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  1. 1. A Publication of and Investment Principles forA Lifetime of Secure Wealth The Most Valuable Secrets Of the World’s Best Investors Revealed!
  2. 2. Page 2 Financial Intelligence Report Special Report In This Report Introduction:• age 3: Lessons from a P How FIR Came to Be Master Investor On the second Friday of every month, at 12 noon Eastern time, international investors dial in on a private number. For the next hour,• age 4: Building a Safe, High- P they will divulge some of their best-kept investing secrets, bringing Income Portfolio clarity to the direction of investments. Everyone voices his or her opinions in a freewheeling conversation that can get a bit heated at• age 5: Sector Investing: P times. Their goal: sharing the best investment ideas from around the How to Beat the SP 500 globe. The best of these ideas become the backbone for articles and Every Year investment opportunities in Financial Intelligence Report. So how did this group of individual investors first form? After the• age 7: Why Will Gold P 2000-2002 market collapse, the need to provide independent guidance Always Have Value? to individual investors was clear. After all, in that freefall, brokers didn’t get their clients out in time. Money managers preferred sitting back and• age 12: What the P collecting their fees, ominous market signals be damned. Government Doesn’t Want Newsmax founder Christopher Ruddy, being a London School of You to Know About Inflation Economics grad, knew how the well-off truly get wealthy. It’s not by listening to office-dwelling brokers or following loudmouthed media pundits. Those only fog an investor’s vision and lead him astray.• age 14: The Dangerous P The secret to investing is to have a well-connected team of insider Dollar: Protecting Your experts who think independently of Wall Street. And Ruddy had Wealth by Investing Abroad assembled such a team for himself. But not being the type to keep all this information hidden or secret, Ruddy decided to publish this• age 17: Use Global Sector P information once a month through Financial Intelligence Report, Investing to Profit From a providing a contrarian viewpoint to the market-making news of the day Soft U.S. Economy and a recommended portfolio of stocks and other investments a person could use to protect his or her assets in good times and bad. The first• age 18: Beware the P issue came out in 2003. The results since have been tremendous. ‘Decoupling’ Myth: Emerging The following report dives back into our pages to find some of the Market Stocks Can Be Risky best articles featured in Financial Intelligence Report. The investment principles illustrated here have held true for decades and have helped• age 20: China Holds the P guide FIR for the past eight years, even through the tumultuous housing bubble and 2008-2009 worldwide financial crisis. Key to U.S. Economic Revival Although our opinionated collection of experts have been known to disagree with each other, all told, there is a running undercurrent• age 21: The Pension Fund P throughout FIR of common core beliefs about the overarching trends of Time Bomb Is Ticking the world economy and the proper way to invest for safety and growth. At the bottom of each article, we’ve provided references to other• age 24: Profit When the U.S. P issues that also covered that same or a similar topic if you’re interested Bond Bubble Bursts in reading further on any subject. You can access these issues as a subscriber at the website,• age 26: Professional Investor P Financial Intelligence Report has been labeled bearish, contrarian, Profiles of Warren Buffett, insider, outsider, and, well, just about everything under the sun, by Walter Schloss, George Soros, fans and doubters alike. But perhaps the best way to illustrate the Jim Rogers, David Skarica philosophy of the newsletter is through a story, when Ruddy visited a friend and mentor, Sir John Templeton. Ruddy recounts the encounter in the following essay, written after Templeton’s passing in 2008.
  3. 3. Page 3 Financial Intelligence Report Special Report Lessons From a Master Investor The world lost a great man in July 2008 when Sir he began investing in foreign stocks. Such an idea seems John Templeton passed away at age 95. Templeton, quite acceptable today but, as Templeton recalled, many most widely known for his investment savvy, founded the Americans viewed it as a betrayal of the country to invest Templeton Funds. His reputation for business acumen is abroad. Templeton didn’t see why in a free-enterprise well-deserved. Many of the “great” stock gurus — I won’t society an individual should limit oneself to one country’s name names — haven’t even beaten the SP 500 over equities when so many opportunities existed elsewhere. the long term. Because of this lack of interest among many Meanwhile, it’s estimated that $100,000 invested with Americans in foreign stocks, he told me, he was able to Templeton in 1954 would’ve grown to more than $20 find tremendous bargains around the world. million by 1992. Over this period, Templeton returned For Templeton, one of the cornerstones of his 14.5 percent annual gains to investors. Money magazine investment philosophy was to ignore conventional dubbed him “the greatest global stock picker of the wisdom. When he moved full time to the Bahamas in the century.” 1980s, he brought his offices with him from Rockefeller I had the honor of visiting Templeton at his Lyford Center. Yet, he revealed, he was quite worried about his Cay, Bahamas, enclave twice in his later years. My last future investment performance. Away from the center of visit with him was in 2006. He was 92 at that time, and things, could he invest wisely? while his body was beginning to show some frailties, his “I actually performed better here than in New York,” mind was remarkably sharp. he said with a smile. His explanation was that, in the He clearly enjoyed talking Bahamas, he saw things more clearly, once he was away about investments and the world from the influence of the New York investment world. economy, but he was most animated Templeton summed up his investment approach this when talking about spirituality and way: “Buy when others are despondently selling, and sell religion. He had put the bulk of when others are greedily buying.” He had a great ability his John Templeton Foundation — to sense the moment of “maximum pessimism.” more than $1.5 billion in assets — Back in 2005, for instance, he plainly saw the housing behind his efforts to help mankind bubble for what it was. He predicted to me then that he Sir John Templeton understand spiritual forces. had little doubt the market for houses would collapse Always the businessman, in the United States. He said home prices would fall as Templeton made a deal with me each time I met him. much as 50 percent in some markets. He would talk to me about the financial world for our His prediction about the housing market was uncanny. readers — but I had to detail in my reports his views on Though he was a contrarian, he was never a pessimist. the importance of a spiritual life. It was a done deal. He was a realist. He predicted that the Dow would tank It is interesting that a man so identified with as a result of the housing crisis but that it would not be Mammon also would be so closely involved with God. In in a permanent trough. He predicted the Dow hitting reflection, these associations are not opposites. Templeton 20,000 in the next decade or so. understood that great moral foundations underpin our At 92, when I visited him last, he was full of life. I free society and free-enterprise system. Our system of asked him his secret for longevity and good health. He contracts works because contracts are honored by honest looked at me and said just two words: “Never retire.” He people. People honor contracts because of their faith and said he wanted to write a book on the subject. He was accountability to a higher power. apparently too busy to accomplish that. As for his legacy in the investment world, Sir John Another secret was exercise. He liked golf, but it took Templeton has left an enduring mark there, as well. If way too much time, he said. He did some calculations one word could sum up his investment philosophy, it is and figured out that if he went into the Atlantic Ocean “contrarian.” Many of us talk about being contrarian, but and walked against the current for 45 minutes, he would most people find it difficult to break from convention. burn as many calories as walking on the golf course for Templeton lived his life as a contrarian. four hours. He soon took up the practice of walking in Even as a young man, Templeton was a pioneer the sea and continued it into his 90s. Indeed, it was the contrarian. He told me how after graduating from Yale, story of his life, always walking against the current.
