Investing in Disturbing Times (4) – What to do in a Depression?

Investing in Disturbing times (4) – What to do in a Depression?

There are a few key points that must be remembered when dealing with the investment choices in a depression or major recession.

The first is that the flow of wealth as a recession progresses into a depression can be simplified as follows. Stocks to Bonds to Bank Accounts to Cash to Gold. And then back to Stocks, and the cycle resumes.

The second is the adage, ‘Buy Low, Sell High”. The third is to keep ahead of the ‘herd’ and by the ‘herd’ we mean the sheeple, the plebs, the masses, the lumpen or whatever you may choose to call the average Joe that follows the majority. You keep ahead by owning today, what the masses will run to tomorrow. The fourth is the core principle, ‘The best defence is good offence’.

Let’s look at the first point. Back in 2007 and 2008 when warnings were sounded about the bubbles in the housing and stock markets, the talking heads in TV, and a host of other experts, said that we were in a new paradigm. Gold was already on the rise, after staying below 400 dollars for the better part of a decade, but was still pooh poohed by some as a barbaric relic.

When equity markets fall, the first shift is usually into bonds. With stocks you own a small part of the company, expecting to share in its profit via dividends and enjoy capital appreciation as prices rise. With bonds, you loan money to the company, and are the first to be paid, so its viewed as being safer than stocks, but with lower returns. When companies start floundering, and earnings fall, wealth seeks the security of bank accounts, waiting for things to turn around.

When banks start collapsing, and the problems become more serious, people cut down on spending and begin saving cash, as well as liquidate what they can to hold more cash. Taken too far, this can lead to too little money chasing after too much goods, causing prices to fall and could lead to a deflationary depression, like Japan enjoyed from 1991. A few of the countries of the former Soviet Union are still in a depression since the fall of communism.

The threat of deflation is one of the excuses used to increase money supply, and the prospect of hyperinflation pushes wealth into Gold, as we see happening today.

The old name for a Depression was Panic, and is perhaps more apt. If you see a person in a continuous state of panic, will the decisions made by that person be reasoned and well judged, or otherwise? There is a news report today that some of the populace of Greece have resorted to buying Gold at prices 40% above spot, or USD 1700 an ounce. Is this a panic reaction to the serious problems affecting their country? Will you still follow suit, if you learned that Silver has been sold at up to 30% above spot due to limited supply, back in 2008? The premium for gold coins and bars do reach 40%, and a premium of 10% above spot prices is still considered to be very acceptable.

Lets look at the current gold chart in USD. The line remains flat till 1971 as the USD was pegged to gold at 35 dollars to the ounce, before Nixon shut the Gold window in 1971. It went up to USD 850 in 1980, and the DOW fell to about 800, so the DOW /Gold ratio actually fell to below 1. Let us say that the same event will occur now, and the price of Gold increases to a point where an ounce of Gold buys the DOW, and let us say that point will be at DOW 5000.

What happens after that? After 1980, stocks rose and the price of gold fell to USD 250, and at the peak 20 years later in 2000, the DOW bought 44.56 ounces of gold. Who were the people that were buying into Gold in 1980 at USD 850 an ounce? The sophisticated investor, or the panicked masses?

Point number 2. Buy Low, Sell High. Perhaps the easiest words to remember, and yet rarely followed. Buy High, Sell Higher is when you think that there will be a greater fool coming along to buy at a higher price than you paid. But if everyone has already bought into the asset, who is the ‘greater fool’ who is going to come along and push prices higher. And even if a ‘greater fool’ does come along, and someone decides to cash out, and the deal gets brokered at a lower price, causing the ‘greater fool’ to panic again and immediately sell, at an even lower price, and suddenly there are no buyers, only sellers, and the price plummets, and you are stuck in a market where prices are falling so fast you cant get out, and you panic, and the world comes crashing down…..

