August 14, 2016 Duh!

Risk/Reward Vol. 318

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HERE

Here are some observations from this week.

1) An article in Tuesday's Wall Street Journal reported that central bankers are surprised that lower rates have spurred excessive savings as opposed to more borrowing and more consumption. Really? Are you kidding? Sorry, bankers, but most people recognize that they are personally responsible for their own well being---including saving for retirement. Unlike central banks, they cannot print more money. When low interest rates rob savers of a decent return, the only rational response is to save more----not spend more. Savings rates in Germany for example are their highest since 1995. The financial world is beginning to awaken to the idea that central banks may have it wrong. I recommend to your attention the opinion piece written by author and hedge fund manager Eric Lonergan in Saturday's Financial Times. Here are three quotes: "Central bank models assume that, when real interest rates fall, consumer spending rises." "This assumed relationship has little empirical support and there are good reasons, particularly when rates are extremely low or negative, to doubt it." "The relationship of spending to lower interest rates may well be the reverse of that assumed by policymakers." And here are some quotes from an article by James Dorn of the Cato Institute in Saturday's Investor's Business Daily. "The manipulation of interest rates by central bankers to support asset prices and fund government debt is a recipe for disaster....Central bankers have too much power and too little humility regarding the limits of monetary policy." Are our central bankers and the economists they employ really just a bunch of unthinking, blind following the blind sheep leading us down a wrong path? I think so.

2) Many commentators are surprised that the price of gold has appreciated 26% year to date given that inflation is near zero? Really? Gold operates not only as a hedge against inflation but also as a hedge against currency debasement. Take a look at the British Pound. As a result of Brexit and the newest round of quantitative easing (discussed below), the pound has fallen 12% against the dollar so far this year and 17% against the Euro. If a Brit had owned gold instead of pounds on January 1st, he/she would have seen an additional commensurate gain since gold prices are denominated in dollars.

3) And speaking of the UK, the Bank of England had an inauspicious beginning to its ambitious bond buying program (quantitative easing) on Tuesday. It could not find enough government bonds (gilts) to buy! That's right, despite a willingness to pay almost any price, it could not catch an ask. Why? Because the current holders either are required to own gilts (eg. pension funds or insurance companies) or they are holding out for even higher bids. In any event, the 10Year gilt hit an all time high that day meaning that it set a record low yield, 0.5%, and the yield on the 2year gilt went negative. Britain's experience is emblematic of the limits of quantitative easing. Already, the BOE owns 25% of all of Britain's sovereign debt. The Bank of Japan owns 1/3rd of Japan's sovereign debt and the ECB owns 25% of Eurozone sovereign debt. No ordinary citizen would be caught dead owning a bond with a negative or nearly negative yield. Can anyone say Ponzi---only this time governments are cheating themselves (or should I say their citizens). Think of the loss each central bank would take if interest rates increase and they try to unload these pigs?

4) Tandem Investment Advisors is one of the investment managers that Barb and I employ for a portion of the money that I do not manage personally. From time to time, Tandem issues investment letters. I highly recommend reading its most recent one which can be found here. http://tandemadvisors.com/wp-content/uploads/2016/07/The-TANDEM-Report-July-2016.pdf Therein it compares the amount of risk that an investor needed to take to achieve a 7.5% return in 1995 (nearly none) to the amount of risk needed to achieve such a return today (almost not worth it). Why? Because of what I have been harping about for lo these past months and years---suppression of rates by central bankers. As noted by Tandem, people like me who should be mostly in bonds cannot get a decent return and are forced to own equities or other like instruments. This causes the stock market bubble to be even more engorged. With all three major indices hitting record highs this week, Tandem's advice is very timely: "We love rising stock prices. But...be mindful of the fact that the higher stock prices go the less the margin of error becomes. Enjoy the party, but stay close to the exit." I always do.

5) Oil prices dipped on Wednesday only to recover nicely on Thursday. The cause of the fall was a report that Saudi Arabia pumped a record 11million barrels/day in July and that both Iraq and Iran are ramping up their production. The rise resulted from comments from the Saudi oil minister that he was open to price stabilization talks at next months OPEC meeting. This insane volatility may last for a while---at least until the Saudi's get closer to selling a portion of their state owned oil company to the public. Then look for some stability.

6) On Thursday, the former head demographer for the United Nations issued a report that by 2030, fifty six (56) countries will have more people over the age of 65 than under the age of 15. And economists still think we can achieve 3+% growth consistently? They have been wrong with their predictions for more than 8 years. What makes them (or you) think they will get it right now? Read Ben Bernanke's Brookings Institute blog issued last week which can be found here. The Fed’s shifting perspective on the economy and its implications for monetary policy | Brookings Institution . Even he doubts the Fed's prognosticating skills.

7) I am still in cash, and happily so.