 Beware
Mike Hoy
August 30, 2004
This is an article that I hope
will give people new insight into the very complex dilemma of
investing for today's income needs. I know that the answers you
seek will not be found in this article in the manner that you
would like to read, but this may be the only place that you will
read what I feel to be the truth about this subject. I am not
saying that I have the answers but I do believe I see very serious
problems on the horizon that could be very dangerous to the investment
portfolios and cash needs that are so very important to investors
who are retired or looking to retire.
The sad fact is; we work our
whole lives in the hope that we can accumulate the wealth necessary
to enjoy and survive, what is supposed to be, our 3Golden Years.2
The ultimate truth is recognizing the fact that many times we
do not have enough of a nest egg to comfortably retire. This
has forced so many people to invest their money in a manner that
has placed them at great financial risk.
When working with traditional
investment philosophies of diversification; there comes a time
when the most prudent investment strategy is to simply take care
of your money. This means keeping your money liquid and safe.
There are many times throughout history that funds are best kept
in a parking place. Investors have been conditioned to believe
that they should always seek a return on their money. This is
not always the case and I believe that the current environment
for stocks and bonds dictates that investors, thinking in the
traditional manner, need to step back and place their funds in
a vehicle that will protect them from losses in the event that
my thinking comes to pass. Time and patience are your best friends
and the end result will be an opportunity to take advantage of
the mistakes of those who failed to recognize the warning signs.
In a true bear market, under traditional investment philosophies,
he who loses the least is the winner. This is the period of time
that we have now entered. Rising interest rates and rising oil
prices delegate traditional investments to a period where they
are best forgotten.
As I have noted in prior articles;
I believe interest rates are about to do a 180 degree turn. I
believe interest rates are about to rise and rise dramatically
as foreign bond holders lose faith in the American drug, excuse
me I mean debt system; both are addictions. As the world sees
the US economy faltering, again, in the short term, interest
rates will fall in the tradition of falling interest rates in
a recession. This will be the bait that attracts the fish to
the hook for the fatal bite before the fish is reeled in and
served up as a scrumptious meal for the smart money that dumped
their bond holdings on the misguided investor.
Japan has already said that
they will not support the dollar in the future. I think they
have finally realized that a weaker dollar may be less damaging
than an excess of US debt, whose repayment will not equal the
purchase price of the original dollar investments. What do they
really have to fear in the first place; we have outsourced all
our manufacturing facilities and the only automobiles we know
how to make get less than 20 miles to the gallon? Seems to me
they could do well with either a rising or falling dollar. I
don't really believe that but the possibility does exist.
In a nutshell; does it make
sense to invest in bonds in a rising interest rate environment?
The most investors can hope for is to have enough of a nest egg;
if they were to buy bonds, to earn a return great enough to pay
their monthly expenses. This is not a good enough reason to invest
in a market where one is trapped, without an exit, in the event
rising rates get out of control. The most one can hope to accomplish
is a laddered bond portfolio where bonds are purchased over a
five year period with bonds maturing each year so that the proceeds
can be reinvested at the current rates of return. This will offer
one the opportunity to have 20% of his or her money invested
at current rates of return. This will enable the investor to
slowly participate in greater income returns in a period of rising
rates.
The question an investor must
ask and answer is the question of being able to survive a 25%
to 50% loss of principal in the event a need arises and they
have to cash in their bonds or bonds funds, at a time interest
rates are higher than when they made their original investments.
If rates are higher than when the original investment was made
then a loss of principal will result as the bonds are sold back
into the market to give the new buyer a current return that equals
the market rate at the time of purchase.