  4. 4. Page 4 Financial Intelligence Report Special Report Building a Safe, High-Income Portfolio This story originally ran in our inaugural issue in same as for a $40 stock that paid $2. There are twoSeptember 2003. It talks about some core principles ways a stock’s yield can grow:of the FIR investing style, including the power of • he company decides to increase its dividend Tdividend stocks, and gives a very concise playbook payments to shareholders.for when it’s time to get defensive. • he stock price falls, meaning investors can buy T into that dividend for less money. The era of double-digit annual gains from a Experts often use the five-year Treasury notemixed portfolio of stocks has gone, and it will not yield as a comparison for searching for dividends,return overnight. According to historical data, the but they say investors should not limit their choicesreal rate of return (returns adjusted for inflation) by omitting stocks that have potential share-pricefrom stocks over the past 200 years lies between 6 appreciation.and 7 percent annually. Investors should make sure that the company has Consider the analysis of Robert Prechter, one plenty of cash on the books and that the dividendof the market’s leading bears. Prechter analyzed is coming from excess cash flow. After shareholdersthe stock market from 1966 through 1994, the are paid, there still should be room for capitalbeginning of the last great rise in the bull market. spending and things like acquisitions, research andHe discovered that between 1966 and 1994, an development, and share buybacks.investment in the Dow Jones industrials would have Investors can tell how much cash a companyproduced a zero gain for an investor. is using to cover its dividends by looking at the Prechter noted that the Dow Jones industrials payout ratio, or the percentage of earnings paid outrose from 1,000 to close to 4,000 points almost in dividends over time. Yields on dividend stocksthree decades later. But he explained that the almost also should not be astronomical. When stocks pay3,000-point increase by 1994 was for naught in sky-high dividends, it could be a red flag and thereal money terms. When inflation is factored in, the payout could be unsustainable, although there areactual cost basis of the shares was about the same as exceptions.30 years earlier. Companies often can and do cut their dividends to save cash. To weed out the ones most likely toChoosing Equities That Protect — pull back their payments, experts say payout ratios should be below 75 percent. That means a companyand Pay Off Long Term is paying less than three-quarters of its profits out Dividend-paying stocks are often lifeboats in as dividends. Using a lower payout ratio is gooda storm. Companies that pay dividends show because companies can afford to keep paying thosea sign not only of financial strength but also dividends.of management discipline and commitment toshareholders. Additionally, recent studies show that dividend Recessionary Stock Investing:payers generally outperform in bull and bear Playing Smart Sectorsmarkets. In one case, analysts studied the median Overall declines in the stock market and thequarterly returns of two groups of stocks, those that economy do not mean that all sectors will performpaid dividends and those that didn’t or paid only poorly. In fact, investors often find sectors thatsmall ones. either flourish in bad economic times or are among When markets get choppy, the added lure of income the first sectors to benefit from the return of a bullcan prevent steep losses in dividend-paying stocks. market. To understand, a dividend yield is a company’s Here are several sectors that seem to work wellannual dividend rate divided by its stock’s latest despite economic bad times and market woes.closing price. For example, the yield for a $20 stock Soft drinks. Companies like Coca-Cola and otherthat paid $1 in dividends last year is 5 percent, the soft-drink bottlers seem to perform well, as do many
  5. 5. Page 5 Financial Intelligence Report Special Reportfood industries during economic bad times. During stream for investors, often paying quality dividends.bull markets, they don’t tend to rise as quickly Telephone companies. Telephone companies —as other sectors but are good long-term stable particularly the old ATT operating companies,investments. which pay dividends and have the net effect of Pharmaceuticals. Drug companies have monopolies — will continue to be solid investmentscontinually posted stronger and stronger profits. for investors in good and bad times.Unless the government gets into the mix and offers Tobacco. Despite government regulations,new regulations to limit drug company profits, these tobacco continues to be an extremely profitableshould continue to pay big dividends. For one thing, investment. Also, worldwide tobacco companiesthere will be a huge demographic boom affecting continue to bring rich dividends to investors.pharmaceuticals as the baby boomers begin to retire at Electric utilities. Not only is there a potentialage 65 in 2010. Pharmaceuticals could explode then. for upside when economic times are good and Other food suppliers. We mentioned soft-drink there is capital appreciation on the stock, but thesemakers, but food companies in general are good companies also pay rich dividends and offer stableinvestments in bad times and good times. share prices. Oil companies. Oil remains one of the mostimportant commodities in the world. And though Editor’s Note: For further reading, see articlesprices may fall in the near future as production regarding asset allocation in issues 8, 20, 26, 33, 42,increases, they will remain a significant revenue 48, 59, 74, 85, and 92. Sector Investing: How to Beat The SP 500 Every Year In the fourth issue, published in January 2004, By correctly timing investments in the boomingwe delved into sector investing, which has been sectors, you can make spectacular profits — or, witha hallmark of our style that has helped the FIR bad timing, suffer spectacular losses.Portfolio consistently beat its SP 500 benchmark. One of the most dramatic examples is the dot- com boom and bust. To wit, during the boom, these The key to making money in financial markets is once-high flyers soared:knowing when to invest in what. As the saying goes, • AOL soared 1,538 percent. Every $10,000“Every dog has its day.” Similarly, every sector has invested grew to more than $163,000.its heyday. • JDS Uniphase went up 2,683 percent. Every In the 1940s, it was defense and natural-resource $10,000 grew to $278,261.stocks. In the 1950s, it was blue chips and industrials. • Yahoo galloped 2,512 percent. Every $20,000In the 1970s, it was computers. In the 1980s, it was invested grew to more than $520, services. In the 1990s, it was the Internet Fund research and rating company Morningstarand high-tech stocks. In bull and bear markets, Inc. tracks 10 different sectors:specific sectors are often winners while others are • Consumer Durablesclear losers — hence the wisdom of sector investing. • Consumer Staples • EnergyWhat Is Sector Investing? • Financial A sector is a portion of the overall stock market • Health Careunited by common characteristics, such as health- • Industrial Cyclicalscare stocks or defense stocks. Sector investing means • Retailfocusing your investments on a particular segment • Servicesthat you expect to benefit from the present and near- • Technologyterm trends. • Utilities
  6. 6. Page 6 Financial Intelligence Report Special ReportChoosing Your Sectors as AMEX midcapitalized stocks or NASDAQ energy stocks only. Like mutual funds, index funds can You can make huge profits by investing in sectors only be traded after the close of business on a stockon their way up. Unlike day trading, in which you exchange.profit based on short-term (even hourly) fluctuations Since 1991, the SP 500 Index has increasedin stock prices, sector investing is long-term fivefold. Just think of what that could have meantinvesting (one year or more) based on understanding to your investments. While the average SP 500and predicting market trends. stock held by the individual investor has increased For instance, when the Berlin Wall and Soviet by a juicy 148 percent, according to Index FundUnion fell, that was obviously the time to bail out of Advisors, an SP 500 index fund has returned andefense stocks. Conversely, right after 9/11 was the astounding 840 percent at the same time. In othertime to jump back in. words, if you had picked your own stocks during Here are some other examples in which sector the last 14 years, you most likely would haveanalysis has proved invaluable: made about 10 percent a year. However, if you had • Between May 2000 and June 2003, the Federal invested the same money in an SP 500 index fund,Reserve System discount rate — the rate the Fed your returns would be nearly 60 percent.charged member banks for borrowing money — fellfrom 6 percent to less than 2 percent. An obviousbeneficiary: real estate. During the same period, Exchange-Traded Funds: A Primerhousing prices in some cities such as San Francisco Exchange-traded funds — or ETFs — are ahave increased 40 percent to more than 100 percent. variation on index funds and have definitely become • From the 1950s to the present, computer prices an increasingly popular investment. In 2004, ETFhave plummeted more than a millionfold. During assets increased by 47 percent to $222 billion,the same period, computer stocks like Apple and according to the investor service Morningstar.Microsoft have soared, resulting in huge profits for The main difference between index funds andinvestors in