Porter Stansberry's Theories of Relativity
Source: By Karen Roche of The Gold Report (7/9/10)
Stansberry & Associates Investment Research Founder Porter Stansberry, who built his reputation on finding safe-value investments that yield years of exceptional returns, shares with The Gold Report readers some of the things he's doing to hedge against market volatility and currency devaluation.
Porter Stansberry: The largest economic bloc in the world having difficulty getting access to additional credit implies a really big slowdown in global GDP. I don't think many people realize that the European Union is actually the largest economic bloc in the world, but people are waking up to the fact that Europe's troubles are not going away. More and more creditors around the world—China being the latest one—are waking up to the fact that loaning more money to Greece, Spain, Italy, Portugal and Ireland isn't going to solve any of their problems. The paper bailouts that the ECB has orchestrated over the last year are not solving the problem. Extending maturities and terms of debt to a bankrupt country doesn't make it solvent. It merely postpones the day of reckoning.
TGR: But we do see those countries taking massive austerity measures. In fact, a big conversation at the G-20 in Toronto focused on the contrast between this movement in Europe and Obama's desire to continue stimulus tactics. Are we in a situation where we'll see competing powerful economic approaches to the debt issue?
PS: I can't say I have a lock on what the outcome will be. I was an emerging markets analyst in the 1990s. If you remember the Thai baht, the Indonesia rupiah, the Malaysian ringgit and on down the line—all of them had to devalue, and most of those countries had to restructure their debts. That's what it took to make their economies more competitive. It was the only way for them to get the hard currency they needed to pay down the principal on their obligations.
From my perspective, nothing Europe has done so far is anywhere in the ballpark of allowing them to pay down the principal on their obligations. They haven't massively devalued their currencies, although Hungary is in the process of doing so with its florint. They certainly haven't lowered the structural costs of their economies, and I don't know that they will be willing or able to do that.
Let me be very clear. I am not at all in favor of competitive devaluation. That's one of the big weaknesses of the world's paper currency standards. Every country gets out of trouble by basically robbing its citizens by taking away their purchasing power, but that is what has to be done in the world as it exists today. For Europe to get back on its feet and to have real growth, it's going to have to massively devalue the euro, and I expect the euro's structure to change significantly. These governments can cut their budgets and live under "austerity," but all that's really going to do is slow down their economies even more and make them even less competitive globally. That's why gold and silver are such important hedges for people to have.
TGR: So austerity won't work.
PS: No, I don't think the European model is going to work. And because it's the world's largest economic bloc, you're not going to see global growth rebound until some kind of drastic restructuring of Europe's sovereign debts takes place, or until the euro massively devalues. As more creditors come to doubt these debt structures, you're going to see a really big problem because Europe will be forced to monetize a lot of debt. That eventually will result in a lot of devaluation and a lot of inflation. Investors see all this coming, and of course are withdrawing from that currency zone.
TGR: Playing forward the concept of the world's largest economic power devaluing currencies and/or restructuring debts, what's the impact in the rest of the world?
PS: Look back to the Great Depression. The stock market crashed in 1929. Banks were on edge all around the world because the values of their assets had fallen, but the value of their obligations hadn't. Look at General Electric Company (NYSE:GE) as an example of these balance sheet stresses today. GE has something like $22 billion worth of mortgages in the United Kingdom; $1 billion in Hungary; maybe $5 million or $6 billion in Poland. All of these things are under water, and they're never coming back. Meanwhile, GE has only $40 billion or so in tangible equity. Their creditors have balked and governments have come in to guarantee the creditors. But it's a stalemate; GE has refused to write down these losses, and sooner or later, the government will have to nationalize it or it will have to go bankrupt. The losses will not go away even if you don't recognize them. The same thing is true of most of the large banks in Europe. The problem is, if you go ahead and devalue the euro, the stresses on the banks in Europe and the contagion to the banking entities in the U.S. would be catastrophic.
There's no way to get the economy going again until these losses have been marked down and taken. That's why this whole thing is just a big train wreck, and it's impossible to move forward because we haven't recognized the losses of 2007, 2008 and 2009.