I know for fact that losses
of 50% on the principal were common back in 1980-81 as a result
of rising rates; I had a client that sold an insured municipal
bond trust where his current rate of return was 6.25% tax free;
he received 50% of his investment back on the sale of the bond
trust. Most people who invest in this manner do so as long term
holders of the investments that they make. When making investments
of this nature the overriding motivation is maximizing current
yield. This is not the investment philosophy that one should
adopt when interest rates are at all time lows. The biggest mistake
that yield investors will make is the mistake of buying the maximum
yield that they can find at what will eventually turn out to
be the worst possible time. This search for extra yield will
lead them to junk bond funds and Ginnie Mae's; if history repeats
itself, these categories of investments will turn out to be the
most risky out there. I believe that if you can just postpone
investments of this nature for the necessary time, which I feel
will be four to six years; it is possible that the yields will
be twice what they are today. That also equates into a savings
of half your principal if a need arises where you have to sell
in the event of an emergency. I know this is not what many of
you would like to read but don't you think it is nice to know
that you had the opportunity to read and learn before it is too
late rather than being in a position that offers no flexibility
after the fact? Think in terms of how far the extra income will
go if you are able to survive and invest your money, down the
road, at substantially higher rates of return! Another very important
point to remember is the fact that the precious metals and natural
resource stocks made phenomenal moves while interest rates were
rising back in the late 70's and early 80's. As I have stated
in prior articles I believe the massive amounts of debt that
the consumer, corporations and the government have accumulated
over the past twenty-five years; coupled with the fact that now
we are accelerating the error of our ways, will guarantee that
interest rates, in the end, will be substantially higher than
they are today.
If you are still in a position
where using a laddered approach does not get you the income necessary
to comfortably retire then don't retire or maintain a separate
job for cash flow to make up the difference. I have a real problem
believing in our authorities when they have purposely used every
means possible to destroy traditional savings. I believe this
is an atrocity that will return to haunt investors in a manner
that they cannot begin to understand in today's financial world.
The savings rate is one of the lowest in history while the debt
levels are at or approaching all time record highs. Record low
interest rates have forced investors to flee the safety of bank
CDs and traditional safe money returns for the high risk of alternative
investments. I do not believe this switching of investment philosophies
was an accidental outcome of the low interest rates; but rather
I believe it was the planned design coupled with the objectives
of allowing the home mortgage refinancing game to continue as
long as possible, the consumer borrowing as much as possible
and the forcing of as much money as possible into the stock market
as a result of low yielding alternatives. The only outcome of
this financial nightmare is an ending that will leave financial
destruction for decades to come. I read very few articles dealing
with the risk of owning long term bonds in a period of rising
interest rates. The biggest mistake an investor can make is the
mistake of buying junk bonds or Ginnie Mae bond funds. Not only
will you suffer an interest rate mark down but a slowing economy
could bring the additional risk of default to your investment.
Yeah, I know Ginnie Mae's are supposed to be guaranteed; go back
and see how they held their value in the 1979-83 period. Where
do you think the capital will come from to replace the foreign
owners of our countries debt when the current owners refuse to
roll their funds over or decide to sell before maturity? How
do you think new funds will be lured into the trap of buying
this questionable paper? Do you think rising interest will be
the bait? Do you think the money will come from the stock market?
I DO!
Incidentally, I feel rates
may fall in the short term as a result of the economy showing
weakness, but I then feel rates will rise as the foreign owners,
of our bonds, flee to greener pastures. I wonder what pastures
those will be? Could it be spelled gold? This is why I believe
gold will not show the weakness that some people still feel is
to come. As these foreign funds flee the traditional safety net
of the US Bond they will seek safety in some other form. I believe
that a percentage of this money will have to find a home in the
yellow metal. It seems to me that the same problems we are experiencing
here in America are also found overseas. So why would the Euro
offer any better safety net than the dollar?
The next trap is the traditional
stock market mutual fund. If interest rates rise; what effect
will this have on corporate earnings? How many of our major corporations
have played the carry trade with their debt borrowings? How many
corporations have huge amounts of debt borrowed in short term
paper at the lowest rate they can pay while refusing to pay a
little bit higher rate to lock in that debt, for what will be
the least expensive borrowing cost they will ever have the opportunity
to take advantage of? The answer is more than what we think and
know. These people have loaned huge amounts of money at fixed
long term rates and borrowed at variable short term rates. This
works fine so long as rates do not rise. As rates rise their
borrowing costs will rise and the financial hit will go right
to the bottom line. This stupidity will sink Fannie Mae and Freddie
Mac. What does this type of financial suicide do to earnings,
in a rising interest rate environment? Most investors do not
have a clue of the earnings which will evaporate as a result
of rising rates down the road. In a period where interest rates
are at historic all time lows, corporations should be looking
to lock their borrowing cost in for the long term at rates they
may never see again. The only reason they don't lock the rates
in is the fact that short term earnings would suffer as a result
of the extra 1%-2% increase in fixed rates. To not take advantage
of the historic low rates is a grave mistake that the shareholders
will pay for down the road.
