Whenever there are such extremes of price, the market almost always swings in the direction of the opposite extreme within a decade or so.

So on top of a paltry 1% annualized return, an investor in real estate today stands the risk of losing half or more of his or her money within the next several years. I would go so far as to assert that real estate is no longer even a legitimate asset class until it collapses--the only question is how much money one will lose, and exactly when.

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    GOLD MINING SHARES ARE APPROACHING A VITAL BUYING POINT, BUT BE PATIENT (June 27, 2007): During the past eight years, there have been three excellent buying points for gold mining shares: November 25-26, 2000; March 13, 2003; and May 16, 2005. Of course, those haven't been the only times when it was profitable to buy gold mining shares, but these three major bottoms led to the strongest rallies during the entire bull market in this sector group.

    I believe that a similar buying opportunity is approaching over the next several months. For one thing, if you look at the dates listed above, and calculate the separation between them, you will see that a late summer or early autumn buying opportunity would fit perfectly into this pattern.

    More importantly than simply the passing of time, however, is the mood of the gold mining sector at this juncture. After great excitement swept the media when gold moved to $730 an ounce in the second week of May 2006, there has been more than a year of repeated disappointments and failed rallies, while the rest of the financial markets--especially emerging markets--have surged forward. This has caused many investors, especially recent ones, to become disenchanted with the group.

    The biggest danger to gold mining shares in the short run is a combination of facts and sentiment. Regarding facts, the U.S. dollar began a rally on May 1 which has put a damper on interest in gold and silver, since the U.S. dollar has a significant negative correlation with precious metals prices. A continued rise in the U.S. dollar, which in my opinion is very likely, will continue to put downward pressure on precious metals and their shares.

    Another critical fact is that the heaviest per-capita physical buying of gold and silver comes from India. Indians buy gold for festivals, holidays, weddings, and other special occasions. There are very few such occasions which are traditionally scheduled for the summer months, so Indian gold buying is not likely to resume in earnest until the middle of September. This leaves gold particularly vulnerable to a sharp decline during the hot summer months.

    Another important factor, which is rarely discussed in the media, is what I call the "brother-in-law effect". The media spends a lot more time talking about the Nasdaq or the "Dow" than it does talking about commodity investments of any kind, so very few people invested in gold mining shares when they were truly undervalued. Only when the media began loudly screaming in the spring of 2006 about how "gold will soon go above $1000 an ounce" did people decide to "finally listen to my brother in law, who has been telling me for years to buy gold mining shares".

    The problem, of course, is that whenever people "finally listen" to advice, it is because the trend has nearly completed its course, and they can't stand to miss out on further spectacular gains. It is hardly surprising that this is the time when a downturn is by far most likely to occur, and in fact that is exactly what has transpired over the past 13-1/2 months, as gold mining shares have surrendered 20% of their total value.

    What we are likely to see is that these late-arriving folks from 2006, who never had any commitment to gold mining shares in the first place, will suffer additional losses and will finally bail out in disgust, muttering various four-letter words about "never listening to my brother-in-law again". [Yes, I know that there are some sisters-in-law involved also, but in this update I'll be chauvinistic and just blame the guys.]

    For that reason, I believe that gold mining shares will decline by an additional 20% in a final panic move. This is characteristic of the behavior in advance of the previous three major bottoms listed at the top of this discussion. A final washing out of uncommitted speculators will likely induce top executives of precious metals companies to purchase their own shares. Such insider buying has historically coincided closely with important buying opportunities in this sector.

    Therefore, one should be alert, but also be patient. I will be sure to update this web site in a timely manner when it is time to jump in with both hands and both feet to buy gold mining shares. For now, those who profit most will be those who do absolutely nothing.

    For additional background information and targets for gold mining share indices, click on the link in the next line.

  • Overview of Gold Mining Shares (updated July 8, 2007)
  • BASE METALS POINT THE WAY LOWER (June 17, 2007): There has been a lot of talk in the media about the supposedly expanding global economy. However, precious metals and their shares have been declining since May 11, 2006, while base metals have fallen significantly since they peaked on May 9, 2007. Base metals in particular have a very strong correlation with worldwide growth prospects, since they are so heavily used in industrial production. Manufacturing has been the mainstay especially of emerging-market economies which have seen by far the strongest GDP growth rates and equity price increases since the spring of 2005. China's stock market has quadrupled just in the past two years.