TGR: The world's governments were quick to jump in 2008 in terms of bailing out the financial institutions. The bill in the U.S. Congress today is leaning toward letting major banks fail. What's worse? Bankruptcies? Or continuing to inflate the money supply or devalue the dollar to cover these banks' liabilities?
PS: I approach things sort of from a moral standpoint, and I think it's immoral to bail out the banks. It's not right for people to be taxed either directly or indirectly through inflation to pay for the investment mistakes of an entity that they had no obligation to. I don't owe Citigroup Inc. (NYSE/NASDAQ:C) anything. The government shouldn't be taking something from me to make good the creditors of Citigroup. It's not my fault; it's their fault. So I am firmly in the camp of letting them fail. GE made a bunch of dumb investments. It's too bad for the equity holders and investors in GE and its creditors of GE, and those losses have to be taken. The longer they're postponed, the more expensive they become, the larger the cost to society, and more importantly the further into the future it pushes an economic recovery.
These bad debts and these losses are not going to go away. They're either going to be papered over through inflation over a period of many years, which would be very painful and very expensive to society, or they've just got to be written down and written off and allow the economy to clear and people to move forward.
TGR: Aren't you dismissing the collateral damage to the general population when a major bank fails?
PS: It's a horrific, horrific thing. But extending it over the next 10 to 15 years and taking the savings of millions of people who had nothing to do with these decisions is no less horrific.
TGR: Point taken. You mentioned earlier that people should have precious metals as a hedge against devalued currencies and impending inflation. For those who don't have gold and silver, is it too late to come to the table? Is it just the right time?
PS: It's certainly not just the right time. Unfortunately, hindsight is 20/20. We were telling our readers to buy gold beginning in 2001 and 2002, but that was simply because we thought the U.S. dollar had become unsustainably strong. We expected it to fall, and since gold is inversely correlated to the dollar and is priced in dollars, our recommendation was just based on value. As inflation was heating up, it made sense as an inflation hedge too. And now we think it makes sense as a catastrophe hedge.
I can briefly sum it up for you. What most people don't understand is that as the world's reserve currency, the U.S. dollar is considered the highest-caliber reserve by central banks and private banks around the world. When foreign countries want to increase their money supply, when private banks want to expand their loan portfolios, they acquire dollars to have in reserve. That has powered an enormous current account deficit and an enormous expansion of government debt in the United States. The U.S. is just no longer a big enough economy to be the world's only reserve currency any more.
This entire system is going to collapse, and there are two compelling reasons why. First, the U.S. government clearly cannot afford these debts. Total government debt outstanding has surpassed $13 trillion; more than 100% of GDP. There's no question that it can't be repaid. But secondly, there's also no question that the world economy needs other reserves because the emerging markets have grown so large and other economies are now much bigger in relation to the U.S. than they were 20 years ago. We need a whole new standard of reserve currency.
TGR: And the alternative would be?
PS: Throughout the history of mankind, even into the 1900s, gold was the only thing all trading partners could agree upon and rely upon. There's no doubt in my mind that gold will become the reserve currency once again. It will drive demand for gold way up, and therefore the price of gold will go way up. There's no way the market has begun to price in that change going forward, and I see it as inevitable.
TGR: Over what timeframe?
PS: That's very hard to say. My bias is that it's going to happen sooner than anyone believes possible, but that still may not be for another five or 10 years. More and more of the U.S. government's creditors are already complaining about quantitative easing and the country's debt load. And the Obama administration has been completely cavalier about the size of these debts. They're continuing to mount—$1.6 trillion.
TGR: Over the next two to three years, does the fact that the U.S. dollar is the world's reserve currency provide a buffer because there's no alternative?
PS: That's exactly right, and that's why any time there's a problem in the world, whether it's Europe's latest refinancing or whatever, people run to the dollar and the Treasury yield falls. You see that time after time. What's interesting to me is that as much as the dollar has strengthened over the last three months compared to the euro, gold keeps setting new highs. Gold is able to compete with the dollar, and that is a really significant change. If you look back over 30 years, you won't find any other period of time where for 90 days, 180 days or even the whole year where the dollar and gold rose in tandem. That's a very, very new phenomenon in the world of currencies, and in my opinion, it is certainly very significant.