these sectors. exchange-traded funds is that with ETFs, you can • During the last 16 months, the euro has risen buy or sell shares whenever an exchange is open.nearly 50 percent against the dollar. By buying In addition, investors are able to trade options oneuros or other hard currencies like Swiss francs, ETFs just like they can with common stocks, addingyou would have received similar returns on your aggressive and defensive trading tools to theirinvestment. armory. One good rule of thumb is never to invest in Investors also can short-sell ETFs just like theysomething you don’t understand. Thus, super- can with many common stocks. That also meansinvestor Warren Buffett generally avoids technology you can bail out of an ETF more quickly in thestocks and instead invests in insurance companies, event of a dramatic market correction.consumer stocks, and health care. The same thinking ETFs don’t sell shares directly to the investor.applies to sector investing. Use common sense and Instead, they issue them in large blocks, calledstick to sectors you understand. “creation units.” These are typically made up of 50,000 or more shares and are generally purchased by large institutions, which in turn split up theseSector Investing Made Easier: large initial blocks of shares and sell them to smallerIndex Funds investors. How would you like to own an investment that The performance of index funds and ETFsrequires little active management on your part yet closely follows the basket of stocks they track. Forproduces up to six times the return you are likely to instance, when the SP 500 goes up 10 percent inreceive by picking your own stocks? If that sounds a year, an index fund that tracks the SP 500 (suchattractive, you might want to consider index funds. as Barclays’ IVV: AMEX) also will tend to go up As the name implies, an index fund invests 10 percent. That makes exchange-traded funds ain a group of stocks selected to closely track the particularly easy and hassle-free method of investingperformance of a stock index, such as the Dow, the during a bull market.SP 500, or a more specific group of stocks — such However, the price of ETFs is not the same as
  7. 7. Page 7 Financial Intelligence Report Special Reportthat of the underlying stocks. Rather, it reflects be sure to check out the prospectus or “productsupply and demand for the ETF itself. Of course, description.” By law, the fund manager must givearbitrage opportunities mean that the two don’t get you this on request.out of line often or for long. While you own ETF shares, the composition There are many different ETFs and index funds of underlying stocks could change and their valueto choose from, including funds that track the might rise or fall. However, you owe no taxes onDow, the SP 500, energy stocks, emerging market them until you sell your shares.stocks, Chinese stocks, and Latin American stocks. That is because of a regulatory loophole thatThe list goes on and on — and it gets larger every asserts that ETFs are created through the trading ofmonth. “equivalent certificates.” This is an in-kind trade and One major advantage of exchange-traded funds is therefore nontaxable. While there is no way ofis that management fees are generally very low — as avoiding capital gains entirely, by delaying this tax,little as 0.9 percent of assets compared to average you can accumulate wealth in an ETF until you sellmutual-fund fees of 1.4 percent. That means when your invest in ETFs, you can save as much as 12 Like other investments, exchange-traded fundspercent a year in management fees. have their own unique nomenclature — and the The government also strictly regulates ETFs, creators of many of these funds seem to have gottenso you can invest with reasonable peace of mind. a bit carried away with cute names. For example,Financial firms are only allowed to offer an ETF SPDRs (pronounced “spiders”) are funds thatafter the fund is closely examined by the Securities track the SP 500 (SPY: AMEX). “SPDR” is anand Exchange Commission to ensure that it meets a abbreviation for “Standard Poor’s Depositorylong list of financial requirements. Effectively, that Receipt.” VIPERs are funds issued by Vanguardmeans ETFs are sold by large institutional firms ( VIPER is an acronym forrather than small, fly-by-night companies. “Vanguard Index Participation Equity Receipt.” And All ETF certificates also must be cleared through Diamonds (DIA: AMEX) is an ETF that tracks allthe Depository Trust Clearing Corporation — the the stocks on the Dow.same government agency that records individualstock sales. This makes ETF transactions transparent Editor’s Note: For further reading, see articlesand highly liquid. If you are considering an ETF, regarding sector investing in issues 20, 23, and 83. Why Will Gold Always Have Value? In Issue 25, November 2005, we wrote about Here’s why gold will always remain a form ofa topic just as hot then as it is these days: the gold money:bullion investment market. As gold itself, the advicestands the test of time. • Unlike paper currency, people desire gold for its aesthetic value — because it is beautiful and has There are many reasons to own gold. For one immeasurable value, being used in metallurgy, art,thing, it is the ultimate insurance for your assets. jewelry, decoration, and electronics. Gold provides you with a variety of ways toprotect yourself. You can either keep possession of it • Typically, tons of ore must be mined to extractor reap the lustrous metal’s countless benefits in the a single ounce of gold. All the gold ever unearthedwake of disaster. in the history of the human race would probably fit For centuries, gold has been accepted in lieu of inside a large home. That scarcity preserves gold’smoney throughout the world, and this will likely high value through the ages. Gold is rare.continue long after today’s paper currencies aregone and forgotten. • Gold is virtually the same price anywhere in the
  8. 8. Page 8 Financial Intelligence Report Special Reportworld. And dividing gold into small amounts does actions have made the United States lose its primenot change its value. Compare this to a diamond, standing with global investors.for example. Two one-carat diamonds aren’t worth Even longtime investors who bought solely innearly as much as one two-carat diamond. Gold is the United States, like Warren Buffett, are noweasily divisible. looking to diversify offshore. Unfortunately, most In Chicago in 1930, a few 1-ounce gold coins of these funds are flowing into the euro or eurozonewould buy the finest suit in town. Today, in any investments. The euro has seen a rally as the dollarlarge American city, those same coins would still buy the best suit in a major clothing store. Gold has But we do not see that currency as a long-held its own against inflation. term option for capital preservation. While the United States is facing many problems, the euro • Gold doesn’t tarnish, and it’s extremely durable. will experience these, as well, and with greaterEven if the gold bullion coins in your home safe effect — such as the demographic time bomb. Inwere to melt during a house fire, the resulting lump the West, the number of seniors as a percent of theof gold would be almost as valuable as the original overall population is soaring. By the year 2050,coins. that amount is expected to increase by 35 percent in Europe and by 28 percent in North America. • Not only can you count on gold being worth This will create severe strains on many governmentas much or more 20 years from now, but you also programs, such as National Health Service in Britaincan convert it almost instantly into cash. Gold is and Social Security in the United States. Already inconvertible. much of Europe, the real dollar value of government retirement benefits for the elderly is plummeting, Every investor, from a single mom with $10,000 and deteriorating government-run hospitals haveto invest to the jet-setting multimillionaire, should long waiting lists.own some gold. Generally, we recommend keeping The European Union’s response to theseabout 5 percent of your net worth in gold and gold- problems has been more socialism — exactly whatrelated investments. If you are a real gold bull and has gotten it into this mess. Even its currencyare especially worried about economic problems and is in trouble. There are serious questions aboutterrorism, then 10 percent may be more appropriate whether the euro is a real currency at all. At leastfor your portfolio. In addition to the “insurance” American money is backed by a sovereign countryfactor, you also may have a great opportunity to with a single armed force. The euro, on the otherpotentially earn very high returns with gold. hand, is a contrived currency for many nations with different banking systems, different ratesSeven Forces Push Gold Upward of inflation, different rates of growth, and even contradictory monetary and fiscal policies. For the first time since 1975 — when private Historically, whenever paper currencies likeownership of gold was once again legalized in the the dollar and euro fall, gold rises. This has beenUnited States — powerful economic forces are the reality for centuries. Essentially, it’s not thatconverging to create what should soon become a gold is rising but that paper currency is falling.major gold bull market. However, no matter how you look at it, as the Understanding these forces could make or break dollar continues to decline, you can expect gold toyour investment portfolio and literally mean the keep rising. As the dollar falls, other commoditiesdifference between making or losing a small fortune. — including steel, timber, and silver — are likely toHere is what you need to know about these seven rise sharply, as well.powerful economic forces: Force No. 2: Soaring worldwide gold demand.Force No. 1: A collapsing dollar. Throughout the world, more and more Investors have been worried about the United individuals and governments are buying gold asStates for a long time. Endless budget deficits, an a safe haven for their funds in troubled financialaging population, massive entitlement programs, times. In 2004 China — the world’s largest country,and a civil legal system gone berserk with trial with more than 1.3 billion people — authorized