Buy Low, Sell High. The DOW is at 8 ounces of Gold, 50% below its 100 year average of 12 ounces, some sectors are already trading at low P/E’s. Copper, Cocoa, Wheat, Coffee etc etc are near all time lows against Gold. Water, the crown prince to the throne of king of commodities, after crude oil abdicates, is the next big thing, and those that get in early can make a pretty penny. Alternative energy is necessary, and companies are working on the many alternatives available, to make them commercially viable. Mining companies still mine Gold and Silver, and other metals, and guess what, you can own shares in them.

Point 3. Stay ahead of the masses. To do this you do not need to do the Bonds to Cash to Gold thing, just buy into the next thing, that represents recovery and growth, equities and commodities and energy and water and so many more choices.

Point 4. The best defence is right action. Do you have an investment time frame that can extend further than tomorrows headline? Knowing what you do today, will you choose to buy into Gold or Stocks if you could beam back to 1980? Or will you beam back, and read the headlines and listen to the talking heads on TV, and buy Gold at USD 850 because everyone else is doing it?

There are three directions for the equity markets from this point forward.

1. They go up, in which case you lose out if you have nothing in them.

2. They stay flat, for an extended period, in which case, you still earn dividends and with some global markets at a P/E of 11, that is still more than enough to outpace inflation.

3. They go down, my personal wish, so that you can average down your purchase price as well as earn ever increasing dividends, and more importantly, do not have to worry about picking market bottoms.

There are three scenarios if you do nothing, depending on which strata of society you fall into.

1. Upper class. You are truly wealthy, and stay in cash and a bit of gold. 20 years down the road, you are worth a quarter of what you are today, but because a quarter for you is still 25 million ringgit, you will be fine, just ‘poorer’.

2. Lower class. Your old habit of buying into gold jewellery as the preferred method of saving, stands you in good stead against inflation. The repatriation of illegals will open up additional income streams for you, and the fact that you are quicker to embrace small scale agriculture and home based enterprises to supplement your income, makes you the most resilient of all three classes.

3. Middle class. You panic perhaps?

In much earlier postings on the economy and investing, my mantra has been Gold, and wait for the opportunity to buy into growth assets when prices drop. I believe the time has come, judging by the increasing cheapness of growth assets as opposed to Gold. As money (paper) continues to buy more money(gold), the smart money can now move into growth assets, because once the masses realise that they have been duped again, money will flow back into the usual areas.

This depression won’t be as devastating as the last one, even though the structural problems in monetary policy are more serious. I give you three reasons.

1. Unemployment. During the last depression, unemployment hit 20%, but most households were single income households at that time; with dual income households now, unemployment will have to reach a higher level to have an equal effect.

2. Globalisation. Greater access to global opportunities allows capital to flow to where it can bring about the greatest increase in productivity. With knowledge flow being nearly instantaneous, technology crosses borders at will to capitalise on opportunities.

3. India and China. 250 years ago, India was the worlds largest economy, and China was second. The reawakening of these two giants, and their contribution to global growth, along with many other developing economies in Latin America and Asia, makes the mid to long term prospects of the global economy look quite yummy.

World War II took the nations out of a depression the last time around. Is the prospect of a major war there today? In war, that nasty business that uses the blood of youths as capital, it is Iron and Industry that is king, and not gold, unless you happen to be in the war zone.

Malaysia, despite its many imperfections in governance and ethical failings, is still a land of plenty, because of its oil and gas reserves (10 and 30 years worth respectively). Coupled with the fact that the illegals will be the first to be forced out, it provides a buffer effect for Malaysian labour. Rain aplenty and fertile soil gives us the additional buffer of being able to return to agriculture as a fail-safe, perhaps something that we should already be doing a bit more seriously.

As a Malaysian, you are in a position to grow your wealth from a position of relative strength, even when compared to our immediate neighbours. Asset allocation determines 90% of the outcome of your wealth. Sit with your financial adviser and get that sorted out, the sooner the better.

Jeevindra Kumar

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