TGR: Will gold take off into a mania phase or is it really more of a measured waltz of the dollar and gold waltzing while the world figures out what the next reserve currency will be?
PS: I have no evidence whatsoever that this will happen—but I can imagine market rumors that some major U.S. trading partner, whether China or Saudi Arabia, is beginning to demand bullion in exchange for goods, and that negotiations are underway to come up with some new exchange program whereby 50% of the trade receipt has to be in gold, 50% can be in dollars, something like that. Of course, the Finance Minister of China or Saudi Arabia will come out on national TV or CNBC and deny these rumors until the cows come home. That's how you'll know it's true. That will lead to a massive re-rating of gold around the world.
Perhaps that's part of the reason the IMF is selling its gold hoard, and of course denying it. My best bet is that Brazil will buy that hoard. Everyone else says China, but I really think Brazil's economy will play a much larger role in the world going forward and Brazil holds almost no gold at all (less than 1% of its reserves) in its foreign exchange reserves.
TGR: Returning to our individual investor's viewpoint, how does the investor protect himself?
PS: I would concentrate on two things. At the end of every year, after I've paid for my Christmas gifts, I see how much money I have left over and put all of it into bullion. It's my own private savings reserve. I don't think of it in terms of making money. You can do this annually, quarterly, monthly—whatever works for you. That's one thing I would encourage everybody to do. Keep your savings in gold and keep it someplace safe. I worry about my gold being confiscated by the government, so I don't keep it in a bank, and I surely won't keep it at home. I don't want anybody invading my house looking for gold. I put it someplace where I don't live and where the government isn't going to look for it.
TGR: You say keep your savings in gold; what about investments?
PS: Two options. If you really want to get into it, plug in all the numbers, figure out the value of each gold producing company's production, and then decide when to buy gold stocks based on the value of the company's production and the price of gold.
But the easy and simple way is just to look at a ratio of SPDR Gold Trust (ETF) (NYSE:GLD) (the largest gold bullion ETF) to Market Vectors Gold Miners (NYSE:GDX) (the gold stock ETF), and buy GDX when it's cheap relative to gold. Look at the spread between the gold stock ETF and the gold bullion ETF. Wait for that spread to be really wide, when gold stocks trade at a really big discount to the value of their production. Buying GDX when it's cheap compared to GLD gives you a nice buffer for volatility because you're buying at a big discount to gold.
The last time you really had a good chance to do that was the panic in '08. If you look at the charts of GLD and GDX that fall, the spread was enormous. At one point it was over 100%, meaning that GLD was twice as expensive as GDX. If you can buy gold stocks when they're cheap relative to gold, you'll always do well.
TGR: What should the spread be if they're at parity?
PS: You'll get a real feel for it if you just eyeball the charts. Oftentimes GDX is at a small premium to GLD, and rarely at a big discount. Over the last year or so, GDX generally has been at a premium, and right now it's about parity. You'll want to wait for the spread to widen to maybe 25% to 30% before you start nibbling at the gold stocks.
TGR: When you decide to nibble at mining companies and so on, does anything in particular appeal to you?
PS: Certainly at times I've bought mining companies that other analysts bring to my attention, but I am not really a single-stock mining guy. I don't know enough about what I'm doing in that arena—or have enough interest in it—to have confidence in my ability to pick a winning mine. There are way too many variables. If I don't understand it, if I can't look at the numbers and know what's going on, I'm not comfortable. There are people who can do that; I am not one of them.
TGR: Anyone in particular who makes you comfortable?
PS: John Doody (Gold Stock Analyst) does a really good job of analyzing the production value of the different mining companies that have real, ongoing production—and he doesn't work for me, so this isn't a plug for my business. Producing mines are a lot easier to analyze than exploration and development plays because you don't have to worry about the value of what may be in the ground. You look at the value of what's coming out of the mine. John does a really good job of showing not only whether gold stocks in general are at a discount to gold, but which gold stocks that are producing gold today are at the biggest discount to gold. His track record is phenomenal. Over the last 20 years or so he's averaged more than 15% a year just using this trading method. Whether gold goes up or down doesn't matter because he's buying stocks at a discount to their production value.