  9. 9. Page 9 Financial Intelligence Report Special ReportChinese banks to market gold bullion and coins. the government and minimize government payouts,As a result, Chinese demand for gold rose by at such as Social Security benefits, military pensions,least 50 percent in 2004, and it has continued to and interest on the national debt. But this wouldgrow since. When a large Chinese department store not surprise a European or Third World investor.started selling gold last year, they sold out in hours. They just take it for granted that their country’s But it’s not just China. “Indian households are official statistics are false. The United States hason a record gold-buying spree as oil-price-driven come to mirror how the rest of the world behaves,inflation threatens to wipe out savings from rising and it is demonstrated in almost every aspect of life.incomes in one of the world’s fastest-growing Here, official inflation rates greatly understateeconomies,” reports Economy News. India, with the real rate of inflation. We estimate that it has1.1 billion citizens, is the world’s second-largest been underestimated by 2 to 5 points each year overcountry, just behind China. India is also the world’s the past 10 years. Fudged inflation numbers meanlargest market for gold, and so far 2005 sales are at your real wealth is declining — just like the valueleast 80 percent higher than they were in 2004. of the dollar. If your investments returned 4 percent In addition, Middle Eastern countries are buying last year, you believe you are slightly ahead, basedgold at a record pace, particularly in the form of on 3 percent For 2005, Arab gold jewelry purchases But the reality is that inflation was at 5 or 6are running 50 percent ahead of 2004 purchases. percent last year, and you suffered negative wealthDemand for gold is also soaring in Indonesia, South of 2 to 3 percent. If your wealth declines at 3America, and many parts of the world. Increasing percent a year compounded, in 10 years, the valuedemand for gold means much higher prices in the of your portfolio has declined by 37 percent.near future. We are now seeing how the federal government sticks the American people with the consequencesForce No. 3: Faltering gold supply. of the big “inflation lie” — in the form of anemic In 2004, gold production fell 13.3 percent. Many salary and benefit increases, underestimatedof the world’s most productive gold mines are personal and business expenses, and ridiculouslyrunning out of ore, and new finds aren’t keeping low interest on savings.pace with rising demand. Globally, markets recognize that the dollar is Although South African mines have been some of depreciating and that it is valued much lower. Itsthe largest producers in the world, gold is becoming 35 to 40 percent decline in recent years pegs it tomore difficult and expensive to extract there. Most exactly how much we believe the phony inflationSouth African gold is at least two miles below the statistics would have caused it to depreciate.surface. As a result, it currently costs $380 to $480 Another area in which the federal governmentan ounce to extract gold at Ashanti, Gold Fields, gets “caught” lying about inflation is commodities.and Harmony — including operating costs. The world no longer wants to trade the same In Australia, gold production fell to a nine- amount of dollars for oil, cotton, wheat, corn,year low in 2004 at mines owned by Australia’s gold, and other commodities, so the prices for U.S.second-largest gold producer. investors go up. It’s interesting to note that other Worldwide, as mined gold supplies are currency holders have not been hit with the sameexhausted, labor costs rise and environmental commodity price increases that the United Statesconcerns make mining more expensive. The has experienced with its withering dollar.inevitable result of falling gold supplies is higher Gold is the most precious of all the prices. Therefore, it is an excellent barometer of the real value of the dollar and other currencies. There isForce No. 4: Much higher inflation. ample evidence that the U.S. government and other Although the official U.S. inflation rate is G-7 countries have sought to manipulate the goldsupposedly still low, the reality is far different. price, artificially lowering its value by dumping As we have previously explained in Financial central banks’ reserves onto the market. And itIntelligence Report, the official government worked — for a while. But the market has found itsstatistics are manipulated to reflect favorably on equilibrium, and gold is back up again.
  10. 10. Page 10 Financial Intelligence Report Special Report But this shouldn’t be surprising. When — maintained the price of gold at $35 by keepinginvestments and the economy appear turbulent, the “official price” artificially low. Then, starting inpeople look for a safe haven in which they can 1975, when the American people were once againpreserve the value of their assets. Gold fits the bill permitted to own gold bullion, the price of goldadmirably — it is one asset that preserves its value exploded to $850 an ounce.year after year, and even century after century. The fact that this “gold boom” occurred is common knowledge. But what few now know isForce No. 5: Weak stock, bond, and real estate that behind-the-scenes manipulation of the goldmarkets. price was secretly reinstated and has been in effect Both equities and bond markets have been very for at least a decade.weak this year, with stock indexes barely changed Up to a third of claimed central bank gold mayfrom their levels in January 2005. (On Jan. 3, 2005 be gone. The bottom line: Only massive financial— the first trading day of the year — the Dow manipulation and concealment has been preventingclosed at 10,630. By mid-October, the Dow closed the price of gold from exploding, like it did betweenat 10,281.) 1975 and 1980. While the Dow and SP 500 could end up Many other financial professionals confirmslightly higher at the end of this year than they did the Sprott Report’s finding that central banklast year — led by technology stocks — we believe manipulation of gold prices is very real. Forthat the outlook for the market next year is gloomy instance, the Gold Anti-Trust Action Committeeand a recession is possible. reported in July 2005, “The gold price has been If there is a recession, it will probably be led by capped at $440 per ounce since last December bya collapse in the home-financing and real estate repeated selling of gold reserves by European centralmarkets. Already, real estate nationwide is showing banks and the European Central Bank itself.”signs of weakness, with stagnant or falling home In fact, on a single day in July 2005, theprices, declining sales volumes in hot markets, and European Central Bank sold nearly 1 million ounceslonger times required to sell houses. of gold. However, this game could end soon, as Think about all the enterprises that depend central banks deplete their gold and more and moreon real estate sales, either directly or indirectly: people become aware of the manipulation.Mortgages, refinancing, consumer loans,construction, moving and storage, furniture and Force No. 7: Gold is again becoming a safe haven.appliance sales, home repairs, heating and air Because of steady gold price increases over theconditioning, and painting and plumbing, to name a past several years and the lackluster performanceswath of them. of many other investments, gold has once again It’s easy to see why at least one-third of the U.S. become attractive as a store of value and a financialeconomy is dependent on real estate. As a result, if safe haven in troubled times.the housing sector “catches a cold,” the overall U.S. As a result of the factors we have mentionedeconomy could catch deadly pneumonia. above — coupled with what appears to be a never- With interest rates continuing to rise, we expect ending war in Iraq and Afghanistan, a yawning babyweak stock, bond, and real estate markets for the boomer crisis, and many other major problems —foreseeable future. In such an environment, precious the stage has been set for a truly explosive rise inmetals and other select commodities are one of the gold prices during the coming years. And then therefew good alternatives for protecting your assets. is the War on Terrorism here at home. If and when such a catastrophe does occur, gold would be one ofForce No. 6: Artificial manipulation of gold prices. the few investments that will soar — a financial life The key to understanding major central banks’ preserver in an age of fear and terrorism.manipulation of the gold price is the realization that FIR’s recommended precious metal investmentsgold is money — and that their fiat currencies are consist of the following:not. From 1933 until 1975, private ownership ofgold bullion was prohibited in the United States, and a) Bullion Coins: One of the best ways to holdthe U.S. government — along with other countries precious metals is in the form of bullion coins.