    If you hear base metals mentioned in the media, it is always about their "powerful rally" which intensified two years ago--at the exact same time that emerging market equities accelerated their rally. Because the two are so closely intertwined, the recent pullback in base metals could be an important omen signifying a parallel decline for emerging-market equity indices. Nickel has already dropped more than 15% since its all-time peak on May 9, with zinc, tin, lead, and copper also noticeably lagging in recent weeks.

    No doubt there are those who believe that the retreat for base metals is temporary. However, as central banks raise interest rates worldwide, this is sure to slow global growth prospects. The housing bubble, which has contributed to the base-metal rally, is now a worldwide phenomenon, and has been fueled primarily by the easy availability of borrowed money and very relaxed lending terms that have often included zero-money-down arrangements. If lenders begin to demand higher down payments as defaults and foreclosures have been increasing in many areas including the U.S., and housing prices thereby suffer a substantial reversal, it will have a profound contractionary and recessionary impact on the entire worldwide economy.

    Base metals prices are an important leading indicator. As they have been falling, the U.S. dollar has been quietly rallying. U.S. Treasuries often complete an important multi-year bottom in advance of a major worldwide equity decline, and such a nadir may have been achieved during the past week. They say "the bell doesn't ring at the top", but all three of these events happening simultaneously are warning that Goldilocks is likely to soon be followed by the three bears.

    IT'S OKAY TO BUY THE U.S. DOLLAR (May 28, 2007): Do you know anyone who is bullish on the U.S. dollar these days? I don't mean wishy-washy bullish, or not terribly bearish, but "let's go greenback, rah rah" bullish? Probably not. However, the U.S. dollar has been steadily rallying since the first day of May, and as important technical resistance levels have been steadily broken one after the next, this rally is likely to accelerate into a major surge in the very near future. I am still expecting the U.S. dollar index to go above 90 before the year is over.

    IT'S ALSO OKAY TO SELL SHORT (May 28, 2007): One rarely reads in the financial media about recommendations for selling short, and when one does encounter such advice, it is almost always to point out companies which have already been out of favor for months or even years and are about to rebound in a big way. It is extremely rare to see someone talking about selling short mutual funds, but that is exactly what I am about to do.

    When you sell short any security, you have to pay all dividends that are credited to owners of that security. However, when you sell short, you get to continue collecting 5% interest or whatever your broker pays on your cash balance, since your cash balance is not reduced by funds which are used for short sales. In addition, all mutual funds have a management fee. [Of course, if your short positions move adversely, then your cash balance will be reduced, but only by the magnitude of the adverse move itself.]

    Therefore, let's compare what happens when you establish a long position versus a short position. A long position is the same thing as buying a stock or fund. Let's suppose that you buy ten thousand dollars of mutual fund ABC. You immediately give up the 5.0% interest that you had been collecting on that ten thousand dollars. You also have to pay the fund's management fee, which we'll assume is exactly 1.0%--just about the median fee for a mutual fund these days. On the plus side, you get to collect the dividends--which if it is a typical technology or "hot" fund, is likely only about 0.5%.

    Let's assume that the assets of fund ABC increase by 5.5% in one year before expenses. At first, you probably think--hey, that's not so bad. But since you gave up 5.0% in interest, and you also have to pay 1.0% in fees, then after collecting your 0.5% dividend, you end up with $10,500. That is the same amount of money you would have had if you had simply kept your money in cash and collected the 5% interest--with much greater volatility, of course.

    Now suppose that you had sold short fund XYZ, and its assets remain exactly unchanged after one year. Notice that after collecting 5.0% interest, and gaining an extra 1.0% from the management fee [which causes the net asset value of the fund to decline], then after paying the 0.5% in dividends, you end up with $10,500.

    This shows that when you sell short a given mutual fund, there is a powerful wind at your back, so favorable that if the particular asset that you are selling short remains unchanged in value, you will end up with the same amount of money as if you had purchased a different mutual fund whose assets had gained 5.5%. Stated another way, by being a short seller, you get a head start of 5.5% annualized over someone who insists on buying stocks instead of selling them. The gain can be even larger if your broker pays you a "short interest credit"--which unfortunately is usually only available to those with an account balance in excess of one million dollars.

    Of course, one does not sell short with the object of simply doing as well as someone who simply left the money in cash. If you sell something short which falls by 10% in one year, your total gain will actually be 15.5%. More importantly, there are absurd bubbles all around the world these days which are just begging to be sold short, such as Chinese equities which are on the verge of collapsing by 50% or more. So you can sell short QQQQ, or EEM, or FXI--the list of favorable funds to sell short goes on and on for pages.