TGR: What's your view of silver? Of The Gold Report's various contributors, many argue that silver will continue to act like an industrial metal until gold takes off to the stratosphere. Many others claim that it's already converting from an industrial metal to a precious metal.
PS: I have an out-of-consensus view that precious metals will become reserve currency standard in the near future, and I would be very surprised for silver not to be a part of that standard in some way, shape or form—whether officially or simply de facto. Historically, silver has been used as money, and demand for silver outside of its use in money has been relatively small compared to demand for silver as money. When silver's been commonly accepted as money, it always traded in a strict ratio to gold of about 15-to-1, meaning it takes about 15 ounces of silver to equal 1 ounce of gold. Right now, the ratio is somewhere around 60, which makes silver very cheap relative to gold.
I like to buy silver, and just like I buy gold stocks (GDX) when they're cheap relative to the price of gold (GLD), I also buy silver when it's cheap relative to the price of gold. For me, that's when the price of gold is more than 60 times the price of silver. But I don't buy silver as a form of savings, just as an investment.
TGR: You've also spoken before about using high-quality discounted bonds as a way to hedge against international currency devaluation. Can you talk a bit about that strategy and how it compares to buying gold equities?
PS: My strategy for buying corporate debt is a lot like my strategy for buying gold stocks. As I explained, I wait for gold stocks to trade at a big discount to gold before I buy them. The same is true in buying corporate debt. I don't buy it anywhere near par. Par is usually around 100 on a bond. I like to look at corporate debt when it trades below 70, and I like to buy it when it trades below 40. These are really distressed instruments, so they end up trading a lot more like equities than bonds.
To do this kind of analysis, though, you really have to know what you're buying. You have to know the tangible equity left in the company and the likelihood for bankruptcy. You have to do a lot of homework. Let me give you one example. AIG is in a quasi-receivership that's held by the federal government, its bonds are trading at a severe discount to par, and you can buy them for around 70. I've looked at all the numbers, debt structure, obligations and assets. I am convinced that AIG's equity—the government owns 80% of it—eventually will be worthless. After paying their debts and selling off assets, I don't think anything will be left over for the common equity holder.
TGR: So stockholders will be left holding the proverbial bag—the empty bag.
PS: But I think the bondholders will be made whole, that the bonds eventually will be worth 100 cents on the dollar. I could make pretty good capital gains if I'm right, if over the next year AIG is able to liquidate enough assets to pay off creditors. There's always a chance that business gets a little bit better, too, and that maybe it will trade at a premium to par.
You can make a lot of money in capital gains in bonds, and of course, if like AIG they're still making interest payments, you get a heck of a lot of cash while you wait. It's a nice position to be in where you have positive carry. AIG bonds now pay something like 15% to 16% yield to maturity; so you earn 15% to 16% to wait while AIG pays off its creditors.
TGR: I think you hit the nail on the head about the detailed work to really understand the underlying assets because clearly these companies are under stress when you're buying their bonds. If day jobs and family obligations don't leave time to do all the homework that's required, are there other ways investors can play in this corporate bonds arena?
PS: Well, I don't actually do a lot of the work myself. I hired a really good analyst, Mike Williams, who puts out our True Income newsletter. That's all he does all day. He's been a bond analyst since 1972. We're not looking for bankruptcy or liquidation, and we're hoping that eventually we'll get paid off at a premium to par, but Mike—who is a very, very thorough analyst—starts with liquidation, the worst-case scenario. If you sold a company today, what would the bonds be worth? How safe are these bonds really? I think it's a huge indictment of the entire credit rating agencies that this kind of research isn't widely available.
TGR: Why do you suppose that research is so hard to come by?
PS: It's because most bond investors are large institutions, such as pension funds and insurance companies, and these people are fundamentally lazy. They won't buy a bond if it's not rated investment grade. Period. The moment bonds are downgraded to "junk" status, nobody even looks at them. That results in huge inefficiencies in the market. If you're careful and know what you're doing, it's a really nice place to invest when the rest of the world is going to hell in a handbasket.