  11. 11. Page 11 Financial Intelligence Report Special ReportThese are coins that sell close to the actual cost of refined bullion. However, you also take the riskmetal. Every family should own some. For gold, that the price of bullion on the open market couldwe recommend 1-ounce coins with low premiums. fall below the extraction cost — and that wouldPremiums (the amount you pay on top of the wipe out the miner’s profits, causing your miningdaily “spot” price of the metal) are lowest for the shares to plummet or even become worthless.Canadian Maple Leaf (4 percent), Mexican Corona Further, not all raw gold in the ground is the same.(2 percent), South African Krugerrand (2 percent), Extraction and recovery costs vary widely fromand Austrian and Hungarian Korona (2 percent). mine to mine and are heavily influenced by oreOne-ounce U.S. Gold Eagles have significantly grade, depth of deposits, and what other mineralshigher premiums (5 percent), but you usually can the gold is mixed with. Also, the metallurgicalrecover most if not all that additional cost when process used to recover gold from ore can beyou sell them. relatively simple or extremely complicated — it For silver, we recommend purchasing “junk depends on the nature of the ore.silver” — pre-1965 U.S. dimes, quarters, and half The higher the cost of extraction and recovery,dollars — which are 90 percent silver by weight. the more operating leverage the miner has. That Always get prices from at least three dealers to means the more the price of gold rises and falls, theget the best bargain. Even if you end up buying larger the effect it has on the miner’s cash flow —locally, getting prices from a couple of large, out- and therefore stock price.of-state dealers will help you negotiate with local The lower the miner’s extraction costs, the lessvenders to get the best price. risky the stock is for investors if the gold price goes You also should buy at least $1,000 worth of down. Of course, it is also less rewarding if thecoins at a time. That’s because most states don’t gold price goes up.charge sales tax on a purchase of that size. The In addition to operating risk, political risk is analternative is to order from an out-of-state dealer extremely important factor for gold mines. A goldyou trust. mine is a captive operation that can’t be moved, like a factory or software business can be. The b) Gold Savings Accounts, CDs, and Certificates: gold-mine owner is at the mercy of the governmentYou also can buy gold-denominated savings in the country where his mine is situated.accounts and CDs from banks in the United States, As mentioned earlier, some of the best-knownCanada, Switzerland, and other countries. In mines (such as those in South Africa) have veryAmerica, we recommend EverBank in Florida, high extraction costs, so their value will tend to go888-882-EVER (3837), up the least as gold rises. As we told you in one of our previous reports, At the opposite end of the spectrum are the so-“Switzerland: Still the Ultimate Investment” called “penny gold stocks” — low-priced shares(May 2005), Swiss banks are another excellent that sell for less than $1. Such stocks are so cheapalternative for storing large amounts of gold. because these companies are not yet producingMost public and private Swiss banks offer gold gold — rather, they’re still exploring. If they findstorage. Another benefit to keeping gold in a a rich strike, the value of the company’s stockSwiss bank is that several offer easy credit against could multiply by 20, 50, or even 100 times in justyour stored gold at rates as low as 1 percent weeks. But more realistically, most are likely to findor less. nothing. In the middle are so-called “junior mining c) Gold Stocks: Unlike purchasing gold bullion stocks,” which have at least some proven reserves.itself, when you buy a gold-mining share, you are But they are still involved in developing theirbuying gold in the ground. Because this gold has properties. These also have high profit potentialyet to be extracted and recovered from the ore, you but with lower risk than penny gold it at a lower price per ounce than when it isabove ground and refined. Editor’s Note: For further reading, see articles Consequently, you get more gold for your regarding the gold market in issues 1, 3, 5, 15, 28,money through mining shares than you do with 32, 33, 64, 71, 73, 83, 84, 85, 87, and 91.
  12. 12. Page 12 Financial Intelligence Report Special Report What the Government Doesn’t Want You to Know About Inflation In this article by John Browne, originally declared, U.S. interest rates would have to riseprinted in Issue 37, released in November 2006, sharply. The cost of government debt, including thea topic that has ramifications today was covered: hundreds of billions of U. S. Treasury debt held bythe insidious threat of inflation on people’s China, would rise dramatically.pocketbooks and investment portfolios. While it Increased interest rates would have a majorwas written years ago, much of what is said may depressing effect on the U.S. economy and onsound eerily similar to problems faced today stock and bond markets, risking a return of thein 2012. stagflation that plagued Western economies in the 1970s. There are therefore pressing economic, So how is it possible that the core Consumer financial, and electoral reasons for the governmentPrice Index, published as an official government to maintain the illusion of low inflation.statistic, is a historically low 2.8 percent? Can it The strongly adversarial party politics of todaybe true? militate against the acceptance of risk, even in No, it cannot. It’s a gigantic con to keep us the national interest. So expect the official rate ofquiet. And judging by the money flowing from real inflation to remain falsely low, until it explodes onestate and commodities into long bonds and stocks, us. Then watch out! In the meantime, be is working and working very well. The trick is that by excluding such items as How Are the Inflationenergy and health costs, and by including only therental equivalent rather than the actual asset price Figures Manipulated?of housing from the index, the core CPI is up only Our readers may well wonder how such gross2.8 percent. manipulation of a key published government With low inflation, government increases in statistic can be achieved, let alone be justified.payments to entitlement programs — like Social As Financial Intelligence Report stated in 2005,Security and government employee raises — are there are several ways in which governments cankept to a minimum. At a time of low interest rates, hide information and keep the CPI artificially low.who can justify a bid for higher wages? These include the following: Also, low “official” inflation has led to lowinterest rates (since the Federal Reserve System 1. Geometric weighting. This allows forsays it looks to inflation for setting its rates) and a the lower weighting of any goods and servicesrelatively low cost of government debt. considered “too volatile” by the government. Today, investors and certain media pundits Their prices are considered as only temporary andforecast a “Goldilocks” economy (not too hot, not therefore disruptive to the statistics. This soundstoo cold, but just right) if the Fed lowers rates in great in theory, but it opens the door to statisticalNovember. And of course, the lower our interest manipulation at the government’s whim.rates, the higher bond and stock markets will roar. 2. Hedonic adjustments. This involves theWhy Are the Inflation reduction of the price increases of certain items by an arbitrary amount, reflecting an increaseBooks Cooked? in “quality.” For instance, one could claim that High inflation is bad for business, particularly today’s Ford cars have scarcely increased in pricethe business of politics. Increases in Social Security since the Model T Fords sold for $300 becausepayments are fixed to inflation and would rise today’s cars are so much more technologicallydramatically. If the true inflation rate were advanced.
  13. 13. Page 13 Financial Intelligence Report Special Report 3. Ignoring quality decreases and “on-sourcing.” the problem for some time — hence the fall ofIn the old days, the post office provided four the dollar against the Swiss franc, gold, and otherdeliveries a day. Gas stations pumped gas, checked depreciating currencies such as the euro, sterling,oil, and cleaned windshields. Today, these services and even the yen. What is truly worrisome ishave been reduced at the post office or at the gas though the Fed has moved to raise interest ratesstation and “on-sourced” to the customer. But the dramatically from a low of 1 percent to more thanhigher effective cost relative to the reduced service 5 percent, the dollar has not strengthened butis not reflected in the makeup of the CPI. weakened. Any modern government faced by inflation and 4. Assumption that consumers will turn to depression will accept inflation. Depression cancheaper alternatives. If the price of a meal at be devastating, both economically and politically,a restaurant went up, customers would move taking many years to correct.elsewhere, so it is not a “justifiable” increase . . . So we can understand a government decision toor so the flawed argument goes. accept inflation, especially if it can distort the real figures in order to disguise inflation in the short 5. Exclusion of goods and services subsidized to medium term. The downside of such a policyby the government. In this conjuring trick, the is that it can so easily lead to the onset of theretail price is included but not the actual cost, stagflation that bedeviled Western economies in thewhich contains the government subsidy. Items airport security, public schooling, interstate If the real inflation rate was to be exposedhighways, and housing for the poor, although publicly at, say, just 7 percent, what panic wouldprovided at greatly increased prices, are largely ensue as the 10-year Treasury fell in price until itexcluded from the makeup of the CPI. Statistical yielded 9 percent, just 2 percent above inflation,manipulation? We think, definitely! without any expectation of future higher rates? Stock markets would plummet as longer-term bond yields and the directly linked mortgage ratesConsequences of Mass Deception rose in even greater panic. We believe you wouldon Inflation not want to be in long-term investments, other Of course, the government has tried desperately than gold, during such a avert the economic depression that loomed after In short, a sudden rise in interest rates would9/11. Every financial spigot was opened at full lead to panic selling in the financial and realforce in an unprecedented manner. estate markets and panic buying of gold and Liquidity and credit were made available at commodities — the exact reverse of what isrecord low rates of interest, sometimes even given happening today.away at negative real rates of interest. Government However, when the true inflation ratespending was unleashed on a massive scale. eventually leaks out, readers of FIR will not be Five years later, it has amazed us and many those in a panic because they will have beenother observers that such actions did not unleash a forewarned.major inflation wave. Of course, there have been some legitimate Editor’s Note: Understanding the role offactors holding inflation down. The Far East, inflation, and the lengths government goes toparticularly China, has exported deflation to the understate it, is critical to investment success.United States on a vast scale. Until 2004, even the Fixed-income investments, in a world wherefall in commodity prices was deflationary. inflation is chronically understated, do not provide But the price of commodities turned around in the kind of principal protection that most investorsa major way in 2005 and 2006. Indeed, they went need when adjusted for the true numbers.wild and yet inflation remained strangely benign. For further reading, see articles on inflation,Why? Because of the “now you see it, now you bonds, and interest rates in issues 10, 18, 26, 27,don’t” cooked books! 28, 29, 32, 36, 39, 42, 45, 52, 65, 80, 81, 86, Foreigners and currency traders have recognized and 90.
