The Merits of Staying in Cash

Includes: GLD, LOW, SLV
by: James Conrad

So, you’ve got some money that you want to invest?  You’ve heard that stock market investing gives better returns that keeping money in the bank?  Besides, you know that banks are reeling from bad loans.  You’ve read stories that some of the smartest economists, like former Chief Economist of the IMF, Kenneth Rogoff, are predicting that at least one of the biggest banks, as well as a lot of small and mid-sized banks, will fail in the next few months.  You decide you don’t want to be invested in banking.  You don’t want to own bank stocks.  You don’t even want to be one of their depositors.  So, what do you do?

You look at the insurance industry.  Not looking good either.  A lot of the big insurers have been caught playing with fire, in the form of credit default insurance on the subprime toxic waste that is plaguing the banks.  AIG (NYSE:AIG), for example, is in just as much trouble as many of the big banks. 

But, how about giving some consideration to the municipal bond insurers?  MBIA (NYSE:MBI) and Ambac (ABK) are in the toilet, and looking like they might end up being flushed, so that’s not somewhere you want to put your money. 

How about the government backed mortgage insurers?   Aren’t they going to get bailed out?  Yes.  But, in the process, the shareholders will probably get wiped out.  So, that won’t work, either.  Freddie Mac (FRE) and Fannie Mae (FNM) are on death row.  The noose is tightening around their necks, already, and death sentence has already essentially been handed down. 

How about chemicals?  Dow (NYSE:DOW) and DuPont (NYSE:DD) are basic materials manufacturers.  Better than banking!  Almost like a commodity, right?  Materials manufacturing must be a good business, mustn’t it? Sorry. Soaring raw material costs, including, but not just oil, are forcing both companies to raise prices so high that customers are balking.  This is likely to adversely impact chemical company profitability over the next year. 

How about oil?  That’s got to be a good bet, right? Wrong.  Major oil companies are facing falling prices in the near term.  The prices will probably soar again, especially if Goldman Sachs has its way.  But, for now, prices are down deeply.  More importantly, in the long term, oil majors are getting kicked out of their hard earned investment properties, all over the world, by arbitrary and capricious governments, from Russia to Venezuela.  Dragged out of nationalized, or “oligarchafied” (in the case of Russia) fields, their future prospects for growth are seriously in doubt.  Beyond the nationalizations, wars are closing or destroying pipelines in Georgia and, since the Russians want higher oil prices, and full control over central Asian supplies, there is every reason they will eventually destroy the Georgian oil pipelines completely.  Then, there are the non-governmental terrorists that the oil majors are dealing with in Nigeria.  The oil majors were counting on all the now lost revenue sources, but now a lot of them are gone.  They might do well, if oil prices spike up, again, before the new year, but long run, over a term of years, oil is going to be replaced.  We can produce synthetic oil from natural gas and coal for an average of $65 per barrel.  Why should we continue to pay the current prices?

How about home improvement stores?  The Wall Street Journal and Barron's have been touting the fact that they've "beat the Street." But, home sales are falling.  Prices are collapsing.  Foreclosures are running rampant. The market for products sold by Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) is quickly degenerating.  Besides, what does “beating the Street” mean, anyway?  It only means that the most recent company’s results are a little better than the wire house analyst predictions.  If you remember the era, you know how reliable and honest such analysts are.  Beyond that, the next set of earnings may be worse than expected.  Remember, Citigroup (NYSE:C) and Merrill Lynch (MER) in October 2007?  Remember, how their CEOs pronounced the end of the credit crisis at that time.  They were either lying or didn’t know what they were talking about.  That seems to be the case, now, with the home improvement giants.

Home Depot’s earnings collapsed by 24% this quarter (see conference call transcript), and are expected to be down 24% for the full year, year over year.  It is trying, at least, to cut its costs, which is more than its competitor, Lowe's, is doing.  Lowe's had a bit of better showing, this quarter, but what of the next?  They predict worse than expected results for the 3rd quarter, but on target results for the whole year.   If so, it means that they are predicting an end to the housing crisis, and the fact that, in 2009, the first big volley of Option ARM foreclosures will hit the street.  So, are the home improvement executives lying, or is it that they just don’t know what they are talking about?

Lowe's earnings sank by 8% (see conference call transcript).  Management admits, in its 10Q report, that May 2, 2008 comparable store sales sank by 8.4%.  That’s big enough.  But, look deeper.  Last year, as of May 2, 2007, comparable store sale sank 6.3%, compared to the year before.  That is more than a 14.7% drop, in a period of only two years! 

Deeper into the report, we find that gross margins have decreased by 30% year over year.  Cash resources have shrunk by 30%.  Comparable store sales are expected to decline 6 to 7 percent this year.  That, to my mind, is very optimistic. Operating margins are expected to decline by 1.8%.  The report claims that the net cost of opening new stores is projected at $103 million, but that is impossible. 

How can they open 120 new Lowe’s stores for only $103 million?  Simple answer.  By mortgages themselves to the hilt.  That type of behavior is what got America into the mess it is now in, in the first place.  Lowe's doesn’t seem to have learned anything. The company owns 87% of its stores, outright, rather than leasing them, so, to come up with the $103 million figure, it must have taken on huge mortgage liabilities, in the midst of a falling commercial real estate market.  These liabilities will not be easy to escape from, like a lease.  In this climate of falling sales, and real estate collapse, it is very unlikely that the stores will be profitable for many years.  The drain on the company’s earnings, assuming the stores are not immediately profitable, is going to be heavy.  The falling value of the land and buildings, over time, and the payments due on these mortgages will stress the company’s future earnings.  Finally, there is the ultimate question.  Are more stores needed, with both margins and sales falling steeply? 

