What to Do in the Face of 'The Mother of All Black Swans'

by: Bo Peng

The Mother of All Black Swans is so big, everybody knows it. It's so big, everybody takes a glance and promptly writes it off as the cosmic background. I'm, of course, talking about the baby boomers.

The complete 2010 census data set is not available yet. So we'll have to rely on the 2000 census data for the time being.
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Back in 2000, US population aged 55 or older stood at 60m, while the age group 45-54 was 38m. Eleven years later, I'll ballpark them at 40m and 35m, respectively. In other words, currently, roughly 40m Americans receive social security and medicaid, but that number will double over the next 10 years, triple over the next 20 years, and quadruple in 30 years.

If you think our current public and private debt situation is bad, look back in a year and you'll miss the good ol' times of yesteryear. Then look back in another year and you'll miss the good ol' times of yesteryear.

This, of course, is one of few certainties in human society, predicted 20 years ago by Harry Dent among others.

In 2000, 84m high-productivity Americans (age 35-55) supported a total population of 285m. Today, roughly the same number in the high-productivity age group support 307m people, an almost 10% increase in burden. In 10 years it'll be roughly the same number (assuming brisk immigration; otherwise it'd be closer to 80m), supporting 340m, a 20% increase in burden from 2000. Add on top of this the near certainty that the USD will cease to be the sole reserve currency in 10 years, unless the Fed, the White House, and the Congress make some drastic reversal in unison, soon -- but this is where my audacity of hope gets thrown into the mad house and abused daily by the nurse, Mr. Realism.

Mr. Harry Dent is arguably the best economic prophet of our time, at least the only one who spelled it out for everyone to see. The triggers for the 08 crisis might have been incidental on many levels; but, in retrospect, some kind of crisis would have been triggered one way or another. Nor is it an accident that the recovery has been so painfully slow despite (or rather, partly thanks to) all the creative stimuli. Aging society -> lower productivity -> lower standard of living.

Some who have seen the trend may have placed their hope on productivity increases, first on the internet and then on financial engineering. Now the hope is on medical breakthroughs. I have no doubt that some day humans' high-productivity age will be 75. But, except for a few niche professions and a few lucky individuals, there's no way that day can come soon enough.

"We are prepared for a lower level of existence."
The Architect, Matrix Reloaded

Yes, of course, fantastic. But how can I try to make my family's future form of existence slightly higher than it could be?

I don't claim to have the answers. But let's see how far we can push this Mother of All Black Swans.

1. When a society faces such a structural productivity decline, one of three things happens: chronic depression, chronic deflation (Japan), or rampant inflation. The Fed's choice is unapologetically inflation, while the UK's Mervyn King at least has the conscience and decency to apologize to savers. Do not sit on cash. Buy gold (GLD, PHYS, DGP) and commodities (NYSEARCA:DBA).

2. Bond vigilantes are circling around the government bonds of Japan and US, waiting for the right trigger. As the oldest boomers are becoming 65 this year, the chance of the right trigger presenting itself will increase dramatically. Do not own bonds, except maybe inflation protected bonds like TIPS. (However, as different countries enter the baby boomer apocalypse at different times, there may be good opportunities playing different sovereignty in timing -- I'm guessing this is the foundation of Bill Gross' advice on going EM. But this can be very tricky and testing if global correlation goes to 1, which is highly likely if/when JGB/UST is in trouble.)

3. If you're tempted to short equities, be careful. A classic monetary inflation scenario, which I have no doubt is what we are seeing now and will write about later, is that equities will have fantastic nominal gains. Such gains may even be sustained as long as corporate earnings keep up with inflation. But the world has seen such shell games too many times to let it pass. As inflation peels away the layers of socio-economic structures and litters them all around, starting from the lower middle class too rich for welfare and the savers living on fixed income, at some point something will snap. Don't worry about getting in on the short too late; when the real one hits, it'll have a long way to go.

4. Nor can I recommend going long equities with good conscience for the simple reason that I know the trigger is just around the corner, I just don't know where the corner is. While the Mother of all Black Swans is for everybody to see, when the attack comes it will be in the form of her cygnets; she'll just lurk in the background supplying ferocity and stamina. Do not buy equities.

5. Real estate is dangerous, too. Aside from all the well-known risks, another factor hasn't gotten much press: as retirees and boomers get screwed out of their life savings and future fixed income, it's becoming increasingly difficult for young people to find jobs. It'll become more and more of a (sad) trend for college grads to move back with their parents over the next 10-20 years. Some localities may have lower risks than others. But even in the best case scenario, real estate value appreciation is probably purely nominal.

This is a narrowly focused strategy -- no cash, equities, or bonds, just gold and commodities. But please bear in mind that this is based on my long-term outlook, not a market timing approach. Pull-backs in gold and commodities are a certainty; the only question is when and by how much. The black cygnets could come tomorrow, or a year or two later. It could be Egypt, Spain, or Lake Michigan (no, nothing's wrong with Lake Michigan, which is the point). I'm not all in gold and commodities now. But I'll be watching very closely.

If you can't or don't want to track your investments daily and have what it takes to take the loss and reverse course when it hits, then perhaps you should consider going all in gold and commodities, or at least trusting some money manager who does.

Disclosure: I am long GLD, DBA.