  14. 14. Page 14 Financial Intelligence Report Special Report The Dangerous Dollar: Protecting Your Wealth by Investing Abroad In June 2004, Issue 8, we published this article, dollars tends to decrease, also.which detailed the U.S. dollar’s continued decline During the last decade, the supply of dollars —in status and value. As of today, it still stands as the also known as the money supply — has increasedworld’s reserve currency, but based on the rampant enormously. The Federal Reserve System, whichdevaluation of the dollar from excessive money controls our money supply, is creating money atcreation by the U.S. government, for how much breakneck speed — up to $1.5 trillion a year. This islonger is that status sustainable? known as monetary inflation, and it results in price increases. For the last 100 years, the U.S. dollar has been Until recently, price increases have been mostone of the strongest and most universally accepted evident in the prices for homes, which have beencurrencies in the world. From New York to Moscow increasing at almost 20 percent a year. You alsoto Beijing to Outer Mongolia, people everywhere see it now in rising prices for gasoline and heatinggladly accepted dollars. People even have risked oil, higher food prices, higher car prices, and evenjail to hoard the greenback. During its heyday, the higher prices for movie tickets. Rapid monetarydollar was “as good as gold,” and indeed, until inflation also results in the very low interest rates1971, the dollar was at least partially backed by we’ve seen the past few At the same time that the U.S. money supply has Then on August 15, 1971, President Richard been increasing, the demand for dollars has beenNixon closed the “gold window” and removed the declining because of, among other factors, lowlast shred of gold backing for the dollar. What has interest rates. This is most evident in the historicallyhappened since is a matter of history. Between 1971 low rate of savings by Americans — now less thanand the end of 2003, the dollar declined in value 1 percent of income. When interest rates are so low,by more than 70 percent and the end is nowhere in it makes sense not to put your money in a bank.sight. Why get just 1 or 2 percent interest when you can The bitter truth is that without gold or some invest in real estate or commodities and get 15 or 20other form of backing, there is nothing to prevent percent appreciation a year?the dollar from falling much, much farther — andindeed, many experts think that is precisely what The Dark Side:will happen in the next five years. That will be Our National Debt Bingeterrible news for the value of many of your dollar-denominated assets, particularly your checking and Low interest rates encouraged massivesavings accounts, and even many stocks. However, indebtedness by individuals, companies, and localit will mean an incredible bonanza if you invest in and state governments. Why not buy that new SUVassets that go up as the dollar goes down — such as or sports car when you can get zero-interest-rategold and strong foreign currencies. loans? Why not buy a bigger house when your new In this article, we look at the immediate prospects payment is less than what you previously paid forfor the dollar and how you could make a mint from a much smaller house? Why not take that dreaminvesting in foreign currencies. vacation when anyone can get five or six credit cards, each with $20,000 “limits”? The result has been the highest debt ever.The Impact of Supply and Demand According to BusinessWeek, the average U.S. citizen As with all goods, the value of the dollar is ruled has personal debt (mortgage, car loan, credit card,by supply and demand. When the supply of dollars etc.) and fixed costs (food, medical care, taxes, etc.)increases, the value of each dollar tends to decline. that consume more than 100 percent of his or herWhen the demand for dollars decreases, the value of disposable income. Total U.S. consumer debt is more
  15. 15. Page 15 Financial Intelligence Report Special Reportthan $2 trillion, or $18,700 per household. And binge is coming to an end and that the decline of thethis is on top of $6.2 trillion in real estate mortgage dollar could accelerate even faster.debt. The disturbing reality is that most U.S.families are financially overextended and extremely The Trade Deficitfinancially vulnerable in the event of a recession oranother economic crisis. Another way to understand why the dollar has So what happens when interest rates increase? been declining is to look at the U.S. trade deficit.Overnight, people with adjustable-rate mortgages Increasingly, the United States has been spendingcould find themselves unable to make their new, more and more and importing ever more foreignhigher monthly payments and could be forced to sell goods, without a proportionate increase in exports.their homes at fire-sale prices. San Francisco financial analyst Robertson Morrow Under this worst-case scenario, the higher interest summarizes the situation:rates on credit cards would mean that millions of “There are two ways for a nation to have afamilies — who are already stretched to the limit strong currency: export goods or export debt. Forfinancially — would be unable to make their credit- the past six years, America’s great export has beencard payments. Higher gas, food, and energy prices not goods but debt. Foreigners sell us oil, cars,could push many over the edge into bankruptcy, computer components, and other goods. In return,taking many highly leveraged businesses along with we sell them debt and other financial instrumentsthem. — government bonds, corporate bonds, and Government itself is also at risk. Uncle Sam has securities backed by the mortgages of Americanalso been on a spending binge. homeowners — for which foreigners have seemed There are just two ways to pay off these huge to have an almost insatiable appetite. From 1997government debts: 1) Vastly increase taxes to 80 to 2002, imports of goods and services increasedpercent or more of income; or 2) inflate the currency by a third, while exports of goods and services— causing the value of the dollar to plummet. were flat. “The measure economists use to quantify this export of debt is the ‘current account.’ Prior toForeign Financial Saviors 1983, America’s current account deficit never Many analysts believe that our financial house exceeded 1 percent of GDP. In 2003, the currentof cards would have come crashing down long ago account deficit [was] more than half a trillionbut for one big factor: massive foreign purchases of dollars — over 5 percent of GDP.”U.S. debt. In essence, Japan, China, and Europe have However, as the dollar has weakened, so too hasbeen financing our decades-long financial binge. the willingness of foreigners to buy and hold U.S. In addition to buying Treasury bills and other debt, causing the dollar to fall ever faster. Add togovernment paper, European, Japanese, and Chinese this volatile situation rising oil prices and massivebanks have been absorbing trillions in U.S. mortgage increases in the U.S. monetary supply by the Fed,paper and other debt. With U.S. real estate prices and you have a recipe for roaring price inflation andsoaring at 15 to 20 percent, buying mortgage paper a collapsing dollar.from U.S. banks seemed like a great investment. Foreign central banks also get a safe place topark their money and an easy way to keep the value How Low Can the Dollar Go?of their currencies down, enabling them to export To reduce the current account deficit from itseven more goods and services to the United States. present level of 5 percent to its historic high of 1And we get to continue our debt binge. So everyone percent, the dollar would have to fall by at leastwins, right? Unfortunately not, because as the dollar another 50 percent. But even that might not befalls, so does the return on investment for these enough. To compete in the global marketplaceforeign central banks. against inexpensive Japanese computers and low The beginning of falling real estate prices, Indian and Chinese labor costs, the dollar may havedeclining offshore investments, rising interest rates, to decline by 80 percent.and rampant price inflation in oil, food, and many It is also likely that as the costs of the Warcommodities indicates that America’s spending on Terrorism mount, the U.S. government will