How about other retailers?  Nope!  No good investments there, either.  All of them got a big boost, just like the home improvement stores, from the Congressional giveaway to consumers, back in April and May.  But, that’s over now, and the country can’t afford to keep giving out money without end.  In short, no matter where you look, the outlook for the stock market is not good.

Over the next two years, we are going to see increased foreclosure activity, especially in 2009/2010, as the Option ARM loans begin to default.  The housing market has little to no chance of recovering until mid-2010 or later.  More likely, we are looking at 2012 for a true recovery.  Even then, it is not likely that we will ever see the go-go days of the housing bubble again.  So, the housing ATM, which fueled a lot of America’s extravagant spending spree, over the past 8 years, has closed down permanently.  In  addition, at some point, soon, interest rates will have to be raised, or the U.S. dollar will utterly collapse.  Since the powers-that-be don’t want that to happen, rates will go up fast.  This will push the nation into severe recession. 

The bottom line…we are unlikely to see any recovery for many years.  The actions of the Federal Reserve and Congress have put off the day of reckoning, but it will come, and because they have both expended money they don’t really have, that reckoning will be that much more severe than if they had allowed it to come naturally. 

Wise investors take note.  There will be a time to buy stocks, but that time is not now.  Keep your money in the bank.  Make sure you don’t put more money into one bank than the FDIC will insure.  If you’ve got more than $100,000, put it in either more than one bank, or carefully construct your POD accounts so that you can extend the insurance coverage. 

Yes, I know what you are thinking.  You don’t want to keep your money in a low-paying bank account with the dollar very likely to fall.  I don’t blame you, especially with inflation biting deeper than ever.  But, what’s worse?  Losing 5% a year in dollar value?  Or, losing 60% of your net worth in a stock market that is sure to collapse deeply within the next year?  

If you’re very worried about the falling value of the dollar, as you should be, there are alternatives.  You can invest in precious metals, for example.  First, I need to warn you.  You must be okay with temporary, but incredibly high levels of volatility caused by futures manipulation.  But, precious metals happen to be very cheap right now.  The ETFs, streetTracks Gold (NYSEARCA:GLD) and iShares Silver (NYSEARCA:SLV), for gold and silver, respectfully, are now selling for very low prices, as is gold bullion.  Meanwhile, the Indian wedding season is right around the corner, putting a lot of demand pressure upon increasingly limited supplies.  In the next few months, a lot of the world’s gold and silver will be heading to the Hindu lands of South Asia.  That is going to stress western markets at a time when there is a great likelihood of one or more major banks failing.  The likelihood of rapidly increasing precious metals prices is very high, during the next few months, though nothing is ever guaranteed.

Note to Readers on Allocated vs. Non-allocated Storage:  

Some well meaning folks object to buying the ETFs, or, for that matter, anything but physical gold bars or coins.  I sympathize with their views, but disagree.  If there is a nuclear war, or civilization comes to an end abruptly, they are right.  Gold stored in the UK will be of little use to an American.  But, I don’t think that will happen in the next few years.  Anything less makes the ETFs a useful trading tool, and method of holding gold and/or silver.  There is, of course, the 0.4% per year fee, but, that is only 4% in ten years, and, assuming that the precious metals continue to rise as they have for 8 years, the cost is negligible. Allocated vault storage, including insurance, usually costs at least that much.

I do endorse the idea of putting part of your total wealth into physical bullion, controlled by you, and kept somewhere that only you, and your family, know about.  This is core wealth that you will have in the event of a mass gold and silver confiscation by western governments.  It did happen once, and with the economy heading toward collapse, the possibility of a return to some kind of gold or silver standard, is quite strong.  One should also not forget the simple pleasures of owning physical gold and silver.  Both metals are nice to handle and look at.  There’s nothing prettier than nice golden bars and coins, or nicely polished white silver ones, except, maybe, jewelry made of the same stuff. 

If you intend to trade, from time to time, however, the ETFs are very practical.  According to the companies that sponsor them, and a number of die-hard gold and silver bugs confirm this, the ETFs are audited, and disclose the bar numbers in allocated storage. Stay away from precious metals schemes in which you are given non-allocated storage, such as the unallocated storage plans now being promoted by the Perth Mint, Kitco and many others.  Perth Mint also has allocated storage available. If you go with them, choose that. 

The problem with unallocated storage is that the sponsors get to use your metal in any way they want. They meet their daily business requirements, with your property, and pay you nothing for the privilege.  They can even write derivatives, like futures contract, using your metal as “cover”, and, if they go bankrupt from doing it, too bad for you.  You will be nothing more than an unsecured creditor.  Generally speaking, unsecured creditors lose all their money in bankruptcy.  Private gold and silver dealers, especially those who cooperated extensively in leasing precious metals (which may include some of the most well-known gold dealers) from bullion banks, when prices were lower, are quite likely to go bankrupt in the near future.  So, don’t accept anything but physical gold, or allocated storage.  If they want to use your gold or silver, they should pay you a lease fee, just like they have to pay to the big bullion banks.

Disclosure: Author owns physical gold, holds a long position in GLD & SLV, and a short position in LOW. No positions in any other stock mentioned.

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