An example of the ultimate
stupidity in this market goes to our intelligent leaders who
decided that the thirty year bond would come to an end. How can
a government, with the debt problems we have, refuse to take
advantage of the opportunity to lock in debt for thirty years
at rates they will never see again? This is a mistake that we
will pay for, in a big way, down the road. I have no respect
for the idiots who make decisions of this nature. Another point
to this is the fact that if the debt is placed for thirty years
there will be no need to worry about the rolling of the debt
as it does not come due on the short term. The liquidation and
refinancing of our debt are going to create a huge demand on
outside capital to replace the foreign money that decides it
wants to move elsewhere and seek a home somewhere other than
in our paper. Interest rates will be forced to rise so that the
new issues will be sold out. The major drawback to this is the
source of funds; where will they come from? I believe the competition
for the dwindling available funds, to float our debt, will eventually
take its toll on the stock market. Where else can the necessary
funds be found to supply the ever growing needs of our Federal
Government? You have to be Larry Kudlow or Jim Cramer to think
that these funds exist in ample supply outside of the stock market.
The real cruncher comes into play with the exploding budget and
trade deficits. There is an ever increasing need to raise more
money because of the out of control debt loads. This is a suction
of funds that will challenge alternative investments and I believe
the necessity of the borrowing will outweigh the viability and
the propaganda of the alternative investments. I would like to
be able to come up with a different ending but all my research
is leading down the same path and that path does not have a happy
ending for those who choose to be optimistic. It is a great thing
to be an optimist; but be an optimist based on knowledge and
fact rather than wishful thinking.
I am sure there are a lot of
you asking the most important question of all 3what am I supposed
to do to keep above water?2 How do I buy and survive four to
six years while rates are rising? The sad truth to this dilemma
is the fact that you must make a choice. You must decide which
path you are going to take. Do you follow the traditional path
with the herd and accept your losses as market losses or do you
step forward and break all the rules of diversification and invest
your money in a manner that can allow you to participate or at
least hope to keep you even in the event the things I have outlined
in this article come to pass. The only way that you can make
a decision is to gain knowledge. I do not believe the events
I have outlined will be triggered overnight. In fact the possibility
exists that there is still time to learn and come up with a game
plan. As you read articles you should try to identify just what
you believe and then concentrate on a strategy to incorporate
investments into that game plan. It is very important to note
that many market catastrophes happen in the month of October.
I wish I had a crystal ball that could tell us exactly where
we should be invested, but I don't. I choose to put my faith
in what I perceive as the direction of the economy, the market
and the world. I also choose to put my faith in history as I
know gold stocks and natural resource stocks performed very well
in the thirties and the seventies. I see no reason to believe
the results will be any different this time; in fact I believe
that this time will be an extension of the past. It is possible
my thinking will be wrong; but at least you had a chance to read
about it before the fact rather than after the fact.
It is also very important to
know that increasing precious metal prices and interest rate
increases traditionally go hand in hand. This is a very sweet
thing as when the time does come to take profits from our pm
holdings; we can turn right around and invest the proceeds at
much higher rates of return; to then be able to enjoy our 3Golden
Years.2 The question I find myself seeking an answer to now is
the question of whether I will feel that investments in government
bonds will be a prudent investment six years down the road. Kind
of makes you think doesn't it? I also know that when I begin
to read about this in the common press; it will then be time
to begin to take profits from my pm holdings. There is no need
to worry about this now as I have every faith in our officials
that they will turn to hyper-inflation before they put a lid
on spending.
I have more to say on this
subject and I hope to follow-up with a report to my e-mail list,
for those who are interested. If you desire to know more of what
I think sign up for my e-mail list. I am going to Las Vegas for
the conference and I am staying at the Mirage; I think this is
an excellent opportunity to meet with the companies we read about
all the time. I hope to write a report after the conference.
August 28, 2004
Mike Hoy
mhoy@neb.rr.com
321gold Inc
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