  16. 16. Page 16 Financial Intelligence Report Special Reportincreasingly do what governments always do to equities, and some war: turn to monetary inflation rather thanto huge, unpopular tax increases. All this adds up to • Currencies: For a variety of reasons, we do nota sharply declining dollar for the foreseeable future. recommend investing in the euro or Japanese yen. First and foremost, foreign goods and imports Europe and Japan continue to experience majorwill get much more expensive — prohibitively structural economic problems and governmentso for many Americans. So look for much lower budgetary problems, as well as their own corporatepurchases of German cars, Italian shoes, and scandals and currency and banking problems.French cheese. Furthermore, Europe and Japan import virtually all Second, commodities, particularly those we their oil, also putting their economies and currenciesheavily import — including oil, selenium, rare at risk.earths, copper, lumber, gold, silver, and platinum — As the dollar declines, the best foreign currencieswill soar. In fact, they already have risen. to invest in are those that are either backed by Third, interest rates will go much higher. gold or strongly linked to commodity prices, hence Fourth, a sharp dollar decline will curtail the retaining their value over time. The following threeconsumption bubble. Not only will foreign goods currencies are our top picks: the Swiss franc, thebe more expensive but so will the price of virtually New Zealand dollar, and the Australian dollar.everything you buy because nearly all goods, Indeed, all three have had tremendousincluding those stamped “Made in America,” use appreciation and will likely continue to rise. Thereimported commodities and parts whose prices are will, of course, be short-term corrections and losses,strongly affected by a falling dollar and rising oil but the long-term outlook is great. (The Britishprices. pound will remain a quality store of value, too, as Between rising prices, higher taxes, and falling long as Britain does not fully engage the Europeanincomes in a declining economy, households will Union and accept the euro as its single currency.)face a serious income squeeze. Currencies of Switzerland, New Zealand, and Fifth, the United States may be forced to cut back Australia are attractive because the countries thaton foreign military operations, which are already issue them are peaceful, free, prosperous, and stable.proving much more expensive than anticipated. They are also not targeted by terrorists and have Finally, for savvy investors, the falling dollar will not experienced anything comparable to the U.S.create huge profits for investors in commodities, corporate scandals and dot-com crash. Switzerlandprecious metals, foreign debt, equities, and also has the most stable banks in the world andcurrencies. much better bank secrecy laws than the United States and most of Europe.Investing Recommendations to There are four main ways to invest in foreign currencies:Protect Against a Falling Dollar 1. Buy foreign currency. You can exchange your As we regularly note, it is critically important for dollars at a currency exchange or bank for foreigninvestors to diversify their holdings. This includes currency and then keep your currency in a safe-investing outside the United States. We are not deposit box. We do not advise that you take thissuggesting that you move most of your portfolio route, but most large U.S. banks provide currencyoffshore. There are and will continue to be strong exchange and safe-deposit boxes.investment opportunities in the United States. 2. Open a savings account denominated in a Still, you must continue to hedge your portfolio. foreign currency.We have suggested that 5 to 10 percent of your 3. Buy a foreign currency denominated CD.portfolio be placed in a mix of gold investments: gold 4. Invest in foreign currency options. Whilecoins, bullion, mining shares, and perhaps options. risky, this method also has the advantage of giving The same advice applies to international you tremendous leverage — as much as 50 to 1.investing. We suggest that 10 to 20 percent of For comparison, if you buy $5,000 worth of Swissyour portfolio be placed in a range of foreign francs and they go up 10 percent, you will makeinvestments, including currencies, foreign bonds, $500, less your transaction fees. However, with
  17. 17. Page 17 Financial Intelligence Report Special Reportthe same $5,000, you could control as much as of this writing, these funds had such track records:$250,000 worth of Swiss francs. If the franc goes up Mutual European Fund (TEMIX), Templeton10 percent, your profit will not be $500 but $25,000 Global Income Fund (GIM), Templeton Global(less transaction fees), or 50 times as much. On the Opportunities Fund (TEGOX), and the Templetondownside, you could lose your entire investment. Global Smaller Companies Fund (TEMGX). • International Funds: It is often difficult to Editor’s Note: For further reading, see articlestrack the activities of foreign equities and debt regarding the U.S. dollar in issues 3, 15, 18, 22, 24,instruments. An excellent approach is to invest in 26, 27, 28, 32, 36, 39, 42, 43, 51, 68, 77, 78,investment funds that have proven track records. As and 86. Use Global Sector Investing to Profit From a Soft U.S. Economy In June 2007, Issue 44 of the newsletter, author been able to rely on America’s solid corporateJohn Browne tackled a familiar but important topic financial reporting, legal system, and accountingfor regular readers of Financial Intelligence Report, regulations. As a result, America has historically ledas he detailed the factors that strongly support the world in terms of consumer demand and wealthhaving a global reach in your portfolio. generation. For sure, most Americans saw the biggest For several years, the buzzword of business has economic and financial opportunities right herebeen “globalization.” Economists will tell you that at home. And investors around the globe saw theglobalization leads to improvements in the standard United States as the best place to put their capital.of living for consumers in the United States andabroad. However, my friend Lou Dobbs at CNN The World Is Changingand many, many others have recently been decrying Over the past two decades, numerous factorsthe effects globalization is having on America. And have changed the fundamentals of the Americanthey may have some very legitimate points. and world economies. One dramatic change was the But whether the effects of globalization should collapse of communism in Russia and the end of thebe considered as a positive development or not, one Cold War during the 1990s.point is clear — globalization is taking place on a As you may know, I was the first representative ofgrand scale and you will need to ride this wave to a NATO country to deal significantly with Mikhailgrow your wealth in the months and years ahead. Gorbachev when he was an agriculture secretary For some people, especially in the United States, for the Soviet Union. When he came to Britain onthinking globally is a new process. a visit, Prime Minister Margaret Thatcher asked Sir John Templeton, the father of modern global me to be his guide. After spending a few days withinvesting, relates that when he first told investors in Gorbachev, I told the prime minister that he wasthe 1930s and ’40s to invest globally, he was viewed a man who would fundamentally change a traitor to America. I believe my comments had an effect on her when Investors here and abroad have long viewed she later said Gorbachev was a man “we could doAmerica as “the land of opportunity.” Up until the business with.”past few years, this perspective has not been terribly Since the fall of the Berlin Wall, the world wassurprising, given America’s vast economic resources truly opened for free trade. As a result, more andand its technological advances, superior educational more countries have implemented free-marketsystem, and overall wealth. policies over the past 15 years. Many of these It was also true that business had been able to countries have only just begun to build up their“keep corruption at bay” and that investors have basic economic infrastructures, and America now
  18. 18. Page 18 Financial Intelligence Report Special Reportfaces a worldwide economic “build-out” many First, we think Americans can no longer ignore thehundreds of times larger than the great build-out of vast financial opportunities offered by investingthe United States following the end of World War II. abroad. Second, we advocate “sector investing” in This massive infrastructure building is taking those sectors of the market that are expected toplace primarily in emerging markets, and it likely benefit the most from underlying economic andwill follow the same course America did over the geopolitical developments, as well as from changespast 100 years. Already we have seen commodity in demographic factors.prices spike in recent years because of the demand As a result, we recommend that our subscribersfrom emerging nations. invest the majority of their financial assets in a Demand for such commodities may slow, but it select group of investments that will benefit becausewill still be on an upward trend as these nations of their links with a key sector or an emergingseek more financial capital, food, raw materials, economy.industrial metals, infrastructure (roads, factories, Sector investing is critical for success. Studiesetc.), and consumer products. This demand will have shown that 75 to 80 percent of a stock’sresult in a major worldwide reallocation of movement is generally the result of major factorsresources and political power. affecting the sector (or specific industry) in which the underlying company operates.Fortunes Will Be Made and Lost We think one of the better ways to implement We can already see the effects of these changes in a successful sector investing strategy is to invest inthe world’s capital markets. Economic growth and exchange-traded markets in many of the world’s emerging We have long posited that the key to makingeconomies have been growing at a rapid rate over money with sector investing is to understand keythe past several years. trends. Understand these trends and invest in the You might ask, “How can I take advantage of sectors that track those trends, and you almostglobalization and the major shifts in economic always will profit.growth and financial returns?” The answer is simple.You must become a global investor. Editor’s Note: For more information on Through the years, Financial Intelligence international investing, please see issues 8,16, 19,Report has been devoted to two main themes. 31, 43, 51, 67, 79, 83, and 92. Beware the ‘Decoupling’ Myth: Emerging Market Stocks Can Be Risky Bob Wiedemer, the in-demand co-author of shown by the Sensex Index, have more than doubledthe best-selling financial tome Aftershock: Protect since the start of 2009.Yourself and Profit in the Next Global Financial Many investors hope that such good returns willMeltdown, joined the Financial Intelligence Report continue and get even better and that the growthBrain Trust team in 2010. He penned this article for in emerging markets will be the next big boom thatIssue 89, published in April 2011. pushes the U.S. economy forward. However, all this assumes that growth in Is it time to go abroad? Many people seem to emerging countries is not tied to growth in thethink so. International stock funds have been the U.S. economy. During the past couple of years, itdarlings of investors. Flows of cash into such funds certainly appeared that way because the Unitednearly doubled to $58.9 billion in 2010 from $30.6 States had slow growth while emerging marketsbillion in 2009. grew rapidly. Some overseas stock markets, such as India’s, as In the past, however, that’s not how people