TGR: Some of your newsletters have been discussing widespread fear and increased volatility in the market, leading toward some type of adjustment. Are we experiencing that adjustment now or are you expecting markets to react more to the downside as all of the currency issues we discussed earlier further unfold?
PS: Outside of some really interesting specialty plays—carry-trade stuff, discounted bonds, these kinds of things—I told my readers back in February that there wasn't anything I could safely recommend to them to buy. Regular blue chips and growth stocks and such were way too expensive. There was no value anywhere to be found. So I said we'd maintain a hedge book this year. For every stock I recommend buying, I pair it with one that I recommend shorting. I really think that's the place to be for now. If stocks were to become significantly cheaper, maybe another 10% or 20% down on the Dow and the S&P, value would appear and I would be able to find it. But right now, I am really happy in the position of being hedged. As to when the stock market will turn, I don't really have an opinion. I can just tell you nothing is cheap enough for me to buy yet, and I wouldn't be surprised if this downtrend lasts for at least the rest of the summer.
TGR: Will the currency issues we discussed force the market down more?
PS: No doubt about it. I think eventually you'll see some global solution to the sovereign debt problem. I hesitate to say what it will be, because I'll probably end up being wrong. But what I foresee is the Fed opening big swap lines with the ECB, and the European Central Bank buying sovereign debts of all these garbage states as they did with Greece. They're just going to do their very best to inflate it away.
Will they be successful? I can't say; this is a huge experiment in central banking. But if and when the Fed starts buying up Spanish debt, the American people will go haywire. They won't stand for it. I don't want to be long in stocks that day, I'll tell you that.
TGR: Any other insights you would like to give to our readers?
PS: We have been in such a bizarre period since 2006. Nothing makes any sense in terms of economics or finance globally. It didn't make sense for people to be able to get a 30-year mortgage with no income, no job and no equity in the home. We haven't yet recovered from all of that and other nonsense that's been going on, and it continues. It doesn't make sense for American's largest and most important conglomerate to be levered 30 times tangible equity. It doesn't make sense for a country like Italy, which has a horrible record of paying creditors, to be able to borrow 110% of GDP. So we have all these things that just don't make any sense going on.
And then people ask, "What should I do with my money?" The thing to do, my friends, is be very, very careful because there are tremendous panics and volatility to come. We are a long way from the lifeguards declaring the "all clear." So be very, very cautious, don't be upset about having a large cash position. I told my readers earlier this year that if they weren't prepared to put half their portfolio in short stocks, if they weren't prepared to truly hedge themselves this year, that they should be 50% in short-term Treasuries and 50% in gold. That's the only way to have a totally safe cash position, because you're hedged with the gold versus the dollar. I am happy to sit in that position for a long time until I see some terrific values.
We're still very, very early in the bull market in precious metals, and despite some public awareness of gold, you don't yet see signs of the kind of market top coming over the next five to 10 years. Last year was the first time since the end of Bretton Woods in 1972 that central banks were net buyers of gold. That is not a trend that will end after one year, not at all. People who think that we must be at the top of the market because gold has gone from $300 to $1,200 really don't understand the gold demand that has yet to manifest in the world's markets. Gold will become the basis of the global economy again, and we're a long, long way from there.
After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry put out his shingle at Stansberry & Associates Investment Research, a private publishing company. Celebrating its 10th anniversary last year, S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They've come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real world, independent research and cover the gamut from value investing to insider trading to short selling. Porter's monthly newsletter, Porter Stansberry's Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns, while his weekly trading service, Porter Stansberry's Put Strategy Report, shows readers the smartest way to book big gains during the ongoing financial crisis.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: None.
3) Porter Stansberry: I personally and/or my family own the following companies mentioned in this interview: None. Stansberry & Associates Investment Research forbids any of its financial writers from having a financial interest in the companies they recommend. Likewise, S&A does not accept any compensation from companies mentioned in its reports. Nor does S&A engage in any 'sell-side' financial services, such as brokerage, money management or investment banking. Our only client is our subscriber.