    The financial markets are feast or famine. Right now, it's famine for long-side buyers who must spend hours trying to find something which is less ridiculously overvalued than everything else. But why struggle? You can sell short with impunity, and get an extra 5.5% as a bonus.

    AS CHINA GOES, SO GOES THE WORLD (May 8, 2007): The great unreported financial story of 2007, (May 28, 2007) now finally getting some well-deserved attention, is the wild bubble in Chinese equities, which on average have quadrupled in the past two years. If the Chinese stock market were to lose half of its value, it would still be far above where it had been in August 2006--and there's no international law which says that it must remain above that particular support level. Buying the Nasdaq in March 2000, when it was above 5000, was an example of ultraconservative behavior compared with buying Chinese equities today. The number of working-class (May 28, 2007) and very recently even lower-class Chinese who are literally lining up at brokerages to buy stocks because their names sound lucky (May 28, 2007) or their numeric identifiers contain 8s and other fortuitous digits would in sheer numbers exceed the total number of participants in all previous worldwide asset bubbles combined.

    While this is the most important financial story of the year, it's not considered "news" by the mainstream media. It will only be reported once the Chinese stock market collapses--and then every single commentator will say "it was blatantly obvious that their market was way overdue for a serious correction". Okay, if it's so obvious, then how come no one is saying it now--BEFORE it happens? Ha! These so-called analysts are all afraid of stating the obvious; it's the emperor's new clothes all over again. No one wants to be the first on their block, because they honestly have no idea what's happening in China, and if the Chinese stock market moves up another 10% or 20% or 50%, they're worried that they'll be thought of as idiots instead of geniuses.

    To be fair to the media, this story was reported in the New York Times and elsewhere for three whole days near the end of February--only to be completely abandoned thereafter in favor of puff pieces about "the Chinese miracle" and plenty of nonsense about "why the Chinese stock market will remain strong for the next century".

    Because the worldwide financial markets are so closely interconnected, the world's stock markets no longer have to automatically follow what happens in the U.S. When China's stock market plunges, the rest of the world will follow--including the United States. That's one of the beauties of globalization and the internet--a financial collapse in one part of the world immediately leads to a financial collapse everywhere. Those who recently purchased real estate or modern art may want to keep this in mind.

    So remember, after the Chinese stock market collapses by more than half before the year is over--you heard it here loudly and clearly, with no punches pulled.

    HOW LOW WILL HUI GO? (September 10, 2006): HUI is the Amex Index of Unhedged Gold Mining Shares. How low will HUI eventually go, exactly, over the next several months? One very useful guide is to observe that on December 2, 2003, HUI reached a peak of 258.60 which was not exceeded for about two years. (November 28, 2006) As a rule, during its bull market which began on November 25-26, 2000, HUI has gone modestly below each such high-water mark during each subsequent extended correction. Another guide is found by measuring the entire gain in HUI from its May 16, 2005 bottom of 165.71 to its May 11, 2006 peak of 401.69. If HUI surrenders exactly 61.8% of this increase--known as the key Fibonacci retracement--it would put HUI at 255.85. It's no coincidence that these two numbers are so close. If history is any guide--which it almost always is--then HUI should move a few percent below each of these numbers, and bottom near (June 27, 2007) 252.50. See "Overview of Gold Mining Shares" link near the top of this update to see why the recent addition of ABX to HUI has caused me to revise my downside target for HUI.

    CURRENT ASSET ALLOCATION (July 8, 2007): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 2%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 35%; Treasuries between 2 and 10 years in duration, such as IEI and IEF, 12.5%; TOC, 0.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 30.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 51.5%; short CFC, 3%; short GLD, 17.5%; short GDX, 2%.

    REMINISCENCE OF THE WEEK (July 8, 2007): My sister got married in Venice six years ago, so several of us spent about a week there during the time of the wedding. I wore my favorite straw hat, which sometimes makes people think that I am impersonating Vincent van Gogh. My sister dressed each day in her unique style, while a friend of my sister had braided her hair with various dyed shades of blue, white, and pink, rather like an exploded peppermint stick. As we visited the fascinating neighborhoods in that old city--Cannaregio is my favorite section--we tried to capture parts of Venice through film. Every time we tried to get a good angle for some shots, especially when we were in a popular part of town, we found ourselves being approached by quite a few tourists who wanted to take photographs of us. Many others pointed, gawked, or otherwise commented on our presence. It was simultaneously flattering and annoying--a little taste of what it must be like for a famous person to travel around the world.

  • Best of Previous Reminiscences
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