  19. 19. Special Report Financial Intelligence Report Page 19looked at the world. Emerging market growth was exported and how fast they can grow.driven by the engine of world economic growth, Also, India still retains some of the economicthe U.S. economy. Remember the old saying: If the instability and infrastructure problems that haveU.S. economy catches a cold, the world comes down plagued it for decades. Fundamentally strongwith pneumonia. countries such as Canada and Germany are Of course, that is because emerging market benefiting greatly from the Chinese constructioneconomies are heavily dependent on exports to us bubble. When that pops, there will be problems.and to Europe for growth. Some people believe Then, when the U.S. economy pops because of itsthat has changed and that emerging market money printing and massive government borrowing,countries, especially China, have developed domestic consumer spending will decline again, multiplyingeconomies that can power their own growth the maladies.without exports. The argument is called “decoupling” in economic Dangerous Bubbles Afootcircles. The sustaining belief is that the rest of theworld needs America less and less, that they have A lot of the move up for emerging market stocks“decoupled” their growth story from our own. can be traced directly back to the U.S. Federal The reality is that most emerging market Reserve System and its money-printing operation.economies are still highly dependent on exports. Stocks rose sharply after the announcement of newAnd those exports are even more important because “quantitative easing” in August 2010, then leveledof the export jobs multiplier. The multiplier means off once it was clear that such easing also meantthat for every job exports directly create, one to two stronger inflation in those countries.more additional jobs are also created as a result. As we know, stock markets can decline much It’s similar to the rule economists use for local faster than economies when things turn south. Aeconomies, such as a city. Every job in a city for great reminder of that is the 15 percent loss on thewhich the resulting products’ demand resides Shanghai Index during a year of explosive Chineseoutside the city, such as when Detroit sends its cars economic growth in 2010. The decline was dueto other U.S. cities, creates one to two additional simply to the fear that growth might slow somewhatsupport jobs — sales, marketing, car parts, finance following interest rate increases.— in Detroit. Many of these markets, including the Chinese I think a large part of the reason people believe stock market, have experienced rapid growth overthat exports are not as important to emerging the past five years, making them ripe for a is the enormous growth China has seen in High economic growth often doesn’t translate into extremely high stock market growth, even in thethe past couple of years. It grew despite a decline in short run.exports resulting from U.S. and European economic So, the rule is simple — playing with bubbles isrecessions and subsequent slow recoveries. dangerous stuff. Properly timed, bubbles can pump up your investment portfolio, but you have to bePlay Emerging Markets With Care willing to take the risk of a sudden and unwelcome So much excitement surrounds emerging market pop.funds that it’s not surprising that the crowd wantsin. In a bubble mood, that’s not a bad place to Editor’s Note: In the few months after thisbe. The key is getting out before the bubble pops. article came out, China’s stock market corrected byAnd that’s the big problem with nearly all foreign nearly 20 percent (quite normal for a developingequities: They are not long-term plays. country’s stock market). Over a longer 10-year time Even countries such as Turkey will have frame, however, the overall gains in the markets ofproblems with Middle East exports if the Chinese emerging economies have trounced stock marketconstruction bubble pops and the prices of oil and returns in mature, market-established countries.other commodities decline on the world markets. Which emerging markets are bubbles? Time will tell. India has the best economic fundamentals in As noted with the previous article, international-terms of the cost-saving nature of its services, but related investment articles can be found in issues 8,there are limits to just how much services can be 16, 19, 31, 43, 51, 67, 79, 83, and 92.
  20. 20. Page 20 Financial Intelligence Report Special Report China Holds the Key to U.S. Economic Revival This article, written for FIR by respected countries — and the nature of that relationship iseconomist John F. Sheehan for the May 2005 issue not friendly but predatory, threatening to destroy(Issue 19), still resonates with its critical analysis America’s economic position. The statistical weightof the U.S.’s precarious position caused by its of this relationship on global trade and capital flowsunbalanced financial relationship with China. is awesome. Since 1995, 60 percent of the world’s cumulative Americans should not underestimate the output demand has come from America, whichenormous leverage they have on the global economy is twice America’s share of global gross domesticin general and on China in particular. But they product (demand). American spending has beenshould not underestimate America’s vulnerability to up 3.5 percent per year since 1995, which is twicea crash from this relationship, either. the increase of the rest of G-7 countries combined. America has become so dependent on Chinese And 75 percent of China’s economy is dedicated toand global lending to finance its imports from China foreign trade, 64 percent of the entire Pacific Rim’sthat the resulting distortions to the international is (up from 55 percent in the early 1990s), andfinancial markets are becoming unmanageable. pretty much all of East Asia’s “intra-Asian trade” isWhatever you hear about the health of the American dedicated to supplying manufacturers that export toeconomy, America is living in a fool’s paradise the U.S. market. That means Asia’s development isbecause it is all on borrowed money. Indeed, the certainly not self-sustaining, and without Americanwhole real estate asset bubble (which also has imports, intra-Asian trade will certainly collapse.financed consumer demand) has been financed by This is especially true for China, which only hasChinese and other Asian purchases of Ginnie Mae, a current account surplus with the United StatesFannie Mae, and Freddie Mac paper, which keeps while it is probably in a deficit with the rest of thethe American real estate market liquid and is bigger world. While China must import capital goods andthan the market for U.S. Treasury securities. raw materials for what it manufactures for America, China and other Asian countries own more than its dependence on other countries for its so-calledhalf of all this paper, meaning they control the inevitable rise is total. Moreover, Asia’s overcapacityliquidity of the American real estate and consumer is so massive, so overdependent on Americancredit market as much as the Federal Reserve Bank. demand, and so geared to American prices that By financing our purchases of Chinese Asia could not absorb its own production even if itmanufactured goods, the Chinese have been turning wanted to.America into an economic colony of China. This isbankrupting our national finances, destroying our Keeping China Afloatcurrency, and hollowing out our industry. Indeed, The inevitability of the rise of Asia and China,we are engaged in a self-destructive co-dependency therefore, is a myth. It is a phenomenon dependentwith China that is unsustainable and has turned on American indulgence. By withholding tradeglobalization into a Chinese-American affair. Most and investment, it can be stopped … like otherof the Third World development foreign direct Asian countries before it, China’s capital-intensiveinvestment has been diverted to China, and most all manufacturing export strategy is hitting a line ofof China’s manufactured exports go to America. diminishing returns. China’s advantage is that unlike All these exports are financed by loans made to most other Asian countries, it has an unlimitedAmericans from Chinese and other Asian central supply of cheap labor. Like other Asian countries,banks. This co-dependency will collapse because however, it is still overdependent on America.the global economy has become overdependent on The only thing that keeps Chinese banks fromthe credit and trading relationship between two collapsing from bad loans is the amazing Chinese